Master of the game

Werner Seifert, stock exchange chieftain and game theorist, likes to use chess as a metaphor for business. To the CEO of Gruppe Deutsche Börse, the long-awaited, much-demanded integration of European bourses and clearing and settlement systems is unfolding with all the drama of a high-stakes tournament match.

"Some players have not been credible contenders. Some aspire to be grand masters," Seifert declared in a speech last fall. He quoted the dictum of British chess whiz Gerald Abrahams: "Good positions don't win games. Good moves do."

Seifert, who fancies himself a grand master, needs to make some good moves in a hurry. Though an early champion of consolidation, he has seen his once-powerful position slowly undermined as his insistence on cost-cutting has scared off potential partners and emboldened an opponent with a softer touch, Jean-François Théodore of Paris-based Euronext.

In a decade as CEO, Seifert has transformed Deutsche Börse into Europe's biggest and best-capitalized exchange operator. With the Frankfurt Stock Exchange at the core of his company, Seifert created the world's biggest derivatives market, Eurex, and last year took full ownership of European custody and settlements firm Clearstream International. As a result, Deutsche Börse is less a trading utility than a portfolio of businesses and technologies that Seifert likes to call "a world-class transaction engine," capable of efficiently serving all of a financial institution's trade-processing needs.

To the 53-year-old Seifert, who declined to be interviewed for this story, efficiency is everything. By driving down costs, efficiency lets Deutsche Börse lower its prices and expand its market share, increasing profits and, presumably, the price of its stock, giving Seifert the currency to acquire weaker exchanges.

This gambit worked well for a while. Deutsche Börse's volume, trading revenue and income soared during the 1990s bull market, and in February 2001 the company went public at E33.50 ($31.35) a share. The stock has recently been trading at E39.85, though it had climbed as high as E51.20 in early 2002. Deutsche Börse still enjoys a peer-leading market capitalization of E4.2 billion. Last year the bourse increased its income 15 percent, to E235.1 million; revenues jumped 46 percent, to E1.1 billion.

But for all these accomplishments, Deutsche Börse has fallen into a stalemate. Seifert's efforts to acquire the London Stock Exchange and, subsequently, the London International Financial Futures and Options Exchange were both embarrassingly rebuffed. The ballyhooed Neuer Markt -- Germany's once-high-flying exchange for fledgling growth companies -- is closing down. And while Seifert's expansion efforts stalled, smaller rivals ParisBourse, Amsterdam Exchanges and Brussels Exchanges merged to create the vibrant Euronext, which had trading volume last year of E2.1 trillion compared with the Frankfurt exchange's E1.3 trillion. Euronext is now bringing Lisbon's Bolsa de Valores de Lisboa e Porto into its fold. It was also Euronext that snatched Liffe from Seifert's grasp.

By and large, independent exchanges look more favorably on combining with Euronext than with Deutsche Börse. Where Seifert insists on austere top-down control, Euronext CEO Théodore gladly cedes autonomy to the bourses that join his operation. Although bankers and exchange executives say they are all for consolidation -- the unification of Europe begs for a more streamlined financial market structure -- they don't share Seifert's obsession with costs, and they're wary of the power he is amassing in his multifaceted, vertically integrated enterprise.

"The consolidation strategy that Deutsche Börse has chosen goes in a totally different direction from our principles," says Werner Frey, CEO of the European Securities Forum, a lobbying group that represents many of the biggest investment banks. "A more federalist strategy, such as the relatively loosely grouped exchanges of Euronext, would be more appealing to our membership."

All of this leaves Seifert locked in a tense standoff with Théodore to define the future of Europe's securities exchanges and clearing mechanisms. And the contrasts between the two CEOs couldn't be more stark: One envisions a survival-of-the-fittest shakeout; the other favors "consolidation lite."

Seifert's mantra is vertical integration -- tightly linking his trading and processing operations on a state-of-the-art technology platform to achieve efficiencies and pricing advantages that no stand-alone exchange, custody operation or clearinghouse can achieve on its own. "'Silo' is a four-letter word to us," he has said.

