Over the years Bourse Consult has built up a reputation for providing high level expertise in some of the more important areas of financial market infrastructure. We are sometimes asked for  examples of specific projects that we have advised on and the sort of bodies we have advised. While client confidentiality does not always allow us to give complete details of the projects we advise on, we thought it would be useful for potential clients if we gave an indication of some of the more recent projects we have been involved with. more >>

There is a high level of interest currently in “access rights” in market infrastructures – that is, the right of of one infrastructure to provide a service to its customers based on the service provided by another infrastructure, for example, to clear trades executed on a given trading platform. It has been one of the most contentious issues in the discussion of EMIR (the draft regulation covering OTC derivatives and clearing houses in Europe) and is at the heart of the the issues raised by the proposed merger of Deutsche Borse and NYSE Euronext. However, the term is often used in a broad way, whereas there are many important distinctions, which can mean that what appears to be an effective “right of access” achieves very little in practice.  This post tries to explain what to look for in judging whether a “right of access” is worth anything. more >>

The European Central Bank has just hosted a wide-ranging conference looking into the future of securities settlement. It was particularly valuable for bringing together an impressive spread of panellists from around the world, as well as the “usual suspects” from within Europe. And while Europe is focused on integrating markets, preparing for T2S and dealing with more urgent problems, it is valuable to be reminded that the rest of the world is moving forward and not always along the same track that Europe is following.

The recurring theme in discussions was the dilemma between consolidation and competition. Is it better to consolidate market infrastructures into a single entity and achieve economies of scale, even at the cost of creating a monopolistic leviathan? Or is it better to retain a (small) number of competing entities, forgoing some efficiency gains but making up for them through the stimulus of competition?

While most of the rest of the world seems to be aiming for consolidation, the consensus for Europe (at least, from the users of infrastructures) prefers competition. As the focus of the discussion was on settlement, this implies that the current settlement infrastructure ought to consolidate down to a small number, say, 3-4 CSDs that will compete with each other by holding down prices and stimulating innovation. However, if this competition is to be effective, it needs to be competition across the whole continent. Consolidation onto one CSD for north-west Europe, one for central Europe and one for southern Europe, for example, would not result in true competition. They would just divide the market rather than fight over it.

The difficulty in arriving at this result is that in order to compete head-to-head, CSDs need access to the same raw material – in their case, issues of securities. And at present access to issuers is controlled by national CSDs. If a foreign CSD wants to hold Spanish, German or French securities, for example, it needs to hold them in the Spanish, German or French CSD and pay a fee to that CSD for doing so. The “home” CSD will thus always have an advantage in offering the securities issued into it.

The key to creating an environment in which there is true competition between CSDs across the continent, therefore, lies in opening up access to issuers. Fortunately, there is a provision in the consultation paper on CSD legislation that would give issuers freedom of choice over the CSD into which their shares are issued. The practical implementation of the proposal, is of course, horribly complicated, because of differences between countries which are rooted in company law, such as whether or not shares or registered, whether they are immobilised or dematerialised and so on. In a separate discussion paper, the Commission has suggested that the freedom to choose CSD could be limited to issues traded on a regulated market and they would still need to comply with the requirements of the governing law of the issue.

In spite of the practical difficulties, however, this seems an admirable objective worth striving for, both to open the door to competition among CSDs and, not least, to bring benefits to issuers, who generally gain least from developments in financial markets, even though without them the markets could not exist.

As news comes that the shareholders of both NYSE-Euronext and Deutsche Borse have approved their proposed merger, leaving the decision firmly in the hands of the European competition authorities, the UK’s Office of Fair Trading has published its report on the proposed BATS-Chi-X merger.

It notes that the LSE/Turquoise, Chi-X and BATS are the only platforms with a market share greater than 1% in trading of UK-listed equities. Chi-X made a profit for the first time in 2010 and BATS is expecting to make a profit for the first time in 2011.

The OFT’s decision to refer the proposed merger to the Competition Commission is based on its concern about the consequences for competition if the number of effective rivals was reduced from three to two. Interestingly, it arrives at this conclusion in spite of the fact that few customers were opposed to the merger and many, indeed, were in favour.

The next step is a review by the Competition Commission, expected by December (assuming the merger is still on by then, as some shareholders in CHi-X are reported to be looking at alternatives).

The news that Deutsche Borse and NYSE Euronext have today notified their proposed merger to the European merger authorities starts a critical decision-making process for financial markets.

It comes at a point when the approach to competition seems mixed. On the one hand, the proposed combination between ICE and Nasdaq to bid for and break up NYSE Euronext was blocked by the US Department of Justice on the grounds that a merger of Nasdaq and the NYSE would be unacceptable. In the UK the proposed acquisition of Chi-X by BATS has been referred to the Competition Commission for a deeper review.

At least in the US and the UK, the competition authorities seem to be serious about preserving competition among trading venues. However, simply blocking mergers between trading platforms is not enough to ensure that there is real competition. For trading platforms to be able to compete, they need access to the same post-trade infrastructure. This means either using the same clearing house or using clearing houses that interoperate with each other.

Here the picture is more mixed. After years waiting for regulatory approval of the interoperability arrangements (which was finally granted), BATS Europe has announced that it will start a three-way clearing arrangement with LCH.Clearnet, EuroCCP and SIS x-clear for BATS Europe. But at the same time, EMCF, which is the default CCP for BATS Europe, is reported as stating that it no longer supports interoperability and will not be joining these arrangements. And the latest version of EMIR limits its requirements on market access to OTC (not exchange-traded) contracts. Interoperability for derivatives is postponed pending a review by ESMA, due by the end of 2014.

