The London Stock Exchange is in talks to buy clearing house LCH.Clearnet, a deal seen as critical for LSE chief executive Xavier Rolet after his failed attempt to take control of Canadian exchange operator TMX.
Media reports have put LSE's bid for the majority of LCH.Clearnet, Europe's largest independent clearing house, at about €1 billion (Dh5.25 billion), although sources stress the difficulty of valuing a not-for-profit company that is owned by its banker and broker customers.
A takeover of LCH, and its key swaps unit SwapClear, could help the London exchange take advantage of new rules intended to overhaul the $600 trillion (Dh2.20 quadrillion) over-the-counter (OTC) markets following the global financial crisis.
Regulators want to run many more OTC products that previously changed hands privately, such as derivatives, through clearing houses to stabilise the financial system.
"Ownership of SwapClear, the crown jewels of LCH, could dramatically improve LSE's position to benefit from OTC derivatives reform," Daniel Garrod, an analyst at Barclays Capital said yesterday.
LSE differs from most of its rivals in not owning the clearing house for its main market, a fact that has become apparent as trading revenues have fallen across the board while earnings from clearing have held up for the LSE's rivals.
Clearing houses, which sit between trading partners, holding cash to be used to refund firms left out of pocket by a counter-party default, won support from regulators for their performance after the collapse of Lehman Brothers in 2008.
Pressure on CEO
LSE's customers and backers were tolerant when Rolet failed to win TMX shareholder support for his planned $3.2 billion merger in June, his first attempt at a major deal.
But the pressure is on him as he makes his second play. When Rolet joined the exchange as CEO in 2009, he indicated that deals were on the cards because he wanted to diversify the group's sources of revenue.
"I suspect Rolet wants to do a deal and this is only one of the potential transactions he is looking at," said James Hamilton, an analyst at Numis.
Rolet faces competition from rival bidders and an uphill battle with LCH's disparate owners if he is to secure a deal and put TMX behind him.
The LSE said yesterday talks with LCH about a possible transaction were at an early stage. A source close to the exchange said the talks had been going on for several weeks. This marks a dramatic u-turn by the exchange after it said in late in May that it was not talking to LCH after the clearer confirmed it had received "various proposals" about a sale.
Nasdaq OMX OTC derivatives specialist Markit, working in partnership with NYSE Euronext, later said they were interested in LCH.
"Markit have good progress in their bid. LSE wants part of the action but doesn't want to be in a bigger group with NYSE and Markit," said the head of trading at a large investment bank in London, which is one of the LSE and LCH's largest clients.
LCH.Clearnet had revenues last year of €553.6 million, the firm said in its annual report.
LSE will likely face scrutiny from its own shareholders of the price it is prepared to pay for the clearing house.
"Given the global exchange market is forming into a handful of large players, it is likely that Rolet wants to do something but it is important to remember the prime drive for any deal is value creation for shareholders," Hamilton said.
The European Commission's controversial Mifid II plan will force OTC dealers to use exchange-type trading platforms and clearing houses, as early as next year, opening up a lucrative new market for exchange groups.
With SwapClear — the main clearing house for interest rate swaps, one of the largest OTC markets — LCH has a crucial headstart over the competition.
Vast shareholder base
The LSE will also have to win over LCH's vast and varied shareholder base. LCH has 98 owners, made up of two large exchange shareholders, NYSE Euronext (9 per cent) and the London Metal Exchange (8 per cent), with the remainder held by a wide range of banks and brokers.
US clearing house the Depository Trust and Clearing Corporation and a bank consortium led by Icap both tried and failed to buy LCH in 2009 citing problems with the diverse board and ownership structure.
JP Morgan is advising LCH, three people familiar with the situation said. Morgan Stanley is advising the LSE.