Moreover, he believes that Deutsche Börse has won the most important of endorsements in the capital markets: Its capitalization is almost double Euronext's E2.3 billion. Both are valued higher than the London Stock Exchange, now at about £917 million ($1.4 billion). The LSE is Europe's biggest stock market by far, trading E4.2 trillion in 2002, but in contrast to its Continental counterparts, the LSE remains primarily an equities operation, with annual revenues of £216 million.

Euronext isn't as lean as Deutsche Börse -- it posted a 24 percent operating margin last year on E997 million in revenues, compared with its Frankfurt rival's 32 percent on E1.1 billion. But Euronext's profit margin was up from 12 percent in 2001, while Deutsche Börse's slipped from 37 percent. Market caps and operating margins, however, don't tell the whole story: Right now it's Théodore who is closing deals and Seifert who's scrambling to hold his ground.

Investors lately have been much harder on Deutsche Börse. With all businesses in the securities industry suffering through a brutal market, Deutsche Börse shares fell 19 percent over the past year, while Euronext dropped 8 percent, to a recent E19.13. Euronext's forward price-earnings multiple of 14.4 exceeds Deutsche Börse's 13.8.

"The difficulties that all of Europe's stock exchanges are experiencing with falling market capitalizations make consolidation increasingly desirable," says Théodore. He believes that his softer approach to mergers will allow him to win the match.

Over the past three years, Théodore has integrated his merged exchanges' back-office technologies but left regional managements intact. He outflanked Seifert with Liffe by making concessions that his opponent considered unthinkable: Théodore adopted Liffe's technology as the derivatives trading platform for all of Euronext, and he left Liffe's top executives in place.

"It looks as if [Seifert] has painted himself into a corner by creating an organization that others are basically hesitant to merge with," says Julien Sebban, an exchanges analyst at Exane Securities in Paris. "Seifert could still win, but the odds are against him."

DEUTSCHE BÖRSE HAS BEEN ON THE MOVE SINCE the Swiss-born Seifert took charge in 1993. A former McKinsey & Co. consultant, he studied game theory while earning his Ph.D. in business and political science from the University of Hamburg. Seifert was an executive at Swiss Reinsurance Co. in Zurich for seven years before Deutsche Börse tapped him to be CEO. He arrived with a mandate from Commerzbank, Deutsche Bank and Dresdner Bank -- Germany's top banks and the biggest shareholders of the bourse at the time -- to create a world-class operation that could help Frankfurt rival London for supremacy among European financial centers.

Seifert inherited the rudiments of his vertical integration strategy from his predecessor, Rüdiger von Rosen, a politically well-connected former central banker. In 1991 von Rosen had helped convince the Frankfurt Chamber of Commerce and Industry to transfer ownership of the hidebound Frankfurt exchange to the newly created, bank-controlled Deutsche Börse. Over the next two years, the banks also transferred the country's fledgling electronic derivatives exchange, Deutsche Terminbörse, or DTB, and the Deutsche Kassenverein settlements organization to Deutsche Börse.

But von Rosen wasn't able to make the various divisions of the expanded organization work effectively together. Nor did he prove tough enough to stand up to the entrenched interests of market makers on the floor of the Frankfurt Stock Exchange, who fought the introduction of an electronic order-matching system.

Fresh from his stint with Swiss Re -- where he turned around the company's general insurance business -- Seifert came to Deutsche Börse ready for battle. "If there ever was a type-A personality, it's him," says a member of the bourse's supervisory board. "He's thoroughly convinced of his own opinion, and he's always got to be doing something."

