Rolet Says Exchanges Need Scale

Shanny Basar

Xavier Rolet, chief executive of the London Stock Exchange Group, said the exchange sector still requires scale despite the possibility of the European Commission blocking its planned merger with Deutsche Börse.

The UK and German exchange groups announced plans for a£29bn ($35bn) “merger of equals” last year before the UK vote to leave the European Union. Although shareholders have voted to agree the merger, it has been under review by regulators, politicians and the European Commission competition authority.

At the beginning of this week the LSE said the deal could collapse as the European Commission has ordered the sale of MTS, the UK exchange group’s Italian bond trading platform. The LSE said in a statement on 26 February: “Taking all relevant factors into account, and acting in the best interests of shareholders, the LSE Board today concluded that it could not commit to the divestment of MTS.”

The Commission is due to announce its decision on or before 3 April 2017. The LSE said this morning in its preliminary results statement for 2016  that the group “continues to work hard on its proposed merger with Deutsche Börse.” However the group is also offering shareholders a 20% rise in the full-year dividend, indicating that the deal is likely to collapse.

Rolet said on a conference call today that he could not prejudge the outcome of the Commission’s review but the trend for mergers will continue as the exchange industry lacks scale which is demanded by issuers, banks and investors.

‘Exchanges are looked at as local operators where politicians like to hang their flag, similar to other industries such as airlines,” Rolet added. “We pursued an acquisition with global reach, but which had a local set-up, and the need for further consolidation will not go away.”

Rolet continued that the LSE would continue to look for smart strategical acquisitions, which are priced at a discount and likely to be accretive. He identified pre-trade risk management, post-trade and capital markets as potential areas where the group could make acquisitions.

In capital markets fintech and crowdfunding could give additional access to capital to smaller firms, outside the LSE’s existing institutional client base. “We will not buy hockey stick businesses which are based on a fad and make losses while promising revenues in two or three years,” added Rolet.

In addition, Rolet highlighted “tremendous’ opportunities for organic growth, especially in LCH, the clearing business. He argued that the new MiFID II regulations come into force across the European Union at the beginning of next year will mandate open access and boost competition. “We will take full advantage of MiFID II and cannot wait,” he added.

Rolet predicted that MiFID II will transform futures trading as open access will require fees to be unbundled.

Last year LSE introduced the CurveGlobal Interest Rate futures platform in partnership with a group of banks and CBOE and 425,000 contracts were traded  between the end of September 2016 and January 2017. In addition the LSE also launched  LCH Spider last year to allow portfolio margining between over-the-counter and listed derivatives and allow clients to use capital more efficiently.

“LCH can cross margin OTC products with related futures that are traded on another exchange such as Deutsche Börse, CME or ICE if they apply to become a Spider customer,” Rolet said. “If they refuse to become a customer spider, liquidity will move and this will be a game changer for the futures industry.”

However, he said clients have benefited from saving billions more dollars of of capital through compression than through portfolio margining. Compression is a process in which clients can “tear-up” offsetting trades to reduce the notional outstanding and number of line items in their portfolio while maintaining the same risk exposure. Use of compression services has increased following the introduction of stricter capital requirements, such as the Basel III leverage ratio, which has led to banks reducing their balance sheets and capital efficiency becoming increasingly important.

Rolet said: “No other clearing house can offer compression across the largest 18 currencies so that is a sweet spot.”

LCH SwapClear cleared $666 trillion in notional last year, up 25% from 2015, and compressed $384 trillion of notional last year, up 17% from 2015. In May 2016, SwapClear said it had compressed over $1 quadrillion of cleared notional since the service launched in 2008.

SwapClear also cleared $1.1 trillion of inflation swaps last year, compared to $0.3 trillion in 2015, following the introduction of following the implementation of non-cleared margin rules last September.

“A few years ago everyone told us we would lose the OTC business due to portfolio margining but we chose to follow the compression road,” added Rolet. “We knew leverage ratios would become increasingly important and with open access to clearing we expect that business to go like gangbusters.”

MiFID II also places caps on equity trading volumes in dark pools, which makes the ability for investors to trade large blocks more valuable. Rolet highlighted the success of the exchange’s Turquoise Plato Block Discovery service which he said brought together the buyside, sellside and a trading venue for the first time.

He said: “Turquoise Plato had a record growth in volumes and has perfect positioning for MiFID II.”

The LSE said Turquoise’s share of European trading grew to 11.7% last year from 8.3% in 2015. The value of trading on Turquoise’s lit book was  €1.2 trillion last year, up 26% year-on-year, while the value traded on the dark book was €159bn, an increase of a third from 2015.

In addition, the average trade size on Turquoise Plato Block Discovery is 30 times industry dark pool average according to the LSE. The group said Turquoise Plato Block Discovery has matched €13.2bn from launch in 2014 to the end of last month, of which 69% has traded since last September.

Professor John Colley, Warwick Business School’s Professor of Practice in the Strategy & International Business Group said in a statement that following the potential end of the merger, the LSEG needed a good set of results which have been delivered and the dividend increase is clearly intended to appease shareholders.

“They thought they would be participating in a much larger business with stronger positions in Europe and internationally,” said Colley. “The dividend increase is also intended to distract from the substantial deal costs written off and the lack of a future strategy.”

Colley continued that shareholders still seem bewildered by the rationale for effectively ending the deal due the the Italian fixed interest trading platform.

“Presumably there are some other concerns which remain opaque to shareholders at present,” said Colley. “Rolet believes he may be postponing his retirement. Perhaps not for that long unless there are more answers and a new strategy.”

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