When IntercontinentalExchange acquired Liffe last year, there were fears that the deal would stymie competition. In fact today there are the most the most fertile grounds for new launches in decades in Europe.
Since ICE acquired Liffe last year, the market for short term interest rates in Europe has fallen off a cliff. Last month the true scale of that drop became apparent with Euribor volumes plummeting 68% year-on-year during July.
This has led some to question whether ICE paid over the odds for Liffe. While valid questions, the greatest threat to ICE’s new market comes from a decision made before talks between the two firms began.
Euribor volumes will come back as growth returns to Europe and uncertainty returns to the outlook for interest rates. CME Group chief executive Phuphinder Gill last year referred to CME as a “coiled spring” in reference to the potential growth that a return to interest rate uncertainty would create and Liffe is no different in that respect.
But Liffe will emerge from the downturn a different beast to the one that entered it. Not just because of a significant change of staff or even the migration to ICE’s technology that is expected to be completed by the end of the year (and is progressing well by reports).
The most fundamental difference and the one that exposes it to competitive threats like never before is the transition of clearing operations away from LCH to ICE Clear Europe. Jeffrey Sprecher inherited the decision to move from LCH to a vertically integrated clearing model, which was taken under the previous management after merger talks with Eurex collapsed.
When the bid by ICE to acquire Liffe was unveiled in December 2012, a separate deal to move clearing facilities to ICE Clear Europe regardless of the outcome of the deal talks was announced. This effectively constituted Liffe throwing in the towel on its ambitious plans to build its own clearinghouse following the decision announced in 2012 to leave LCH.Clearnet within 12 months.
At the time that looked like a rash move but it is only now that its implications are being fully realised. Back in 2012, the full impact of the OTC clearing mandate had not been fully appreciated.
People knew of course that it would change market structure and would increase margin requirements considerably but the most fundamental change was not fully realised. That change is that in the new world firms will execute based on where they want to clear and not, as has always been the case previously, clear based on where they want to execute.
The change has as much significance as the advent of electronic trading in terms of the implications for liquidity on execution platforms. As the regime for cross-margining takes hold and models to calculate VaR-based margins for futures against OTC derivatives become entrenched, liquidity will shift to wherever firms can get the most efficient margin savings.
And for all the pessimists about the outlook for LCH following Liffe’s (and the LME’s departure from the CCP), it holds by far the largest clearing pool for swaps in the world within SwapClear. Therefore, any execution platform (or indeed platforms) that can clear futurised interest rate swaps and listed interest rate futures against or within SwapClear will have the greatest opportunity to emerge victorious in the new world.
This is why the London Stock Exchange is building a new interest rates platform and why NLX chose to clear through LCH rather than the CCP owned by parent company Nasdaq. It is also why Eurex relaunched Euribor last year and plans to launch a swap future and a suite of short term interest rate futures in September while building up its fledgling swap clearing services within Eurex Clearing.
It is also why Liffe’s decision to leave LCH could turn out to be its greatest mistake since the failure to react to the threat that DTB posed in the 1990s.
The path forward is not set in stone and there are no inevitabilities in how the market will develop. SwapClear clearly has to agree and be able to be opened up to cross-margining and there are significant regulatory and practical hurdles to overcome to achieve that.
There is also the chance that ICE can develop its swaps clearing service to take market share from SwapClear before it has the chance to open up. Or indeed do a deal with SwapClear itself.
But with regulatory winds firmly behind opening up CCPs to execution venues and such a strong business case for the LSE to use its influence over SwapClear to open up, the arguments for a more open model within LCH’s prize asset are growing and with them, the threat to Liffe’s interest rate franchise.