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London Stock Exchange deal in the clear
The OFT has recently published its decision[i] approving the acquisition of LCH.Clearnet Group Limited (“LCH”) by the London Stock Exchange Group plc (“LSEG”).
LSEG is the holding company of the London Stock Exchange and Borsa Italia, the regulated markets for the UK and Italy respectively. These are responsible for running a number of trading venues on which equities securities, fixed income securities and exchange traded derivatives are traded. LCH is a clearing house which provides clearing services[ii] for trade executed on trading venues and over-the-counter (“OTC”) markets worldwide for a wide range of asset classes.
The OFT’s analysis demonstrates the keen interest it shows in financial markets and the detail it will go into in analysing competition in the sector; a role it is set to retain within the new regulatory framework for financial services.
What will LSEG acquire?
LSEG will acquire a controlling interest of up to 60% of LCH with existing shareholders continuing to hold 40%[iii]. LSEG will appoint four of the 17 directors to the LCH Board, including the CEO, and will have approval rights over a further eight. However, LSEG has agreed not to use its shareholding to remove directors not appointed by it unless it is reasonable to do so.
All contractual arrangements between LSEG and LCH are to be concluded on an arms’ length basis. Steps will also be taken to protect against competitively sensitive information on rival venues and users reaching LSEG. LCH is to enshrine within its Articles of Association a commitment to (i) provide access to its clearing services on terms that are “fair, reasonable, open and non-discriminatory”; (ii) not favour any exchange over another; and (iii) not give LSEG’s trading users preferential treatment over those of any other exchange.
The LSE has since renegotiated the original purchase price down (reportedly to about €340m), to take account of new EU rules requiring clearing houses to hold more capital.
Why is LSEG acquiring LCH.Clearnet?
The deal will enhance LSEG’s presence in post-trade services. LSEG already owns CC&G[iv], which provides clearing services but only for Italian equities. However, LCH.Clearnet is a clearing house that is active on an international basis. LSEG states that the deal will enable it to achieve efficiencies and greater innovation across the full trading cycle.
A clearing house (i) will register and process the trade once it has taken place; (ii) may act as a central counterparty (“CCP”) between the buyer and seller in a trade, thereby taking on the risk from the trade for its clearing members; (iii) and can carry out netting[v] functions to reduce the number of open positions that need to be cleared and settled.
What relevant markets did the OFT examine in its assessment?
The OFT generally suggested a narrow approach towards defining the relevant markets but in many instances it left the precise market open as no competition concerns arose. Following the European Commission’s recent analysis in Deutsche BÖrse/NYSE Euronext[vi], the OFT looked at eachindividual asset class separately, namely (i) fixed income securities; (ii) equities securities; and (iii) derivatives. However, unlike the Commission, the OFT also examined trading services and clearing services separately[vii], although this is in line with previous UK merger decisions[viii].
For the clearing and trading of both fixed income and equities securities, the OFT considered it appropriate to distinguish between specific types of instrument and recognised that many CCPs specialise in clearing specific securities. The OFT has also now drawn a distinction between the more traditional voice brokered trading services and electronic trading, which has grown dramatically in recent years. In considering derivatives trading and clearing, the OFT’s thinking followed Deutsche BÖrse/NYSE Euronext, suggesting segmentation of the market by (i) venue of execution (i.e. derivatives on exchange v. those traded OTC); (ii) type of underlying asset; and (iii) type of contract (future, swap or option).
For all these product markets, the OFT considered the geographic scope to be at least EEA wide.
What did the OFT conclude about the impact on competition in these markets?
Under the Enterprise Act 2002, the OFT has a duty to refer a merger to the Competition Commission for a full scale review if it believes that a merger will result in a substantial lessening of competition in any relevant market(s) in the UK[ix].
The OFT considered there was no realistic prospect of a SLC between LCH and CC&G in the clearing Italian trades or a loss of potential competition for clearing French and Spanish government bonds. Nor was there evidence to suggest that other CCPs would be foreclosed from fixed income clearing. Moreover, whilst LCH might have had the ability to foreclose rivals to LSEG’s fixed own incometrading service, MTS, such as ICAP and Tullet Prebon, it had no incentive to do so. In fact, such a strategy was unlikely to have a detrimental effect on competition anyway, because of strong competitors, the threat of customer sponsored entry, and the corporate governance provisions summarised above.
The parties’ overlap in clearing Italian equities also did not cause the OFT concern. The deal only brought about a small increment in market share, and customers did not consider LCH and CC&G to be close competitors. Furthermore, there was strong competition on the market from EuroCCP and EMCF. The OFT considered that LSEG would have a limited ability to foreclose rival providers of equities clearing in relation to certain types of equities, in particular UK-listed equities but would have little incentive to do so; it would not be profitable and customers were unlikely to switch to LSEG. Similarly, the OFT considered LSEG to have only a limited ability to foreclose competing equitiestrading venues through its ownership of LCH, because there was a choice of four other CCPs. Even venues that relied wholly on LCH (e.g. NYSE Euronext) could switch to other CCPs; LCH contracts also provided some protection and rights of redress. Significantly, the OFT found that such foreclosure would simply not be profitable.
