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LSE makes high-stakes move on LCH.Clearnet

London Stock Exchange (LSE) CEO Xavier Rolet speaks during a news conference regarding the attempted merger of the TSX and the LSE in Toronto, Feb. 9, 2011.

Mark Blinch/Reuters/Mark Blinch/Reuters

The London Stock Exchange is in talks to buy clearing house LCH.Clearnet, a deal seen as critical for LSE Chief Executive Xavier Rolet after his failed attempt to take control of Canadian exchange operator TMX.

Media reports have valued LSE's bid for the majority of LCH.Clearnet, Europe's largest independent clearing house, at about €1-billion, although sources stress the difficulty of putting a price on a not-for-profit company that is owned by its bank and trading customers.

A takeover of LCH could help the London exchange to take advantage of new rules that will overhaul the $600-trillion (U.S.) over-the-counter (OTC) markets in the wake of the global financial crisis.

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Regulators want to run many more OTC products, such as derivatives, that previously changed hands privately through clearing houses to stabilize the financial system.

LSE differs from most of its rivals in not owning the clearing house for its main market, a fact that has become apparent as trading revenues have fallen across the board while clearing earnings have held up for the LSE's rivals.

Clearing houses, which sit between trading partners, holding cash to be used to refund firms left out of pocket by a counterparty default, won support from regulators for their performance after the collapse of Lehman Brothers in 2008.

LSE's clients and backers were philosophical when Mr. Rolet failed to win TMX shareholder support for his planned $3.2-billion merger in June – his first attempt at a major deal – but the pressure is on him as he makes his second play.

"I suspect Rolet wants to do a deal and this is only one of the potential transactions he is looking at," said James Hamilton, an analyst at Numis.

Traders and analysts said buying LCH makes sense for the LSE, but Mr. Rolet faces opposition from rival bidders as well as a uphill battle with LCH's owners if he is to secure a deal and put TMX behind him.

The LSE said on Friday talks with LCH about a possible transaction were at an early stage. A source close to the exchange said the talks had been going on for "several weeks."

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This marks a dramatic u-turn by the exchange after it said in late May that it was not talking with LCH after the clearer confirmed it had received "various proposals" about a sale.

Nasdaq OMX OTC derivatives specialist Markit, working in partnership with NYSE Euronext, later said they were interested in LCH.

"Markit have good progress in their bid. LSE wants part of the action but doesn't want to be in a bigger group with NYSE and Markit," said the head of trading at a large investment bank in London, which is one of the LSE and LCH's largest clients.

LCH.Clearnet had revenues last year of €553.6-million, the firm said in its annual report.

LSE will likely face scrutiny from its own shareholders of the price it is prepared to pay for the clearing house.

"Given the global exchange market is forming into a handful of large players, it is likely that Rolet wants to do something but it is important to remember the prime drive for any deal is value creation for shareholders," Mr. Hamilton said.

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The European Commission's controversial Mifid II plan will force, as early as next year, OTC dealers to use exchange-type trading platforms and clearing houses, opening up a lucrative new market for exchange groups.

As the main clearing house for interest rate swaps – one of the largest OTC markets – LCH has a crucial head start over the competition, a fact not lost on the world's largest exchange groups.

"Clearing seems to be the area where exchanges think they can make their money and the LSE move on LCH looks like a derivatives play," said a senior trader in London.

The LSE also faces the challenge of having to convince LCH's vast and varied shareholder base to back its deal.

LCH has 98 owners, made up of two large exchange shareholders – NYSE Euronext (9 per cent) and the London Metal Exchange (8 per cent) – with the remainder held by banks and brokers of all shapes and sizes.

U.S. clearing house the Depository Trust & Clearing Corporation and a bank consortium led by Icap both tried and failed to buy LCH in 2009 citing problems with the diverse board and ownership structure.

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