Photographer: Martin Leissl/Bloomberg

Don't Say Europe's Biggest Exchange Takeover Is Too Big to Fail

  • Deutsche Boerse and LSE will keep clearinghouses separate
  • Clearinghouses for CME and ICE are systemically important

Deutsche Boerse AG and London Stock Exchange Group Plc want to create a European trading champion. They just don’t want regulators to think it’s too big to fail.

The companies took pains in their announcement on Wednesday to emphasize that the combined firm, holding some $170 billion in collateral from their customers, would help reduce risk in the multi-trillion dollar derivatives market. They also stressed the union wouldn’t hurt competition or potentially destabilize the wider financial system.

They said the resulting company, which would be the world’s biggest exchange operator by revenue, would continue to operate multiple clearinghouses rather than consolidating risk in a single entity house. Regulatory oversight, data centers and management would also remain separate.

“Too big to fail is something people should be thinking about,” said Arjun Bowry, a Bloomberg Intelligence analyst. “It’s an issue that should be discussed, especially with regulatory mandates requiring more trades to be cleared.”

By retaining separate clearinghouses and granting other exchanges access to them, LSE and Deutsche Boerse hope to avoid any claims that they are creating a monopoly in a vital part of financial-market infrastructure. New rules obliging traders to clear most European interest-rate swaps come into force in June.

‘Reasonable Arguments’

“We do have reasonable arguments for this to be actually enhancing and increasing competition on a global scale,” Carsten Kengeter, Deutsche Boerse’s chief executive officer, said in a Bloomberg Television interview on Wednesday. Kengeter will hold the same position in the combined company.

LSE’s LCH.Clearnet Group Ltd. operates the world’s largest clearinghouse for interest-rate swaps, while Deutsche Boerse’s Eurex operates one of the biggest for futures. After the 2008 financial crisis, clearinghouses grew rapidly as regulators around the world turned to them to guarantee trades in large parts of the $553 trillion global swaps market.

The facilities hold collateral from their members that can be used to honor transactions if a trader goes bankrupt. Although they reduce the damage caused by a default, clearinghouses impose a cost on traders. The Anglo-German tie-up hopes to ease the costs on its customers even though it will keep the two clearinghouses as separate entities. 

Offsetting Swaps

LCH.Clearnet and Eurex held 150 billion euros ($169.5 billion) of collateral on behalf of their members as of Dec. 31, according to the merger statement. The London-based clearer is developing a system that allows traders to offset their swap positions at LCH.Clearnet with their futures holdings at Eurex. The project, which works even though the two clearinghouses are separate, should enable customers to reduce the total amount of collateral they must set aside.

“We can cross margin our over-the-counter clearing with their listed derivatives without merging the clearinghouses, and without comingling the risk-management framework,” LSE Group CEO Xavier Rolet said in a Bloomberg Television interview on Wednesday. Rolet will step aside if the companies complete their merger.

Systemically Important

In the U.S., some clearinghouses, including those owned by CME Group Inc. and Intercontinental Exchange Inc., both of which are considering bids for the LSE, were already designated as systemically important by regulators. They are subject to heightened supervision as a result.

“Globally, there is a focus on ensuring comprehensive and strong supervision of these platforms,” Federal Reserve Chair Janet Yellen said in February. “Creating those
central clearing platforms has importantly diminished risk in the financial system. But they are a source of risk.”

In the U.K., the Bank of England, which oversees LCH, said this month that it would oversee clearinghouses’ governance, stress testing, ability to handle defaults and their resilience against cyber attacks. The bank also said it will review the business model of clearing to ensure that public companies allocate sufficient resources to identify and reduce market risks.

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