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Deutsche Börse 'fighting uphill battle' with new clearing platform

Even with a new clearing business setup, Deutsche Börse AG will have a hard time competing with London Stock Exchange Group Plc's well-established interest-rate-swap business, according to equity analysts.

The German stock exchange operator announced Oct. 9 that its Eurex Clearing AG subsidiary developed a partnership program allowing the company to share revenues with its partners, most of which are large banking groups. Bank of America Merrill Lynch, Citigroup Inc., Commerzbank AG, Deutsche Bank AG, JPMorgan Chase & Co. and Morgan Stanley are among those to have registered their interest in participating in the program, which is designed to speed up the development of a liquid, EU-based alternative for the clearing of interest rate swaps.

However, taking on the top player in the global interest rate swap market, LSE's clearing arm LCH Group Holdings Ltd., will be difficult for Deutsche Börse even if it offers a similar model as that company, according to Eric Compton, equity analyst at independent investment research firm Morningstar.

"We definitely think DB is fighting an uphill battle here," he said in an email.

No tangible benefit

Compton said LCH's interest rate swap clearing arm, SwapClear, has a market share of over 90% of the open interest in that segment, and he pointed out that all of the interested banks specifically mentioned in Eurex Clearing's statement are already members of SwapClear, too.

"It's hard for us to see what the benefit would be for the dealers to switch," he wrote, saying the reasons for that view were that "it makes sense for a dealer to keep all of their open notional in one place — and because the dealers are already part owners of LCH, similar to the setup Deutsche Börse is trying to create."

However, there is the possibility that banks decide to join both clearing platforms and use their partnership as leverage to get pricing concessions or a greater proportion of the economic interest within the central counterparty clearing houses, Compton suggested.

Under the new program, Eurex Clearing will reward its 10 most active participants with a significant share in the economics of its multicurrency interest-rate-swap offering on a permanent basis, as well as a position in its governance and committee structure.

Nevertheless, at this early stage in the process, it is difficult to assess what the actual impact would be, Peter Lenardos, managing director and head of pan-European diversified financials at RBC Capital Markets, said in an email. The proposal reads well, but how Deutsche Börse performs is more important, he added.

"Further, interest rate swaps have liquidity in London, thereby making it more collaterally efficient for parties to transact there," Lenardos noted.

The U.K.'s decision to leave the EU and, with that, the single market has put London's position as the leading global center for the clearing of euro-denominated derivatives at risk. However, the city's position compared to other big clearing centers is critical. About $574 billion of euro-denominated interest rate derivatives were cleared daily in the U.K. in April 2016 — much of it through LCH — compared with $101 billion in France, $7 billion in the U.S. and $1 billion in Hong Kong, according to BIS data.

Despite Brexit, the position of LCH in the clearing market is likely to remain strong, according to Compton. London Stock Exchange previously announced that it is registered in both the EU and the U.K., so if it is forced to clear euro-denominated instruments within the EU in future, the company will have a way to work around that, he wrote.