The reason the decision on the Deutsche Borse-NYSE Euronext merger is so important is that it simultaneously touches all the most important issues in European market infrastructure: a merger of the two most important derivative exchanges, a merger of two major equity exchanges and the ownership of a leading clearing house (Eurex Clearing) – one which has so far declined to enter into any interoperability arrangements with other clearing houses.

It is no exaggeration to say that the decision in this case will shape the European financial infrastructure.

As I (eventually) predicted, the LSE finally failed to convince enough of the TMX shareholders to support their bid to “merge” with (i.e. take over) TMX and the deal has now fallen through. In the end this looked fairly inevitable. Informed opinion in Toronto was convinced the deal would not work and stories about the way in which the LSE had treated the Italians after the takeover of the Borsa Milan (my last blog) will not have helped.

Does this mean that the Maple deal will now succeed? Not necessarily. Canadian competition regulators will want to look very carefully at the implications of merging the Alpha Trading alternative trading system with TMX. Ironically one of the most likely outcomes will be the retention of the status quo, with neither the Maple bid nor the LSE bid winning. But the Canadian banks in the Maple consortium will be happy. Their main objective was to block the LSE bid, and in this they have succeeded.

Where does this leave the LSE? Rather exposed, I think. Watch out for further speculation that Nasdaq OMX might revive its interest in the London exchange. The LSE is now in play.

While all the recent headlines about oil and refined products have been regarding OPEC’s inability to agree an increase in production and the IEA’s decision to release 60 million barrels from its strategic reserve, a far more important announcement, with potential long term implications, has received little, if any, attention.

China has announced it will review its retail pricing formula. So why is this so important? Well, global oil demand growth is lead by India, Saudi Arabia and China with their growing economies and subsidised energy prices. That means that their industries and retail consumers are not exposed to the full force of international, free market prices. Since they do not feel any financial pain when prices go up there is no incentive for them to reduce consumption.

At present the Chinese pricing mechanism is designed to adjust the price of gasoline, diesel, and jet-kero if the price of a basket of crudes rises or falls by 4pc over a trading month (20 – 22 days). The proposed change reduces the amount the basket has to rise or fall, by an as yet undisclosed amount, and reduces the period down to 10 days. If China does alter their pricing mechanism to make it more responsive to market forces, and at the same time removes the management of the system away from the politicians and into the hands of the energy companies, we could see a dramatic reduction in demand from the Chinese consumer as they start to feel the effect of high international oil prices. That is as long as it does not lead to social unrest!

My last blog suggested that the best outcome for LIFFE would be a tie up with ICE. At which point ICE and Nasdaq OMX withdrew their bid. In the latest demonstration of my powers of prediction I circulated a presentation last week in which I concluded that the LSE bid for TMX in Canada had a 60/40 chance of succeeding. The latest gossip from Toronto suggests that these proportions should perhaps be reversed. more >>

With crude prices at over $115 per barrel and gasoline in the US at near record levels, it is hardly surprising that yet again the International Energy Agency (IEA) is calling on OPEC to increase production and that US Senators are asking the US antitrust regulator to investigate. What these people seem to forget, or perhaps do not appreciate, is that crude is not homogeneous and that a refiner cannot use all grades of crudes and produce more than just gasoline. The international crude markets have lost approximately 1.4 million barrel per day (b/d) of light sweet crude due to the fighting in Libya. Whilst Saudi Arabia has replaced this lost production on a volume basis, this extra crude has twice and in some cases three times the sulphur content than that of the lost Libyan production. Refineries, especially less complex ones in Europe, cannot handle this extra sulphur and therefore have the choice of chasing reduced light sweet production, and therefore pushing up the price, or reducing throughputs. Should refineries choose to run heavier types of crude they can actually produce less gasoline, but more of the heavier, less valuable, products. Product where there is no increase in demand reducing their margins, if not turning them negative. Even with some sour crudes trading at their largest discounts to the Brent benchmark for two and half years the economics do not stack up for some refiners. European refinery throughputs are down nearly 500,000 b/d compared with last year. And let’s not forget that most of the US gasoline problem is of their own making, they have as many as 50 different grades of gasoline throughout the year – winter/summer and from state to state, the tax on gasoline is extremely low, so there is no incentive for efficient use and to reduce consumption and no new refinery has been built in the US for something like 30 years. The only surprise is, not that we have high prices, but that politicians continue to make demands that have no basis in fact – or is it!

There was an intriguing reference in the FT report of Reto Francioni’s remarks at the Deutsche Borse shareholder meeting. According to the FT, he referred to the “progressive introduction” of Eurex Clearing across the whole group and extension of risk management to all cash and derivatives markets. “A global clearing infrastructure will be formed which will significantly enhance risk management and efficiency in the use of capital for our customers.”

Taken literally, this seems to imply that Eurex Clearing would be introduced as the clearing house not just across all the group’s European markets (as everyone expects) but also for the NYSE in the USA. If this is indeed what he meant, then it is a very significant proposal, as it implies that the ambition is to create an integrated trans-Atlantic exchange group supported by a single clearing house.

However, the challenges in the way of this ambition are also huge. Not just the regulatory and legal challenges of creating a clearing house that can operate across European and US jurisdictions. Even greater would be the challenge of dislodging DTCC from its role as central counterparty for the NYSE. This is a role that is deeply hardwired into the US market. Dislodging DTCC would mean breaking up the common post-trade infrastructure which supports vigorous competition between US equity trading platforms. That may be the idea, of course.