When Laura Cha landed at Heathrow last Thursday, she was ostensibly in town to see friends and family and to catch up with Mark Tucker, the chairman of HSBC, on whose board she sits. But the US-educated executive was also on a secret mission, codenamed Project Lima. As chairman of Hong Kong Exchanges and Clearing (HKEX), she and her chief executive, Charles Li, had requested a meeting with their opposite numbers at the London Stock Exchange.
On Monday morning at 10am, they descended on the LSE’s headquarters in Paternoster Square in the shadow of St Paul’s Cathedral, and in a 50-minute meeting they dropped their bombshell. The HKEX wanted to buy the LSE for £32bn. If consummated, the deal would be among the year’s top 10 mergers and acquisitions, and by far the biggest exchange takeover in history.
“It’s a brave move at a time of total chaos in the world,” says the head of investment banking at one Wall Street group, pointing to the UK’s messy attempt to leave the EU, US-China trade tensions and Hong Kong’s battle to maintain its semi-autonomous relationship with China that has been played out in weeks of street protests.
Monday’s meeting was described as civil, even if LSE bosses — who felt ambushed — were not brimming with enthusiasm. A 10-page offer document was dispatched a couple of hours later. But any hopes that Ms Cha and Mr Li might have had of a swiftly agreed deal quickly evaporated. The LSE’s advisers counselled that the exchange should not engage. HKEX understood this to be linked to legal restrictions on competing M&A stemming from the LSE’s pending $27bn acquisition of data business Refinitiv. In an attempt to shake up the LSE’s cool response with a direct appeal to its shareholders, HKEX went public less than 48 hours later.
On Friday, the board of the London exchange formally rejected the bid. No one expects that to be the end of the matter. Terms will be sweetened. Talks will be sought. Shareholders, currently keen on the Refinitiv transaction, may or may not be swayed.
The deals are mutually exclusive, in part because an enlarged LSE-Refinitiv would be unaffordable for HKEX, or indeed most other buyers. So investors have a stark choice.
The Hong Kong offer is designed to build an east-west hub for the market infrastructure that facilitates the trading and processing of shares and other securities. Such a deal would continue a theme of global consolidation under way for more than a decade, with Brexit a new contributory spur.
“The UK’s withdrawal from the EU is likely to trigger 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 global scale will be ever more important in market infrastructure.”
The LSE controls some of that infrastructure, such as LCH, the world’s biggest clearing house. “[The LSE] owns very valuable global assets, which will probably be viewed by some operators as tiebreaking in the global consolidation game,” says Xavier Rolet, the former LSE chief executive. “We are likely to see pressure towards two or three global giants.”
Linking London with Asia would add to the pressure on competing exchanges, both in the US and Europe. “If this deal happened, continental Europe would be completely left behind,” says one former executive at German rival Deutsche Börse, which failed in a bid to buy the LSE in 2017 in the politically-charged wake of the Brexit vote.
That vision of combining global exchanges is a starkly different proposition from the LSE’s own current plan to buy Refinitiv, which would pivot the group away from its core businesses and increase its steadier subscription-based revenue from data services.
So far, those that have expressed a preference seem minded to back the Refinitiv agreement. “I’m certainly supportive of the Refinitiv deal, and the market is as well,” says Iacopo Dalu, an analyst at Janus Henderson, a top 50 shareholder. “So the hurdle for HKEX [ . . .] is clearly very high.”
But the commercial logic of the bid is only a small part in the calculus of whether it will succeed. The political and regulatory obstacles are vast.
A decade ago, when Kraft launched a hostile bid for Cadbury and eventually bought the much loved British company, a political maelstrom led to a tightening of regulation. “A chocolate company is not exactly critical infrastructure so HKEX is going to find this really tough,” says one mergers and acquisitions adviser.
In response to the HKEX offer announcement on Wednesday, the UK government pointed to legislation that allows state intervention on “specified public interest grounds, which include national security [and] the stability of the UK financial system”. Andrea Leadsom, business secretary, said she would look “very carefully at anything that potentially had security implications for the UK”.
