(Business Law Currents) The European Commission yesterday blocked the $9 billion mega-merger of Deutsche Bourse and NYSE Euronext, scuppering the transatlantic deal and revealing how badly management may have underestimated European antitrust authorities.

Putting perhaps the final nail in the coffin of a year of disastrous exchange mergers, the decision ends what might have been the world’s largest stock and derivative exchange, and reinforces the increasingly tough stance taken by European regulators on financial competition issues.

The European Commission landed the blame for the failed deal squarely at the feet of both companies’ management, claiming that “we tried to find a solution, but the remedies offered fell far short of resolving the concerns”. Joaquin Almunia, Vice President of the Competition Commission, concluded that “the merger between Deutsche Boerse and NYSE Euronext would have led to a near-monopoly in European financial derivatives worldwide. These markets are at the heart of the financial system and it is crucial for the whole European economy that they remain competitive.”

The Commission found that Eurex, operated by Deutsche Boerse, and Liffe, operated by NYSE Euronext, compete head-to-head and are each other’s closest competitors. Allowing the merger would have eliminated this global competition and would have created a “quasi-monopoly in a number of asset classes, leading to significant harm to derivative users and the European economy as a whole”. With no effective competitive constraint left in the market, there would be no price competition and less innovation.

The Commission was not persuaded by the parties’ arguments that the Commission should allow for over-the-counter (OTC) derivatives when calculating the parties’ dominance in the derivatives market. The Commission found that exchange-traded derivatives (ETDs) are highly liquid, relatively small in size (around €100,000 per trade) and fully standardised contracts in their legal and economic terms and conditions. In contrast, the Commission found that OTC derivatives are typically much bigger (around €200,000,000 per trade) that allow for customization of their legal and economic terms and conditions. The Commission’s investigation showed that ETDs and OTCs are not generally considered as substitutes by customers, since they use them for different purposes and in different circumstances. The Commission also noted that some users of exchanges are not authorised to operate in the OTC market due to risk management considerations.

Contrary to some earlier press reports, the Commission did not confine its review of the market to only European competitors, but also included the Chicago Mercantile Exchange (CME) as a competitor in the derivatives market. The Commission concluded however that the CME only marginally competes with the parties in the asset classes concerned.

A further concern of the Commission was that both Eurex and Liffe operate closed vertical silos linking their exchange to their own clearing house – an anti-competitive practice that the European Commission has vowed to crack down on. The Commission found that the merger would have resulted in a single vertical silo, trading and clearing more than 90% of the global market of European financial ETDs. The proposed merger would have made it very difficult for a new player to enter the market because of the advantages a vertically integrated exchange has in clearing similar contracts in a single clearing house.

The Commission dismissed the remedies proposed by the companies as inadequate. In particular, the Commission found that the offer to sell Liffe’s European single stock equity derivatives products where these compete with Eurex would have created a competitor that was “too small and not diversified enough to be viable on a stand-alone basis”.

In the more commercially significant area of European interest rate derivatives, the companies did not offer to sell overlapping derivatives products, but only offered to provide access to the merged company’s clearing for some categories of “new” contracts. The Commission considered this “insufficient, in particular because it did not extend to existing competing products. There were also fundamental concerns about the workability and the effectiveness of such an access remedy”.

The Commission concluded that it had no alternative but to prohibit the merger, stating that the concentration of markets “would significantly impede effective competition.”