Here we go again…

By John Gubert

Some fifteen years or so ago, as a board member of CRESTCo Ltd, the precursor of Euroclear UK and Ireland Ltd, I chaired discussions between Clearstream and CRESTCo to maximise the post trade value of the then planned Deutsche Boerse (“DB”) and London Stock Exchange (“LSE”) bid. I was also involved in some of the debates around the proposal. The chairmanship was given to me as a reward for being a large client of both entities and known to both managements. I have to admit that successfully chairing those meetings was impossible as it was akin to seeking agreement with two parties with management styles and diplomatic tendencies that drew heavily on the traditions of a Genghis Khan.

The bid was, at the time, taking place in an inauspicious atmosphere with the LSE being seen as a failing Exchange, whilst the retail brokerage community, especially, reacted with blind hatred at the concept of German dominance of the London market. This was not helped by DB suggesting, in a public meeting, that new issuance and other activities in London would be overseen by the German regulator, BaFin. Indeed, at the same ridiculous public meeting, there was even a suggestion from the team, selling the merger proposal, that UK based company regulatory documentation would have to be in German.

The LSE and DB are much changed since that era, both in terms of business profile, management structure and corporate performance. The atmosphere remains febrile, though, and, especially with the impending EU referendum in the UK, emotion will be an important component in the discussions. Even if the new company will have its operation centred in London, there will be fears that its heart will remain in Frankfurt. Let us hope, if the transaction proves viable, that management do not fall into the trap of believing that financial logic will drive its success alone. And in the 2000 bid, that financial logic was blended with irresponsible misuse of fact, especially in the value accredited to the post trade benefits.

The old transaction focused post trade on how to enhance the value of clearing, an embryonic service for SETS, aligning the LSE, LCH and CRESTCo, had only been launched in 1997. It also looked at cooperation between Clearstream and CREST, although it was the clearing side that offered the greatest traction and potential for cost savings.

In today’s market, clearing and settlement have also a role to play. As a survivor of the battles of the last millennium to rationalise the EU post trade markets, I recall the debates on merging LCH and EUREX Clearing as well as Euroclear and Clearstream.

The potential for post trade rationalisation, especially in the clearing space, is ripe with the greater convergence of process as a result of EMIR and other developments. Surely, in the clearing space, a merger of the entities owning EUREX and a majority stake in LCH Clearnet should be followed by a merging of those two entities. The minority shareholders of LCH Clearnet, who own over 40% of the company, will need to be supportive. But a single entity would result in total uniformity of risk management. Collateral management could be simplified with greater potential for offset and thus economies in an area of scarce resource. And the combined vehicle would be world class in scale and quality, competing with the best in the USA and elsewhere, and having the potential for growth into new areas especially in the vibrant derivatives markets.

And we also need to question how the CSD space could be better organised. The reality is that Euroclear has failed to deliver the desired benefits of operating multiple domestic CSDs. Their solution is too federal; the market needs a single solution both in terms of gateway or management and also in terms of operating model. It can be argued that a German-UK axis on the CSD front would be more powerful than the current Euronext/LSE associated settlement engines. The footprint becomes more powerful with the common ownership of the bulk of trade flows into both Clearstream Frankfurt and Euroclear UK and Ireland. The lack of common currency is a disadvantage and there is a risk, given the possibility of the UK exiting the EU that the markets diverge in the future rather than converge. But, assuming that BREXIT is not the chosen route for the UK, a single CSD of the two largest EU markets would be a powerful catalyst for future convergence of EU CSDs as a whole. That would create the real value that T2S, as simply a settlement engine, has failed to engender.

And we should not forget the opportunities in the trade reporting and information management space with uniform processes across the larger space offering the potential for further harmonisation of markets and market practises, beyond the main client markets of Germany, London and Ireland.

All of this cannot be achieved in the short term but there is plenty of low hanging fruit. LCH merged with Clearnet and the much vaunted benefits did not materialise. CRESTCo merged with Euroclear and the single EU domestic CSD market still looks far away. Is this merger going to break the trend? It has the necessary structure, the right footprint and, apparently, the appropriate management cultures. Convergence of infrastructure is needed to eliminate complexity, risk and cost. Let us hope that the bid, if successful, proves to be much more this time than an affiliation under a single corporate brand.