In the spring of 2012, the board of the London Stock Exchange was debating whether to buy central counterparty LCH.Clearnet. Clearing mandates for over-the-counter products were approaching, and LSE’s then-chief executive, Xavier Rolet, was championing the deal as a chance to take control of the world’s largest swaps clearing platform.
He faced opposition from investors who believed that new regulation – the European Market Infrastructure Regulation and the Dodd-Frank Act – would create greater opportunities for cross-product platforms of the kind touted by rivals CME Group and Eurex.
“Many of our shareholders were concerned,” Rolet told Risk.net prior to his departure. “The question was, ‘Why are you paying all that money for a platform that is dying operationally and is on the wrong end of the future direction owing to Emir, Dodd-Frank and the benefits of cross-margining between listed and OTC?’”.
Rolet saw it differently. He believed greater efficiency could be delivered within a single product silo – through the compression of interest rate swaps – than by chasing potential offsets between different products.
Rolet won, of course, and was proved correct. Over the past four years, LCH’s clients have compressed a mind-boggling $2 quadrillion in swaps notional, and counting. That has translated into real capital savings for dealers: $25 billion in 2016 alone, according to the CCP.
LCH has set about hoovering up the lion’s share of the interest rate swap market, the magnetic pull of netting proving too strong for dealers and, ultimately, most clients, too.
The second leg of the argument has also proved correct: cross-margining is yet to deliver on its promise. While it continues to offer real savings for clients at CME and Eurex, it has not been enough of a draw to lever much of the swaps market from LCH.
Over the past four years, LCH’s clients have compressed a mind-boggling $2 quadrillion in swaps notional, and counting
But while Rolet was right six years ago, those arguments may not be correct in perpetuity. Things change – and one of the things that could change in the short term is the combination of interest rate futures behemoth CME with Nex, which contains the world’s largest interdealer cash Treasuries platform.
Savings from CME’s current swaps-versus-futures offering come from just two product sets. Throw in a third leg in the form of cash Treasuries – if the exchange seeks to set up its own clearing house – and things start to look interesting. Add in the potential for offsets from the clearing of repo as well, where CME is waiting for regulatory approval, and things start to look very different again.
Three-way cross-margining has been attempted before, but never achieved; four-way would surely be a first. For now, any theoretical offsets between the four products are paper savings; CME’s deal for Nex may be rejected by regulators; the exchange may fail to gain approval to clear repos.
Rolet’s call still looks correct; but his logic may be facing a brand-new test.
Editing by Duncan Wood