Exchanges: Hong Kong puts London's loyalty to the test after Brexit

When Laura Cha landed in Heathrow last Thursday, she was apparently in town to see her friends and family and catch up with Mark Tucker, the HSBC president, whose board she sits on. But the US-trained executive was also on a secret mission, codenamed Project Lima. As president of Hong Kong's Exchanges and Clearing (HKEX), she and her managing director, Charles Li, had requested a meeting with their counterparts on the London Stock Exchange.

Monday morning at 10 am, they went to the headquarters of the LSE on Paternoster Square, in the shadow of St. Paul's Cathedral, and at a meeting of 50 minutes, they dropped their bomb. The HKEX wanted to buy the LSE for 32 billion pounds sterling. If completed, the deal would be among the top 10 mergers and acquisitions of the year, and by far the largest exchange takeover in history.

"It's a brave gesture in a time of total chaos in the world," said the bank's investment manager of a Wall Street group, highlighting the disorderly attempt of the United Kingdom to dispel trade tensions between the European Union, the United States and China and the Hong Kong struggle to maintain its semi-autonomous relationship with China that has been played for weeks of protests from street.

Monday's meeting was described as civil, even though the LSE leaders – who felt ambushed – were full of enthusiasm. A 10-page offer document was sent a few hours later. But all hopes that Ms. Cha and Mr. Li could have hoped for a deal quickly concluded quickly evaporated. LSE advisers advised that the exchange not be engaged. HKEX understood that this was related to the legal restrictions on competing mergers and acquisitions resulting from LSE's ongoing $ 27 billion refinvest business acquisition. In an attempt to upset the LSE's cold reaction by directly calling its shareholders, HKEX became public less than 48 hours later.

On Friday, the board of the London Stock Exchange officially rejected the offer. Nobody expects this to be the end of the question. The conditions will be softened. Discussions will be sought. Shareholders who are currently interested in the Refinitiv transaction may or may not be influenced.

The agreements are mutually exclusive, in part because an expanded LSE-Refinitiv would be unaffordable for HKEX, or for most other buyers. Investors have a difficult choice.

The Hong Kong offer aims to build an east-west hub for market infrastructure facilitating trading and processing of stocks and other securities. Such an agreement would remain a global consolidation theme in progress for more than a decade, with Brexit a new contributor.

"The withdrawal of the UK from the EU is likely to bring about a profound change in the shape of cross-border business," says Huw van Steenis, a former analyst who spent a year advising Bank of England Governor Mark Carney. "This and technology mean that the global scale will be increasingly important in the market infrastructure."

The LSE controls some LCH, the world's largest clearing house. "[The LSE] has very valuable global assets, which will likely be perceived by some operators as a breakthrough in the game of global consolidation, "said Xavier Rolet, former managing director of LSE. "We will probably see the pressure on two or three world giants."

Linking London to Asia would increase pressure on competing trade, both in the United States and in Europe. "If this agreement were reached, continental Europe would be completely left behind," says a former ruler of his German rival Deutsche Börse, who failed in order to buy the LSE in 2017 in the wake of the Brexit vote.

This view of the global trade mix is ​​a radically different proposition from LSE's current plan to acquire Refinitiv, which would divert the group from its core businesses and increase its more stable revenue-driven data services.

Until now, those who have expressed a preference seem to want to support the Refinitiv agreement. "I am certainly in favor of the Refinitiv agreement, as is the market," said Iacopo Dalu, an analyst at Janus Henderson, one of the top 50 shareholders. "So, the obstacle for HKEX [ . . .] is clearly very high. "

But the commercial logic of the offer represents only a tiny part of the calculation of its success. The political and regulatory obstacles are immense.

Ten years ago, when Kraft launched a hostile bid for Cadbury and finally bought the beloved British company, a political maelstrom resulted in a tightening of regulation. "A chocolate manufacturing company is not an essential infrastructure, which is why HKEX will find it very difficult," says a M & A advisor.

