The end game for trading costs
With integrated exchange groups pulling in the opposite direction from independent CCPs and trading venues, will the deadlock prevent lower trading costs?
If German exchange Deutsche Börse and transatlantic venue operator NYSE Euronext get regulatory approval to merge, they will form the largest exchange in Europe, extending the exchange/clearing/settlement silo model that Deutsche Börse currently operates. The German exchange operates Eurex Clearing, a joint venture with SIX Swiss Exchange, and owns Clearstream, the central securities depository.
That will make the integrated model dominant and leave rival firms to consider the cost advantages of operating their own clearing houses. The London Stock Exchange (LSE), which mainly clears through CCP LCH.Clearnet, is said to be considering this option already.
In the longer term the siloed model could still be legislated against by MEPs who, in deciding the final version of the European markets infrastructure regulation (EMIR), may force clearing houses to interoperate.
However in the short term the merger of Deutsche Börse/NYSE Euronext would be influential. It is driven by cost reduction and rivals like the LSE would have to cut costs in order to compete against a business of such scale.
Is there a way out of this potential stalemate?
Well it's worth considering that the US, which is seen as both reliable and more cost effective the Europe for post-trade processing, has a single organisation, the Depositary Trust and Clearing Corporation (DTCC), responsible for clearing and settlement. Post-trade processing fees are said to be 10% of those in Europe. The US had to go through 30 years of rationalisation of CCPs, to get to this point.
The DTCC was formed from a merger of the National Securities Clearing Corporation (NSCC) and the Depository Trust Company (DTC) in 1999, which in turn had been formed to deal with the paperwork crisis that came to a head in the 1970s, as the post-trade processing of securities transactions began to become unmanageable.
The two back-office service providers were initially created to process trades executed on the New York Stock Exchange (NYSE) and the American Stock Exchange (now NYSE Amex Equities).
Between 1977 and 1995 five regional exchanges stopped providing post-trade services, leaving customers to migrate to the NSCC and DTC. That left the firms in a dominant position, which their merger consolidated to a monopoly, based on scale of business.
Could a similar process happen across the Atlantic?
The structure of the market is different quite different but that doesn't rule outa similar pattern of consolidation
Firstly, settlement costs are already going to be lowered by the Target 2 Securities project, run by the European Central Bank (ECB), to build a single utility for cross-border settlement. By providing a harmonised system the ECB plans to remove much of the complexity and cost with associated with settling trades in Europe. This is expected to go live in 2014.
There is political pressure to lower clearing costs. As the integrated exchange/clearing model doesn't allow competitive pressure on clearing fees, MiFID would appear to run counter to the silo model in the long term. But the current deadlock in the European Parliament the matter will not be resolved outright.
In the medium term, CCPs may have to consolidate. LCH.Clearnet saw revenues fall from €907.3 million in 2009 to €553.6 million in 2010. Pan-European CCPs EMCF and EuroCCP, a subsidiary of the DTCC, are said to be considering a merger.
If CCPs were to merge it may well create a similar position to the US. But it will take time and pressure from the market.
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