Whatever comes out of merger proposals between stock exchanges, trading is only one part of what it takes to complete a transaction. As the European Commission says in a draft working paper, it is “post-trading” – the clearing and settlement that turns trades into completed transactions – that is “the very essence of markets”. LCH.Clearnet, as the largest European central counterparty (CCP) clearing house, welcomes the Commission’s call for an integrated European Union financial market without national barriers, together with its estimate of the benefit to European gross domestic product.
Within the financial community, the goal of greater integration is widely shared. One approach is to offer users a choice of CCP to clear their trades, before settlement. The London Stock Exchange has appeared to endorse this approach by announcing its intention to offer users a choice between LCH.Clearnet and SIS x-clear. It has yet to publish its specific proposals and we will study them carefully to see whether they offer real benefits for our users. Attractive though the idea of competition may sound in principle, there are issues that its proposal will have to address.
Interoperability, where competing CCPs co-operate and have access to each other’s flow of trades for clearing, is a commonly advanced approach. With goodwill, such a structure might be made to work. The downsides are, however, at least threefold: to accommodate the product set of every other CCP, the fixed costs of all CCPs would grow; the costs of process harmonisation, for both CCPs and their users, would be substantial; and a high level of co-operation would be required, particularly in risk management. Because of all the barriers that would need to be surmounted and the collaboration required, the question has to be asked – why not go the final step and decide
on consolidation? CCPs are largely fixed-cost businesses, so average costs fall as the total volume of cleared trades increases. By bringing together CCPs, overall fixed costs to financial markets could be significantly reduced. The end-point would be to have a single pan-European CCP, which most users believe to be best for the market.
Monopoly abuse is a valid concern. Whether independent or owned by an exchange providing trade flows, CCPs operate under a contractual monopoly. With just one clearer across Europe, the potential problem of monopoly abuse would be dealt with by a combination of ownership and voting limits, governance arrangements, regulatory controls and competition law.
Consolidation of CCPs would become even more important if the current bids resulted in a consolidation of exchanges. We agree with the Commission that “when a CCP provides its services to a single trading platform, it is the latter that has the greatest bargaining power”. Yet most trading platforms are publicly quoted companies that prioritise shareholders’ interest. So, as trading platforms consolidate, there will be greater need for an effective CCP to protect user interests.
Most larger market participants share our view about potential benefits of consolidation and smaller ones would also benefit from economies of scale. However, this leaves open how best to make this happen. Some clearers operate within vertical silos, in which they are owned by an exchange. The Commission rightly highlights the negative implications of these because of their ability and incentive to foreclose competition. However, these features make them valuable for their owners and present an obstacle to a purely market-driven solution.
We believe that to achieve consolidation, and because structural barriers posed by exchange ownership and control mean that markets are unlikely to reach a solution by themselves, the Commission will need to offer guidance and intervention including: structural checks such as limits on percentage ownership of CCPs and constraints on the use of influence; behavioural checks, to ensure independent governance; codification of relations between CCPs and exchange shareholders, such as explicit service contracts on IT and key non-IT services, independent tariff setting and transparency over payment arrangements; active use of competition law; and willingness to use legislation as a last resort.
In conjunction with action by the infrastructure players, this approach should achieve a more integrated financial market in the long-term interests of users across Europe.
The writer is chief executive of LCH.Clearnet Group, owned 45.1 per cent by exchanges (including Euronext) and 45.1 per cent by market users, with the balance held by Euroclear
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