MILAN/PARIS (Reuters) – Talks between Fiat Chrysler (FCHA.MI) and Peugeot owner PSA (PEUP.PA) over a potential tie-up that could create a $50 billion (£39 billion) car giant gathered pace on Wednesday, with one source saying a deal could be announced as early as Thursday.

The two groups said in separate statements they were holding discussions aimed at creating one of the world’s leading auto makers, better placed to tackle a host of costly technological and regulatory challenges facing the global auto industry.

A deal could be announced as early as Thursday, a source familiar with the discussions said. A Fiat Chrysler Automobiles (FCA) spokesperson declined to comment on a timeline.

After ditching a proposed merger with Renault (RENA.PA) in June, FCA Chairman John Elkann confirmed the group’s bid to pursue an alternative alliance as carmakers face huge investments in electrification, emission reduction and autonomous driving technologies.

Milan-listed shares in FCA rallied more the 10% on Wednesday, after ending up more than 7.5% on Tuesday in New York. Peugeot share rose more than 6% to hit their highest in more than 11 years.

Even if a combination of PSA and FCA succeeds in overcoming political, financial and governance hurdles, the new enterprise would still face substantial challenges.

The deal is being put together as automakers face a global downturn in demand at a time when the cost of investments into low-emission technologies are rising as deadlines to meet ever more stringent anti-pollution rules loom.

Morningstar senior equity analyst Richard Hilgert said in a note that total volumes of FCA and PSA, including China joint venture partners, amounted to 8.7 million vehicles last year, ranking the eventual combined group fourth behind Volkswagen (VOWG_p.DE), Toyota (7203.T) and the Renault/Nissan Alliance (7201.T), each at more than 10 million vehicles.

“We view the combination of these two companies as reasonable given global competition, high capital intensity, and industry disruption from electrified powertrain as well as autonomous technologies,” Hilgert said.

France is closely monitoring the merger discussions, with special attention given to governance matters, a French finance ministry source told Reuters on Wednesday. Paris has a 12% stake in PSA through state bank BPI.

Italy’s Industry Minister Stefano Patuanelli said on Wednesday that Rome – which has no stake in FCA – was following talks between the two groups but declined to comment further on a “market operation”.

Rome is keen to avoid major job losses in Italy, where 58,000 workers are employed by FCA, and with most of its Italian plants heavily underused.

Closing factories is politically problematic, but carmakers can glean savings by combining vehicle platforms and plants, pooling research and development efforts and increasing economies of scale in procurement.

EMISSIONS CRUNCH

The talks come as European carmakers struggle to meet tough carbon dioxide emissions targets.

Strategy firm PA Consulting has forecast FCA faces a fine of 700 million euros ($777 million) unless it radically changes its emissions profile to sell more electric and hybrid cars.

FCA, which lacks adequate green technology, has agreed to pay Tesla hundreds of millions of euros to pool emissions credits in an effort to escape penalties.

It has also announced a 5-billion-euro investment plan in Italy to 2021, to help the group launch its first electric and hybrid models, revamp luxury brand Maserati and fill capacity at its Italian plants.

FCA’s first full-electric model, the small 500 BEV, is scheduled to reach customers next year.

But a combination with Peugeot would give the carmaker access to PSA’s CMP modular platform, which has already spawned the Peugeot e-208 and the Opel Corsa-e mini.

MORE ADVANTAGES

Investors have speculated for years that FCA – itself the product of an Italian-U.S. merger – was hunting for a further partner, encouraged by the rhetoric of the company’s late chief executive Sergio Marchionne.

FCA, controlled by Exor (EXOR.MI), the holding company of Italy’s Agnelli family, had discussed a combination with PSA earlier this year, before it proposed a $35 billion merger with Renault.

At that time, FCA said a deal with Renault offered more advantages than a combination with PSA, but Elkann, a scion of the Agnelli family, broke off talks after French government officials intervened and pushed for Renault first to resolve tensions with its Japanese partner Nissan.

In addition to the French government’s 12% shareholding in PSA, the Peugeot family and the Chinese government each have a similar holding.

The Chinese presence might trigger doubts in the United States over a potential merger, as trade tensions between Washington and Beijing remain high.

Max Warburton, an analyst at Bernstein, said the combination of FCA and PSA had more logic and greater chance of success than the previously attempted FCA-Renault deal, but said PSA offered few synergies in the United States, Latin America and China. “The focus will be Europe,” he said.

PSA’s supervisory board is due to meet on Wednesday to discuss the potential deal, two sources close to the matter said. FCA said in its statement it had nothing more to add for the time being.

Graphic: Fiat versus Peugeot shares – here