LSE building its defences

Information services has grown to become LSE’s largest division by revenue, following the transformational $2.7bn acquisition of index compiler and asset manager Russell Investments in 2014. The purchase of those brands – which were combined with its FTSE International business – gave the group the firepower to compete with index providers such as MSCI and the S&P Dow Jones and helped expand its presence in the US.

FTSE Russell Indexes grew revenue by 19 per cent at constant currencies to £309m during the first half of 2018. That business has benefited from the explosive growth in ETFs. Assets under management benchmarked by the FTSE Russell Indexes rose more than a fifth to $646bn. The rising popularity of passive and smart beta investing has also contributed to rising demand for information services, including real-time data. Between 2013 and 2017 FTSE Russell revenue grew at a compound annual rate of 32 per cent. What’s more, the high fixed costs associated with these types of businesses means there is plenty of potential for margin growth as the group scales up further. Management is targeting a group adjusted cash profit margin of around 55 per cent this year, up from 51.7 per cent in 2007.

Tighter risk management of derivatives trading following the financial crisis, which has been reinforced with the introduction of the new Markets in Financial Instruments Directive (Mifid II) last year, has boosted demand for clearing services. At the 2009 G20 summit global leaders pledged to reform the over-the-counter (OTC) derivatives market to improve the transparency of these financial instruments. That included a requirement for all standardised OTC derivative contracts to be traded on exchanges or electronic trading platforms and where appropriate cleared through central counterparties.

LSE’s majority-owned post-trade clearing business, LCH – in which it recently increased its stake from 68 per cent to 83 per cent – has benefited from this more stringent regulation. Its SwapClear business cleared a record notional $576 trillion during the first half, up almost a quarter on the prior year. Meanwhile the phasing in of new bilateral margin rules for uncleared derivatives from 2016 – including FX forward contracts – has also acted as a catalyst for traders to start clearing centrally, boosting growth for ForexSwap. In 2017 that business notionally cleared more than $11 trillion, compared with $3.2 trillion in the previous year. Further currency and equity market volatility, along with uncertainty over the extent of interest rate rises next year, could provide another shot in the arm for derivatives trading – and by extension clearing services.

Admittedly, the group’s capital markets business – which is more reliant on IPO activity and secondary fundraisings – could be hit by further market turmoil. However, that is becoming a much less important contributor to revenue. During the first half, it generated less than a quarter of the group total, down from almost half in 2010.

There has been inevitable concern over European access to London clearing houses in the event of a no-deal Brexit. However, in a bid to avoid disruption the European Commission has granted European derivatives traders a 12-month grace period, which would grant them access under equivalence rights.