European Clearing: Big shifts ahead

11 March 2024


Market watchers expect dramatic changes in the European clearinghouse landscape over the next few years, including more competition for the clearing of interest rate swaps, a big operational migration at Euronext, and consolidation in energy derivatives clearing.

Perhaps the most dramatic change on the horizon is the mandate by European policymakers that will require market participants to shift some of their euro-denominated interest rate swaps to clearinghouses on the continent.

LCH Ltd, the London-based clearinghouse that is part of the London Stock Exchange Group, has been the leader in the clearing of interest rate swaps for more than two decades. Currently, it has 95% of the euro-denominated interest rate swaps market, according to Clarus Financial Technology, a data provider that tracks developments in swaps trading and clearing.

EU policymakers have long argued that the European financial system faces a systemic risk by having such a high percentage cleared outside the eurozone. The key question was how to shift the balance – through a regulatory mandate or by relying on the forces of market competition.

European policymakers have opted for the former. A revised version of EMIR, the EU law that governs derivatives clearing, includes a requirement that market participants keep a percentage of their interest rate swaps and futures in "active accounts" with a European central counterparty.

Several EU clearinghouses are eager to take advantage of this emerging opportunity, particularly Germany's Eurex, Sweden's Nasdaq Clearing and Spain's BME, a subsidiary of Switzerland's SIX.

Of these contenders, Eurex seems to be the best positioned to capture channel-hopping clients. Although it currently has only 5% of the euro swaps market, the Frankfurt clearinghouse is far ahead of the other continental CCPs in building out an offering and attracting inflows from clients, according to Clarus statistics.

It also has a potential advantage due to its strengths in other interest rate markets. Eurex is the dominant player in the European bond futures markets and touts its ability to offer more efficient margin requirements for portfolios that combine bond futures and interest rate swaps.

The exchange also has set its sights on the Euribor market, the most important short-term interest rate in the eurozone. That market is currently dominated by ICE Futures Europe, the London-based arm of Intercontinental Exchange, but Eurex is hoping to attract some of that business. In November it relaunched its Euribor futures in partnership with liquidity providers and clearing firms. If it can attract a significant share of that market, it will be able to offer a single clearing solution for a full set of derivatives based on European interest rates.

To strengthen its position, Eurex has brought in Robbert Booij as the next chief executive officer of its exchange. Booij, who will join in July, comes from ABN AMRO, the Dutch bank, where he was the regional head of its derivatives trading and clearing business. Thomas Book, the executive at Deutsche Börse, the parent organization of Eurex, who oversees its trading and clearing businesses, commented that Booij's familiarity with clients makes him the "perfect candidate" to lead the exchange's efforts to grow its trading business.

Further north, Nasdaq Clearing is also making moves to attract more clients for its swaps clearing service by focusing on the needs of clients in the Nordic market. The Stockholm-headquartered clearinghouse has an existing business in clearing interest rate derivatives denominated in the Swedish kronor, and it is about to expand to include three other currencies: the euro, the Danish kronor, and the Norwegian kronor.

Further south, BME/SIX is also trying to expand its role. BME currently provides clearing for futures and options traded on its affiliate exchange MEFF as well as cash equities, repos, Swiss bonds and energy derivatives. The clearinghouse also offers clearing for interest rate swaps, forward rate agreements and overnight indexed swaps, and touts its service as an "attractive alternative" for complying with the active account requirements.

Customers are wary of a mandated solution, however, especially if it forces them to move a fixed percentage of their portfolios to a European clearinghouse. Pension funds in particular will be impacted. They tend to hold very large positions in swaps, and until recently were exempt from clearing requirements.

Speaking at a recent conference on clearing organized by ECMI/CEPS, the Brussels think tank, Bas Zebregs, senior legal counsel at APG Asset Management, the Dutch pension fund, cautioned that working out the right percentage of trades to be moved may be difficult.

