Solitary silo

It has happened in North America, and it is beginning in Europe. Traditional stock exchanges already face tough competition from new multilateral trading facilities such as Chi-X Europe Ltd. The threat will get more fierce in the fall with the debut of new players such as the major investment banks' equities trading platform, Turquoise, and the European operation of Bats Trading Inc.

The prospect of greater competition has already led to consolidation, with the New York Stock Exchange's acquisition of the Euronext exchanges and Nasdaq Stock Market Inc.'s linkup with the Nordic OMX Group to become Nasdaq OMX Group Inc.

The latter plans to roll out its own MTF platform, Nasdaq OMX, later this year.

London Stock Exchange plc seems isolated in more ways than one. Not only does it face ever tougher challenges from rival exchanges and MTFs, it also takes a radically different approach to clearing. While Germany's Deutsche Börse AG operates a closed "vertical silo," forcing its clients to settle and clear through its Clearstream subsidiary, London has long espoused competition for post-trade business. Its "horizontal" model has relied on LCH.Clearnet Group Ltd. for settlement and clearing in the U.K., yet equities traders may use alternatives if they desire. But LCH.Clearnet, unlike Clearstream, is independent. The LSE uses it, NYSE Euronext's Liffe derivatives market does too and so do international players such as ICE Futures Europe. None of them has exclusive access.

The truth, however, is that until a gaggle of new clearing businesses appeared recently to serve the new MTFs, LCH.Clearnet, with few rivals, got fat and complacent. Now, however, it has come under threat on two flanks. On the equities side, Chi-X, owned by Silver Lake's brokerage Instinet LLC, has decided to use Fortis Bank of Belgium's European Multilateral Clearing Facility NV rather than LCH.Clearnet. Nasdaq OMX and Bats are signed up to follow suit. Turquoise has agreed to use another new player, Euro Central Counterparty Ltd., a subsidiary of New York's Depository Trust & Clearing Corp.

But far more damaging is the threat to the horizontal model itself from derivatives traders. From July, ICE will migrate its post-trade business in-house and pull out of LCH.Clearnet altogether. NYSE Euronext, meanwhile, has persuaded LCH.Clearnet to operate a separate clearing arrangement for Liffe, with what LSE chief executive Clara Furse (pictured) has described as "the characteristics of a silo," to protect Liffe from competition. You cannot blame LCH.Clearnet from falling into line. Its existence is threatened if it does not.

The worry now is that the equities markets may also start moving toward more use of vertical silo systems. This matters to the LSE, which has no derivatives trading business in the U.K., although it has established derivatives platforms for Russia and the Nordic countries and acquired one in Italy when it bought Milan's Borsa Italiana SpA last year. The venerable London exchange would clearly be at a massive disadvantage if a hostile competitor dominating LCH.Clearnet were to lock it out of its traditional clearing facilities.

Don't write off the London Stock Exchange or its redoubtable CEO just yet. Furse is a tenacious corporate guerrilla, who saw off a hostile takeover attempt by Nasdaq last year (and must now tread carefully again, since New York's second exchange could stage another bid). Countering claims the LSE is losing market share, her team points out that the arrival of Chi-X has, in fact, increased the market for all.

As for the clearing problem, so far it has not hit equities. A European Union voluntary code of conduct on exchanges is strongly supportive of the horizontal model. The LSE has so far backed the EU position loudly and clearly and opposes the vertical model.

But some observers are skeptical. With the acquisition of Borsa Italiana, the LSE for the first time also acquired a clearing subsidiary, which could serve as the basis for a Europewide business. Furse has launched a review of London's post-trading options and has decided the time has come for a debate. One way to protect the LSE's profits might be to set up a vertical silo of its own. No timetable has been set for a decision, but while it hesitates, the LSE's own share price is sinking. The exchange's staunch support of the horizontal model may have to ease when the future of the London Stock Exchange itself is in doubt.