NYSE Euronext’s new “concept” leaves clearer in the cold

Global exchange group NYSE Euronext has cited shifts in market structure and a desire for greater control over the trading cycle for its decision to take clearing in-house, but costs are also a likely driver of its plan to replace clearing house LCH.Clearnet.
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Global exchange group NYSE Euronext has cited shifts in market structure and a desire for greater control over the trading cycle for its decision to take clearing in-house, but costs are also a likely driver of its plan to replace clearing house LCH.Clearnet.

On 12 May, NYSE Euronext announced its intention to end its relationship with LCH.Clearnet, which clears for the firm’s four equities exchanges in Europe and its dark trading venue SmartPool, ahead of building two purpose-built clearing houses in Paris and London by 2012.

The exchange group also said it would conclude its outsourcing arrangement with LCH.Clearnet for its NYSE Liffe derivatives exchange. Last year, NYSE Liffe began clearing its own London-listed derivatives, while retaining LCH.Clearnet for banking, guarantee and default management arrangements.

“The concept of the exchange is changing,” Garry Jones, executive vice president and global head of derivatives, NYSE Euronext, told theTRADEnews.com. “Our goal now is to be an integrator of financial communities rather than just a trading exchange. We want to use our strength in technology to provide a full suite of trading services to our customers.”

Jones predicted that moving all derivatives processes in-house would enhance the exchange’s competitive position. “In the listed derivatives space, our biggest competitors are exchanges such as Eurex and CME, which both have in-house clearing,” he said. “By controlling the whole of our derivatives clearing service, we will not only benefit from extra revenue, but also reduced time to market when launching new products.”

The decision ends a long-standing relationship between NYSE Euronext and LCH.Clearnet. Before its merger with the London Clearing House in 2003, Clearnet SA was a clearing subsidiary of Euronext, which now operates the domestic bourses in Paris, Lisbon, Brussels and Amsterdam as part of the merged NYSE Euronext group. Euronext leased its clearing technology to LCH.Clearnet, an arrangement that continued after the exchange’s merger with the New York Stock Exchange in April 2007.

According to Andrew Mitchell, exchanges analyst at Macquarie, NYSE’s plans could signal a further return to the vertically-integrated exchange model in Europe.

“NYSE Euronext’s plans are an interesting indicator of how the exchange landscape may develop in the future. There does seem to a trend towards a more siloed exchange model,” said Mitchell. “As well as [Spanish exchange operator] Bolsas Y Mercados Españoles and Deutsche Börse, which are already vertically integrated, the London Stock Exchange has also hinted it may extend the use of its Italian CC&G clearing house.”

NYSE Euronext’s strategy has been positively received by its customers. Julien Kasparian, head of UK sales and market infrastructure at BNP Paribas Securities Services, thinks the exchange group’s decision was driven in part by a desire to reduce post-trade costs.

“Lower execution fees in Europe since MiFID mean that post-trade costs are now a much higher proportion of the total transaction cost cycle, hence all the current focus on post trade,” said Kasparian. “NYSE is now poised to create something that will bring post-trade cost efficiencies to their members in a bundled and neat fashion.”

LCH.Clearnet has come under pressure from exchanges to reduce clearing costs. In February, UK central securities depository Euroclear UK and Ireland reduced clearing costs for London Stock Exchange (LSE) members by reducing its charge for trade netting, a service it provides to the LSE on behalf of LCH.Clearnet. The fee reduction came following significant pressure by LSE CEO Xavier Rolet on Euroclear and LCH.Clearnet.

In its role as a general clearing member, BNP Paribas clears up to 40% of the cash equities traded on NYSE Euronext.

In 2009, LCH.Clearnet was the subject of two failed takeover attempts. The first came from US post-trade services utility DTCC, 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 of the ‘Lily Consortium’, a group of banks that owns 50% of LCH.Clearnet. This bid was also dropped because it was deemed to have achieved its dual aim of blocking a rival offer and gaining its members greater representation on the LCH board.

Many market participants have been hoping to benefit from a reduction in post-trade costs from increased interoperability between Europe’s clearing houses. Progress has been slow, and NYSE Euronext’s new clearing plans could throw another spanner in the works. Although the exchange has not ruled out linking to other CCPs and allowing them access to its trading venues, Jones says the case for interoperability remains unproven. “There is very little academic research looking at the consequences when one clearing house goes down, in terms of who takes the margin for cross liability,” he says.

The imminent departure of NYSE Euronext’s business has already started to have an impact on LCH.Clearnet, which was given a ‘CreditWatch negative’ status by ratings agency Standard and Poors on 14 May.

“The loss of one of its largest clearing contracts will severely impact LCH.Clearnet’s business in France and to some extent in its UK business too,” read the note from S&P. “In our view, LCH.Clearnet’s profitability was very dependent on business from the NYSE Euronext clearing contracts.”

In 2009, LCH.Clearnet Group received €60.6 million from clearing equity transactions, 47.1% down on 2008. Equities accounted for 27% of LCH.Clearnet’s clearing revenue (total: €221.3 million) in 2009 and 6.6% of its total revenue of €907.3 million. As well as clearing services, LCH revenues included interest from cash and collateral margins (€376.2 million) and a one-off cancellation payment of €260.4 million from NYSE Euronext upon the termination of clearing services for NYSE Liffe.

According to data vendor Thomson Reuters, NYSE Euronext’s European cash markets in Lisbon, Amsterdam, Brussels and Paris executed a total of 159,790,729 trades during 2009.

At the start of July 2009, LCH.Clearnet SA reduced its fees for clearing equities to an average of €0.10, from a previous average of €0.23. This puts the value of clearing NYSE Euronext’s cash equities exchanges at around €26.4 million, or 43.5% of LCH.Clearnet Group’s 2009 equity clearing revenues. LCH.Clearnet subsequently reduced average equity clearing fees to €0.05 in January 2010.

According to a spokesperson from LCH.Clearnet, the steep decline in equity revenue was due to increasing competitive pressure in Europe.

“Our cuts in fees last year, combined with increasing fragmentation of liquidity and greater competition between central counterparties have been the main factors in the reduction of equity clearing revenue,” said the spokesperson. “Given these kinds of cost pressures, diversification is, and always has been, important for our business.”

Recent examples of diversification include the extension of interest rate swap clearing to buy-side market participants last year, having previously only been available to the inter-bank market, and the recent launch of clearing services for the Hong Kong Mercantile Exchange and power trading venue Nodal Exchange. LCH.Clearnet is also positioned to benefit from the commitment of regulators on both sides of the Atlantic to clearing centrally a much larger proportion of over-the-counter derivatives.