Has the London Stock Exchange met its Asian match?

It has been a long time coming but the London Stock Exchange may have finally met its match. A match which Charles Li, chief executive of Hong Kong’s giant exchange, certainly believes is one made in heaven.

This is what the HKEX boss had to say when he stunned the world this week with a cheeky £30bn bid for the London stock market:  “This is a deal which will redefine global capital markets for decades to come.”

What’s more the American educated former journalist expressed his courtly love for the older institution, saying that he had nothing but the greatest admiration for the City of London: “Together, we will connect East and West, be more diversified and we will be able to offer customers greater innovation, risk management and trading opportunities.”

What a smoothie. Maybe Li went too far with his comment that their potential union was like Romeo and Juliet, considering the ending of that love story. Even so, you get the point that he thinks this is a big passion in the making.

And Li may be right. Not everyone thinks so. In fact, the instant reaction to the deal was that it was a non-starter, that neither the LSE nor the UK authorities would countenance such a merger with China hovering in the background and Hong Kong itself in such a fragile state.

Yet the commercial argument for the merger is, as Li says, game-changing. The London exchange is one of the world’s biggest, the biggest in Europe and the most international. It is already a natural gateway between the continent and the East, with many Chinese and Asian-based corporates taking out dual listings on both the London and Hong Kong exchanges.

If you were a match-maker, then this is the deal that makes most sense for London. It’s not a new idea, but has been chewed over for decades.

Back in April 2011 I wrote that the obvious expansion for the London exchange, then run by the brilliant if not mercurial Xavier Rolet, was to make a move on Hong Kong because it would give him the eastern leg of the golden triangle into mainland China and the Pacific. It was a no-brainer: exchanges go where people, companies and governments are hungry for capital. And that’s east. Behind the scenes, there were talks about partnerships and mergers but none came to fruition.

Then, of course, it would have been London in the driving seat. Now it’s the Hong Kong exchange – which bought London’s Metal Exchange a few years ago – that will be the bigger partner if the two were to merge under Li’s takeover.  Under the present terms, the LSE would control about 41% of the shares.

There are many reasons why the merger has legs: HKEX is currently the biggest market for initial public offerings (IPOs) in the world. It is one of the biggest outlets for technology and biotechnology IPOs – raising HK$26bn this year –  and an 18-hour trading day could be offered if the two businesses join forces.

For its part, the LSE has a big chunk of Asian and Chinese based businesses, either listing or raising bonds.There are more yuan bonds listed on the LSE than anywhere else in the world, it’s the biggest centre for exchange traded funds and it has close relations with the Shanghai stock market on shared technology and regulatory frameworks. At the same time, London is the place that Asian companies want to come to raise money because it’s the stop-over to the Middle East, India and Africa where economies are growing the fastest. And, certainly for now, the liquidity is in London. Putting the two together would be a powerful force, one that with all the right conditions agreed, should bring more business and jobs to the UK plc.

Now for the downsides, which on the surface look insurmountable  They are commercial, political and regulatory. Some of the criticisms of the proposed deal are valid, others are naive.

The first point is that Hong Kong’s offer is conditional on the London exchange dropping its £20bn takeover of Refinitiv, the data giant owned by Blackstone and Thomson Reuters, to turn the LSE into a rival to Bloomberg. While ghosting this deal might be costly – having to pay off those beastly investment bankers  – it is doable despite losing some face. But still doable.

There are at least four powerful groups which will be fighting this deal with all their might. First off, the sharedholders. HKEX’s share and cash offer values the LSE at £83.61, a decent premium on the shares which closed up 6% at £72. But they will want to squeeze more and Li is not naive. He will have to pay a higher dowry for his prize.

Second, there will be predictable outrage that such a national institution as the LSE should not be gobbled up by the Hong Kong upstart, whose biggest shareholder with 6% just happens to be the Chinese government.

Particularly now. There’s no doubt the UK government would feel queasy about giving its backing to such a merger at such a fragile time with the pro-democracy protests in Hong Kong and their fight with the China authorities. Andrea Leadsom, the business secretary, is going to have her work cut out on this one.

Third, the EU’s competition hawks and nativist politicians will be on red alert, especially now with Brexit negotiations. The last thing EU countries will want to see is London have such an eastern advantage over their own national exchanges in Frankfurt, owned by Deutsche Borse and Paris, owned by Euronext: both past suitors of London. All that Brexit guff about a global Britain would have a ring of truth about it.

The fourth group are the Americans who are bound to flip over the deal, and might even threaten a potential US-UK trade deal if the UK goes ahead because of the potential of this new grouping to rival America’s own exchanges.

That’s nothing new. The US authorities have always taken an astonishingly over-protectionist and hypocritical view of their exchanges, having stopped several attempts at mergers between Nasdaq and London. Yet they saw nothing wrong with the CME’s own takeover of Britain’s ICAP, as close to an exchange as you can get.

Hong Kong’s move might even provoke a rival offer from the Intercontinental Exchange, owner of the New York Exchange – and which was once part of Euronext – which has had its eye on London for as long as one can remember. That in turn might provoke other offers.

Finally, there will be regulatory worries.  HKEX’s chairwoman, Laura Cha, has been swift to assure would be critics by saying that both businesses would be overseen by their home regulators in the event of a deal, with the Financial Conduct Authority being given oversight of LSE activities.

There is no reason not to believe her: having the FCA as one of the regulators would only help give greater credibility to HK’s reputation, and transparency, in the region. But whether her Chinese masters might want to change the game later down the road is another matter altogether.

Yet the most troublesome – and understandable – reason for the UK to be against the merger is an emotional one: the notion that the London Stock Exchange, after 20 years of broken engagements and failed relations with a number of potential suitors in the US, Canada and Europe, could end up in the arms of an Asian suitor, might be the last straw.

But that begs the bigger question today of what we mean by ownership. The London exchange is of course already owned by foreigners – the biggest investors are, in Theresa May’s inimitable words, citizens of nowhere. The Quatari’s, through the QIA investment fund, own 10%, America’s Blackrock has around 6.9% while the Capital Group has a similar amount. Lindsell Train – British – has 5%. The other investors come from everywhere in the world.

And so do investors in HKEX. The top ten own only 16.8% between them: they are UBS, Vanguard, Invesco, Norges Bank and State Street Global and the rest are also citizens of everywhere, and nowhere.

The reality is that modern technology means that trading is borderless: and that exchanges are becoming more global and trans-national creatures by the nanosecond. That brings scale and it’s inevitable that it will not be long before there are only three or four giant exchange to data providers in the world.

Does London want to be part of one of those groupings? If it does, then merging with Hong Kong rather than Refinitiv might be the smartest strategic option. The LSE’s board has a tough job ahead, whether to recommend this or a higher offer or face another hostile battle that takes time and money away from running the business.

And if it does merge? I have one caveat: the LSE should open up the books to AIM, the junior market, to potential buyers. Left by itself and caught up in such a vast international group, Aim could easily become forgotten about. Far better to hand it over to some buccaneering types who would focus on building up another domestic, better focused and enterprising stock market. And start building London all over again.