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Thursday, February 23, 2012 6:53:30 AM

LSE/LCH merger holds significant benefits - Berenberg

The London Stock Exchange (LSE) is well positioned to secure a takeover of clearing house LCH.Clearnet, according to private German bank Berenberg, but the UK bourse should be wary of the potential for NYSE Euronext to frustrate its efforts. 

In its latest analyst report on diversified financials, Berenberg stated that a deal between the Anglo-French clearer and the UK bourse would offer a number of opportunities for both parties.  

These include the fact that the LSE advocates a horizontal exchange model and will not use the acquisition of LCH.Clearnet to build a vertical silo, as well as its existing experience working with major dealers through the LSE-owned Turquoise multilateral trading facility.

The LSE purchased a 60% stake in Turquoise in February 2010 from brokers including BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Bank of America Merrill Lynch, Morgan Stanley, Société Générale, and UBS. The LSE then sold a further three 3% stakes in Turquoise to Barclays Bank, J.P. Morgan Cazenove, Nomura a month later. LCH.Clearnet is 83% owned by its members.

The main advantage in trying to purchase the Anglo-French clearing house, said Berenberg, would be the potential for it to build up a presence in the derivatives market.

“Huge levels of open interest held in LCH.Clearnet (swaps, repos, bonds) offer significant cross margining opportunities, potentially allowing LSE’s fledging Turquoise derivatives platform to compete against established exchanges in interest rate derivatives,” read the Berenberg note.

LCH.Clearnet operates SwapClear, which clears over 50% of all interest rate swap trades globally.

In annual filings last week, LCH.Clearnet revealed that last year, SwapClear grew steadily to US$283 trillion in notional principal outstanding. Average daily volumes rose year-on-year by 30% to 1,930 trade sides and 25 new members were added, bringing the service’s total membership to 61.

The LSE launched derivatives trading on Turquoise last June but has so far failed to gain significant traction, partly because of a hostile competitive environment.

“This deal would support LSE's ambitions in derivatives.” said Richard Perrott, analyst at Berenberg and author of the report. “Otherwise, the exchange would have to look to regulatory changes via Europe's pending Markets in Financial Instruments Regulation (MiFIR) to boost Turquoise derivatives. But it would be risky to rely on just this.”

The current version of MiFIR, a new regulation that will accompany MiFID II, proposes fungibility for listed derivatives clearing – meaning contracts traded on one exchange can be opened at one clearing house and closed on another – and could compel central counterparties to accept clearing of instruments on a non-discriminatory and transparent basis, regardless of the trading venue on which a transaction is executed.

The Berenberg note also highlighted the possibility for NYSE Euronext to hinder the LSE/LCH deal, given that it owns around 10% of the clearer. However, the German bank also stated that, “relations between NYSE and LCH.Clearnet have often been acrimonious, and NYSE’s move to create NYSE Liffe Clearing marked a further divide”.

The LSE and LCH.Clearnet entered exclusive merger discussions in September 2011.

Speaking after the firm’s results presentation last week, LCH.Clearnet CEO Ian Axe said a decision on the deal was expected “shortly”.

In recent years, the CCP has been the subject of a number of failed takeover approaches, including bids from US post-trade utility the Depository Trust and Clearing Corporation and the Lily consortium, a group of banks including ICAP that owned 50% of LCH.Clearnet.

Anish Puaar +44 (0)20 7397 3817 anish.puaar@thetrade.ltd.uk