Back to the Börse

In the ‘90s, Reto Francioni turned Deutsche Börse into a powerhouse. Now he’s returned to set Frankfurt’s drifting exchange on a fresh course.

Courtesy generally grants a new chief executive a few months before investors cast judgment or make demands. Reto Francioni didn’t get a single day.

Even before the 50-year-old Swiss executive was set to start his job as CEO of Deutsche Börse earlier this month, rebel shareholders, including Harris Associates and the Children’s Investment Fund, began pushing for Europe’s biggest stock exchange to consider merging with its leading rival, Paris-based Euronext. Such a move -- a huge strategic change of course for Deutsche Börse -- would face major regulatory hurdles, but the suggestion can’t be dismissed because of the clout of the shareholders: Harris and TCI led the revolt that forced Deutsche Börse to withdraw its £1.3 billion ($2.5 billion) bid for the London Stock Exchange earlier this year and Werner Seifert, the bid’s architect, to resign as chief executive in May.

That failure has left Deutsche Börse bereft of strategy and leadership for the past six months. Now it’s up to Francioni to pick up the pieces, and he doesn’t have a moment to waste.

As Institutional Investor went to press, the U.K.'s Competition Commission was preparing to issue a pivotal report laying down conditions for any future bid for the LSE. Euronext chief executive Jean-François Théodore is keen to acquire the London exchange and create Europe’s dominant equity marketplace, but he faces potential opposition from some of the same shareholders that blocked Seifert’s bid, which are also major investors in Euronext.

As if restive shareholders weren’t enough to contend with, Francioni also faces pressure from Deutsche Börse’s main customers. Leading securities houses have stepped up their campaign to force the German exchange and its rivals to lower trading fees. Any attempt at consolidation among exchanges should respect certain principles, including the need to reduce fees on trading derivatives, declared Alan Yarrow, vice chairman of Dresdner Kleinwort Wasserstein and chairman of the London Investment Banking Association, at a recent futures and options conference in Bürgenstock, Switzerland.

“We’re all jockeying for position,” says Yarrow. “This is the intermission after the first act of a three-act play.”

At the same time, the European Commission is pressing to remove barriers in clearing and settlement to reduce the cost of cross-border securities trading. This regulatory stance threatens to punch a hole in Deutsche Börse’s vertically integrated silo structure, in which all trades must be cleared through Clearstream, its wholly owned -- and highly profitable -- subsidiary.

Francioni must also decide whether to continue with Eurex US, Deutsche Börse’s loss-making derivatives venture in Chicago. Aggressive countermoves by the Chicago Board of Trade and the Chicago Mercantile Exchange have prevented Eurex US from gaining market share, but pulling the plug on the 21-month-old venture would be an embarrassing retreat for Deutsche Börse.

The challenges are daunting, but few people could be better prepared than Francioni to face them. The former banker played a key role in Frankfurt’s transformation from a dozy regional market into a European powerhouse by spearheading the development of Deutsche Börse’s electronic trading system, Xetra, during the 1990s. For the past three years, he has served as chairman of SWX Swiss Exchange, the operator of the Swiss equity market and Deutsche Börse’s joint venture partner in derivatives exchange Eurex.

“He did a good job before at Deutsche Börse. He did a good job at SWX,” says Mamoun Tazi, a financial services analyst at Man Securities in London. “Let him get in the saddle and show us what he can do now.”

Others believe that the Swiss executive’s diplomatic nature will help him repair shareholder relations that were frayed during Seifert’s tenure. “Francioni will calm things down,” says Paul Achleitner, chief financial officer of German insurer Allianz.

Francioni is clearly aware of the urgency of the situation. Even before his nomination as CEO was announced, he traveled to London with Kurt Viermetz, the recently installed board member who took over as chairman of Deutsche Börse’s supervisory board last month. There they met with key shareholders, including TCI managing partner Christopher Hohn and managers from Atticus Capital, a New Yorkbased hedge fund manager, and Harris Associates.

Francioni declined to be interviewed for this article because he was still working at SWX, but Viermetz, speaking to II one day after his appointment as chairman, indicated that the new management would adopt a different approach in an effort to expand the exchange’s reach.

