Given the flurry of merger and acquisition (M&A) activity in the exchange industry, NASDAQ OMX Inc. (NDAQ) and NYSE Euronext Inc. (NYX) have been showing interest in buying LCH.Clearnet for over a fortnight now, according to Financial Times. The companies’ bidding offer projections range from €350 million to €1.0 billion.
Meanwhile, LCH.Clearnet, a leading clearinghouse for swaps in Europe owned by multiple banks and market participants, has also confirmed the bid offers from industry giants. While NYSE reported to offer €500 million, NASDAQ offered about €350 million. However, London Stock Exchange plc (LSE), which was previously reported to have made a purchase offer worth €1.0 billion, denied any such move currently.
Wind of Change
Clearinghouses operate as central counterparties or middlemen and guarantee every buy and sell order executed by the trading parties, thereby reducing the risk if a trader defaults. This clearing business is becoming more attractive and significant given the stringent derivatives trading regulations in both the US and Europe.
The financial regulations and legislations, including the US Dodd-Frank Act, now warrant that the derivative products like interest rate, credit default and other swaps should be processed through the clearers to maintain transparency and stabilize the financial system. Therefore, exchange operators either have their own clearinghouses or seek the services of third party experts like LCH.Clearnet, to get their clearing strategies reassessed.
LCH.Clearnet enjoys a booming interest rate swaps (IRS) business in London, where it operates through SwapClear. Recently, the clearinghouse also initiated this service in the US, targeting non-banks IRS users and directly competing with CME Group Inc. (CME) who has also launched a similar IRS service recently.
Hence, the exchange operators are keen on taking over the leading clearinghouse in order to gain operating efficiencies and scale. This is based on the opinion that possessing a clearinghouse will not only enhance revenue growth at exchanges but also gives them a monopolistic control over of derivatives trading and clearing while freezing competition.
Now that derivatives growth has long past equities growth, due to the well-known futures contracts, it further justifies the recent growth in demand for clearinghouses. Meanwhile, there has been a rapid escalation in clearing services in Europe that has led LCH.Clearnet to look for strategic business development options.
Competitive Advantage for NYSE
Recently, the stock exchange industry has picked up pace with the changing market needs and consequently become a hub for M&A activities over the last few months. While LSE is on its way to complete a merger with Toronto Stock Exchange owner TMX Group, the NYSE’s $10 billion deal with Deutsche Boerse, entered in February this year, is undergoing rigorous sessions of investigations by regulatory authorities and is expected to be completed by a year’s time.
While NYSE Euronext has the largest stake of 9% in LCH.Clearnet, its merger partner, Deutsche Boerse, already runs its own clearinghouse called Eurex. Consequently, acquisition of LCH.Clearnet along with the Deutsche merger would drastically strengthen NYSE’s market share.
Hence, the complete takeover of NYSE would not only enhance its customer synergies between listed and OTC markets but also be able to complement its previous plan of setting up a clearinghouse in Europe by 2012.
Therefore, NYSE has teamed up with Markit, a financial information company specialising in over-the-counter (OTC) derivatives, in a €10 a share bid that values LCH.Clearnet at under €500 million.
Diversifying Requisite for NASDAQ
After the failure of NYSE takeover bid last month, NASDAQ is desperate to proceed with a business combination that could help it diversify beyond continents. The LCH.Clearnet at this stage apparently looks an attractive and feasible option that could help NASDAQ’s derivative business grow in London.
The company’s OTC derivatives clearer in the US, International Derivatives Clearing Group (IDCG), has failed to generate any growth impetus in IRS due to very few members and intense competition from NYSE and CME. Hence, acquiring LCH.Clearnet for clearing cash equities and OTC derivatives could help NASDAQ diversify its portfolio amid budding growth opportunities.
On the Edge
Overall though, LCH.Clearnet takeover proposal is currently at an initial stage and there is every possibility of a ‘no-deal’ scenario. Moreover, LCH.Clearnet has about 98 shareholders with many more banks involved in revenue-sharing and decision-making.
As they say, “Too many cooks…” and this kind of ownership arrangement could further make the takeover and approval process quite complex. Hence, we remain on the edge currently to view the future course of action.
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