A confirmed bid by exchange operator NYSE Euronext and Markit, a financial information service provider, for Anglo-French clearing house LCH.Clearnet suggests the primacy of future OTC clearing revenues over current profit margins, market participants observed.
On Wednesday, NYSE Euronext chief executive Duncan Niederauer confirmed his firm's interest, but emphasised its subsidiary role. “It's a Markit proposal, and we are one of the parties,” he said, speaking at an investor conference held by Deutsche Börse, the German exchange group with which NYSE Euronext is currently working to complete a US$9.7 billion merger.
The DB/NYSE deal is subject to approval by European competition authorities which are expected to focus on the dominant position that would be created by the merged entity's ownership of Liffe, the London-based derivatives venue purchased by Euronext in 2001, and partial ownership of Eurex, the listed derivatives venue jointly owned by Deutsche Börse and SIX Swiss Exchange. NYSE Euronext currently has a 9% stake in LCH.Clearnet.
According to Diego Valiante, research fellow at the Centre for Europe Policy Studies, ongoing regulatory reform in the OTC derivatives market heightens the value of post-trade services. Following the financial crisis, regulators in the US and Europe are now thrashing out rules to improve transparency and reduce risk in OTC derivatives by pushing as many instruments on exchange as possible, mandating central clearing and minimising counterparty exposure among brokers.
“The deal may not look financially attractive as LCH.Clearnet has relatively low margins, particularly compared to Eurex,” Valiante told theTRADEnews.com. “However, the combination of Markit and LCH.Clearnet will provide the links and clients to compete in the OTC space.”
LCH.Clearnet, a not-for-profit entity currently owned 83% by users and 17% by exchanges, has operated SwapClear, an interest rate swap (IRS) clearing service for inter-dealer brokers, since 1999. Following the financial crisis, SwapClear was extended to US and European buy-side firms. SwapClear currently handles 40% of the total IRS market. According to the Bank for International Settlements, there were over US$465 trillion worth of IRS contracts outstanding at the end of 2010. SwapClear volumes are likely to grow as bilateral OTC arrangements are wound down.
Markit owns MarkitSERV, a single gateway for global OTC derivative transactions processing that connects more than 120 brokers and 1,700 buy-side firms to central counterparties, trade repositories and third-party administrators.
For NYSE Euronext, an ownership stake in SwapClear via LCH.Clearnet would eliminate the need to establish its own OTC clearing services in Europe.
But if the deal goes ahead it would represent something of a shift in strategy for NYSE Euronext. The exchange group announced its intention to end its relationship with the clearer in May 2010 ahead of building two purpose-built clearing houses in Paris and London by 2012. At the moment, LCH provides clearing for NYSE Euronext's four equities exchanges in Amsterdam, Paris, Brussels and Lisbon as well as its dark trading venue SmartPool. NYSE Liffe dropped LCH.Clearnet in favour of its own clearing house, NYSE Liffe Clearing, in 2009, but still uses LCH for banking, guarantee and default management arrangements. NYSE Euronext's future arrangements for clearing cash equities and listed derivatives will depend in part on the deliberations of competition watchdogs but market participants have observed that use of Deutsche Börse's existing post-trade facilities could be operationally and politically challenging.
New legislation will also play a significant role in determining the ownership and structure of the post-trade market infrastructure for derivatives in Europe. Although the draft of the European market infrastructure regulation (EMIR) passed by the European Parliament bars interoperability and therefore competition between CCPs in the European derivatives market, this position has also to be approved by national governments via the Council of the European Union. It is still undecided which OTC instruments will be forced onto exchange and central clearing and which facets of EMIR will apply to the listed and OTC derivatives markets.
However, Alex McDonald, CEO of the Wholesale Markets Brokers' Association, a trade body that represents inter-dealer brokers, cautions that the purchase of LCH.Clearnet could raise clearing costs if new legislation does not favour competition between CCPs.
“If the competition clauses in EMIR were to be introduced to enshrine fair and open access to clearing, then we would have no problem with LCH.Clearnet being acquired,” he said.
LCH.Clearnet was the subject of two failed takeover attempts in 2009. The first came from US post-trade services utility the Depository Trust Clearing Corporation, which sought to reposition LCH.Clearnet as a user-owned and governed clearer. However, DTCC withdrew its €739 million bid as shareholders struggled to decide between its bid and that tabled by a consortium of banks.