“Our goal is to turn Deutsche Börse into one of the leading capital market centers of the world,” Viermetz says in his sunny office at the Munich headquarters of Hypo Real Estate Holding, where he also serves as chairman. “Surely we will be the leading group in Europe. Surely we will be doing a good job for Germany and Europe, and we will be dealing with many more products than we have today.”

Francioni will need some time to formulate a detailed strategy, but already Viermetz suggests there will be major changes in the way Deutsche Börse pursues its goals. The 66-year-old banker talks of cooperation and alliances with other exchanges rather than mergers. There are, he says, too many regulatory and political barriers to transformational takeovers, not to mention the difficulty of getting shareholders to back them.

“These endless questions -- Do you buy LSE? Do you buy Euronext? -- are not helpful,” Viermetz insists. “Consolidation in Europe does not mean exclusively just to make bids on other stock exchanges. There are all sorts of ways to cooperate, platformwise, technologywise, even productwise. Some of it has not yet been done and executed.”

Francioni has long believed that alliances rather than mergers are the best way to pursue consolidation in Europe, says one person close to Deutsche Börse. When Seifert first proposed to merge with the LSE in 2000, Francioni disagreed with the move, sources close to the Swiss executive say. He left Deutsche Börse shortly before the offer was announced.

Francioni and Viermetz enjoy some unquestioned advantages. Deutsche Börse is the world’s second-largest exchange by market capitalization, at E8.1 billion ($9.7 billion), trailing the Chicago Mercantile Exchange ($11 billion). It is nearly twice the size of Euronext, which has a market cap of E4.1 billion, and more than three times larger than the LSE (E2.4 billion).

Notwithstanding its difficulty penetrating the U.S. market, it boasts the world’s largest derivatives exchange in Eurex as well as the highly profitable Clearstream subsidiary. Those businesses helped Deutsche Börse post net income of E266.1 million on revenues of E1.45 billion in 2004, well ahead of Euronext (E149.7 million in earnings, E886.8 million in revenues) and the LSE (E90.5 million and E378 million for the year ended March 31). The German group posted a 51 percent rise in net income in the first half of 2005, to E218.6 million.

For all its strengths, however, Deutsche Börse has a smaller equity market than its two main rivals. The market capitalization of stocks listed on the German exchange is just E960 billion, compared with E2.2 trillion for Euronext and E2.5 trillion for the LSE; equity trading averaged E4.5 billion a day in the first three quarters of this year, behind Euronext’s E6.8 billion and the LSE’s E5.9 billion.

This equity gap was underscored by George Ugeux, chairman and CEO of New Yorkbased Galileo Global Advisors and former director of international relations at the New York Stock Exchange, in a presentation to the Deutsche Börse board at the meeting last month that appointed Francioni. What Ugeux showed, Viermetz says, was that in equity trading, “we are far behind New York and London. We don’t have enough listings in Germany. We have no real equity culture.”

It was precisely to address that weakness that former CEO Seifert launched his new bid for the LSE in December. In making that move, however, Seifert failed to take account of a dramatic shift in his own shareholder base -- with aggressive U.S. and U.K. funds having displaced more-passive German institutions.

TCI and Harris Associates campaigned vigorously against the bid, with support from Atticus and Fidelity Investments. They contended that Seifert was offering too much for the London exchange and demanded that he return excess capital to shareholders instead. The investors also protested management’s decision not to hold a shareholder vote on the deal.

Deutsche Börse bowed to the opposition and withdrew its bid in March; two months later, after shareholders submitted a motion calling for his sacking, Seifert resigned. Rolf Breuer, then chairman of the supervisory board and also a target of shareholder wrath, stayed on only long enough to pick his successor, Viermetz. Seven other board members also resigned.

The shareholders won other key changes. Deutsche Börse agreed to distribute E1.5 billion in capital to shareholders by the end of 2007, including about E800 million this year. Shareholders also placed two men on the exchange’s board: Richard Hayden, founder of hedge fund group GSC Partners and a former vice chairman of Goldman Sachs Europe, who was among the investors pushing for Seifert’s departure; and Friedrich Merz, a conservative politician and TCI’s German lawyer.

The prospect for continued activism by shareholders received a boost last month when Germany’s securities regulator, the Bundesanstalt für Finanzdienstleistungsaufsicht, announced that, because of a lack of evidence, it was dropping an investigation into possible collusion by the foreign investors in blocking the bid and overthrowing management.

