Euroclear and Clearstream are talking to each other again.
It is understood that the talks have taken place at a relatively low level, and are more in the nature of an exploratory discussion at this stage than a prelude to full-blown merger talks. But why have talks resumed now, after years of ill-disguised hostility?
One factor is T2S, the European Central Bank plan to build a single European CSD, which threatens both ICSDs. But the main impetus behind the discussions is different: It seems that the strategic challenges confronting Clearstream parent Deutsche Boerse are affecting the future of its settlement arm.
The cash-generative nature of the Clearstream business is valuable to Deutsche Boerse, but also a constraint on the ability of the group to solve its strategic problems at the trading level.
Having failed to pull off mergers with either the London Stock Exchange or Euronext, and failed to break into the American derivatives markets decisively via Eurex US, the Swiss-German stock exchange group announced on 30 April that it had agreed to pay $2.8 billion for the New-York-based International Securities Exchange (ISE) via its Eurex subsidiary, owned jointly with Swiss Stock Exchange group SWX.
Deutsche Brse said it planned to finance its share of the purchase price initially through a bridging loan of approximately Euros 1.5 billion (approximately US$ 2 billion) plus cash it has in hand. The bridging loan was to be taken out through retention of future earnings (approximately Euros 200 million, or US$ 270 million) plus a mixture of senior and hybrid debt worth around Euros 1.3 billion (US$ 1.77 billion).
Interestingly, Deutsche Boerse added that the long term loan was dependent on implementation of a so-called “ringfencing” structure currently under development which aims to move Deutsche Brse from a net cash to a net debt position, with the goal of increasing capital efficiency, but without imperilling the creditworthiness of Clearstream and Eurex.
Deutsche Borse has been under pressure from shareholders (notably hedge funds TCI and Atticus Capital, which have now been joined by Highfields Capital Management, Third Point, Lone Pine, Tiger and Tudor) since even before former CEO Werner Seifert was forced out to reduce its cash pile through heavier dividend payments and share buy-backs.
Gearing up the balance sheet is part of the same process, but not a step much liked by banking regulators – and Clearstream Banking is, after all, a bank, with credit ratings that are vital to its business.
In other words, Clearstream may be throwing off cash, but it is also a constraint on the ability of Deutsche Boerse to satisfy is shareholders and fulfill its wider strategic ambitions by borrowing money to make acquisitions. Hence the interest of Deutsche Boerse in a possible sale.
The Clearstream management, which is coming under pressure from the price-cutting strategy of Euroclear anyway, have looked at a range of options. A merger with Euroclear is one, but a private equity-financed MBO is another, as is an alliance with a commercial banking group – such as an agent banking nework.
Meanwhile, the vociferous hedge funds on the Deusche Boerse shareholder register have made clear they are not convinced that the ISE deal is a better alternative than an intensification of the share buy-back programme. But without an acquisition, Deutsche Boerse could soon find itself prey rather than predator, especially now OMX is being acquired by Nasdaq.
In this volatile environment, it is scarcely surprising that Euroclear should be interested in finding out what Clearstream wants to do.