LME pushes ahead with clearing house study

LONDON Tue May 31, 2011 7:47pm BST

A telephone clerk trades lead on the London Metal Exchange September 23, 2008. REUTERS/Suzanne Plunkett

A telephone clerk trades lead on the London Metal Exchange September 23, 2008.

Credit: Reuters/Suzanne Plunkett

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LONDON (Reuters) - The London Metal Exchange on Tuesday fleshed out a strategy to create its own clearing house, still at the feasibility stage, saying that incumbent LCH.Clearnet may not be best placed for the job.

Members of the LME, the world's leading industrial metals futures exchange, currently pay for the task to be done by Europe's largest independent clearing house, LCH.Clearnet.

They said they LME's proposal still lacked detail and poses questions about the potential cost and security, given a changing regulatory landscape.

The LME statement expressed concern that given LCH.Clearnet's diminishing exchange portfolio it was focussing on a growing market in over-the-counter derivatives clearing, to the detriment of the exchanges for which it currently clears.

In an emailed response, LCH.Clearnet said, "Market participants tell us they are looking for proven, efficient and consolidated clearing offerings. LCH.Clearnet is best placed to continue to deliver this."

The London Metal Exchange said earlier this month that it was considering building its own clearing system, which it believes would add to earnings.

It said on Tuesday the results of a feasibility survey that began in August 2010 should be ready "in the coming months."

Market participants are taking a wait-and-see approach as the LME's proposal given a lack of detail. They say they can see the potential for added cost but not yet for return.

Exchange members said they were concerned about contributing to a number of default funds, as well a potential loss of margin offsets and capital requirements as European regulators get tougher on over the counter trade.

A default fund is the capital held by a clearing house in case one of its members defaults.

Market sources also raised concerns about a new entrant to the clearing landscape just as the sector could be ripe for consolidation.

European clearinghouse LCH.Clearnet confirmed on Saturday it has received offers from exchange operators interested in pursuing some form of business tie-up but said talks were still at an early stage.

"There is no doubt the LME could provide a clearing house. The question is does the world want that?" said an executive at a category one member of the exchange. "It's going to depend on what people think about the market evolution."

"My view is that it is more difficult to see that people will want more clearing houses rather than less...In an ideal world you would have one clearing house that gives you the maximum netting and the minimum amount you need to put up."

In its statement the LME said: "The LME executive has been concerned that the decisions by ICE, NYSE Liffe and the LSE to self-clear would undermine LCH.Clearnet's viability as a clearing house for exchanges."

It also suggested that the clearing house has engaged in competitive practices that are not in the LME's best interests by launching independently cleared products in steel.

DETAIL

A new clearing house would aim to maintain existing clearing fees and revenue models so members would receive the same rate of return on margins and defaults, said the exchange.

"It is a matter of record that LCH.Clearnet collects some 10 million pounds annually in direct fees for clearing LME trades," the LME said.

"Modelling... indicates that treasury revenue from members' margin funds brings LCH.Clearnet a further return that is a multiple of the clearing fee income."

Treasury revenue, partially paid back to members, is essentially the return from cash posted as collateral.

The exchange also said work on establishing the size of any potential default fund has not begun.

"Would we be happy with that clearing house? Until you see how that is going to be set up, what the capital layer is, what the default fund is, what the insurance layer is, what the cascade is, you can't tell," the executive said.

The LME said it has not made a final decision on how it would finance a new clearing house but that expects little problem in raising debt finance.

It also said it would consider a rights issue if there was sufficient shareholder appetite.

(Reporting by Melanie Burton and Susan Thomas, editing by William Hardy)

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