Viermetz has moved quickly to repair relations with shareholders. Together with his good friend Breuer, he picked four other new supervisory board members, including two to bolster the board’s international representation.

The first is Craig Heimark, a managing partner of Hawthorne Group, a Palo Alto, Californiabased information technology consulting firm, whom Viermetz first met in the early 1990s when the Californian worked for O’Connor & Associates, a Chicago-based derivatives house. Viermetz, then a senior executive at J.P. Morgan & Co. in New York, advised Swiss Bank Corp. on its acquisition of O’Connor in 1992. Heimark’s IT expertise will help Deutsche Börse pursue its expansion efforts, Viermetz says.

To reach out to exchange users, Viermetz tapped Richard Berliand, the London-based chairman of J.P. Morgan Futures and vice chairman of the Futures Industry Association. Berliand’s expertise could come in handy if regulators force Deutsche Börse to break its exclusive clearing ties with Clearstream; he is a former director of the London Clearing House who played a key role in the 2003 merger of Euronext’s Clearnet subsidiary with LCH.

Those appointments should go a long way toward strengthening the board, Viermetz contends. “I took the opportunity to think about a broader restructuring of the board, to make it more international and to bring in specialists like Craig,” he says.

VIERMETZ’S INTERNATIONAL CREDENTIALS ARE solid. A jowly banker with a ready smile, he began his career as a foreign exchange trader at Deutsche Bank, then spent nearly three decades working for J.P. Morgan in Paris, New York and Frankfurt. He oversaw the bank’s foreign exchange, swap, commodities and securities trading in the late 1980s, then rose to become vice chairman -- and the firm’s first non-American board member.

At October’s supervisory board meeting, when Viermetz officially took the reins, the new board of directors raised a champagne toast to Breuer, who had overseen the successful transformation over the previous 15 years of one of Europe’s oldest exchanges -- dating back to 1585 -- into one of the world’s leading and most innovative markets.

Although the new management is determined to repair the damage caused by the London bid and consider new strategies for growth, Viermetz and Francioni do not represent anything like a radical change in leadership. Viermetz is keen to stress continuity and gives ample credit to Breuer for turning the Frankfurt exchange into a European powerhouse beginning with the recruitment of Seifert and Francioni in 1993.

“Frankfurt at the time was a middle-class exchange,” he says. Breuer and Seifert “were looking at New York and London, which weren’t doing anything different either, so they jumped in and did it -- the electronic platform. That took a lot of courage. It took the power and conviction of Germany’s leading banker to do it.”

Francioni was hired in 1993 from Switzerland’s Association Tripartite Bourses, where he was working to develop an electronic trading system, to take charge of the German exchange’s equities market and to sit on the group executive committee. While Breuer and Seifert, a former McKinsey & Co. consultant, provided the strategic direction, Francioni was the technocrat overhauling the exchange’s technology.

In 1997, Deutsche Börse launched electronic trading platform Xetra, making Frankfurt one of the world’s first exchanges to move to screen-based trading. “Xetra was Breuer’s idea -- that we needed an electronic platform -- but Reto was the guy who knew how to do it,” says Norbert Essing, former head of communications at Deutsche Börse.

“Reto was responsible not just for developing it, but for dealing with the floor traders. He rearranged their jobs, and a lot of those guys are no longer in the industry,” says Robert Schwartz, a professor of finance at Baruch College’s Zicklin School of Business in New York. He and Francioni coauthored the book Equity Markets in Action, published in 2004.

Also in 1997, Francioni launched the Neuer Markt, which became an overnight sensation for trading European technology stocks at the height of the high-tech boom. On the back of that success, he was named as Seifert’s deputy in 1999. It was only a year later, however, that he resigned over his objection to Seifert’s planned merger with the London Stock Exchange.

After a short stint as chief executive of ConSors Discount Broker in Nuremberg, Germany, Francioni went back to Switzerland as chairman of SWX in 2002. His departure from Frankfurt saved him the embarrassment of presiding over the collapse of the Neuer Markt, which Deutsche Börse shut down in 2003 after the failure of many once-high-flying companies.

Like Seifert, Francioni speaks English, French, German and Italian fluently. Unlike his predecessor, who had a reputation among staff for arrogance, he speaks slowly, deliberately and diplomatically. He has not been known to say a bad word about his former boss.

