Euronext faces a bind over LSE Clearnet sale

Rivals like CME Group seen as possible bidders

The London Stock Exchange’s move to sell off its French clearing business has left France’s stock market operator Euronext facing a dilemma. The Paris-based exchange has begun talks with LSE to buy LCH Clearnet SA according to sources familiar with the negotiations. The British bourse has put the platform up for sale to help get its $28 billion merger with Deutsche Boerse approved by European competition authorities, and Euronext is seen as the faraway favorite to buy it.

The deal would strengthen Euronext’s position in the competitive European clearing market following its acquisition of a 20 percent stake in Netherlands-based clearing house EuroCCP. It would also give it control of a platform that it provides much of the revenue for and would allow it to avoid relying on a competitor’s clearing house for an essential service.

Clearing forms a critical part of the financial system’s plumbing, guaranteeing a trade is completed even if one side of the transaction goes bust. Clearing is becoming a growth sector in trading as new rules intended to apply lessons from the financial crisis mean far more derivatives will have to pass through a clearing house, ensuring their volumes will swell in coming years. But there’s a catch. If Euronext buys Clearnet SA, the chances of LSE getting the nod from competition regulators to merge with Deutsche Boerse increase as it would ease concerns about a concentration in the clearing market. But the deal would still leave Euronext a minnow compared with a combined AngloGerman exchange.

“Of course Euronext is keen to acquire Clearnet,” said a source directly involved in the talks. “But Euronext is probably even more keen to see the LSE-Deutsche Boerse merger fail.”

Euronext said in a statement that it is “obviously considering this situation (LCH.Clearnet SA), because this asset belonged to Euronext until 2003.” But it declined to comment on whether the company is currently in talks with LSE. “We are a natural buyer but not at any price, especially since our clients represent approximately half of the revenues of the company,” it added.

Politics at play

A decision by Euronext, which also operates exchanges in Belgium, Netherlands, and Portugal, to buy Clearnet would be watched not just by the London and German exchanges - politicians in France also have an interest. The French government wants critical market infrastructure to be locally owned, and President Francois Hollande and other European policymakers say euro-denominated derivatives contracts should be cleared in the single currency area.

The bulk of euro-denominated swaps are currently cleared by the London half of LCH Clearnet. But Euronext buying up Clearnet in France could help drive euro clearing to Paris and a French-owned exchange. But like Euronext the French government - as well as those in Portugal and Belgium - have also spoken out against LSE and Deutsche Boerse combining, saying a deal would create an exchange so large it could make it more expensive for some companies in Europe raise money on the capital markets.

Buying Clearnet would not be enough to instantly transform Euronext’s footprint in the industry though - and the merger of the London and Frankfurt exchanges would be a ready made channel for shifting euro-denominated clearing from London to Deutsche Boerse’s Eurex clearing unit in any case. People familiar with Euronext’s thinking say the exchange’s management does not feel under obligation to buy Clearnet and has “alternative options”, pointing to the EuroCPP deal as an example, though the latter clears shares and has no immediate plans to move into derivatives.

Euronext could take its time and wait until there’s more clarity on whether the LSEDeutsche Boerse deal will go through - last month the European competition regulator raised a series of concerns about the proposed merger. But LSE is unlikely to offload the asset if the deal with Deutsche Boerse is rejected, so there is only a limited time to decide. It would also be easier for Euronext to secure a deal now as its clearing contract with LCH Clearnet expires in December 2018, which in market structure time scale is a very short time frame given all the tests and authorizations required if it is to find an alternative clearing house.

Britain’s decision to leave the European Union has also made LCH’s French arm more attractive to non-EU players as it would allow them to operate in the continent without having a so-called “passporting” deal in place. Chicago-based CME Group, which was touted as a possible rival bidder for Deutsche Boerse, might want to bid, sector bankers said. CME declined to comment. The cash-rich exchange has been slowly building up a presence in London, where it already has a clearing house. Industry officials say Asian exchanges might also be interested in Clearnet as a gateway into the EU.

That leaves Euronext with limited bargaining power and time with LSE, as others might seize the opportunity if they fail to agree a deal. Analysts at KBW say Euronext is under-leveraged compared to other exchanges, so has the firepower to ensure a deal goes through. The whole of LCH-Clearnet is estimated to be worth around 600 million euros ($650 million) based on what LSE paid for its controlling stake in 2012, with Clearnet expected to sell for less than that. One banker in the exchange industry estimated it could be worth 400 million euros. The question is whether they see the platform as a good enough consolation prize for an LSEDeutsche Boerse merger.— Reuters