A fight for LIFFE?

Much of the debate surrounding the current competing bids for NYSE Euronext from Deutsche Börse and Nasdaq/ICE has concentrated on the equities business. But from the point of view of London, what really matters is the future of LIFFE, its prime derivatives market and, it could be argued, one of the jewels in London’s crown.

If the DB bid for the NYSE goes ahead the European regulators will undoubtedly be concerned by the competition implications for the merger of two currently competing exchanges, viz. LIFFE and Eurex. This concern will almost certainly give rise to a protracted examination of the merger by the European competition authorities. It is possible that they will eventually give clearance to the merger. If this happens then, in my view, it could be extremely damaging to London as I would expect the DB (as the dominant partner in the NYSE merger with 60% of the equity) to concentrate all derivatives trading in Eurex rather than LIFFE. The DB will of course at the outset deny that this will happen, but eventually it will – look at what happened to the EOE in Amsterdam.

It is also possible that as a price for the DB/NYSE merger going ahead the European competition authorities might argue that LIFFE should be hived off and sold as a separate entity. If this were to happen, then it would seriously upset the chances of the DB/NYSE merger going ahead. But if it does go ahead without LIFFE then the obvious outcome would be for the LSE to purchase LIFFE. This would be a huge help to the LSE as the lack of a serious derivatives business is one of its main drawbacks.

However, on the face of it, the DB/NYSE merger looks at the very least a serious threat to the long term viability of LIFFE. In the best possible case – a LIFFE/LSE merger – this would benefit London significantly. But I do not regard this as a likely outcome. There is history between these two exchanges. The LSE tried and failed to buy LIFFE in 2002, and there is little love lost between the two organisations.

A secondary concern would be the future of the clearing business. DB has an integrated trading/clearing operation, Eurex Clearing AG. This operates as a CCP (central counterparty) for all equities traded on the DB’s exchange and also clears trades on the Eurex Derivatives market as well as Eurex Bonds and Repos. It is in direct competition with the LCH. At the moment the LCH clears business for the LME, and some of LIFFE’s business (although LIFFE is migrating business away to their own integrated clearing operations, and the LME has suggested that it might do the same). ICE Futures used to use LCH but now does all its own clearing.

LCH also has a substantial Swaps and Repo operation. It is likely that as a result of the desire of regulators to bring OTC derivatives business (in particular Credit Default Swaps) into clearing houses (and possibly onto exchanges) that this part of LCH business will grow. However, at the moment, the LCH’s existence has been made a little fragile by the defection of LIFFE and ICE Futures, and possibly the LME, and by the announcement that the LSE intends giving its customers the option to use clearing houses other than the LCH. LCH’s current CEO is stepping down in July 2011.

A successful bid by DB for the NYSE, with DB taking over LIFFE would strengthen considerably the power of DB to control the clearing business in Europe, to the detriment of the LCH.

 

On the other hand if the Nasdaq/ICE bid for the NYSE succeeds then the intention would be that the equities business would be divorced from the derivatives business. Nasdaq OMX would end up owning NYSE Euronext and ICE would end up owning LIFFE. I understand that it is not the intention that Nasdaq OMX and ICE should merge – they would remain independent entities.

On the face of it, this would be a better outcome for LIFFE. It would continue to compete with Eurex, and the European competition authorities would be unlikely to challenge the deal. Furthermore it would deprive DB of the ability to grow its clearing business in competition with LCH. As the former CEO of an exchange subsequently purchased by ICE (the International Petroleum Exchange) I am of the opinion that LIFFE’s derivatives business would be far better looked after by ICE than by DB. ICE’s founder, Jeff Sprecher, has been a phenomenally successful entrepreneur who set up ICE as recently as 2000, and who has succeeded in turning it into a major exchange operator in a very short space of time.

But if the Nasdaq/ICE bid won, what would be the outcome? DB would be pretty unhappy that their ambition had been thwarted. They would be looking around for another target, given that they, like other major exchanges, are suffering from the competitive pressures from BATS and Chi-X. The most likely alternative target for DB would be the LSE. DB has twice tried and failed to merge with the LSE. This might be third time lucky. A DB/LSE merger could actually work to the benefit of London (depending of course on the ability to create a single listing platform and its location). Watch this space.

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