Early on Seifert worked to increase the Frankfurt Stock Exchange's volume by lengthening trading hours, bringing foreign bankers onto Deutsche Börse's supervisory board and creating "remote memberships" for brokers and traders based outside Germany. In 1996 he merged Germany's other clearing and settlement organization, the Auslandskassenverein, with the Kassenverein to form Deutsche Börse Clearing. And in 1997 he oversaw the introduction of Xetra, the electronic trading system and order book for Frankfurt-listed equities. That same year he launched the Neuer Markt, which burnished the Börse's high-tech image and helped propel its own valuation.

Meanwhile, brokers and investors in Europe were becoming increasingly dismayed about the economics of trading. In what would soon be a single-currency marketplace, the costs of dealing across a patchwork of national and regional bourses remained unacceptably high. Determined that Deutsche Börse would have a strong say in how a more efficient market structure would evolve, Seifert began to maneuver. In the fall of 1998, he signed a pact to merge Deutsche Terminbörse with the Swiss Options and Financial Futures Exchange, known as Soffex.

Reconstituted as Eurex, the electronic exchange became the first cross-border derivatives market in the world, and it displaced Liffe as the largest in Europe. DTB registered a notable triumph in 1999 when it took over the leading role in trading Europe's benchmark Bund futures and options contracts from the more expensive trading floor of Liffe in London. As the flagship exchange organization of Europe's largest economy, Deutsche Börse was beginning to look unstoppable.

Then Seifert overreached. Soon after inking the Soffex deal, he started courting Théodore, a former French government bureaucrat who had been running ParisBourse since 1991. The two were on the verge of a technology swap: Paris would take Eurex's system for futures and options trading and develop a replacement for the Börse's Xetra system. The deal would be the basis for a Continental equities and derivatives platform that other exchanges could join -- a platform that would compete with London.

But Seifert was also negotiating a bigger deal, with the London Stock Exchange. In the summer of 1998, he and LSE chief executive Gavin Casey announced plans to work toward a common trading platform for Europe's 300 largest issues. That effectively killed the Franco-German proposal. The French, as well as other potential partners in regional centers like Amsterdam and Brussels, feared that they would lose influence if they became junior partners of London and Frankfurt.

The London-Frankfurt discussions led to a spring 2000 agreement to merge their equity markets into a cross-border exchange to be known as iX. Soon that also came unraveled. Suspicious of any grab for power -- and critical of the fact that emerging U.K. companies would have had to list in Frankfurt and submit to German regulation -- rank-and-file members of the London exchange rebelled, scuttling the deal. Seifert survived, but London CEO Casey was ousted.

Deutsche Börse was humiliated by this turn of events, which galvanized its rivals and provided the impetus for Euronext. ParisBourse's Théodore went out of his way to make his partners happy. For starters, he allocated 60 percent of Euronext's equity to ParisBourse, 32 percent to Amsterdam Exchanges and 8 percent to Brussels Exchanges, even though, according to their relative trading volumes, the percentages should have been 75, 22 and 3, respectively.

"He made the kinds of concessions that you have to make to merge cross-border with quasinational institutions like exchanges," says Joachim Müller, an exchanges analyst at J.P. Morgan Securities in London.

At that point, Euronext wasn't much bigger than the Frankfurt Stock Exchange in terms of aggregate market cap or trading volume. "If the development of Euronext had stopped there, it would have remained a second-tier operation behind Deutsche Börse and the LSE and not really a candidate to be the lead consolidator," says Martin Ekers, head of equity dealing for Morley Fund Management in London.

Then Liffe, which had transformed itself into a sleek, fully electronic operation, became available. Both Seifert and Théodore had war chests for acquisitions: Deutsche Börse had floated a 25.5 percent stake in a February 2001 IPO, raising E1 billion; Euronext had raised about half that much from a July IPO of similar proportions. Clara Furse, who had replaced Casey as the LSE's chief executive in January 2001, was more hamstrung. The LSE, which had illiquid shares (mostly owned by its customers) that occasionally traded over the counter, also had listed in July, but it did not raise new capital in the process.

