When Xavier Rolet first announced the London Stock Exchange’s intention to build a proper derivatives business, it was met with snorts of derision at an industry conference from Garry Jones, head of NYSE Liffe. That was in June.
Then there was virtual radio silence from the LSE on its plans.
On Thursday Mr Rolet showed a bit more leg, setting a date for the launch of equity options products - as yet unnamed - in the first half of next year. The LSE is to use Turquoise, the trading platform now run with some of its biggest bank customers, to roll out a pan-European offering.
The sceptics are, no doubt, still there, and not merely those running a derivatives incumbent against which the LSE is pitting itself, like Mr Jones.
After all, when has any exchange managed to make anything but minimal inroads into rival territory in derivatives? Eurex ultimately failed in its attempt to take on the Chicago Board of Trade in US Treasury bond futures in 2003, although the Windy City exchange was helped by a regulatory decision on a crucial technicality to do with the moving of open interest from one clearing house to another.
Euronext-Liffe (as NYSE Liffe was then) failed to take on the Chicago Mercantile Exchange in eurodollar contracts.
Is the LSE also tilting at windmills? Does it stand a chance of breaking into the pan-European equity options business, as Mr Rolet hopes? John Lothian, who runs The John Lothian Newsletter out of Chicago and who has seen many such battles, thinks Mr Rolet has “bitten off a rather chewy competitive challenge”.
As has been said many times, the LSE’s biggest mistake was failing to buy the London International Financial Futures Exchange (Liffe). The defence offered up, when people explain then-CEO Clara Furse’s failure to clinch the deal, was that it was viewed as too expensive.
Hindsight is a wonderful thing, but even in those days it was evident to sharper minds in the exchange business that locking in the higher-margin, growth story of derivatives was essential for any exchange with global ambitions. As it was, Liffe went to Euronext and thence to NYSE Euronext. Look what that has done to NYSE Euronext: NYSE Liffe has an operating margin of 48 per cent, substantially more than its parent’s cash equities business.
So Mr Rolet is right to have a go. The LSE derives only 6 per cent of revenues from derivatives at the moment. He told the Financial Times that the aim - over an unspecified period - is to get that up to 25 per cent.
How? The idea is to start with equity options, and not necessarily UK equity options, although those will undoubtedly come later. The LSE has the advantage of controlling the underlying asset - secondary trading in UK shares - which helps if you are building an options business off that underlying.
But Mr Rolet’s aim is not so much at NYSE Liffe or Eurex, it seems, as capturing activity in equity options in Europe that takes place over-the-counter (OTC). This is large, in comparison with the way equity options are traded in the US. Eighty per cent of equity options in Europe are OTC, Mr Rolet estimates. You could make a case that with the general regulatory push for OTC activity to move on-exchange, he might therefore be on to something.
Mr Rolet adds that the UK equity options market is illiquid and claims that Eurex’s equity options markets sometimes can be too. He claims that market participants want some consistency brought to the way corporate actions are handled, and that bringing an exchange-led offering will help.
The choice of Turquoise also makes sense and is part of the trend we’ve been seeing at some exchanges for “remutualisation” with their biggest customers as they contemplate new initiatives. NYSE Euronext did this with NYSE Arca Options last year, teaming up with the banks. Danny Garrod, analyst at Barclays, says: “Turquoise has the right partnership structure (banks own 49 per cent of it) to increase its chance of successful traction”.
It is too early to say how this will go. But Mr Rolet knows he has to hurry. In a sign of that, the LSE is to use as its clearing solution for Turquoise a combination of LCH.Clearnet and Cassa di Compensazione e Garanzia (CC&G), Borsa Italiana’s clearer.
We had been led to believe that Mr Rolet was more interested in trying to build his own clearer, with some of the banks. That has not panned out so far - although cannot, equally, be ruled out yet. But if you want to get a derivatives business off the ground, you need a clearing solution in place right from the get-go, and a combination of LCH.Clearnet and CC&G - which LSE clients are already using - makes sense for now.
What we really need to see is what products the LSE has in mind. The absence of a compelling story here is one reasons why some of the US banks that the LSE has been courting about building a clearing house default have been lukewarm. Why commit to building a clearer - which would mostly be for derivatives - if it is not clear where the new derivatives product proposition is going to be?
Meanwhile, the proposed deal between Singapore’s SGX and Australia’s ASX exchange has re-ignited talk of further global exchange M&A. The LSE is vulnerable, as Mr Rolet knows. Would NYSE Euronext or Deutsche Börse have a go? Possibly.
The next six months will be decisive in determining the LSE’s fate.
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