Just a few years ago there appeared to be a process of consolidation in the European clearing business that would eventually produce a single central clearing entity. Something along the lines of the DTCC in the USA or at the very least the result would have left fewer clearers in the market and with the possibility of interoperability between them. A code of conduct was created between clearing houses and recently tested with a hot debate between LCH.Clearnet and SIX x-clear. The code of conduct held fast and co-operation between the clearing houses appears to be on a sound course bringing a type of consolidation without losing the entities involved.

However, the environment for clearers has been drastically altered by the news that the DTCC is buying LCH.Clearnet and merging their business. Although the details have yet to be published and the deal not finalised, with March 2009 muted as the conclusive date, the fact that this deal is so advanced is testament to the desire for consolidation in this sector.

SIX x-clear, the Central Counterparty (CCP) and licensed Swiss bank, has an aggressive development plan and is leading the revolution for Clearers in Europe and the DTCC purchase of LCH.Clearnet is a vindication of their own structure model.    

Marco Strimer is CEO of SIX x-clear, and comments “As a proponent of the user-owned, user-governed model we welcome LCH.Clearnet's shift to the at-cost based structure which we have operated since our inception.  As we have seen with Lehman Brothers, risk management is the most important function of a CCP and has proven critical at time of default.  Given the rapidly changing market environment real-time calculation of risk exposures is the best form of risk management and we strongly believe it should be standard across the industry."

MiFID is altering the landscape for order and executions putting great pressure on traditional stock exchanges to retain their business and also bringing into question the structure of clearing and settlement operations within the financial services firm.

For many financial services firms, the back office systems are a product of many years of legacy developments, which has maintained the ability of systems to support the front office. New business usually entails some form of systems development if not the purchase of a bespoke system especially for the business. The results have been an evolutionary hotchpotch of architecture strung together by middleware with any gaps in the system plugged by spreadsheets. Thus when changes to the market infrastructure happen, there is enormous pressure put on technology to continue to support the business. 

Although consolidation within the Stock Exchanges has stopped for the moment there is the emergence of numerous MTFs (Multi Lateral Trading Facilities) that bring new challenges in the order and execution space and also in clearing and settlement.

For the financial services firm, the securities markets in Europe are undergoing a change process with increased chances of creating a real cost effective industry wide STP solution for cross-border clearing and settlement. The consolidation of Clearers is a big step towards creating a central Clearer or if that is not possible at least a close collaborative network of Clearers.

Why is central clearing important? The question has many answers and all are vitally important to Europe as a combative single financial market. The most obvious benefit of a central clearer is the ability to cross margin across different assets allowing a significant reduction in costs but the ability of netting all assets and accounts for financial services cannot be under valued. The financial services firms are going to be confronted with a series of vertical order/execution MTFs, all with their clearer of choice, to be integrated within their legacy clearing structures. It will take some time for the financial services firm to rationalise the best clearing arrangement for their business. 

In the current financial crises we have a perfect opportunity to analysis the benefits of the central counterparty and effective margining, using quality assets. The Lehman Brothers demise would have been far more painful for everyone if LCH.Clearnet had not been a huge factor in the Lehman operation. Within a very short time of the Lehman announcement LCH.Clearnet had come to terms with the situation and been able to reassure the market that the majority of the Lehman business was margined and the majority of settlements in process could continue. It has been estimated that as much as 90% of the Lehman business was with the DTCC and LCH.Clearnet with the remaining business external with OTC products making up the bulk. There is no better illustration of the benefits of a central clearer.

With an agreed deal between the DTCC and LCH.Clearnet the market has increased the security of financial services firms and their clients. This deal brings the USA and Europe much closer together in a business operational sense. How does this impact SIX x-clear, as they have been extremely successful to date and could this merger threaten their plans.

Marco Strimer of SIX x-clear comments “The merger highlights some interesting points regarding the structure of the clearing and settlement landscape in Europe.  Demand for growth in new markets at SIX x-clear is very much driven by client demand.  We continue to focus on our European operations and are committed to best practice and reducing tariffs in the trading and exchange markets, fully supporting interoperability and the European Code of Conduct on Clearing and Settlement”.

