Europe's banks take first step on clearing path
LONDON (Reuters) - While international exchange mergers have captured headlines this year, Europe's top investment banks have without much fanfare taken their first big step to make the murky world of clearing more competitive.
After some five years of waiting, they got their way last week when share-trading platforms BATS Europe and UBS MTF became the first to offer clients a choice of clearing provider, through an arrangement known as "interoperability."
"Consolidating clearing and settlement ... for cash equities offers significant benefits for investors, particularly those operating in multiple markets," said Robert Barnes, the Chief Executive of UBS MTF, the Swiss bank's trading platform.
Clearing houses sit between trading firms and their partners, holding cash they use to refund any parties left out of pocket by a counterparty default, as was the case when Lehman Brothers collapsed in 2008.
Europe's exchanges and trading platforms have until now used only one clearing house, meaning banks and other firms trading on an exchange or platform had to use the relevant clearing providers and pay the fees the clearer demanded.
Traders have complained this is inefficient because there is no competitive pressure on clearers to cut fees and argued they should embrace competition via interoperability -- which allows clients to consolidate their flow with one provider, giving them better volume discounts.
Traders said clearing fees account for as much as a third of the total cost of doing business in Europe, and interoperability could cut this in half, saving large trading houses tens of millions of euros a year.
Europe's exchanges, clearing houses and top trading firms signed a code of conduct to work towards interoperability in late 2006 but progress was slowed by resistance from incumbents protecting their interests and, latterly, regulatory oversight.
Europe's regulators feared that linking clearing houses via interoperability -- a model created before the collapse of Lehman -- might increase systemic risk because the collapse of one interoperable clearing house could take the others with it.
But three clearing houses -- U.S.-owned EuroCCP, British firm LCH.Clearnet and Swiss house SIX X-Clear -- allayed these fears, and late last month the UK and Swiss regulators finally gave them the all-clear to embrace interoperability .
BATS Europe and UBS MTF then became the first platforms to support interoperability on July 29, setting a precedent other platforms, such as BATS's planned merger partner Chi-X Europe and the London Stock Exchange's (LSE.L) Turquoise, are likely to follow.
"This step will put additional pressure on other trading venues and clearing houses to open themselves up," said Ashok Krishnan, head of execution services for Europe, the Middle East and Africa at Bank of America Merrill Lynch.
Bank of America Merrill Lynch (BAC.N), Citigroup (C.N), Credit Suisse (CSGN.VX), Morgan Stanley (MS.N) and Nomura (9716.T) endorsed the moves by BATS and UBS MTF by signing up last Wednesday to use EuroCCP, the smallest of the clearers.
This sent a message to rival clearing houses that the banks plan to use interoperability to their advantage and shift business from one clearing provider to another to drive down the total cost of trading.
EuroCCP, LCH and X-Clear plan to win business from each other and rivals such as Dutch firm EMCF and German house Eurex Clearing by enabling clients to consolidate their business and hit higher volume discounts.
Clearing houses, like exchanges, have a tiered fee model that means clients pay less for individual trades if they exceed certain thresholds, acting as an incentive to firms to place more of their business with one provider.
BATS and UBS hope to win market share from Chi-X Europe and Turquoise, as well as large exchange rivals the LSE, Deutsche Boerse (DB1Gn.DE) and NYSE Euronext (NYX.N) by offering trading firms a lower all-in cost of trading.
The banks' decision to support EuroCCP partly reflects their innate suspicion of exchanges.
"We want to show the market is moving forward and a number of banks plan to support EuroCCP, which is a strong solution partly because it is not exchange-owned," said Andrew Bowley, managing director, head of electronic trading product management at Nomura.
EuroCCP is owned by U.S. clearing giant the Depository Trust & Clearing Corporation, the bank-owned utility that operates on a not-for-profit basis.
EMCF is 22 percent-owned by Nasdaq OMX (NDAQ.O), with the rest held by ABN Amro ABNNV.UL. LCH has been mooted as a takeover target for Nasdaq OMX and NYSE Euronext and X-Clear belongs to the Swiss Exchange.
Traders accept there is a long way to go before all Europe's exchanges and clearing houses support interoperability and there will likely be resistance from those with everything to lose but they feel interoperability is a vital step to making the European market more competitive.
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