LSE/LCH deal presents derivatives cost saving opportunities

The purchase of a majority stake in Anglo-French multi-asset clearing house LCH.Clearnet by the London Stock Exchange could eventually lead to lower clearing costs for members through synergies with the exchange’s existing clearing facilities 

The purchase of Anglo-French multi-asset clearing house LCH.Clearnet by the London Stock Exchange (LSE) could eventually lead to lower clearing costs for members through synergies with the exchange’s existing clearing facilities 

The LSE announced this morning that it will become the majority owner of LCH.Clearnet, holding 60% of the firm’s issued share capital. LCH.Clearnet shareholders, most of which are users, will retain the remaining 40%.

“The transaction will be transformative, delivering a strong, customer-focused clearing partnership between LSE, LCH.Clearnet and the broker-dealer community,” said Xavier Rolet, CEO, LSE. “We will seek to promote greater innovation, choice and competition in the listed derivatives market through this new-style open-access clearing model, building on the successes we have already had with our existing equity and fixed income trading partnerships, Turquoise and MTS."

By building up its post-trade capabilities, the LSE could help to lower post-trade costs for its members through collaboration with Cassa di Compensazione e Garanzia (CC&G). The LSE has said it will not integrate CC&G, the Italian clearing house it acquired as part of its takeover of Borsa Italiana in 2007, with LCH.Clearnet, which is in part believed to be due to the partial retention of the latter’s user-ownership structure.

“Given that the LSE already owns CC&G, there are netting and margin efficiencies that could lower the cost of clearing for its members,” Tony Freeman, head of industry relations at post-trade processing firm Omgeo, told “Use of margin can be consolidated between the two clearing houses for large brokers that are active in the UK, French and Italian markets and provide an immediate cost benefit.”

But Richard Perrott, analyst at German private bank Berenberg, pointed out that potential cost savings between LCH.Clearnet and CC&G could be a longer-term goal.

“It may take a long time for national regulators to agree on an appropriate margin and netting structure,” he said. “However, there is already an element of interoperability between LCH.Clearnet and CC&G in the repo market, which may help to accelerate these discussions.”

Perrott adds that further clearing efficiencies could be gained through cross-margining opportunities, i.e. paying margin based on correlations between different assets that are cleared through LCH.Clearnet. This is an approach that is already gaining popularity in the US with NYSE Euronext’s New York Portfolio Clearing venture, which clears interest rate futures contracts and cross-margins eligible positions against US Treasury and agency securities and repurchase agreements.

One of the main prospects of the acquisition identified by the LSE are “opportunities to develop listed fixed income and equities derivatives”, indicating a clear drive to capitalise on impending derivatives regulation.

The European market infrastructure regulation, which is due to come into force at the beginning of next year, will push many OTC derivatives instruments onto exchanges and through clearing houses.

As well as new revenue opportunities through LCH.Clearnet’s SwapClear business, which clears 50% of the global interest rate swap market, the deal also presents a chance for the LSE to finally build volumes on its Turquoise Derivatives market, which currently only offers FTSE index options and futures and has so far struggled to gain traction.

Market observers have suggested that one reason for the low volumes on Turquoise Derivatives is a refusal by NYSE Liffe, the derivatives market owned by NYSE Euronext, to allow LCH.Clearnet to offset margin in FTSE 100 index futures.

“Allowing cross-margining could kick start greater competition in the listed derivatives space, which should ultimately lower trading costs for member firms and buy-side traders,” said Perrott.

Under the terms of the transaction, LCH.Clearnet shareholders will receive €20 per share, giving the firm a total implied value of €813 million. For its 60% stake, the LSE will pay a maximum of €463 million, which will be financed using the bourse’s existing cash resources and bank facilities.

The target completion period for the acquisition is Q4 2012 and the LSE said it expects to accrue revenue synergies of €40 million within five years.