The LSE offered £577.8 million, with 63 percent of the purchase price in its newly liquid shares. Euronext made a £555 million all-cash bid, which was about the same as Deutsche Börse had contemplated offering, according to sources. Deutsche Börse, however, never submitted a formal bid, and Euronext carried the day. Liffe members were attracted to Théodore's approach to cost-cutting, which was less aggressive than either of his rivals'.

"Seifert had the opportunity to create the only major derivatives market in Europe and vastly increase Deutsche Börse's appeal as a European consolidator, yet he let the chance slip away because he was unwilling to offer either the same terms as Euronext or more money," says a former senior Deutsche Börse executive. "His drive for control helped him push through important changes in the domestic market, but it's always hurt him when he's tried to make big international moves."

Seifert still has many options. Speaking in September at the Global Securities Financing Summit, a gathering of bankers, regulators and other invited guests at Clearstream's headquarters in Luxembourg, he noted that there are still plenty of acquisition targets up for grabs, most notably the LSE. Then there are the second-tier exchanges: Italy's Borsa Italiana, Spain's Bolsas y Mercados Españoles and SWX Swiss Exchange.

"The timing and the degree of consolidation are very much dependent on the increased availability of targets," Seifert said in the speech, titled "Games Exchanges Play -- and Who Might Rewrite the Rules." Apart from Deutsche Börse, Euronext and the LSE, the only other European exchange organization with publicly traded shares -- making valuation and pursuit easier -- is Sweden's OM, owner of Stockholmsbörsen. But the Stockholm market is too small to be of more than passing interest to the rival consolidators. The cross-border merger pace will accelerate, Seifert suggested, when Europe completes its long-delayed harmonization of securities regulations, which some European Union officials optimistically predict will be complete by 2005. (To critics of Seifert, that's all wishful thinking. They note that neither regulatory confusion nor lack of public listings prevented Théodore from combining the Paris, Amsterdam, Brussels, Lisbon and Liffe markets.)

Seifert's September spiel emphasized tangible assets. "We are located with significant operations in Switzerland, Luxembourg, the U.S. and, of course, Germany," he boasted. "We maintain offices in London, Paris, New York, Chicago, Mexico City, São Paulo and Dubai. We serve the exchanges in Dublin, Vienna, Helsinki, Zurich and the Chicago Board of Trade with our trading platforms; all in all, we run 19 markets centrally."

Soon that will be 18. The Chicago Board of Trade decided early this year to replace its Eurex-based technology with Euronext's Liffe Connect. Deutsche Börse hopes to recover by launching a U.S. derivatives exchange of its own next year, but the CBOT's move leaves Seifert reeling from another stinging defeat at the hands of Théodore.

FRUSTRATED ON THE DEAL-MAKING FRONT, Seifert has turned his attention to home.

Last July Deutsche Börse paid the 93-bank consortium Cedel International E1.74 billion to purchase the 50 percent of Clearstream that it didn't already own. That brought more than 2,000 Clearstream employees fully into Deutsche Börse, which now has a total workforce of 3,300. The closer the connection between Clearstream and the market operations, Seifert believes, the more processing services it can cross-sell and the more favorable its pricing can be.

In January he realigned his six-member management board to, as the press release explained, "make even better use of the vertical integration effects" stemming from the Clearstream consolidation. Seifert divided key responsibilities between two executives who emerged as his chief lieutenants: Eurex CEO Rudolf Ferscha, 41, who took charge of trading and clearing services, including Eurex and the Frankfurt exchange; and Clearstream CEO Andre Roelants, 59, now deputy chief executive of Deutsche Börse, who is responsible for banking and custody services.

The integration is paying dividends. Through technology upgrades and a 5 percent staff reduction, Seifert lowered Clear-stream's annual costs by 33 percent last year. Although the division's revenues fell 6 percent in 2002, to E277 million, operating profit increased by more than 30 percent to E125.4 million. Those improvements, on top of cost-cutting and revenue gains at Eurex, will help push Deutsche Börse's operating profit at least 25 percent higher this year, to E440 million, the group's chief financial officer, Mathias Hlubek, said in March.