“How high is that percentage? That’s of course the key question. We can start with a very low number and hope that people will follow, but in the end, if we end up with a significant percentage, that's worrying to pension funds and other market participants,” Zebregs said.

Clearing firms take a similar perspective. As the intermediaries between the clearinghouses and clients, they warn that an active account requirement would make it more expensive for customers by fragmenting liquidity. LCH's SwapClear business in London offers clearing for swaps in 27 currencies, making it far more efficient for customers operating at a global level. Moving just the euro-denominated portion of a swaps portfolio to a different clearinghouse in Europe would divide the market and reduce the potential for margin offsets across currencies.

It would also create an additional burden for European clients and the clearing firms that need to maintain accounts at more than one clearinghouse. Firms based in the US or the UK will not be subject to the active account requirement. In contrast, European clients would be forced to move part of their swaps portfolio to an EU clearinghouse, while continuing to clear the bulk of their portfolio at LCH.

Gilbert Sintès, head of European ETD and OTC clearing at Spain's Grupo Santander, welcomes having more choices for swaps clearing on the continent, especially for small and medium-sized firms. He cautions, however, that the mandated approach, with its minimum threshold of trades that must be cleared in the EU, could put European firms at a "serious competitive disadvantage." 

What’s next for Euronext

Another important change ahead for European clearinghouses is the change in strategy at Euronext. The Paris-based exchange operator has long relied on a third party, LCH SA, the French clearinghouse owned by LSEG, to provide central clearing for the trades executed on its exchanges. That changed when Euronext bought Borsa Italiana, which operated its own clearinghouse, Cassa di Compensazione e Garanzia (CC&G).

Euronext's chief executive, Stephane Boujnah, saw the opportunity to bring clearing inhouse by withdrawing from LCH SA and transforming CC&G into Euronext Clearing. Clearing firms agree that it is a good move for Euronext in terms of its business strategy but worry about the timetable for the transition. The exchange plans to move its futures and options contracts this summer, and a lot of work will be required to ensure that operations move smoothly from day one.

“From a high level, it makes sense,” says Per Haga, global head of product for prime derivatives services at Barclays. “As a market structure, it helps make credible competition. The challenge is the ambitious timeline versus the nimbleness of the industry to move alongside that.”

Euronext also has embarked on a closely-related project – a change in its margin risk calculation process from SPAN (Standard Portfolio Analysis of Risk) to VaR (Value at Risk). The VaR methodology is more sophisticated in how it measures risks, and several other major clearinghouses are making similar transitions. It does require clearing firms and clients to change the way they calculate margin, however.

According to Haga, the key thing to watch is the testing of the new CCP before its projected launch this summer. Typically, this process involves connecting all member firms and going through all phases of the clearing cycle, including options expirations and physical deliveries. Although CC&G has plenty of experience with the derivatives traded in the Italian market, the new contracts that are being added – including several commodity futures – have certain features that are new to CC&G. “Testing is extremely important,” he says.

Consolidation in commodities

Another key event this year in European derivatives will be the integration of Nasdaq’s power derivatives trading and clearing business into the European Energy Exchange, a Deutsche

Börse unit based in Leipzig. EEX’s acquisition of Nasdaq Power will leave European energy trading dominated by two clearinghouses – the ICE-owned Endex in the Netherlands for gas and EEX in Leipzig for electricity.

The transaction is pending review by the EU's competition authorities. Four countries have raised concerns about potential anti-competitive effects and have asked the European Commission to review the deal, according to a European Commission press release.

For EEX, the move will give it greater reach in the European power markets. Once the transaction is approved, Nasdaq will transfer open positions in its Nordic, French, and German power futures as well as European carbon emission allowance futures to EEX’s clearinghouse, European Commodity Clearing.

In the meantime, EEX has introduced "zonal futures" to the Nordic market. These futures correspond to smaller coverage areas within the Nordic power system, rather than as differentials to a system-wide price. EEX says this approach is in place in many other European power markets and will give market participants better hedging and trading opportunities.

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