Streetwise Professor Argues That Synergies in Clearing Are Pushing Exchange Consolidation
Commentary by Bob Zwirb
In a Streetwise Professor blog post titled "Clear the Way: LSE (and LCH!) on the Block," University of Houston Finance Professor Craig Pirrong discussed the implications of the proposed merger between the London Stock Exchange and Eurex. Professor Pirrong asserted that "consolidation is nearly inevitable": "With swaps clearing mandates, the scale of clearing has been increased so much, and [so many] new scope economies have been created, that the consolidated entities will inevitably be huge, and systemically important."
Professor Pirrong noted that although potentially large synergies exist on the clearing side – in particular, the "ability to portfolio margin across interest rate products" – they are overshadowed by the need for economies of scale to be involved in the kind of modernized clearing that is required to meet recent swap clearing mandates.
In addition, Professor Pirrong stated that the merger highlights "the new dynamics of exchange combinations. . . . Now it's all about clearing, and [over-the-counter] clearing in particular. Which means that systemic risk concerns, which were largely overlooked in the pre-crisis exchange mergers, will move front and center."
Commentary
A recent story, titled "Central Clearing Doesn't End Risk," in The Wall Street Journal cites a study by Ivana Ruffini of the Chicago Federal Reserve Bank's Economic Research Department. The study concludes that while central clearing "reduces risk through multilateral netting, collateralization of positions, pricing, and default management practices," it also "concentrates risk into a [central counterparty], and financial intermediation introduces new risks." In addition to concentrating risk, clearing mandates also increase what antitrust experts refer to as "market concentration" by reducing the number of firms in an industry, as Professor Pirrong's analysis illustrates. This effect is ironic, since one of the primary objectives of former CFTC Chairman Gary Gensler, a key architect of Dodd-Frank, was to promote greater market participation and prevent the markets themselves from being dominated by a handful of large institutions. It appears that the opposite is taking place in the derivatives market, due in no small part to the impact of the financial reforms enacted in 2010.