Part Three: LSE Group’s post-trade strategy moves to the fore

In the third of a four part series this week, Daniel Maguire, the Group Head of Post Trade at London Stock Exchange Group and Chief Executive Officer of LCH Group, talks to Luke Jeffs about repo and CDS clearing

While LCH and Eurex Clearing respectfully disagree over the future of Euro clearing, Europe’s two largest clearing firms are also contesting another thriving market: repo.

Easy to overlook in the low interest rate environment that has characterised recent decades, the repo market is currently booming as firms increasingly use these instruments to alleviate their short-term funding problems.

Maguire said: “Our repo business is growing at pace. LCH Ltd provides a gilt clearing business and LCH SA a Eurozone government bonds clearing service. Prior to 2018, we had some Eurozone debt in LCH Ltd also – this was inefficient for customers. Following consultation with them, we agreed to migrate and consolidate our Eurozone debt offering in one clearing house, LCH SA – this was driven by market participants seeking greater balance sheet netting and funding efficiency.”

LCH RepoClear, based in the clearing house’s French division, processed €288 trillion (£257tn) of Euro debt and UK gilts last year, up more than a fifth (21%) on 2021 which was also a record year at €238tn, the firm said in February.

Maguire said: “In repo clearing, the efficiencies and associated savings are in balance sheet netting, so you trade bilaterally but give up to the clearing house so that your net settlement against the clearing house is a small percentage of the gross nominal. The shift from LCH Ltd to LCH SA of Eurozone debt happened in 2018 and then the volumes started to grow. The more netting you can get, the more you can trade, so it is a more efficient model.

“We have seen the increased attractiveness of Eurozone debt relative to others from a collateralisation point of view, so we have taken an active role in “internationalising” the service to build an international fraternity of Australian, Canadian Japanese, Hong Kong and Swiss banks.”

Maguire said there are three key drivers in the repo market: “Firstly, government debt issuance will continue at higher rates of interest than we have seen over the past number of years. Secondly, banks’ balance sheets continue to be constrained so anything that can help alleviate that is only a good thing. And, thirdly, buy-side and sell-side need more reliable access to funding and liquidity, and clearing is certainly helpful in this regard.”

Maguire is convinced that, based on these three themes, the fundamentals for the repo market are strong but he is fully aware this is a competitive market. As well as Eurex Clearing, CME offers repo clearing through its Chicago-based CCP, leveraging the US exchange’s fixed income trading platform BrokerTec.

Maguire continued: “We’ve started with dealer-to-dealer, and have expanded that, and we now have a sponsored clearing model where we are bringing in the buy-side. Additionally, in LCH SA we will soon integrate our GC (General Collateral) repo service with the much bigger classic repo service.”

A lot of RepoClear’s recent growth has been in the dealer-to-dealer space, signing up new dealers from around the world, said Maguire, before adding: “But I think the next generation of growth will come from the other half of that market, so the dealer-to-client business where people come through a sponsored model, as well as by combining the two repo services into one which will bring even greater efficiency for customers.

“With the environment we are in now, it’s becoming more compelling to access guaranteed funding and liquidity. For example, pension funds in Europe will need access to cash to pay variation margin on cleared swaps as the clearing exemption for EU pension funds expires in June 2023. We’ve got tools to help people do that so it’s about bringing the SwapClear and RepoClear solutions together to help people fix some of those challenges.”

Maguire concluded: “RepoClear has been around for a while – it was launched in 1998! – but it’s experiencing a second coming in some ways as funding and liquidity are becoming more important, in addition to the tremendous netting benefits generated from clearing.”

Credit Clearing

Another space where LCH is doing well is credit derivatives and specifically credit default swaps. Here, LCH has for more than a decade competed with Intercontinental Exchange’s ICE Clear Credit, which has historically had the larger CDS clearing book.

CDSClear, also based in Paris, has continued to roll out new services, extending its coverage of the credit derivatives universe, most recently by launching credit index options clearing in late March.

Another factor in CDSClear’s recent growth has been ICE’s June 2022 announcement that it would stop clearing CDS in London in March 2023 and transfer that business to Chicago.

Maguire said: “Five years ago, CDSClear, which is part of LCH SA, had around 5% of the Euro CDS index market and we are over 50% now. That has been hard-earned – building up product, building up liquidity and building up a deep partnership with customers. The fact that we have been investing for a while now and building and improving the service, product and risk management, has meant that people have a real alternative to the incumbent clearing house and that has been positive for us.”

CDSClear has positioned itself perfectly to pick up the business coming out of ICE Clear Credit’s London business and is looking to harness further that momentum to expand in Asia and even the US.

Maguire said: “The growth of CDSClear is a great story and has meant LCH SA has followed a similar path to LCH Ltd and SwapClear in the internationalisation of the services and its users. We started to clear US index families a few years back as well as Asian ex-Japan and Australian indices and Sovereign single names last year.

“LCH SA is also regulated by the CFTC and the Securities and Exchange Commission (SEC) due to it holding licences to clear CDS indices and single names for US firms. Our goal is to be the premier global CDS offering and cover all major products and we will keep investing and expanding. We really wanted to make sure we consolidate in Europe in the first instance, and we are feeling pretty positive about that, which is giving us the confidence to go beyond Europe in the future.”

Maguire concluded: “This story also shows that it is possible to move liquidity from one clearing house to another if there is broad market support from all global participants and if there is a compelling economic rationale.”

To be continued on May 18