In response to the announcement of the HKEX bid on Wednesday, the UK government has raised legislation allowing state intervention for "specified public interest reasons, which include national security. [and] the stability of the UK financial system. "Andrea Leadsom, secretary of business, said she would look" very carefully at anything that could have security implications for the UK ".

Attempt to acquire a The country's critical financial infrastructure is at risk of posing political problems at any time. And much more today. "This is not the perfect time to do it," concedes a person close to HKEX familiar with the offer. "But this testifies to the enormity of the business and economic logic that we have followed."

Ms. Cha, who worked with her board of directors and the HKEX bankers at the Moelis consulting firm for a year to conclude the deal, remains indifferent. Mass demonstrations at home and a contract in competition with the LSE will not deter it.

The commercial logic is powerful. An agreement would allow the London Stock Exchange and its shareholders to benefit from the growth of Greater China, which remains one of the fastest growing economies in the world.

The merged group would form a bridge linking the huge Chinese savings bank to London, the world's most international financial center. HKEX estimates that $ 150 million could be deployed in capital markets over the next 10 to 20 years, largely via London. At the moment, Hong Kong rivals London and New York to attract international companies looking to go public or raise funds. A combined hub of Hong Kong and London could be a dominant global force.

"It would be unassailable," says one person involved in the deal.

Hong Kong's strength in fundraising in China is another attraction. HKEX is an essential means for Chinese companies to increasingly want to raise equity and debt rather than resorting to bank loans to finance their operations.

Chinese companies have accounted for 78.5% of the $ 442 billion in stock market investments made in Hong Kong since the beginning of 1998, according to FT calculations based on Dealogic data. According to EY, HKEX led the world trade rankings last year, raising $ 36.5 billion, surpassing London's total of $ 8 billion, while Brexit has dampened demand.

But the attractions of such a dynamic perspective are also the main political obstacle to this agreement. The United States is about to be a big loser of competition through such an agreement, Washington's policymakers probably will not be understanding.

The Commodity Futures Trading Commission, the US regulatory agency for derivatives, also monitors LCH and is a powerful voice. The takeover of HKEX will cause "serious concern," said Christopher Giancarlo, former CFTC boss this week.

People close to HKEX said that "conversations" with British politicians had already started and that no concerns had been expressed about the confidentiality of the data, a major concern of the US authorities when they were dealing with Chinese companies.

It also intensified the offensive by claiming that the rival Refinitiv operation was much riskier, given the legacy debt levels that accompanied the purchase and that its current ownership of the London Metal Exchange had proved its reliability. To allay concerns about corporate governance, the Hong Kong Stock Exchange is committed to reforming the structure of its board of directors.

However, the stubborn dispute between Hong Kong and Beijing is suspended and growing fears that it will lead to repression, undermining the common ground uniting the territory with Western standards and the rule of law.

Although Beijing recognizes the crucial role that Hong Kong plays as a vector of global markets, it has been exasperated by what it sees as the weakness of the leaders of the Hong Kong authorities. HKEX is also competitively threatened by growth in trade in Shanghai and Shenzhen. "HKEX is looking for a long-term lifeline," says a seasoned financier. This may not be the best reason for LSE shareholders – or the UK government – to support an agreement.

When David Cameron was British Prime Minister and George Osborne, Chancellor, the mood music was much more positive. In 2015, Osborne declared a "golden age" for Sino-British relations. And despite the 2016 Brexit vote, momentum has been maintained with the then foreign secretary, Boris Johnson, who coined the phrase "Global Britain" and underlined the Importance of good trade relations with China.

But suspicion of China has grown, especially in the United States. In a growing trade war, the United States has imposed tariffs on more than $ 360 billion worth of Chinese goods, and Beijing has returned the favor with its own tariffs. Forced to choose a party, Mr. Johnson, currently prime minister, seems to want to weave his closest ties with the United States after Brexit, rather than with China.

The Hong Kong approach by the LSE in the amount of 32 billion pounds is the most important test to date about the true openness of "Global Britain" of Mr. Johnson.

Other reports by Daniel Thomas and Owen Walker in London; Jamil Anderlini and Henny Sender in Hong Kong