Why Hong Kong’s audacious bid for the London Stock Exchange may be doomed

Hong Kong’s bid to acquire the London Stock Exchange could be a game changer for global markets, but chances are it won’t succeed.

Hong Kong Exchanges and Clearing (HKEX) announced an unsolicited £30 billion ($37 billion) bid on Wednesday, saying that the deal would “create a truly global market infrastructure group connecting the East and West.”

The takeover would create the world’s third biggest stock exchange group behind the New York Stock Exchange and Nasdaq in terms of the value of companies listed on those markets, according to the operators’ data.

But worries about Chinese influence over vital financial infrastructure and concerns about reduced competition are likely to cause regulators to block the deal. Analysts at Citi downgraded HKEX’s stock to “sell” on news of the LSE offer, saying the bid price was high and the deal faces regulatory risks.

Global authorities have become increasingly concerned about reduced competition among market operators, blocking some major mergers and acquisitions, including the proposed merger between LSE and Deutsche Boerse in 2017, Fitch Ratings said in a note.

“This is very unlikely to pass government scrutiny. There will be significant concerns around Chinese ownership,” said John Colley, a professor of strategy and international business at Warwick Business School. “One suspects that the UK government will view this as an unsuitable owner of such an important central element of the financial community in London.”

The Hong Kong government directly appoints half of the HKEX board, according to its website. And the chairman’s appointment must be approved by Hong Kong’s chief executive, Carrie Lam.

“The London Stock Exchange is a critically important part of the UK financial system, so as you would expect, the government and the regulators will be looking at the details closely,” a UK government spokesperson said Wednesday.

It’s not just UK regulators that might be concerned. The London Clearing House, owned by the LSE, is responsible for clearing almost all domestic interest rate swaps in the United States and is co-regulated by the Bank of England and the US Commodity Futures Trading Commission, Xavier Rolet, the former CEO of the LSE, told the BBC on Thursday.

“I would expect US regulators to be interested,” he said.

Fitch Ratings said US and UK regulators may be concerned about data and information security given “increasing control by Chinese authorities over Hong Kong.”

The LSE has other options

LSE shareholders may yet kill the proposed deal before it seriously starts to bother regulators. Hong Kong’s offer is conditional on the London exchange terminating its own game-changing acquisition of financial data provider Refinitiv.

“LSE shareholders are reasonably convinced by the Refinitiv deal and so may be unwilling to change track for this proposed deal,” said Colley.

That £22 billion ($27 billion) deal, announced only last month, seeks to transform the LSE into a global markets and information juggernaut to rival Michael Bloomberg’s financial data empire. Investors have welcomed the transaction, sending shares in the LSE up 27% since it was announced.

In its first public comment on Hong Kong’s offer, the LSE restated its commitment to the Refinitiv transaction. And its shareholders seem unconvinced by the surprise bid. LSE shares were trading 16% below the offer price on Thursday.

HKEX’s cash and share bid values the LSE at £29.6 billion ($36.4 billion), with cash making up less than half of the total. Shareholders would end up with a substantial amount of shares of “uncertain future value,” Colley said in an email.

Yet some analysts said the combination could make strategic sense.

The deal would give the LSE a big stake in Asia, which is where growth in financial assets will come from, Manish Singh, chief investment officer at Crossbridge Capital told CNN Business.

London is already the leading offshore trading hub for China’s currency outside Asia and wants to maintain that position.

Could another bidder emerge?

The LSE has received a takeover approach every two-and-a-half years on average since listing in 2000, according to Chris Turner, an analyst at Berenberg. In most cases the deals were blocked by shareholders or regulators, Dealogic data show.

But if a new bidding war erupts, Intercontinental Exchange (ICE), which owns the New York Stock Exchange, was the “most natural acquirer” among the US exchanges for LSE assets, said Kyle Voigt, an analyst at Keefe, Bruyette & Woods in New York.

ICE mulled a bid for the LSE back in 2016, prompted by merger talks between LSE and Germany’s Deutsche Borse.

A new ICE bid at a premium to Hong Kong’s offer would result in earnings dilution for ICE, even when cost savings are accounted for. “This would make a deal challenging,” Voigt said.

Rolet, the former LSE CEO, said that consolidation among global exchanges was likely to continue.

“I would expect the strategy departments of large American exchanges to be having sleepless nights in the coming weeks,” he said.

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