UPDATE: NYSE, Deutsche Boerse Face Questions As Deal Nears Brink

NYSE Euronext (NYX) and Deutsche Boerse AG (DB1.XE, DBOEF) will be forced to rethink fundamental aspects of their plans to grow trading services if the European Union nixes their deal, which investors and analysts see as increasingly likely.

Remaining independent would upend both firms' strategies for deepening their business in processing financial transactions, especially in sophisticated swap deals, and poses a setback for efforts to forge partnerships in fast-growing Asian markets.

EU antitrust examiners on Tuesday recommended prohibiting the deal from moving forward, their chief concern being the potential for a European monopoly being formed in exchange-traded futures and options, according to a senior EU official.

The merger candidates have yet to receive notice of the recommendation, but NYSE Euronext Chief Executive Duncan Niederauer on Wednesday called the analysis "fundamentally flawed" because it overlooks competing markets in privately traded derivatives as well as overseas rival exchanges.

Executives of both companies met to discuss the merger Wednesday in a pre-scheduled meeting. Final say on the transaction lies with the 27 EU commissioners, who are slated to formally discuss the matter on Feb. 1 and due to deliver a ruling by Feb. 9.

Shares in Deutsche Boerse closed down 1.2% at EUR41.16 and NYSE Euronext shares were off 0.9% at $27.55, with stock market benchmarks generally lower Wednesday.

Analysts have diverged on whether the companies may be better off without their deal. Niamh Alexander, an analyst with Keefe Bruyette & Woods, on Wednesday downgraded NYSE Euronext to market perform from outperform on a "very low probability" of the merger closing, and this expectation now being factored into the stock price.

Sandler O'Neill analyst Rich Repetto on Tuesday determined that NYSE Euronext was worth more as an independent company, around $30 per share. Some investors believe that the merger plan has weighed on the stock since it would enlarge NYSE's exposure to Europe, where an ongoing debt crisis and potential tax on trading represent threats to financial services firms.

UBS analyst Arnaud Giblat lowered his price target for Deutsche Boerse's stock to EUR56 from EUR60, saying he now forecasts only a 20% likelihood of a deal happening compared with 50% before, and that his previous price target included EUR8 a share in expected deal synergies. He said "political will" among European regulators to approve the merger was still there, as a merged company would put European regulators in a better position to oversee securities trading.

Executives of the exchanges continue to back their deal as the best long-term plan for their shareowners and for customers, who would see an estimated EUR3 billion in savings on collateral by combining trade-clearing services.

Should the EU block the tie-up, NYSE Euronext must reassess its clearing plan. The New York Stock Exchange parent ahead of the Deutsche Boerse deal had intended to create its own trade-clearing facility to back its European markets, reducing reliance on London-based clearer LCH.Clearnet and adding a new stream of revenue.

Those plans were put on hold after the exchanges struck their deal, which aims to route NYSE Euronext's trading to Deutsche Boerse's existing clearinghouse.

James Rothenberg, an investor in NYSE Euronext, said Wednesday he had suggested to executives an alternative joint venture on trade-clearing between the companies to gain some of the planned cost savings, and could also allow some collaboration on new contracts. The different structure could make it more acceptable to EU regulators, he said.

Both firms would also have to reassess plans to win business from bank-dominated swap markets. Regulators seek to move such transactions into clearinghouses and regulated trading platforms in an effort to reduce systemic risk.

The enlarged and more-efficient clearinghouse of the merged entity was seen as a powerful magnet for such trading, but on their own neither NYSE Euronext or Deutsche Boerse has made as much headway in the market as U.S.-based competitors like IntercontinentalExchange Inc. (ICE) and CME Group Inc. (CME).

NYSE Euronext and Deutsche Boerse would also face renewed pressure to strengthen ties to Asian markets, which in 2010 became the world's busiest region for derivatives trading by contract volume and has emerged as a key source of new share-listings.

Both exchange groups already maintain their own ties to some exchanges in the region, but executives had pitched the merged company as the preferred partner to fast-growing Asian platforms, particularly in China, where CME, ICE and Nasdaq OMX Group Inc. (NDAQ) have been laying their own groundwork.

-By Jacob Bunge and Ulrike Dauer, Dow Jones Newswires; 312 750 4117; jacob.bunge@dowjones.com

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