Exchange traded derivatives
The OFT did not consider there to be a realistic prospect of an SLC in the clearing of EU ETDs post-transaction because of the small increment to market share and the absence of close competition between LCH and CC&G. The OFT found there was no evidence to suggest that the transaction would affect CCP access to the financial indices licensed by FTSE International, a subsidiary of LSEG. The OFT considered whether the transaction would increase barriers to new entry or impede innovation in ETD trading services. Third parties had concerns that LCH was the only stand-alone CCP for ETDs in the EU and that its integration into LSEG would lead to foreclosure of rival venues for ETDs and the ability to block new products. Other trading venues already had vertically integrated clearing houses (such as Deutsche BÖrse / Eurex Trading) and these were not open to other trading venues. The OFT recognised this theory of harm but found it to be unrealistic. It would not be in LSEG’s interests to impede innovation or to discriminate against new entrants: both strategies would not enhance its ability to compete against NYSE Euronext or Eurex. Moreover, the OFT felt that bringing Turquoise and LCH together would enable them to invest in and develop their offerings, thereby actually increasing competition in a market that has few effective competitors. For the same reasons, the OFT was not concerned about the possible foreclosure of existing rival ETD trading services.
Where else has the deal been reviewed?
The parties had pushed for the European Commission to review the deal. Under the EU Merger Regulation[x] it is open to the parties to ask the European Commission to review a merger, even where the jurisdictional thresholds are not met, instead of making a number of notifications to different member states[xi]. The advantage of this is that it can reduce the administrative burden on the parties by enabling them to take advantage of the “one stop shop” offered by the European Commission[xii]. (Interestingly, on 28 January 2013, Intercontinental Exchange Inc. indicated its intention to follow the same strategy by asking the European Commission to review its plans to buy NYSE Euronext to avoid multiple probes in the UK, Portugal and Spain.)
However, the OFT objected to this on the grounds that any competition concerns were most likely to arise in the UK and therefore it was best placed to review the transaction. Because one member state did not agree, the parties’ referral request was not granted. The Portuguese Competition Authority then submitted a separate member state referral request[xiii] asking the European Commission to take jurisdiction and this was joined by the authorities in Spain and France. The European Commission refused to accept jurisdiction and so the deal has now been reviewed and cleared in Spain, France, the UK and Portugal.
How relevant was the (changing) regulatory backdrop to this acquisition?
The OFT acknowledged that the parties are subject to regulatory supervision in the UK. As a Recognised Clearing House, LCH is regulated by the FSA and its payments system is supervised by the Bank of England. LCH’s authorisation requires it to make transparent and non-discriminatory rules, based on objective criteria, governing access to its CCP services. The OFT also highlighted (i) proposals to change the regulatory regime in the UK as it applies to CCPs and settlement systems, with greater responsibility transferred to the Bank of England; and (ii) the imminent introduction of the new Financial Conduct Authority[xiv] (“FCA”), which will have a specific objective to promote effective competition in financial services in the interests of consumers. Nonetheless, the OFT had doubts whether the Financial Services Authority would be able to address all potential competition concerns; it therefore only took account of the planned strengthened regulatory framework as one of a number of factors.
Similarly, the OFT felt it could not place great reliance on either the recent European Markets Infrastructure Regulation (“EMIR”)[xv] - because the accompanying technical standards for authorisation of CCPs (ESMA standards[xvi]) are currently in draft – or the MiFID II package of measures[xvii] requiring open-access to clearing facilities, as this was not sufficiently far advanced.
In spite of concerns expressed in the past about the clearing market, and specifically about the LSE establishing its own clearing house[xviii], the OFT has conducted a thorough review and concluded that in practice a LSEG/LCH merger will not lead to a substantial lessening of competition on the relevant markets.
The merger certainly comes at an interesting time in terms of further consolidation in financial markets and significant regulatory changes. The new FCA is to be entrusted with responsibility for actively promoting competition in financial markets. This marks a step up from the FSA’s current duty to “have regard to …the need to minimise the adverse effects on competition” and “the desirability of facilitating competition” between those it oversees. For the time being[xix] the FCA will not have the power to apply general UK competition law in the sectors it regulates; this will remain with the OFT. That said, the FCA will be empowered to ask the OFT to examine competition in a financial services market in the UK and it is clear that the Government is putting effective competition at the heart of its new UK regulatory regime for financial markets.
For more information, please contact Rachel Iley or Elisabetta Rotondo.
[ii] Clearing services arise once a trade has taken place. Clearing houses (a) register and process the trade; (b) may act as a central counterparty (CCP), effectively taking on the risk arising from the trade for its clearing members; (c) it may also perform netting functions, offsetting a party’s trading obligations against the CCP. Clearing houses can be vertically integrated within a trading venue (such as Deutsche Boerse / Eurex Clearing) or can be standalone companies such as LCH.
[vii] This takes a more narrow approach than the European Commission, which in Deutsche BÖrse/NYSE Euronext assessed competition in exchange traded derivatives on markets comprising trading and clearing together (paragraph 243), although it recognised that alternative models existed for providing derivatives trading and clearing services to users.
[ix] The test for reference is whether the OFT believes that it is or may be the case that arrangements are in progress or contemplation which, if carried into effect, will result in the creation of a relevant merger situation; and the creation of that situation has resulted, or may be expected to result, in a substantial lessening of competition within any market or markets in the United Kingdom for goods or services. A ‘relevant merger situation’ is created if two or more enterprises have ceased to be distinct enterprises; and the value of the turnover in the United Kingdom of the enterprise being taken over exceeds £70 million; or as a result of the transaction, in relation to the supply of goods or services of any description, a 25 per cent share of supply in the UK (or a substantial part thereof) is created or enhanced. In the last financial year, LCH had a turnover over £70 million in the UK.
[xii] If the Article 4(5) referral is successful, the European Commission then has exclusive competence to assess the transaction, and member states are barred from applying their individual merger controls to it.
[xvii] Proposal for a Directive of the European Parliament and of the Council on markets in financial instruments dated 20 October 2011, at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2011:0656:FIN:en:PDF
[xviii] See for example third party concerns considered by the OFT in its review of the proposed acquisition of the LSE by Macquarie London Exchange Investments (2006): “if the LSE were to establish its own clearing house, this may create an ability to foreclose competing UK exchanges from clearing services”