Inbox For Incoming LSEG Chief
David Schwimmer takes over as chief executive of London Stock Exchange Group next week and needs to focus on the potential move of euro clearing, expanding over-the-counter clearing and information services according to Berenberg, the German bank.
Chris Turner, an analyst at Berenberg, said in a report that Schwimmer has large boots to fill as during his predecessor’s eight-year term, the London Stock Exchange Group transformed from a cash equity exchange “slipping towards insignificance” into the de facto clearing house of the over-the-counter markets and a top-three global index provider.
In April the UK exchange group announced that Schwimmer would replace Xavier Rolet as chief executive. Schwimmer previously had a twenty-year career at Goldman Sachs, most recently as global head of market structure and global head of metals and mining in investment banking.
Turner wrote: “Although the challenges in Schwimmer’s inbox are less existential, he inherits a P/E multiple double that of his predecessor, so any mis-steps are likely to be more heavily punished by the market.”
The analyst said the European Union’s attempts to move Euro clearing away from LCH, the London exchange’s clearing house, when the UK leaves the trading bloc will be an issue for the new chief executive. Turner noted that in addition to the LSE, this will also disadvantage US exchanges such as ICE which dominates trading in Euribor futures and has a clearing house in London.
“Schwimmer’s strong relationship with US regulators and politicians (not least, from his time as chief of staff to Goldman Sachs’ president and chief operating officer), as well as with US exchanges themselves (he spent seven years as a banker covering the sector), means he is well-placed to marshal these parties to oppose attempts to balkanise the global post-trade infrastructure,” added Turner.
Christopher Giancarlo, chairman of the US Commodity Futures Trading Commission, also warned in a speech in May that there needs to be greater harmonization of cross-border regulation for clearing houses, rather than fragmentation.
Giancarlo said: “My concern lies with parts of the EU proposal that would subject U.S. CCPs to overlapping EU regulation and supervision without due deference to CFTC regulation and supervision – due deference that was already agreed to between the EU and the United States in the 2016 common approach for transatlantic CCPs. We spent three years working on that agreement and remain committed to it. We do not want to renegotiate it.”
Turner continued that approximately 80% of interest rate swaps globally are now cleared, and 90% of these are cleared at LCH. As a result Schwimmer needs to persuade investors this strength can be parlayed into other areas.
ForexClear and CurveGlobal
“More immediately, progress on key initiatives such as ForexClear and CurveGlobal can potentially be accelerated by leveraging Schwimmer’s C-suite contacts,” added Turner.
CurveGlobal is the LSE Group’s derivatives venture with a number of dealer banks and the Cboe. In April CurveGlobal launched three month Sonia Futures ahead of the transition from benchmarking sterling assets against the Libor index to the new Sonia index in 2021.
A record volume week for the @CurveGlobal Three month SONIA future with 21,094 lots traded, including two record volume days making CurveGlobal over 83% of the three month SONIA futures market volume last week. #LIBORreform #SONIA pic.twitter.com/HRsJyBstrV
— CurveGlobal (@CurveGlobal) July 23, 2018
Rival ICE has also launched Sonia futures :
Open interest in SONIA futures reaches all time high of 14,034 contracts on July 24, 2018, representing £33bn. Market participants are realizing better capital efficiencies by trading and clearing Sterling and SONIA futures on one platform. pic.twitter.com/pAhhBesKcQ
— ICE (@ICE_Markets) July 25, 2018
This month LCH also launched deliverable foreign exchange options clearing. LCH said in a statement that Barclays, Citi and J.P. Morgan were among the first participants to use the service, with further banks expected to shortly start clearing the product.
“The move incorporates the first physical FX settlement service for cleared FX products, which LCH has developed in collaboration with CLS,” added LCH. “Clearing FX Options extends LCH’s ForexClear service, a leading clearer of FX non-deliverable forwards (NDFs), clearing around $70bn in average daily volume.”
.@LCH_Clearing's #ForexClear pioneers clearing of physically delivered FX Options, with the settlement model developed in collaboration with @CLSGroup https://t.co/ICIP4vTKL2 pic.twitter.com/tBrdqnAgj6
— LCH (@LCH_Clearing) July 11, 2018
NDFs are derivatives that are used to hedge or speculate against currencies where exchange controls make it difficult for overseas investors to make a physical cash settlement, for example, the Chinese renminbi. Clearing of NDFs has been boosted since margin rules came into force requiring all financial counterparties to post collateral for initial and variation margin against over-the-counter derivatives contracts that are not cleared.
Turner also wrote that the exchange-trade fund market is increasingly concentrated in the hands of a small number of asset managers which could be a long-term challenge for LSE’s index business. The exchange launched FTSE Russell, the new integrated businesses of FTSE Group and Russell Indexes in 2015. The exchange had purchased Russell Investments, the asset manager and index compiler, and then sold the fund management arm to TA Associates, a private equity firm.
“While Schwimmer’s resume lacks asset management experience, the fragmented information services landscape is rapidly consolidating,” said Turner. “By leveraging his M&A background (as well as LSE’s balance sheet) Schwimmer can accelerate the pace at which LSE broadens its information services away from plain-vanilla ETFs.”
Octavio Marenzi, chief executive of capital markets management consultancy Opimas, told Markets Media in April that the appointment of an investment banker suggests that the LSEG board in interested is a deal, but suitable targets will be hard to find.
“However, after years of trying to pull this off, it is difficult to see what direction this will take,” Marenzi added. “The large US exchanges would certainly be the obvious candidates, but after Deutsche Börse was rebuffed by regulators, such an acquisition would have difficulty obtaining regulatory approval.”
Another market participant told Markets Media in April that it is interesting that an investment banker was chosen, which indicates the importance of M&A to the exchange, both as an acquirer and a potential target.
Turner concluded that consensus expectations suggest LSE will fail to achieve its 2019 EBITDA margin target of 55%, although Schwimmer could easily reach this target through targeted cost cuts or disposals.
“We believe Schwimmer is more likely to de-emphasise this target, and focus instead on ensuring the visibility of the group’s top-line growth,” said the analyst. “Since most of LSE’s business lines incur negligible marginal costs, operational leverage will naturally drive margin expansion over time.”
As much as 50% of the market could be cleared.
The posting of initial and variation margin reduces counterparty credit risk.
Post-crisis regulation has pushed markets toward centralised clearing.
The clearing house aims to increase operational efficiency as it experiences growth across asset classes.
Supervisors should focus on continued implementation of agreed principles for the clearing ecosystem.