Risk 25 firms of the future: Newedge

Nicolas Breteau, Newedge

It's not easy for participants in today’s markets to predict the future – but, for Newedge, there is an added complication. The firm is jointly owned by Société Générale and the investment banking arm of Crédit Agricole, and there has been speculation for more than a year that the French banks could sell.

Newedge chief executive Nicolas Breteau admits they could, but says that is true for shareholders in any business and insists the company is not being auctioned off. But there have been some talks with potential buyers – particularly banks that want to get into the futures clearing business, Breteau says. Some would-be investors have enquired about buying a stake in Newedge, while others have looked at buying the firm outright.

“The transformation of the OTC world is putting pressure on large investment banks to get into this space, so it’s natural for them to look at who is number one in this business. We have had discussions with some players, but we could be in the same situation a year from now – we could have more shareholders or we could have only one shareholder. Everything is possible,” he says.

Breteau says the firm has been profitable throughout the crisis but admits it is under pressure to cut costs and refocus – net income fell from €95 million in 2010 to €33 million last year. “Interest rates are at a record low level and futures commission merchants (FCMs) used to make money on Treasury margin. Regulation is requiring us to invest heavily in reporting, systems, controls and quality people, and market volumes are not where they used to be. So we are facing challenges and we are having to adjust to all of this,” he says.

At the same time, the firm hopes to move into the OTC markets – a “fantastic opportunity,” says Breteau – but there are obstacles, most notably the membership criteria set by OTC clearing houses. One of those has been removed by the US Commodity Futures Trading Commission (CFTC), which ruled in October last year that central counterparties (CCPs) could only require member firms to hold a maximum of $50 million in capital – at that point, CCPs had set the bar at anything up to $5 billion (Risk May 2012, page 6).

An efficient market should be made up of different players and we definitely have something different to offer

“We have been a strong advocate of lowering what I consider arbitrary barriers to entry and I think regulators have taken a very positive stance on that. Those barriers were just designed to protect the OTC space as a private club,” says Breteau.

But clearing houses also require members to play a part in default management – the process of unwinding and sharing out the trades of a collapsed member firm. That means FCMs need to have trading expertise. But Newedge doesn’t trade OTC products, so the firm outsources the job to its owners, the two French dealers. What would happen if the French banks sold the firm? Breteau doesn’t say, but claims its approach has won the approval of the big CCPs – and Newedge hopes to be able to clear interest rate swaps at CME Group by the time Risk 25 goes to press. In addition, the firm will join LCH.Clearnet’s SwapClear service in Europe this year and aims to join the US service at a later date.

Newedge’s main OTC clearing clients are likely to be the banks, insurers, hedge funds and principal trading groups (PTGs) that already use the firm to clear listed derivatives – they may be able to achieve margin efficiencies by clearing futures and OTC business with the same FCM.

That client list is one of the reasons dealers are wary of Newedge. It is not only a rival for OTC clearing services, but it could also become the gateway for new liquidity providers that will compete with the dealers for execution business. When Breteau refers to PTGs, he means firms like the Chicago-based DRW Trading Group, which have traditionally been shut out of the OTC market because of their reluctance to take counterparty credit risk. With clearing set to remove that obstacle, those firms are now knocking on the door. All they need is an FCM to let them in, and that could be Newedge.

“An efficient market should be made up of different players and we definitely have something different to offer. We are not a dealer, we have no intention of becoming a dealer, so all the capital we have is dedicated to this business – there is no risk of it being used to support proprietary trading, for example. We are completely fair and unconflicted,” Breteau says.