EuroMTS is close to choosing between London Clearing House (LCH) and Clearnet as its Central Counter-Party (CCP) service provider, and a decision is expected by Christmas. The Italian-born fixed income trading platform has learnt the lesson of the repo market, where BrokerTec has emerged as the dominant trading platform almost entirely because it hired LCH subsidiary RepoClear as a CCP provider. Eurex, RepoClear and Clearnet have all made presentations to Euro MTS. The Swiss-Germans were eliminated, and Euro MTS is now choosing between the British and French alternatives. On the face of it, RepoClear ought to be the clear front-runner. Although it currently covers only the Belgian, Dutch and German government bond markets, LCH says that on the busiest days in the market RepoClear can net Euros 400 billion of gross trades down to Euros 100 billion a day. This compares with Euros 1 billion a day of netted trades at Clearnet and a mere Euros 500 million at Eurex Clearing. LCH adds that the 38 members using RepoClear already have a 95 per cent share of the cleared repo market in Europe – thought to be somewhere between 30 and 40 per cent of the total repo market – and that it expects their number to rise shortly to 50 in number. Importantly, the new users include Continental banks active in the repo markets such as HVB.
“The choice of CCP for Euro MTS ought to be a no-brainer,” says Arun Aggarwal, managing director, business management, at LCH. “By putting cash clearing into the same pool as the repo market, market participants will get the maximum benefit in terms of netting, and the lowest costs and minimal risks, because the underlying bonds are the same and all the major European players on Euro MTS are already members. In today’s economic climate we offer the most cost-effective solution, and the one which adds most shareholder value for Euro MTS. But of course it does not quite work like that.” Indeed, it does not. Understandably, Euro MTS believes that it will be delivering the transaction flows for netting and clearing, and that it should therefore be richly compensated by its chosen CCP provider in the shape of a revenue share or sizeable equity stake. LCH is doubtless countering that transaction volumes belong to the members of the market, rather than the trading platform – and that they should decide where to clear (and settle) as well as where to trade. Others at Euro MTS are fearful that giving participants the right to choose where to clear could let to a loss of business to other platforms. The situation is further complicated by a revival of interest in a merger between LCH and Clearnet in the wake of the Euronext acquisition of LIFFE, which is tempting some senior figures at Euro MTS to argue for a postponement of a decision between the two as likely to become irrelevant.
This being Europe, national political interests are also playing a role not only in the selection process, but seem to govern the pace of CCP consolidation in general. RepoClear says it could extend its service to the important Italian government bond market – where the Cassa di Compensazione Garanzia, the CCP which serves the Italian domestic derivative and cash markets, does not cover the repo market – almost immediately, but cannot get approval from the Italian regulatory authorities. “We are in the process, but we have been in that process for a year,” sighs Aggarwal. Could this be linked to the fact that Italy is the birthplace of MTS? LCH is too polite to say so, but clearly there is a fear in Italy that competition will lead to a loss of control. RepoClear has bitter experience of European politico-legal constraints: it took another year to clear a legal barrier to netting repo transactions in Belgium. So rather than waste energy on Italian politics as well, RepoClear has opted to concentrate instead on the UK gilts market, where it expects to introduce a clearing and netting service in the second quarter of 2002. It hopes this will encourage more members to join, further increasing its clout in the European marketplace.
This is a triumph of hope over experience: in Europe political considerations often account for more than commercial realities. The ownership and governance of the EuroMTS CCP are already the most important factors in the battle between LCH and Claernet. Because Euro MTS is effectively run by boards of local potentates in each market which it serves, its structure effectively institutionalises the interests of national banks, broker-dealers, finance ministries and central banks who would regard foreign ownership of the Euro MTS CCP as synonymous with loss of control of the government debt markets. Whether this disadvantages LCH more than Clearnet is a moot point. Clearnet remains primarily French, which may increase its appeal to certain Euro MTS board members. LCH has a dominant position in repo clearing but, although BrokerTec (and e-Speed, to which LCH also provides a service) funnel a trickle of cash market business to LCH, the London-based CCP will have a limited impact in the cash market unless and until it wins Euro MTS as a client.
Another problem facing LCH – familiar to anyone who has had business dealings with an investment bank – is that a service admired by the repo desk may not even be known to the cash market desk(s). “We may be dealing with the repo desk of a bank in London, but it does not mean we deal with the repo desk of the same bank in Frankfurt or Paris,” admits Aggarwal. “Setting aside the fact that there are different government bond markets working within different regulatory regimes throughout Europe, there are different desks in different locations even within the same bank.” In other words, to win the right to provide CCP services to the European government bond markets, LCH must sell itself to new audiences even within firms who already use its services in the repo market.