NYSE’s Reputation And Derivatives Business Can Gain From LIBOR Win

NYSE Euronext (NYSE:NYX) announced this week that it will take over the administration of the London Interbank Offer Rate (LIBOR) from the British Bankers’ Association (BBA). LIBOR is a set of indices calculated for ten currencies and 15 borrowing periods, and represents the short term borrowing costs for large global banks operating in London financial markets or with London-based counter-parties. It is one of the world’s most widely used benchmarks for determining the cost of short term loans with securities worth at least $350 trillion benchmarked against it around the globe. ^[1]

The announcement came after the U.S. exchange outbid three other companies, including the London Stock Exchange, in a tender process for gaining control of the benchmark rate. ^[2] The tender was held because the banks involved in calculating LIBOR were found to have rigged the benchmark rate during the financial crisis of 2008. This caused widespread criticism about the way in which the benchmark rate was calculated, and led the U.K. regulators to recommend that the BBA be stripped of its responsibility of managing the LIBOR. The U.K. Financial Conduct Authority was regulating the benchmark on a temporary basis since then and the selection of NYSE as the new administrator is an important milestone in the LIBOR reform process. The handover is expected to be completed by early 2014. (Read more about the LIBOR scandal here)

See our full analysis for NYSE Euronext

We believe that this development is a major accomplishment for NYSE even though it may not be a big deal financially. The U.K. regulator’s decision to hand over the administration of this benchmark rate to NYSE endorses the strength of the company’s systems, infrastructure and governance. Further, since LIBOR is widely used to benchmark derivative contracts around the globe, the image boost from this decision should be helpful to NYSE LIFFE, which is a major player in the European interest rate derivatives market and is prepping to defend its market share from new entrants like the CME Group (NASDAQ:CME).

Market Data Revenue To Be Positively Impacted But No Direct Impact On Valuation

We believe that this a good deal for NYSE Euronext and is going to positively impact its market data revenue. According to the Wall Street Journal, the exchange operator is paying only a token amount of £1 (or $1.49) for LIBOR, while the current revenue from the benchmark is estimated to be around £2 million (about $2.98 million) per year. ^[3] Given the negligible costs involved in acquiring the entity, the transaction seems to be profitable for NYSE and should be additive to the company’s market data revenue.

However, the direct impact from this deal on the company’s valuation is expected to be insignificant. That is because $2 million is less than 5 basis points (0.05%) of NYSE Euronext’s total revenue and only 0.5% of its net income. With such a small contribution, any potential increase in the LIBOR licensing fee is unlikely to impact the exchange operator’s valuation in a major way.

However, The Image Boost May Be Invaluable

NYSE Euronext won the control of LIBOR by beating three other companies – namely the London Stock Exchange, Bloomberg LLP and Markit – in a bidding process. ^[4] Since the bidding amount is reported to be only £1, it is clear that the U.K. regulators did not expect to gain financially from the transaction and were only concerned about restoring the reputation of the benchmark. As evident from the tender notice, they chose the best candidate based on governance track record, business model and financial strength, among several other criteria.

Hence, the fact that NYSE Euronext was chosen over other strong players like the London Stock Exchange seems like a major endorsement for NYSE Euronext’s governance procedures, and is likely to boost its brand in Europe. The decision should especially be helpful for the company because its LIFFE business is one of the major players in the European interest rate derivative segment, where a lot of contracts are benchmarked to the LIBOR.

This Is Another Positive For The IntercontinentalExchange’s European Derivatives Campaign

The European derivatives market accounts for a large share of derivative trading around the world and is set to grow rapidly in the coming years as regulations such as the Dodd Frank Act in the U.S. and EMIR in Europe push over-the-counter (OTC) derivatives towards centralized clearing channels. This has captured the attention of some of the world’s largest securities exchanges and they are trying to expand into the region to benefit from this growth. While the CME Group, which is the world’s largest derivatives exchange, is building out its European derivatives business from scratch, its archrival the IntercontinentalExchange (ICE) is in the process of acquiring NYSE Euronext in order to gain control of NYSE LIFFE, the leader in the European interest rate derivatives market. (Read more in our previous article here)

Among all the new entrants, ICE has a clear advantage because of its acquisition of NYSE Euronext. Once the acquisition is complete, LIFFE will provide it with a ready-made platform to race ahead of other new entrants in this market. The fact that NYSE now has control of LIBOR is another plus for ICE because it will become the new owner of LIBOR after the acquisition is complete. This is likely to increase ICE’s credibility in the market, differentiate it from other players, and facilitate the acceptance of its products.

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1. Behind the Libor Scandal, New York Times, July 10, 2012 [↩]
2. NYSE Euronext to Take Over Libor, New York Times, July 9, 2013 [↩]
3. Sold for £1. NYSE Euronext Takes Over Libor, Wall Street Journal, July 9, 2013 [↩]
4. Lombard: NYSE’s Libor victory shows who washes cleanest wins, Financial Times, July 9, 2013 [↩]