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LCH.Clearnet buys U.S. rival

by Suzanne Miller | Published April 24, 2012 at 4:08 PM

Looking to grab a bigger foothold in the U.S. derivatives clearing market, LCH.Clearnet Group Ltd. is in talks to buy rival firm International Derivatives Clearing Group LLC for an undisclosed sum. LCH -- Europe's biggest clearinghouse, which is itself in talks to be bought by London Stock Exchange Group plc -- appears to be building a consortium of clearing partners in the U.S. and Europe, aiming to consolidate control in the massive but still-fragmented OTC derivatives market.

LCH announced Tuesday, April 24, that it will buy Nasdaq OMX Group Inc.'s majority stake in IDCG and in return give Nasdaq a stake in LCH. As of November 2010, that stake was roughly 80% of IDCG. "An important part of the deal is that Nasdaq would gain a stake in LCH. It's the beginning of a strategic relationship in the U.S. and Europe," a Nasdaq spokesperson said in a statement.

"The acquisition of IDCG would be a natural expansion of LCH.Clearnet's horizontal clearing model and further evidence of its commitment to the SwapClear service joining the existing 'one-pot' cross-margining arrangement" between NYSE Euronext's New York Portfolio Clearing LLC and the Depository Trust & Clearing Corp., LCH said in a statement.

The one-pot margin pool essentially means the parties will centralize compatible pools of collateral for different derivatives contracts, a key move aimed at cutting costs and attracting more members and clients. Nasdaq, the NYSE and other exchanges have been anxious to expand their presence in the derivatives clearing space as they face stalling growth in more traditional parts of their business, such as stock listings. Derivatives clearing was one of the driving forces behind merger talks between the NYSE and Deutsche Börse AG before Brussels quashed the deal in February. While the clearing business on its own isn't especially lucrative in generating revenues, it's an important magnet for bundling other client business -- essentially, for building a one-stop-shopping model aimed at helping clients save on increasing capital costs. LCH's plan to purchase IDCG and efforts to forge partnerships with others hint at how tough it has been to tackle the U.S. buy-side market on its own. While LCH has continued from its New York base the past year, the buy side (hedge funds, asset managers and others) has been reluctant to embrace clearing before regulators force them to do so. Rules are still being finalized, but the ultimate cost of complying has been a big roadblock.

At the moment, the OTC clearing market is largely represented by the dealer-to-dealer community, where the focus is largely on clearing so-called plain-vanilla instruments that are less expensive to clear than customized contracts more typically used by institutional investors. Paul Rowady, a senior analyst at Tabb Group in Chicago, reckoned that total additional collateral costs for the buy side could theoretically reach as high as $2 trillion, if all derivative asset classes and contracts were included. That's unlikely, he admitted, but the point is that clearing OTC derivatives is going to be very expensive, perhaps prohibitively so for many. That could hurt liquidity and, by extension, business opportunities for those such as LCH that are hoping to gain more market share.

For example, Richard Prager, head of global trading at BlackRock Inc., has said publicly that he's still reviewing the cost tradeoffs of clearing OTC derivatives -- indicating his firm is not yet a clearing convert. Clearing specialists have worried that big investors, faced with all the new costs and compliance obligations, may simply opt out.

As such, Rowady thinks LCH's latest move will give a little something to everyone. "I think it's incrementally positive for all players. Without the consortium, the pieces are not worth as much."

As for IDCG, talks to sell itself mark a humbling moment. Just four years ago, IDCG launched its clearing operation as a direct challenge to bigger players such as LCH. It was a bold move to appeal to firms that lacked the deep-pocketed access of global bank dealers in the OTC derivatives market. IDCG launched in 2007 before it had a single member signed up, just a few months before the March 2008 collapse of Bear Stearns Cos. and the onset of the credit crunch. One of IDCG's earliest members was MF Global Holdings Ltd., which has since gone down in a scandal-ridden bankruptcy.

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