The history of the derivatives markets is an annual of
failed exchange launches.
Whether rival products or new exchange launches, it is
notoriously hard to shift liquidity from an incumbent and it is
into this litany of failure that the London Stock Exchange will
launch its new rates platform.
Following FOW’s exclusive story yesterday that
six global banks had signed up to support the London Stock
Exchange’s new interest rates exchange, an
official statement from the exchange this morning has revealed
Two new details stand out.
First is that US options giant the Chicago Board Options
Exchange is among the investors.
The second is that Michael Davie will serve as chairman of
the exchange and in the new role of head of rates services
across the LSE group.
Both indicate the ambition of the LSE for the new exchange
but it is the latter that is perhaps the most significant for
reasons outlined below.
The Nikkei and the Bund are the most celebrated of the rare
instances in the modern history of the derivatives markets in
which liquidity in an established contract has been moved from
one exchange to another.
These are the exceptions that prove the rule that it is
nearly impossible to achieve a wholesale shift of
Exchanges commonly launch look-a-like rivals to incumbent
contracts with incentives and zero fees, but these alone are
never enough to move liquidity.
Both the Nikkei and the Bund moved due to fundamental
underlying conditions in market structure.
In the case of the Nikkei, it was draconian regulation by
the Japanese that opened the opportunity for Singapore.
For the Bund, it was the advent of electronic trading and
DTB’s embrace of the new technology in contrast to
Liffe’s incumbent resistance.
Both were game-changers in the market rather than in the
contract structure or approach of the exchange.
So what are the game-changers for CurveGlobal? Principally
there are two inter-linked trends that the LSE will seek to
The first is portfolio margining between swaps and exchange
traded products. The offsets and efficiencies this offers in a
capital constrained world are potentially huge for banks.
With SwapClear opening up its swaps portfolio to
cross-margining, an unprecedented opportunity to test the
benefits of portfolio margining will come in the first
If the savings and efficiencies are as great as has been
suggested, the pendulum will swing strongly in
Curve’s favour. We may well be entering a market
environment in which the decision on where to trade is based on
where you want to clear, rather than the status quo in which
the market clears based on where it wants to trade.
A change of attitude within the banks?
One thing that held back Nasdaq NLX 1.0 was the reluctance
of banks to really participate in the market. While many signed
up at the start, few ever engaged with the market in any
Bill Templer, who has been heading up the launch of the
exchange at the LSE, has learned the lessons and engaged with
the banks early and predicated the launch on the agreement of a
sizable number of the larger banks in the market coming on
With Bank of America Merrill Lynch, Barclays, Citi, Goldman
Sachs, JP Morgan and Société
Générale publically signing up to the exchange
from launch one hurdle has been jumped. All have invested in
the new launch, aligning their interests with the exchange.
Equally encouraging is the appointment of Michael Davie to
chair the exchange and head up rates services at the LSE.
Davie is a swaps man through-and-through having run
SwapClear since 2010 after 14 years at JP Morgan.
Curve will not succeed without the backing of the OTC desks
within banks. They remain in many – but not all
– investment banks the dominant influence on trading
policy and where trades are directed.
With the backing of not just the banks but the OTC desks,
Curve has another advantage above other recent attempts to take
liquidity from an incumbent.
The third advantage is the participation of the CBOE. The
deal is more than just a strategic investment for the US
Ed Tilly, CEO of the CBOE, said that the firm will "leverage
its trading and product development expertise" to develop new
opportunities for curve.
CBOE therefore can open up Curve to the US market through
its futures exchange as well as harnessing its volatility
expertise to launch new contracts – expect a sterling
volatility index in the coming years.
The elephants in the room
CurveGlobal certainly has advantages in the combination of
portfolio margining, the backing of large banks and their OTC
desks and direct access to the US market.
In this respect it looks stronger than previous attempts to
take liquidity from ICE and Eurex. But what of the
Jeff Sprecher and his team at the Intercontinental Exchange
are unlikely to take the challenge lightly.
As outlined by FOW in July, ICE
has a number of options to protect the franchise it bought
in a multi-billion dollar deal in 2012.
Should it secure portfolio margining at SwapClear, which
Mifid and the LSE’s commitment to open access
guarantee it can if it wants to – it will eliminate
many of the competitive advantages of CurveGlobal.
FOW understands it is in talks with LCH over open access and
has a number of structures that can enable this, including the
launch of a secondary trading platform that will effectively
offer elective clearing without diminishing its liquidity
Eurex too will fight back. Curve is launching products
across the yield curve so threatens its bund, bobl, schatz
The exchange was the first to market in Europe with its
Prisma cross-margining methodology enabling portfolio margining
between OTC and exchange-traded derivatives and has built open
interest in its clearing house in Euro denominated swaps.
Whether the continued dominance of LCH in both sterling and
euro products will be enough to move enough of the ETD market
over to Curve is one of the many fascinating questions that
will be answered in the coming months and years.
NLX will also be in a position to offer cross margining at
SwapClear next year – long touted as its core
advantage. It too is seeking to secure the backing of
international banks and could soon announce it had secured the
backing of some of the banks not signed up to Curve, and indeed
some that have.
There are some notable absences from the LSE's list of
banks. No German banks, neither Swiss giant UBS or Credit
Suisse, no ABN or BNP Paribas. A flush but no full
The perils of over incentivising
How Templer and his team bring the rest of the market on
board will also be crucial to the long term success of the
Another lesson learned by NLX is the double edged sword of
Market makers and proprietary trading firms are eager to
trade on the basis of incentives.
However, as FOW outlined in a recent whitepaper, they have
effect on Commodity Trading Advisors and asset managers for
whom the financial benefits of the trade are outweighed by the
impact they have on the market.
FOW understands that Templer has been engaging with market
makers and proprietary trading businesses extensively over the
past two months but details of any incentives are yet to be
He will need to tread the fine line between true incentives
to trade and incentives that result in trading simply for the
Do the deal?
With a second quarter launch planned there is still time to
do the deal that many in the market want – except
Rumours of a possible merger between NLX and Curve have been
around since it was first revealed that the LSE was planning a
new rates platform.
Talks did happen but it was clear that NLX owner Nasdaq and
the LSE had vastly different views on the price of the
In 2016, once both have access to SwapClear, Curve and NLX
will effectively offer the same products with the same Unique
Selling Points, potentially backed by different banks.
This diminishes the chances of success for either market and
so a deal between the two would strengthen the challenge to
No one has ever made money betting against Jeff
But his exchange group faces its biggest challenge in Europe
to date with the launch of CurveGlobal.