Francioni, who wears black-framed glasses that match his thick curly black hair, is a family man, devoted to his wife and two university-age sons. Throughout his first stint at Deutsche Börse, the family remained in Brugg, Switzerland, while he commuted to Frankfurt. The Aare River, near his home, remains his retreat: a place where Francioni, a passionate fly fisherman, can relax.

The most urgent challenge facing the new CEO is to shore up Deutsche Börse’s position in Europe. Euronext’s Théodore has made no secret of his desire to acquire the LSE, which would leave Frankfurt trailing even farther behind in equity trading. He has suggested that Euronext would be willing to relinquish control of LCH.Clearnet to satisfy the U.K. Competition Commission, which, in its preliminary report last summer, cited the lack of competing clearing and settlement arrangements as its main concern about a potential bid. It’s unclear whether Théodore could win shareholder support for a bid, though, or whether he could exit LCH.Clearnet quickly on good terms.

“Everyone is making the blind assumption we’d make a bid right off the block,” says one source at Euronext. “They are underestimating the enormity of this undertaking.”

Deutsche Börse has said that it reserves the right to make a counteroffer for the LSE if Euronext bids. Shareholders may have other ideas, though. In September, Harris Associates, which own a 2.6 percent stake in Deutsche Börse and a 10 percent stake in Euronext, told the Wall Street Journal Europe that it would favor a merger of the two continental exchanges. TCI also favors such a deal, people close to the exchanges say.

Managements in both Paris and Frankfurt are widely believed to be hostile to a merger of the two exchanges. A source close to Euronext says Théodore is determined to create Europe’s dominant equity market, which only an LSE deal would do. Deutsche Börse’s vertical integration -- in particular its exclusive clearing link with Clearstream -- is also a major obstacle to a combination with Euronext, just as it was to Frankfurt’s bid for the LSE.

Viermetz defends Deutsche Börse’s ownership of Clearstream, and it’s not hard to see why. The subsidiary is the group’s largest business, generating 38 percent of total revenues and 34 percent of earnings before interest, tax and amortization in the second quarter.

Having a one-stop trading and clearing platform is more efficient for customers, Viermetz contends. “I hear from many clients, particularly on the Continent, that they are very happy with our vertical structure,” he says. “It makes a very easy life for them, for their trading activities. As long as that is so, we will defend it.”

Most London securities firms want to break open Frankfurt’s silo and promote competition in clearing to drive down the cost of cross-border trading. The London Investment Banking Association, a lobbying group for the major securities firms, says Clearstream has kept fees steady even though the actual cost of settling a government bond trade, for example, has fallen by 70 percent since 2002. The organization wants open access to clearing and settlement systems so firms can choose the cheapest and most efficient route for carrying out a transaction.

“To achieve proper competition you have to break down the monopolistic silo,” says LIBA chairman Yarrow. “They have a captive market. You can’t trade in Germany without going through Clearstream.”

European regulators also are knocking on the Frankfurt silo. Charlie McCreevy, the European Union’s Internal Market commissioner, stepped up his complaints about the cost of clearing and settlement in a recent speech at an investment conference in Luxembourg. He cited figures showing that clearing cross-border transactions can cost up to six times as much as domestic trades and warned the industry to take steps to reduce those costs by next March or face EU regulation or legislation.

Eddy Wymeersch, head of Belgium’s Banking and Finance Commission and chairman of the Committee of European Securities Regulators’ task force on clearing and settlement, says he, too, has “very clear reservations about the vertical silo” because of the impact on costs.

Francioni also must figure out what to do with Eurex US. Launched with great fanfare early last year in a bold bid to challenge the CME and the CBOT on their own turf, Eurex US has so far failed to win any significant market share because of the aggressive response of its Chicago rivals, which have launched a common clearinghouse and slashed fees.

Analysts estimate that Eurex US is generating losses of E10 million to E15 million a year. That is a relatively small amount given Deutsche Börse’s size, but Viermetz appears eager to stanch the red ink. He says management needs to look at a variety of options, from partnering with other exchanges to seeking investment from a private equity firm.

“If you believe this is a global business, then it is really worthwhile thinking about a changing role, thinking about a partnership,” he says. “There are various means of curtailing our exposure and staying in the market.” Although he doesn’t want a hasty decision, Viermetz says management will need to fix Eurex’s US problems within about three months.

For Francioni the clock is ticking.