As expected the star of the show in Wednesday’s half year figures from the London Stock Exchange was its Italian clearing business.
Income was up 225 per cent on a year ago, as the LSE sweated the margin posted by clients of Cassa di Compensazione e Garanzia (CCG). By that, we mean the LSE parked the cash (around €5bn) with Italian banks, who are desperate for overnight deposits.
From the LSE half yearly report:
Treasury income through the central counterparty business continued the strong performance in the immediately preceding H2 period last year, rising from £34.6 million to £54.3 million as a result of stronger trading levels, with a resulting higher quantum of cash margin held, and rising deposit yields. The Group has achieved a significant and sustainable step up in performance, although the high returns achieved in recent months have been elevated by both volatility in Italian markets and continuing low liquidity in the Italian interbank market with consequent high demand for cash from CC&G.
(To put that figure in perspective its around 16 per cent of group revenues and a much higher percentage of group profits).
Now, that’s not as odd as its seems. All the world’s clearing businesses reinvest the margin and collateral posted by clients in overnight deposits, the repo market, commercial paper and the like. It’s standard practice and one reason why fees are so low.
The LSE has been fortunate enough to find itself in the right place at the right time. Italian banks need cash and have been prepared to pay up for it. In fact, it’s not just Italian banks but European banks with operations in Italy and the LSE making deposits for up to three days.
Of course there are risks. If, heaven forbid, an Italian bank went down the LSE are liable for the customer money they have put on deposit.
However, the LSE has a close relationship with the Bank of Italy and presumably has some line of sight as to which banks are strong and not so strong and can make investment decisions accordingly.
The LSE also been taking more practical steps.
Risk management in the CCP business has remained a key focus amid volatile markets, with frequent reviews of the highly prudent risk controls in place. Treasury investment policies have been tightened. Term deposits for cash margin placed with banks have been shortened and faster call-back facilities put in place.
And at the absolute extreme, we suppose, the Bank of Italy would stand behind its central counter-party in the event that one of its banks went bust. Because it really wouldn’t be good to have your securities markets freeze up. Well, that has to be the hope.
For investors the other question is whether earnings from CCG have peaked.
(Note the LSE is spending €62mn to buy out the minorities in the business. The seller is rumoured to be Unicredit).
Many analysts believe they have.
Merrill Lynch:
Our estimates assume net treasury income peaked in Q2FY12 (3 months to Sept’11) as we believe the recent hike in margin requirements at the LSE’s Italian clearing house (CC&G) could prompt some banks to switch business to the ECB repo facility where terms are more favourable. Our estimates assume H2 net treasury income down 36% sequentially.
JP Morgan:
Treasury income remained strong in October; our estimates assume a quarterly run-rate of £15m in future, a substantial decline from the result achieved in the first six months of the financial year (£54m).
At pixel time, shares in the LSE were 11p higher at 841p.
Related link:
LSE boosted by Italian clearing unit – FT