Germans Enlist Help to Move Trillions in Swaps From U.K.

(Bloomberg) -- After the war of words on euro clearing and Brexit, the real action has begun.

Deutsche Boerse AG is building a service that can move trillions of dollars in derivatives trades from LCH Ltd. in London to its own clearinghouse, Eurex Clearing, in Frankfurt. It’s working with four companies to provide the technology for the move.

Eurex Clearing has enlisted interdealer brokers BGC Partners Inc. and Cie. Financiere Tradition SA, a subsidiary of Michael Spencer’s NEX Group Plc called TriOptima, and a firm called Quantile Technologies Ltd., a person familiar with the matter said. These four firms have been discussing how to handle the challenge with Deutsche Boerse, and will sell the switching service to their clients once it is ready.

The German owner of the Frankfurt Stock Exchange aims to receive positions from LCH long before the U.K. leaves the European Union on March 29, according to Matthias Graulich, a board director at Eurex Clearing. Banks and fund managers based in an EU country will lose access to LCH -- the world’s biggest clearinghouse -- if Britain leaves the 28-nation bloc without an agreement.

Compression Services

The four companies working with Deutsche Boerse all operate so-called compression services that banks and fund managers use to reduce the complexity of their interest-rate swap positions. The same services can be used to close a position at LCH and simultaneously create an identical position at Eurex Clearing without changing the risk being taken by the bank or fund.

Eurex Clearing is the only clearinghouse, or CCP, in the EU outside Britain that has the regulatory approval to clear trades of interest-rate swaps -- the world’s biggest derivatives market. The Frankfurt-based CCP has intensified its efforts to clear more swaps this year, but its share of the market is tiny compared with LCH, which is majority owned by London Stock Exchange Group Plc.

LSE on Friday announced that it’s increasing its ownership in LCH to more than 80 percent by acquiring a 15.1 percent stake from minority investors for as much as 438 million euros ($500 million).

“We are in discussion with providers of compression services who -- before Brexit -- can support facilitating switches from one clearinghouse to another,” Graulich, who runs the interest-rate swap clearing project at Eurex Clearing, said in an interview. “Facilitating the possibility to transfer risk from one CCP to another is an important aspect in particular for EU27 clients to prepare for Brexit.”

Tradition and NEX declined to comment. BGC, whose Capitalab unit runs its compression service, and Quantile Technologies weren’t immediately available to comment. A spokesman for LSE wasn’t immediately available to comment.

LCH looks after more than $200 billion of cash and bonds on behalf of the banks and funds that use it to protect their derivatives trades. It recently contacted the banks to remind them that it requires three months’ notice if a bank -- or a bank’s customer -- wants to switch its existing positions to a different institution, according to a person familiar with the matter, implying they must make a decision by late December to be ready for Brexit day.

The company, which is the biggest counterparty for most Wall Street banks, is the most important circuit breaker in the world’s financial markets. When a trader defaults, LCH ensures that the contagion doesn’t spread. In the 2008 financial crisis, the firm wound down a $9 trillion portfolio of swaps owned by Lehman Brothers without taking any of the collateral deposited by the other banks.

Eurex Clearing has separately agreed to let TriOptima use its compression service in its clearinghouse this December, Graulich also said. That’s the first time that it has allowed an outside firm to simplify interest-rate swap positions held by its members. By simplifying existing contracts, banks and funds will find it easier to add to their positions at Eurex Clearing.

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