ASX pitch in its best interests

The two clearing house subsidiaries that will receive 81 per cent of the $553 million that ASX is raising from its shareholders don’t make enough money in their own right to justify the investment.
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ASX chief executive Elmer Funke Kupper was right, however, when he said on Tuesday that there was really no choice. ASX needs the capital injection to stay in the global game, and keep its hopes of a mega-merger with a big foreign exchange alive.

Funke Kupper’s TISNA (there is no alternative) comment was directed firstly at a new regulatory hurdle the exchange faces. It needs to boost the quality of the capital in its equities clearing business, and boost both the quality and amount of default funding inside its futures clearing business to meet tough new global capital standards that are emerging in the wake of the great global financial debacle.

European regulators will require that futures clearing houses be backed by enough funding to cover not just the largest participant as now demanded, but the largest two participants.

There is a a $370 million default safety net inside the ASX’s futures clearing house right now, $150 million of it non-recourse debt, $100 million of it sourced from the ASX and $120 million from clearing participants. The safety net will expand to $650 million to meet the new standard, and it will be 100 per cent equity: $450 million will come from the ASX, which will use issue proceeds to replace the $150 million debt line and inject an additional $200 million, and $200 million will come from participants, half of it tied to the planned introduction of clearing of over-the-counter derivatives.

The ASX’s share-clearing subsidiary is separately backed by $250 million of default funding. That will not rise, but $100 million of non-recourse debt will be replaced with $100 million of new ASX equity sourced from the share issue.

The issue is pitched at $30 a share, 16 per cent below last Friday’s closing price and 23 per cent below a peak of $39.15 reached on May 22 before the market correction. It will raise $539 million after underwriter and long-time ASX adviser UBS, lawyers and others are paid, and ASX will retain $89 million after injecting $450 million into the clearing houses.

ASX reports only the share clearing house’s revenue contribution. Futures clearing income is lumped in with futures trading income. Based on the equities clearing house’s 37 per cent share of total equities revenue and ASX’s overall earnings before interest, tax, depreciation and amortisation of 77¢ in the dollar, however, the futures clearing house’s return on expanded equity will fall from about 15 per cent to 8 per cent, and 12 per cent for ASX’s funding share.

ASX is nevertheless moving a bit early – it doesn’t need to seek European authorisation to continue clearing until mid-September and a decision could take another nine months – and it is doing so because the funding move has a major strategic overlay.

By embracing the new regulatory regime ASX adds momentum to a planned expansion of a derivatives business that has already lifted the derivative business’s share of group revenue from 24 per cent to 31 per cent since 2009-10, making it the group’s biggest revenue centre. Sharemarket revenue has fallen from 25 per cent to 18 per cent over the same time, and the gap could widen as ASX adds new derivatives services including over-the-counter derivative clearing, and client clearing.

That may not restore the clearing business’s return on equity. It should however boost returns over time, and more importantly, ASX is maintaining its status as an exchange that offers the world trading, clearing and settlement of both equities and derivatives including interest rate futures, where it is the fourth-largest exchange in the world and the largest in Asia, with turnover of about $44 trillion a year.

That sort of horizontal and vertical integration is the holy grail for the exchanges, and it makes ASX a potential merger player under a Coalition government despite its unsuccessful attempt to merge with Singapore Exchange in 2011. Only four other exchanges have similar breadth and depth: Deutsche Bourse, the Toronto Exchange, and two others in this region – Singapore Exchange, and the Hong Kong Exchange.

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The original release of this article first appeared on the website of Hangzhou Night Net.

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