Finance & economics | Frankfurters’ foray

In a pre-Brexit skirmish with the City, Eurex takes on LCH

A German bid to loosen London’s grip on clearing euro interest-rate swaps

SEEN from the continent, it just isn’t right. LCH, a firm mostly owned by the London Stock Exchange (LSE), dominates the clearing of interest-rate derivatives. Each day it clears $3.4trn-worth, counting both sides of a trade. (The simplest variety is a swap of fixed and floating rates, allowing counterparties to reduce or increase their exposure to changes in rates.) In euro-denominated derivatives, the biggest category after dollars, LCH’s market share comfortably exceeds 90%, according to Clarus Financial Technology, a research firm.

Eurex, the derivatives arm of Deutsche Börse, owner of the Frankfurt Stock Exchange, wants to change that. So do European Union politicians and regulators, once Britain quits the EU. On November 20th Eurex’s clearing division said that so far around 20 banks, including lots of heavyweights, had joined a “partnership programme” to boost its interest-rate business. (The most notable absentees are Goldman Sachs and two big French banks, BNP Paribas and Société Générale.)

Though volumes on Eurex are rising fast, its task looks hard. Central counterparties (CCPs) such as LCH and Eurex allow contracts to be offset against each other, reducing the overall exposure of banks and their clients—and allowing banks to economise on equity. Monopoly is natural: the deeper and more liquid the pool of contracts, the better. Bankers say clearing on LCH tends to be cheaper than elsewhere.

To give banks an incentive to use Eurex, the German house is promising the ten most active a slice of its takings. That echoes the arrangement in London, where the banks that founded LCH share in its revenues, as well as still owning stakes (LSE has 57%). Three other factors, Eurex hopes, will also help lure business to Frankfurt.

One is that banks and their clients want an alternative liquid market, and that they will value choice more highly as regulations require more derivatives to be cleared through CCPs, such as LCH and Eurex. The second is the fear, however remote, of the catastrophic failure of a single, dominant CCP. Because Eurex has a banking licence, it would be able to call on the European Central Bank (ECB) quickly should disaster strike.

The third is Brexit. Long before Britain voted to leave the EU, the ECB attempted to force euro-derivatives clearing into the euro area. EU judges thwarted it in 2015, but it may try again. In June it proposed amending its statutes to give it explicit power to supervise clearing houses, including those outside the EU. The European Commission also suggested that “systemically important” clearers could be obliged to make their home in the EU.

Though forced relocation looks unlikely, no one can yet be sure. It would be more of a blow to jobs in London than to LCH itself, which has an arm in Paris. But it does banks no harm to join Eurex’s programme. They already use Eurex anyway, if on a small scale; if their clients want to use it more, so must they. Eurex, says a banker, is offering a “free option”.

To Frankfurt’s boosters, euro clearing is a big prize—bigger, surely, than the European Banking Authority, a regulator, which EU ministers decided on November 20th would shift from London to Paris after Brexit. And the Frankfurters have upset the odds before. In the 1990s the Deutsche Terminbörse, Eurex’s ancestor, wrested trade in ten-year German government-bond futures from London’s grasp. Repeating the trick with euro clearing looks a tall order. But with Brexit, who knows?

This article appeared in the Finance & economics section of the print edition under the headline "Frankfurters’ foray"

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