The 29bn euro (£24.5bn) merger of the London Stock Exchange and Deutsche Boerse could collapse after the LSE said the deal was unlikely to be approved by the European Commission.
The commission had ordered the LSE to sell its 60% stake in MTS, a fixed-income trading platform.
However, the LSE said the request was "disproportionate".
It warned investors it would struggle to sell MTS and that such a sale would harm its ongoing business.
As a result, the LSE said: "Based on the commission's current position, LSE believes that the commission is unlikely to provide clearance for the merger."
The two rival exchanges announced plans for a "merger of equals" about a year ago, aiming to create a giant trading powerhouse that would better compete against US rivals.
They had already agreed to sell part of LSE's clearing business, LCH, to satisfy competition concerns before the commission's surprise demand concerning MTS earlier this month.
The Commission had given the exchanges until Monday to come up with a proposal to meet that demand.
LSE said that such a sale would need regulatory approval from several European governments and would hurt its wider Italian business.Image copyright Getty Images
"Taking all relevant factors into account, and acting in the best interests of shareholders, the LSE Board today concluded that it could not commit to the divestment of MTS," the exchange said on Sunday night.
MTS is a relatively small part of LSE's business, but it is a major platform for trading European government bonds, particularly in Italy, where it is classified as a "systemically important regulated business".
The LSE group also owns the Milan-based Borsa Italiana.
The LSE said it remained convinced about the merits of a merger, but joining forces with Deutsche Boerse would be impossible unless the commission changed its stance.
The European Commission and Deutsche Boerse both declined to comment.