On Wednesday, NYSE Euronext Inc. announced its intention of building clearinghouse – NYSE Liffe Clearing – in London that should be operational between the second and third quarters of 2013. This is a significant attempt to erect an exchange entity on a vertical clearing model.
Initially, NYSE projects to commence the clearing of derivative contracts, while the equity trades will still be cleared by LCH.Clearnet, which cleared all of the company’s trades until now, for the time being. Besides, management also aims to transfer all the derivative trades from Amsterdam, Brussels, Lisbon and Paris to London by the first quarter of 2014.
Necessity to Invest in Clearinghouse
Clearinghouses operate as central counterparties or middlemen and guarantee every buy and sell order executed by the trading parties, thereby reducing the risk if a trader defaults. This clearing business is becoming more lucrative and significant given the stringent derivatives trading regulations in both the US and Europe.
The financial regulations and legislations now warrant that the derivative products like interest rate, credit default and other swaps should be processed through the clearers to maintain transparency and stabilize the financial system. Therefore, either exchange operators such as CME Group Inc. (CME - Analyst Report) and IntercontinentalExchange Inc. (ICE - Analyst Report) have their own clearinghouses or some like London Stock Exchange (LSE) seek the services of third party experts like LCH.Clearnet, to get their clearing strategies reassessed. LCH.Clearnet’s primary business comes from NYSE, LSE and London Metals Exchange (LME).
Moreover, while NYSE had been planning about building two clearinghouses since 2008 – in Paris and London, the immediate urgency on initiating a clearinghouse in London was sensed now as arch-rival LSE is into high-level negotiations to acquire a majority stake in LCH.Clearnet, since September last year. NYSE holds only 9% stake in LCH.Clearnet and had been eyeing it for most of last year. The company also plans to renegotiate new terms with LCH.Clearnet.
Meanwhile, NYSE’s clearinghouse plans had also got shelved last year as it was involved in the merger with Deutsche Boerse, which had its own clearinghouse – Eurex Clearing. However, the merger got terminated due to regulatory snags in February this year.
Nevertheless, seeking its own clearinghouse has become a priority for NYSE as other business propositions have subsided and competition has risen intensely. Hence, the company projects to incur about $85 million in building its new clearinghouse that is anticipated to generate cost synergies of about $30 million annually.
Although expenses related to building the new clearing facility will likely weigh on the financials for some time, we believe that the new clearinghouse should help NYSE by enhancing its capital and cost efficiencies, while also rendering it a competitive advantage in the peer group, besides helping it adhere to the regulatory provisions. Overall, these efforts will not only help NYSE strengthen its fundamentals but will also aid in benefiting from a satisfactory clientele, thereby boosting the long-term operating growth potential of the company.
Currently, NYSE carries a Zacks Rank #3, implying a short-term Hold rating and a long-term Neutral stance.