Many bankers, however, still don't share Seifert's enthusiasm for vertical integration -- and they question the propriety of an exchange owning a settlement utility.

"Linking the clearing and settling houses that are either owned or allied with the principal securities exchanges in Europe is a logical first step before you link the exchanges themselves," says the European Securities Forum's Frey. "But our membership would like to see clearers and settlers stay independent of the ownership structures of the major exchanges so they can link with as many other exchanges as possible. Keeping them independent but linked will lead to efficiency without stifling either choice or innovation."

For all of its successes, Deutsche Börse, like exchanges the world over, is watching its core equities business suffer. The market capitalization of the bourse's listed stocks plummeted 45.3 percent last year -- the worst showing in the developed world. Euronext's listed value fell 30.4 percent, and London's 24.3 percent, according to the Brussels-based Federation of European Securities Exchanges. Frankfurt's trading volume fell 25 percent last year, to E1.3 trillion, compared with an 8 percent drop for Euronext, to E2.1 trillion, and a 17 percent decline for London, to E4.2 trillion.

To be sure, Deutsche Börse's diversification offsets the impact of the stock slump. The Frankfurt exchange, the weakest of the three major businesses, accounted for 19 percent of Deutsche Börse's E1.1 billion in revenues last year but only E17.4 million, or 5 percent, of the E351.2 million in operating income. At Euronext, by contrast, stock trading accounted for 19 percent of the E997 million in sales and 46 percent of the E237.8 million operating profit.

Can Seifert's vertically integrated colossus overcome the suspicion of other market participants to lead the way for European exchange integration? Many observers think Seifert's acquisition options are dwindling. But Seifert publicly denies that Deutsche Börse has to acquire to achieve its ultimate goal of maximizing shareholder value. Explains Deutsche Börse spokesman Walter Allwicher, "If an attractive opportunity arises, acquisition is an option we will seriously consider, but doing a deal is not a make-or-break issue for us."

Still, Seifert could recover from his recent setbacks with a bold stroke. Not one to shy away from a fight, he could go all-out and make a run at Euronext. Such a move would have to be hostile, however, and Seifert would surely have a hard time breaking down the loyalties that Théodore has so skillfully nurtured. Short of that, Deutsche Börse may again consider the possibility of a merger with the London Stock Exchange.

The LSE certainly is affordable, with a market cap one third that of Deutsche Börse. This time, analysts say, Seifert might try a tactical feint: The struggling Frankfurt Stock Exchange could benefit from consolidation with the stronger LSE. Seifert could even offer to let LSE chief Furse run the combined bourse so that he could focus on the derivatives and clearing businesses that he finds more promising.

Even here, though, Théodore may have outflanked Seifert. Although Euronext hasn't pushed vertical integration to the extent that Deutsche Börse has, Théodore has cultivated close ties with clearing and settlement organizations that could thwart Seifert. Euronext, for example, owns 3.5 percent of Clearstream's rival Euroclear, which on Théodore's urging merged in September with London's CrestCo. Clearnet, a clearinghouse owned 80 percent by Euronext and 20 percent by Brussels-based Euroclear, is nearing a merger agreement with the independent London Clearing House, of which Euronext owns 17 percent through its acquisition of Liffe.

These Euronext positions effectively block Seifert's routes to vertical integration in London -- and could put Euronext in a strong position to woo the LSE.

"We don't believe that linkups between Crest and Euroclear or a possible deal between LCH and Clearnet would in any way make us an outsider in some sort of consolidation contest involving the LSE," retorts Deutsche Börse's Allwicher. "Remember, there are no ownership links between the LSE and either Crest or the LCH."

But Morley Fund Management's Ekers sees Euronext having an advantage: "Once Euronext's and the LSE's clearing and settling are firmly united, it would make sense, in terms of efficiency, if the two stock exchanges linked as well."

With Euronext's position strong indeed, Seifert had better have some good moves in mind if he wants to win this game.