NYSE Euronext’s decision to stop using LCH.Clearnet and create two new clearing houses of its own will lead to a substantial change in the European derivatives clearing landscape, and will feed into the debate about interoperability.
The Financial Services Authority is in the process of reviewing interoperability between clearing houses in the UK. Interoperability means giving exchange users the right to choose where their trades are cleared. They might then choose to use a central counterparty (CCP) in their domestic market, for example, rather than having to use the clearing house favoured by the exchange.
A market participant sympathetic to LCH.Clearnet argued that NYSE’s move was meant to enable it to control clearing for all trades on its platforms. “It’s about competitive advantage,” said the source, “about control of clearing, and about control of what’s traded on your market.”
From this perspective, the move could be seen as a blow to efforts to encourage interoperability.
However, a spokesperson for NYSE Euronext Liffe in London said: “The new clearing house in Paris will conform with all EU regulatory requirements. If the EU position is that interoperable operation should be at the discretion of each clearing house then we will assess the economic, competitive and prudential costs and benefits of interoperability and consult with our customers and local regulators before commencing such operation.”
The source sympathetic to LCH.Clearnet said: “There’s a value chain there, and obvious synergies,” adding that he thought NYSE Euronext’s move was designed to lock end users in to clearing on its own execution platforms.
“NYSE Euronext is the only major exchange that doesn’t have control of its clearing,” said the exchange’s spokesperson in response. “This stood out to our board and we therefore decided to change this. The new clearing houses are part of NYSE Euronext’s strategic plan to offer clearing services in the UK and the euro zone. This will improve the situation for customers, giving them operational synergies and risk offset synergies.”
LCH.Clearnet announced on May 12 that its contract to clear NYSE Euronext’s European securities would end in late 2012, leaving the exchange group free to establish two new, purpose-built clearing houses, based in London and Paris. The exchange group estimates the move will net it €100m a year in revenues from 2013.
The bourse began making steps in that direction last year, when it established NYSE Liffe Clearing for its Liffe platform, which became a self-clearing recognised investment exchange. This enabled NYSE to bring in house – and away from LCH.Clearnet – clearing of its London-listed derivatives. However, NYSE still outsources the deeper elements of its derivatives clearing – banking, guarantee and default management arrangements – to LCH.Clearnet. That will cease in 2012.
Falling revenues
The timing of NYSE's decision surprised LCH.Clearnet. LCH estimates that in 2009 it lost €24.5m of derivatives and swaps clearing revenue from the NYSE Liffe disengagement, out of a total €31.7m fall in its derivatives revenues.
However, LCH did receive a break payment of €260.4m from NYSE, as a result of the contract change. No such fee will be payable this time.
LCH’s accounts for 2009 show its revenue from derivatives clearing shrinking by 24% to €98.7m. The fall in equities clearing revenue was even more stark – it virtually halved from €114.6m to €60.6m.
Total revenue for the group was €907.3m, down from €1.59bn in 2008. Total clearing fees fell by 34.6% from €338.2m to €221.3m, but the really big hit came from lower interest earned on cash and collateral margin, a whopping 67.3% decline from €1.15bn to €376m.
Euronext says the two new clearing houses, built at a cost of €60m, will realign clearing along asset class lines to better meet customer needs. The new London clearing house will handle listed interest rate, commodities and FX products, while the new Paris-based entity will clear equities and equity derivatives.
The market source suggested Euronext’s move was also aimed at establishing control over cleared products, adding: “look at what ICE did last year”.
Intercontinental Exchange set up its own credit default swap clearing subsidiary, ICE Trust, in March last year, having first bought the Clearing Corporation (TCC), a nascent CDS clearing venture set up by a consortium of leading investment banks, in 2008.
Under an agreement struck with the banks that owned TCC, ICE gives them 50% of the profits, as of 2010, from the clearing venture, giving the banks a strong vested interest in clearing CDS trades through ICE.
Price competition
For its part, NYSE Euronext suggests its move will benefit customers by offering common clearing systems “to keep migration frictions as low as possible across all NYSE Euronext-listed asset classes”.
The exchange also thinks bringing clearing in house will create operational savings. It promises “attractive economic terms” as well as capital savings through better distribution and aggregation of risk-correlated instruments.
The group intends to offer clearing for OTC products and other trading platforms, emphasising its attractive and competitive commercial terms.
Roger Liddell, chief executive of LCH.Clearnet, has in the past voiced concerns that clearing houses competing on margin could result in a race to the bottom, whereby commercial concerns override risk management.
Asked whether the NYSE move raised the spectre of clearers again competing on price to attract market participants, the source was sceptical. “It could do – but it’d be hard to say that’s what Deutsche Börse have been doing for the past 10 years.” By implication, Eurex’s clearing fees have not been particularly low.
Asked to comment on this view, Deutsche Börse pointed out that it had adjusted its Xetra clearing fees during the last year, as well as allowing market participants the freedom to settle transactions in their domestic market at greatly reduced cost.
The NYSE spokesperson refused to go into detail on pricing, but confirmed that “NYSE Euronext will be competitive on price.”
Duncan Niederauer, NYSE Euronext’s CEO, said in a statement: “This is an exciting and enterprise-transforming project that will greatly benefit our customers and further enhance the company’s presence in Europe’s two most important financial centres, London and Paris.
“After successfully commissioning our new mission-critical trading infrastructure, UTP, across all of our businesses globally, we are now committed to investing similarly in mission-critical post-trade infrastructure in Europe.”
Liddell said in a statement: “We have enjoyed a long relationship with NYSE Euronext and are looking forward to continuing to work with them until the contracts end. This is an important and exciting time for clearing with regulators and policymakers globally looking to clearing to reduce systemic risk.
“LCH.Clearnet is well placed to benefit from this. It has unique clearing experience and is the only clearing house with 10 years of market leading experience in clearing OTC products. We shall seek to continue to diversify our revenues as we develop new exchange and OTC initiatives.”
Tom Osborn +44 207 779 8361 tosborn@fow.com