How the NYSE can save its mega merger

January 13, 2012, 8:01 PM UTC

High hopes when the deal was announced.

The $17 billion mega merger between the New York Stock Exchange and Germany’s Deutsche Boerse may look dead, but there’s still a pulse. Company officials have just under three weeks to convince top leaders in the European Union that the combined company won’t be the monopolistic menace that anti-trust technocrats fear. The company could possibly revive this deal if it is willing to play a bit of politics and go on the offensive against its largest competitors: the big banks.

Selling the largest exchange merger in history to regulators in the U.S. and Europe was never going to be easy, but the NYSE and Deutsche Boerse executives managed to downplay the regulatory risk when they announced their deal nearly a year ago. They believed officials on both sides of the Atlantic would recognize that the exchange industry had gone global, making concentrations in certain business lines irrelevant. The NYSE was so confident that the deal would pass regulatory scrutiny that it even successfully fought off a stronger bid for the company from U.S. rivals the CME Group (CME) and the IntercontinentalExchange (ICE).

But things didn’t go as planned. While U.S. antitrust officials swallowed their nationalist pride and approved the merger in December, their European counterparts remained hostile. On Wednesday, Duncan Niederauer, the chief executive of the NYSE (NYX), told employees in a video message that European antitrust officials were going to advise European ministers to block the merger. Niederauer said that the antitrust officials didn’t understand the competitive landscape of the exchange space and that the company would fight the decision.

The European antitrust office’s opinion is non-binding, but it does carry significant weight with the EU executive body, who ultimately approves mergers. The antitrust office just could not get over the fact that the combined company would control 93% of the exchange traded derivatives market in Europe. Company officials refused to spin off their derivatives units to appease regulators as it would erase the economic benefits of the merger. They agreed to offload their equity derivative business and freeze their fees associated with European derivative trades for three years following the merger. But that wasn’t enough.

The case may seem hopeless, but not all is lost. There have been a few rare cases where the executive committee disregards the recommendations of the antitrust unit and allows a merger to go through. Some examples include Boeing’s 1997 acquisition of rival MacDonnell Douglas and Oracle’s 2010 acquisition of Sun Microsystems.

There are a few ways that the NYSE and Deutsche Boerse can play this last round. They will need to get several of the EU ministers to raise objections to the antitrust unit’s recommendations when the EU executive body meets to consider the deal on February 1. The company will need to quickly present its side of the argument to each of the ministers before that meeting.

They argue, as do many analysts that follow the exchanges, that the combined company won’t actually control the derivatives market in Europe. That’s because 85% of derivatives trading in Europe is actually done off exchange in the over-the-counter market. So while it is true that the combined company would control 93% of exchange-traded European derivatives, those only add up to 15% of the total derivatives market when factoring in all those OTC trades.

The company could also try politicizing the issue as a way to pressure ministers into voting its way. The U.S. trade minister to the EU is already on the ground in Brussels lobbying on the NYSE’s behalf, according to a person close to the situation. A call from the White House isn’t out of the realm of possibility and could go a long way in changing a few minds on the committee. In addition, company officials could also argue that the massive exchange would create a strong regulated market to counter the growing power of the loosely regulated futures markets in Asia.

To be sure, this lobbying effort won’t be a walk in the park. The company will need to fight against the lobbying power of a formidable opponent – the big banks. The banks control the lucrative shadow trading world of dark pools and OTC trades and are not happy about the possibility of losing that business to a regulated exchange. The larger NYSE/ Deutsche Boerse futures platform would offer customers more liquidity, which could draw investors out of the shadows and onto the exchange.

Calling a vote against the merger a vote for the banks could help the exchanges gain some populist points with the EU ministers, especially given how terribly out of favor the banks are in Europe at this moment. The exchanges have tried to avoid a messy public conflict with the banks because they’re not only their biggest competitors but they are also, ironically, their biggest customers. Exchange officials had to be sensitive when dealing with this issue.

But an official inside the NYSE tells Fortune that the exchanges are now willing to accept any consequences that may come from the banks if it means getting the merger approved. So while this merger looks like it has been knocked out, don’t start counting down just yet.

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