Jeremy Grant has raised an interesting point in his Quick View in the FT Trading Room, where he discusses the debate in the US about whether central counterparties (CCPs) should have access to the Federal Reserve’s Discount Window in a crisis.

This debate brings into focus the curious No-Man’s Land occupied by CCPs. Just what kind of institution are they? And where do they fit in the financial regulatory structure? more >>

Both Turquoise and NYSE Arca Europe announced last week that they were to launch markets in US shares during European hours.  Will these ventures work when attempts in the past have been curiously unsuccessful?

In the late 80s the LSE’s SEAQ International market was launched with the prime objective of establishing a liquid US equity market in European time but, whilst it succeeded in creating liquid markets in the blue chips from all other major global markets, US equity trading never lived up to expectations.  The overlap of trading hours with London meant that European investors could wail until New York was open, and the enormous liquidity available in the home market meant that most of them preferred to do so.

In the 90’s, at the height of the tech boom, there was a burst of excitement about trading Nasdaq stocks in London for the European market. CREST established a settlement link with DTCC. DTCC set up a European central counterparty. Market-makers, such as Knight Securities, established high-profile London operations. Then the excitement deflated as the air went out of the tech bubble. The market-makers and the DTCC European CCP closed down. The CREST-DTCC link remains in place but now is probably used mainly by brokers providing services for retail clients.

Have things changed enough since these two earlier ventures for Turquoise and NYSE Arca Europe to fare better?  Well perhaps.  Algo trading, global networks and smart order routing could effectively level the playing field for the European MTFs during US market hours. But inevitably total liquidity in US equities earlier in the European day will be lower and there will be the risk of being caught out by announcements made just before the US opens. Will these factors continue to keep trading on the MTFs thin until New York opens?

In general, the success of a trading initiative depends on the efficiency of the post-trade arrangements behind it. Again, DTCC has a European clearing house, EuroCCP, which will provide clearing of US securities in Europe with settlement in DTCC in the US. The real question is whether this is enough for traders to regard the European MTFs as part of the same trading space as the US. Or is it necessary to go a step further and make European trading fully fungible with US trading through a single clearing process?

Peter Cox & Hugh Simpson

Jeremy Grant’s article in today’s Financial Times reports on the House of Lords’ view that European clearing houses should not be regulated by a EU authority since the EU would not be able to bail out a clearing house if it collapsed.  The Lords report, which can be found here, concludes that “in the absence of any crossborder fiscal burden-sharing arrangements for failing financial institutions, central counterparties cannot be supervised at an EU level because the EU itself does not have the financial resource within the budget to bail out a large central counterparty”.

This surely confuses two elements of the governance structure for clearing houses – regulation and emergency financial support.  In current governance structures the responsibility for these two elements is quite separate.  The FSA would not provide financial support in the event of the London Clearing House going bust.

The real question is whether a European-level regulatory authority would improve the regulation of clearing houses.