How better would the market be if all business was cleared through a single agent giving the market real confidence in their counterparty in times of seismic industry earthquakes?  However, this is highly unlikely to happen in any reasonable time frame and it's very doubtful it ever will. A code of conduct between clearers in the European markets and also beyond into wider markets appears to be a more realistic target.

The DTCC has provided the USA market with a low cost clearing business for decades through its supreme ability to net assets across the industry. Multi-asset netting has reduced the clearing costs to fractions of a penny, whilst the more fragmented clearing situation in Europe maintains a clearing cost, many times the US value. Unless Europe creates a similar set up to that of the DTCC, by close integration and harmonisation of communication standards, by the many clearers in Europe, we cannot begin to believe that there is any chance of achieving the benefits enjoyed in the USA. Without European clearers committing to the code of conduct and actively pushing forward to create an integrated clearing network, Europe will struggle to achieve its political objectives of a single market, let alone on a global scale.

So MiFID although created to accelerate the single capital market has instead caused a more fragmented market stalling the natural consolidation that was beginning to happen in the late 1990s and early 2000.  With new trading venues and a far more complex dealing materialising, the clearing and settlement infrastructure has now also become far more complicated. This illogical conclusion has been caused by the laudable attempt within MiFID to use competition in the markets to drive change and bring down costs, whilst increasing investor services.

When reading through the MiFID articles, the only thing that is clear, is the intent to write the directive in as flexible way as possible, allowing each EU States market to transpose into domestic law. The articles are open to interpretation by all and with a deliberate attempt to give the market and its participants as much rope as possible. Unfortunately so much rope is in danger of hanging many firms and strangling the industry, stopping it from evolving naturally to deal with global industry problems.

Across the EU, each market has to deal with a historic level of change forced by legislation, in a time when global financial markets are in turmoil, if not meltdown. Perhaps, its time to look again at the political objective and be more prescriptive in the changes and the time is right to squeeze out latitude and provide more direction to financial services firms.

A new order is being created in Europe at the worst time possible and more thought needs to be given by financial services firms to their business structures. For this reason the emergence of the SIX Group is a viable alternative to the confused picture in the market today. Based in Switzerland the SIX Group is a collaboration of SWX Group, SIS Group and Telekurs Group, who are very serious players, able to create a global service, making best use of technology to provide the market solution many firms are looking for. The fact that they are Swiss and outside of the EU can only be of huge benefit, as the EU struggles to bring about an orderly change to achieve its political objectives.

SIX x-clear have recently agreed with the London Stock Exchange (LSE) that under the clearing code of conduct, choice with be given to firms on which Clearer they wish to chose, LCH.Clearnet or SIX x-clear. With interoperability between SIX x-clear and LCH.Clearnet in operation, the firm can move towards cross asset servicing.

Marco Strimer comments “The clearing landscape is rapidly evolving and it's important to focus on innovation and client service.  SIX x-clear is fully focused on targeting the markets that clients want us to and delivering efficiencies in terms of tariff, technology and risk management.  The winners in the provision of risk management services in the cash equities markets are the customers, the exchanges and the markets more broadly, who effectively manage their counterparty risk.

 So it appears out of the confusion that SIX x-clear is able to present to financial services, an extremely logical solution to the cross border clearing question and offer immediate future proofing as the firms begin their rationalisation of clearing.

In summary, although it’s early days in the reconstruction of the European Capital Market and it’s very unlikely that there will be any evolution to create a genuine central clearing model in Europe, the code of conduct between Clearers is a beacon of hope. The DTCC and LCH Clearnet deal if successful will be a welcome addition to the changes required in the European and Global clearing structure. Although there is no single Clearer likely to emerge, there is a choice of services, technology, structure and location for financial services firms. SIX x-clear have moved the clearing business forward in Europe and it will be interesting to see if the merged DTCC and LCH Clearnet can measure up.       

SIX x-clear has the security of the Swiss borders to provide a safe haven for firms to ride out the crisis afflicting the markets today and this should not be undervalued. Clearly this is and will continue to be attractive to many firms, as there are already over 140 live, with SIX x-clear.

It will be interesting in the future to see how SIX x-clear might be a catalyst for change within Europe and how they can use their horizontal approach for order, execution, clearing and settlement to solve the difficult problems facing financial markets today. At least SIX x-clear can prove that central does mean central, in clearing, even though orders and execution will be fragmented for sometime to come.   

By Gary Wright, MSI