A panel of experts at the Futures Industry Association’s annual conference in Boca Raton, Fla. concluded in March that clearing is where the action will be this year, and that is certainly true in Europe where after two decades of a slow drift towards centralized, consolidated clearing and settlement of futures and equities, a dramatic shift toward proliferation, competition, and vertical integration has taken place.
NYSE Euronext is launching a new clearinghouse for its Liffe futures subsidiary and other futures exchanges are talking of doing the same. Meanwhile, on the equities front – and in line with the European Union Commission’s call for centralized clearing – a start-up called EuroCCP says it wants to become the counterparty for equities trades across the continent, just as the Depository Trust & Clearing Corporation (DTCC) does in the United States.
And no wonder — London-based EuroCCP is a subsidiary of the DTCC, and was set up specifically to clear trades from pan-European multilateral trading facility Project Turquoise. Both DTCC and Turquoise are consortium owned by the major banks that use the services.
LiffeClear, on the other hand, will provide clearing for derivatives traded on Euronext.Liffe, but will outsource the actual guaranteeing and banking arrangements to LCH.Clearnet, through which Euronext.Liffe currently clears its business.
So, why bother making the change? The answer, in part, is control — for the way things stand now, it’s not really clear in Europe who controls the liquidity an exchange runs through a clearinghouse. This means customers could decide to leave their liquidity with the clearinghouse should an exchange switch to another clearinghouse, as ICE is doing as it switches from LCH.Clearnet to ICEClear.
That scenario led to a pre-emptive tug-of-war over ICE’s liquidity on LCH.Clearnet last year, delaying the European Climate Exchange’s (ECX) Certified Emission Reduction (CER) futures last year. If Euronext.Liffe owns its own clearinghouse, such disputes wouldn’t happen, even if the guaranteeing and banking functions are outsourced to LCH.Clearnet.
And the idea is catching. ECX’s parent company, Climate Exchange PLC, could form its own clearing house for energy and emissions products – and it isn’t even a real exchange yet, dependent as it is on ICE’s platform.
LCH.Clearnet doesn’t appear to be entering the Euronext.Liffe deal willingly, and it’s possible LiffeClear wouldn’t have been proposed if LCH.Clearnet weren’t in talks with Project Rainbow. Now speculation abounds in London over how Rainbow will respond to LiffeClear’s outsourcing deal — after all, without the ability to outsource, Euronext.Liffe would need a year at least to set up its own clearinghouse. Rainbow has a first-rate legal team, and you can bet they will find some grounds to challenge the LiffeClear arrangement with regulators, who have long had their sights on vertical clearinghouses, albeit mostly in the equities sector.
Deutsche Börse so far has taken the brunt of that regulatory pressure, with a vertically integrated clearing and settlement apparatus that can margin equities against derivatives in two separate clearinghouses under the same ownership. As a result of vertical structures in equities, cross-border clearing of equities transactions remains much more expensive than in the
United States.
The European Commission is set to release new guidelines for breaking down these barriers at the beginning of 2009. The Commission has a long-standing threat to mandate consolidation unless clearinghouses can either merge on their own or blend into some sort of interoperability model to enable cross-border trades, but so far the only link of that sort in the works is a link between Switzerland’s SIS x-clear and LCH.Clearnet.
ICE, for its part, says it formed ICEClear because current clearinghouses just aren’t up to the task of clearing their over-the-counter (OTC) and exchange-traded products — raising the other cherry on the clearing sundae: OTC business.
