The American CSD, the Depository Trust & Clearing Corporation (DTCC) announced today that it had merged with the London-based CCP LCH.Clearnet. The two organizations announced jointly this morning that they had signed non-binding heads of terms regarding the proposed merger of the two companies.
DTCC and LCH.Clearnet said in a joint statement that the merger “aims to create the world’s leading clearing house.” The merged entities will operate on a user-owned, user-governed basis, with LCH.Clearnet moving to an at-cost based structure comparable to DTCC’s within three years. A user-owned, user-governed clearance and settlement infrastructure will return excess revenue to users in the form of rebates, discounts or tariff reductions, once costs are covered.
As a result of the transaction, LCH.Clearnet shareholders will receive total consideration of up to 739 million (10 a share), the majority of which would be funded through LCH.Clearnet’s revenue.
“The critical role and value of clearing houses has been highlighted by recent events,” says Chris Tupker, Chairman of LCH.Clearnet. “The merger of our companies will enable our users to benefit from a broader geographic footprint and a greater range of expertise as well as realising important efficiencies and economies of scale. For our shareholders, the merger would offer the opportunity of receiving a substantial consideration. Furthermore, it would enable both the European and U.S. financial communities to benefit from the services of a user-owned, user-governed, at-cost model across a broader range of markets and asset classes.”
The deal brings to an end an unhappy period for LCH.Clearnet, which struggled to fulfill the promises laid out at the time of the merger between London Clearing House and the French CCP Clearnet in 2003. A failed attempt to create a single technology platform led eventually to the resignation in July 2006 of LCH.Clearnet CEO David Hardy, and a write of 13.9 million.
DTCC already own a CCP in London EuroCCP, which secured the contract to provide clearing services to Turquoise, the European equity trading platform owned by the major investment banks. DTCC says that, once commercial, legal, tax and regulatory issues are resolved, it will join with the new LCH.Clearnet HoldCo to form a single European clearing business.
Euroclear, currently the largest shareholder in LCH.Clearnet with a holding of 15.8%, says it supports the transaction in principle. The Brussels-based ICSD will remain a shareholder in LCH.Clearnet HoldCo.
DTCC says the merger will result in “significant synergies and efficiency gains,” mainly in technology savings, as well as “significantly enhanced economies of scale” plus operational savings and increased efficiencies in collateral management. DTCC says “initial indications” suggest that synergies amount to approximately 7 – 8% of the combined group’s operating costs.
The American CSD adds that both the U.S. and Europe will be supported by a common infrastructure for the first time, offering the prospect of reductions in the costs of LCH.Clearnet’s and DTCC’s services for equities in both Europe and America.
Another goal will be transatlantic access to default funds and potentially increased cross-margining, which will increase the efficiency of users’ capital contributions participants.
Marco Strimer, CEO of Swiss CCP SIX x-clear, which encountered some initial problems earlier this year in reaching an inter-operability agreement with LCH.Clearnet after the London Stock Exchange appointed it as an alternative CCOP, has nevertheless welcomed the deal. “As we have seen with Lehman Brothers, risk management is the most important function of a CCP and has proven critical at time of default,” he says. “Given the rapidly changing market environment real-time calculation of risk exposures is the best form of risk management and we strongly believe it should be standard across the industry. The merger highlights some interesting points regarding the structure of the clearing and settlement landscape in Europe. Demand for growth in new markets at SIX x-clear is very much driven by client demand. We continue to focus on our European operations and are committed to best practice and reducing tariffs in the trading and exchange markets, fully supporting interoperability and the European Code of Conduct on Clearing and Settlement. The clearing landscape is rapidly evolving and it’s important to focus on innovation and client service. SIX x-clear is fully focused on targeting the markets that clients want us to and delivering efficiencies in terms of tariff, technology and risk management. The winners in the provision of risk management services in the cash equities markets are the customers, the exchanges and the markets more broadly, who effectively manage their counterparty list.”
The range of markets and services covered by the new DTCC-LCH.Clearnet entity will include equities, fixed income instruments, exchange-traded derivatives and commodities, mutual funds, annuities and OTC products such as interest rate swaps, credit default swaps, carbon emissions and freight contracts.
The joint client base includes several thousand broker/dealers, banks, institutional investors, hedge funds, trust companies, mutual funds and insurance carriers and other third parties who market financial products.
“By combining DTCC and LCH.Clearnet’s natural synergies and complementary skills, we expect our customers will not only see significant cost savings in the clearance and settlement of the many securities and instruments we already service, but also greater access to a more diverse range of product offerings and support of emerging asset classes,” says Donald F. Donahue, Chairman and Chief Executive Officer of DTCC. “A good example is the potential to leverage the expertise between Swapclear’s support of interest rate derivatives and Deriv/SERV’s capabilities in credit default swaps. We are also very excited to gain the expertise and shared commitment to serving customers that is so evident among LCH.Clearnet employees. DTCC has grown over the past decade through the combination of multiple clearing corporations and depositories. Our success, as an organization, is tied to our ability to work, collaborate and partner with others in the industry, never losing sight of our larger goal to reduce risk and costs for our users.”
By the terms of the merger, DTCC will acquire 100% of the ordinary shares in LCH.Clearnet. The transaction will result in LCH.Clearnet shareholders receiving total consideration of up to 10 a share. The consideration will consist of DTCC voting shares; shares in the vehicle acquiring LCH.Clearnet, which carry rights to receive LCH.Clearnet future profits available for distribution for up to three years; and a pre-closing special dividend from LCH.Clearnet. On the basis of 10 a share, the approximate implied equity value of LCH.Clearnet would be 739m.
Assuming no changes in share count, the total number of new DTCC voting shares issued to LCH.Clearnet shareholders will be 12,186, representing 34% of DTCC’s enlarged share capital.
The combined group will follow DTCC’s existing practice of regular mandatory rebalancing of its shareholder base to ensure that share ownership is in line with usage. Consequently, within 12 to 18 months of the completion of the merger, it is intended that there will be a rebalancing among the former LCH.Clearnet shareholders to bring ownership fully into line with usage.
Former LCH.Clearnet shareholders will have substantial representation on the board of LCH.Clearnet HoldCo, and Roger Liddell will be the CEO of the new LCH.Clearnet HoldCo and Donald F. Donahue will be the chairman. LCH.Clearnet will also benefit from having significant representation on the board of DTCC, including management representation.
With effect from the completion of the merger, all of the newly combined group’s European business will be brought under common management.
Euroclear, which is LCH.Clearnet’s largest shareholder with a holding of 15.8%, has agreed to support the merger in principle, subject to final terms and conditions. Immediately after the completion of the proposed transaction, it is expected that Euroclear will acquire a similar proportion of shares in the new LCH.Clearnet HoldCo. This investment will help cement a strong partnership between the two organisations, allowing Euroclear and LCH.Clearnet to maximise service advantages and efficiency opportunities for users.
LCH.Clearnet and DTCC shall continue negotiating on the basis of the non-binding heads of terms. LCH.Clearnet and DTCC anticipate being in a position to sign definitive documentation and announce the detailed terms of the transaction by 15 March 2009. The signing of binding transaction documentation is subject to a number of conditions including; consultation with the Works Council in the French subsidiary of LCH.Clearnet, the approval of shareholders, including receipt of binding commitments to support the transaction from certain LCH.Clearnet shareholders, the approval of relevant regulators and certain tax authorities and the completion of satisfactory mutual due diligence.