February 12, 2012 8:43 pm

LCH.Clearnet to gain from market reforms

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Ask Ian Axe about the business he inherited last year and he answers with a biblical reference. “It was a bit of a Noah’s Ark. There were two of everything,” says the chief executive of LCH.Clearnet, the London-based clearing house.

The company was formed in 2003 from the merger of the London Clearing House and Clearnet, clearer for the Paris markets. But it made slow progress in eliminating overlapping technology platforms.

Now LCH.Clearnet is caught up in sweeping regulatory changes and industry consolidation. The 2008 financial crisis sparked an overhaul of safety systems in markets, producing reforms by the G20 economies such as the Dodd-Frank act in the US and the European Market Infrastructure Regulation, finalised in Brussels last week.

They propel clearing houses such as LCH.Clearnet to the forefront of efforts to prevent another financial collapse by insisting that swaths of the over-the-counter derivatives markets be processed through clearing houses.

A clearing house acts as buyer to every seller and seller to every buyer in shares, derivatives or bonds, guaranteeing that the deal is completed even if one side defaults.

LCH.Clearnet is in pole position to capitalise on these developments. But it faces competition from CME Group, the Chicago-based exchange and clearing house operator, for a share of OTC interest rate derivatives clearing business that is increasingly coming from asset managers and other non-bank users of derivatives.

This has persuaded Mr Axe that LCH.Clearnet must become more commercially driven, even though it is not publicly listed like CME and Deutsche Börse. the German exchange. Like the CME, the Börse owns its own clearer and, fresh from the collapse of its planned tie-up with US operator NYSE Euronext, enters the fray with the launch of OTC interest rate derivatives clearing in Europe in March.

LCH.Clearnet is 83 per cent owned by banks and brokers, with the rest held equally between NYSE Euronext and the London Metal Exchange. Both are the clearer’s single biggest customers.

“The old strategy was far more of a utility mindset but it is now one of a commercial mindset where we can reinvest in ourselves,” says Mr Axe.

Since he became chief executive 10 months ago, LCH.Clearnet has been expanding its SwapClear OTC interest rate derivatives clearing service in the US to capitalise on the Dodd-Frank act.

Last week, the clearer said increased OTC interest rate clearing volumes helped drive a 16 per cent rise in clearing income, contributing to an 81 per cent rise in operating profit to €106.9m.

There are plans to launch clearing of foreign exchange derivatives shortly. Mr Axe says the group will expand into “carefully chosen pockets of excellence in Asian listed markets”.

But LCH.Clearnet’s future as a standalone entity is in doubt. In October, the clearer and the London Stock Exchange said they were in exclusive talks about the UK bourse taking a 51 per cent stake. Reports have said the LSE is willing to offer up to €21 a share, valuing LCH.Clearnet at about €1bn.

LCH.Clearnet’s governance and ownership make it hard to value. Two attempts to buy the clearer – one by The Depository Trust & Clearing Corporation, the US post-trade group, and the other by a consortium led by interdealer broker Icap – ended in failure, partly for that reason.

The chances of an LSE deal are seen to be better this time, in part because the LSE appears to be offering a premium. Analysts also see industrial logic in the UK bourse owning its own clearer at a time when the G20 agenda is driving much of the exchange and clearing business.

Mr Axe indicates that talks are nearing an end but will not comment on a possible deal. “I think my board want me to focus on running the business and driving the transformation as best and as efficiently as possible,” he says.

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