When IntercontinentalExchange acquired Liffe last year,
there were fears that the deal would stymie competition. In
fact today there are the most the most fertile grounds for new
launches in decades in Europe.
Since ICE acquired Liffe last year, the market for short
term interest rates in Europe has fallen off a cliff. Last
month the true scale of that drop became apparent with Euribor
volumes plummeting 68% year-on-year during July.
This has led some to question whether ICE paid over the odds
for Liffe. While valid questions, the greatest threat to
ICE’s new market comes from a decision made before
talks between the two firms began.
Euribor volumes will come back as growth returns to Europe
and uncertainty returns to the outlook for interest rates. CME
Group chief executive Phuphinder Gill last year referred to CME
as a "coiled spring" in reference to the potential growth that
a return to interest rate uncertainty would create and Liffe is
no different in that respect.
But Liffe will emerge from the downturn a different beast to
the one that entered it. Not just because of a significant
change of staff or even the migration to ICE’s
technology that is expected to be completed by the end of the
year (and is progressing well by reports).
The most fundamental difference and the one that exposes it
to competitive threats like never before is the transition of
clearing operations away from LCH to ICE Clear Europe. Jeffrey
Sprecher inherited the decision to move from LCH to a
vertically integrated clearing model, which was taken under the
previous management after merger talks with Eurex
When the bid by ICE to acquire Liffe was unveiled in
December 2012, a separate deal to move clearing facilities to
ICE Clear Europe regardless of the outcome of the deal talks
was announced. This effectively constituted Liffe throwing in
the towel on its ambitious plans to build its own clearinghouse
following the decision announced in 2012 to leave LCH.Clearnet
within 12 months.
At the time that looked like a rash move but it is only now
that its implications are being fully realised. Back in 2012,
the full impact of the OTC clearing mandate had not been fully
People knew of course that it would change market structure
and would increase margin requirements considerably but the
most fundamental change was not fully realised. That change is
that in the new world firms will execute based on where they
want to clear and not, as has always been the case previously,
clear based on where they want to execute.
The change has as much significance as the advent of
electronic trading in terms of the implications for liquidity
on execution platforms. As the regime for cross-margining takes
hold and models to calculate VaR-based margins for futures
against OTC derivatives become entrenched, liquidity will shift
to wherever firms can get the most efficient margin
And for all the pessimists about the outlook for LCH
following Liffe’s (and the LME’s
departure from the CCP), it holds by far the largest clearing
pool for swaps in the world within SwapClear. Therefore, any
execution platform (or indeed platforms) that can clear
futurised interest rate swaps and listed interest rate futures
against or within SwapClear will have the greatest opportunity
to emerge victorious in the new world.
This is why the London Stock Exchange is building a new
interest rates platform and why NLX chose to clear through LCH
rather than the CCP owned by parent company Nasdaq. It is also
why Eurex relaunched Euribor last year and plans to launch a
swap future and a suite of short term interest rate futures in
September while building up its fledgling swap clearing
services within Eurex Clearing.
It is also why Liffe’s decision to leave LCH
could turn out to be its greatest mistake since the failure to
react to the threat that DTB posed in the 1990s.
The path forward is not set in stone and there are no
inevitabilities in how the market will develop. SwapClear
clearly has to agree and be able to be opened up to
cross-margining and there are significant regulatory and
practical hurdles to overcome to achieve that.
There is also the chance that ICE can develop its swaps
clearing service to take market share from SwapClear before it
has the chance to open up. Or indeed do a deal with SwapClear
But with regulatory winds firmly behind opening up CCPs to
execution venues and such a strong business case for the LSE to
use its influence over SwapClear to open up, the arguments for
a more open model within LCH’s prize asset are
growing and with them, the threat to Liffe’s
interest rate franchise.