Brokers bidding against themselves in LCH battle

US post-trade processing firm Depository Trust and Clearing Corporation's (DTCC) member-owned structure could complicate its battle to acquire European clearing house LCH.Clearnet.
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US post-trade processing firm Depository Trust and Clearing Corporation’s (DTCC) member-owned structure could complicate its battle to acquire European clearing house LCH.Clearnet.

The DTCC revealed its bid for LCH.Clearnet last October, but earlier this month a consortium of brokers, including inter-dealer broker ICAP, signalled its intention to launch a counter-offer. Many of the firms reportedly involved in the consortium either have significant US subsidiaries that are member-owners of DTCC, or, in the case of US institutions, are members themselves.

In challenging the DTCC for possession of LCH.Clearnet, consortium members are effectively competing with an organisation in which they collectively own a substantial stake.

“We don’t want get into a bidding situation where a firm is bidding against a branch of the same firm,” said a source familiar with the situation.

The brokers reported to be involved in the consortium with ICAP are BNP Paribas, Citi, Deutsche Bank, HSBC, J.P. Morgan, Royal Bank of Scotland, Société Générale and UBS. ICAP is the only firm that has publicly confirmed its participation.

Four of the reported consortium participants sit on the DTCC’s board of directors, according to the DTCC’s annual report for 2007. In total, 17 of the firm’s 21 directors are drawn from clearing agency participants, including Ronald Purpora, president, ICAP Securities USA, David Weisbrod, managing director, J. P. Morgan, Ellen Alemany, CEO, RBS Americas and Michele Trogni, global head of operations, UBS.

DTCC spokesman Steve Letzler confirmed that the firm remains in negotiations with LCH and is planning to contact consortium members to discuss “our potential bid for LCH.Clearnet and their intentions”.

While some news reports have suggested the consortium is trying to keep LCH.Clearnet out of the hands of what is often characterised as a US clearing monopoly, some observers think the brokers have their eyes on clearing revenues. Central counterparty clearing, especially for OTC trading, has become a hot topic since the collapse of investment bank Lehman Brothers, which sharpened buy- and sell-side traders focus on counterparty risk.

“If this were a bad deal, nobody would stand up and shout that they are doing this to keep control of the firm in Europe,” said Phillip Silitschanu, senior analyst at research and advisory firm Aite Group. “There is money to be had. Central clearing and settlement is going to be big business in the next few years.”

It is widely expected that the consortium, if successful, will use LCH’s deriatives clearing capabilities to create an OTC clearing solution. “A lot of people are focusing on that side of the business, and if they didn’t move into it, a lot of people would wonder why,” said Silitschanu. “It is a wide open field right now and one that is only going to increase in importance in the next two to four years. There is the potential to make a lot of money there.”

LCH.Clearnet clears for a range of European equity exchanges and platforms, including NYSE Euronext, the London Stock Exchange and NYSE Euronext’s SmartPool MTF. It also offers clearing for a number of other instruments, including exchange traded derivatives, fixed income, swaps, commodities and energy.

Brokers may be attracted to the clearing business because of dwindling profit margins on the trading side of their business. “There is diversity of revenue in clearing that perhaps mitigates some of the emphasis on the more commoditised and harder parts of the business,” said Miranda Mizen, senior consultant at research and consulting form TABB Group.

Many of the post-Lehman clearing initiatives unveiled so far have been exchange-led – for example NYSE Euronext Liffe’s BClear solution. The brokers’ bid for LCH may be an attempt to keep OTC business off-exchange in its entirety.

“The bid could be a revenue play by the brokers, but I suspect it is potentially more strategic,” said Sarah-Jane Dennis a consultant at investment management consultancy Investit. “If OTC clearing via exchanges gathers momentum, there is a good chance that the more extensively traded OTC contracts will become semi-standardised. This would potentially eat away at sell-side revenues.”