Attempting to acquire a country’s critical financial infrastructure at any time is likely to be politically challenging. And much more so today. “This is not the optimal time to be doing this,” concedes one person close to HKEX familiar with the bid. “But it speaks to the enormity of the commercial and economic logic that we have proceeded.”
Ms Cha, who worked with her board and HKEX’s bankers at advisory firm Moelis for a year to put the deal together, remains unconcerned. Mass street protests at home and a competing LSE deal are not going to deter her.
The commercial rationale is powerful. A deal would allow the London exchange and its shareholders to tap into the growth of greater China, still one of the fastest-growing economies in the world.
The combined group would form a bridge, linking the vast pool of Chinese savings with London, the world’s most international centre of finance. HKEX estimates that $150tn could be deployed into capital markets over the next 10-20 years, much of that via London. Currently Hong Kong vies with London as well as New York to attract global companies looking to go public or raise funds. A combined Hong Kong-London hub could be a dominant global force.
“It would be unassailable,” says one person involved in the deal.
Another appeal is Hong Kong’s strength in Chinese fundraisings. HKEX is a key conduit for the fast-growing appetite of Chinese companies to raise equity and debt, rather than rely on bank loans to fund their operations.
Chinese companies accounted for 78.5 per cent of the $442bn in stock market flotations carried out in Hong Kong since the start of 1998, according to FT calculations based on Dealogic data. According to EY, HKEX topped the global exchanges league table last year, raising $36.5bn, trouncing London’s tally of $8bn, as Brexit curbed demand.
But the very attractions of such a dynamic outlook is also the putative deal’s biggest political hurdle. With the US set to be a big competitive loser from such a deal, Washington policymakers are unlikely to be sympathetic.
The Commodity Futures Trading Commission, the US derivatives regulator, also has oversight of LCH and is a powerful voice. It will feel “great concern” about a HKEX takeover, said Christopher Giancarlo, the CFTC’s former boss this week
People close to HKEX say it has already begun “conversations” with UK politicians and that no concerns have been expressed about data privacy, a major worry of US authorities when dealing with Chinese companies.
It also intensified the offensive arguing that the rival Refinitiv deal is far riskier, given the inherited levels of debt that come with the purchase and that its existing ownership of the London Metal Exchange has proven its trustworthiness. To pacify corporate governance concerns, the Hong Kong exchange has pledged to reform its board structure.
Hanging over the whole deal, though, is Hong Kong’s bitter dispute with Beijing and mounting fears it will lead to a crackdown, undermining the territory’s common ground with western standards and rule of law.
Though Beijing acknowledges the crucial role Hong Kong plays as a conduit to world markets, it has been infuriated by what it sees as the weak leadership of the Hong Kong authorities. HKEX is also threatened competitively by the growth of exchanges in Shanghai and Shenzhen. “HKEX is looking for a long-term lifeline,” says one veteran financier. That may not be the best reason for LSE shareholders — or the British government — to support a deal.
When David Cameron was UK prime minister and George Osborne chancellor, the mood music was far more positive. In 2015 Mr Osborne declared a “golden era” for Sino-British relations. And despite the 2016 Brexit vote, the momentum was maintained with then foreign secretary Boris Johnson coining the phrase “Global Britain” and stressing the importance of good trade relations with China.
But suspicion of China has grown, particularly in the US. In a mounting trade war the US has imposed tariffs on more than $360bn of Chinese goods, and Beijing has reciprocated with tariffs of its own. Forced to pick a side, Mr Johnson, now prime minister, seems keen to forge his closest post-Brexit ties with the US, rather than China.
Hong Kong’s £32bn approach for the LSE is the biggest test yet of just how open-minded Mr Johnson’s “Global Britain” will really be.
Additional reporting by Daniel Thomas and Owen Walker in London; Jamil Anderlini and Henny Sender in Hong Kong