Deutsche Borse and LSE Merger: Will this Work?

Any time now, Deutsche Borse will be launching their merger with the London Stock Exchange (LSE). Yet we didn’t hear anything from the politicians about what could be damaging to London.

For many years, Italian companies have been listed under the market owned by London. A great concern nowadays is the future of the clearing houses and the fact that a German company is taking over the LSE which may result to clearing ends up in Frankfurt.

London Stock Exchange
LSE boss Xavier Rolet backs the merger with Germany’s Deutsche Börse Facundo Arrizabalaga/EPA

Why Clearing Houses Matter

Clearing houses allow trading from equities to interests which can happen when either one of the parties involved defaults. They fuel financial markets. Aside from that, it is also the core of action of the G20 nations to make sure that the world’s financial system is stable enough by reducing the risks. On top of that, cross margin clearing can be seen in the huge interest-rate markets. Majority of the interest-rate swap market happens on the over-the-counter markets with a simpler clearing system.

Cross-Margin Clearing

With cross-margin clearing, banks are allowed to net all their interest-rate derivatives held in a single clearing house, thereby decreasing their capital they need to meet the margin.

Interest swaps, on the other hand, involve sovereign and corporate bonds that dates 30 to 100 years; the margin needed by these clearing houses may change quickly and significantly. Therefore, netting them out would benefit the banks, as well as the entire financial system.

Interest-Rate Derivatives Market

There are 3 clearing houses that operate in the interest-rate derivatives market; and these are the LSE’s LCH.Clearnet, Deutsche Borse’s Eurex, and ICE, which operates exclusively in the US. However, if Deutsche Borse incorporates with LCH.Clearnet, there will only be one clearing house in Europe — and that is in Frankfurt.

Technologically speaking, Eurex is superior to LCH.Clearnet. In fact, its business model can drive the synergies the merger requires. According to German politicians, they won’t let trillions of euros of interest-rate swaps be traded in German Bund.

Xavier Rolet, the chief executive officer of LSE, has emphasized last week that clearing plays a highly significant role behind the merger talks with Deutsche Borse. Although he won the fig leaf of the merged entity, he may be losing the fight for the business to be taken away from Frankfurt.

Both Deutsche and LSE have less than two weeks to reach an agreement; but they could still buy themselves sometime.

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