London Stock Exchange chief Xavier Rolet aims to put last year's failed bid for Canada's TMX Group behind him by forging ahead with plans to diversify.

Higher charges on short-term funding for ailing Italian banks boosted LSE's quarterly income but analysts warned this revenue stream was not sustainable long term.

The LSE, which Friday comfortably beat quarterly revenue forecasts with a 17 percent rise, said it has completed its purchase of the remaining 50 percent of index firm FTSE and was continuing talks to buy clearing house LCH.Clearnet.

Our diversification strategy continues to pay dividends and the breadth and balance of our offering gives our portfolio a good element of natural hedge, said Rolet.

The exchange reported income of 196 million pounds in the three months to December, its financial third quarter, compared with an analyst forecast of 181 million.

The main driving force behind its growth was treasury income from its Italian clearing house, which rose 126 percent to 33.5 million pounds. But its main capital markets business was down 4 percent to 68.9 million pounds.

The headline LSE numbers are decent but they are skewed by the revenue from net treasury income which is not sustainable, said Peter Lenardos, an analyst at RBC Capital Markets.

The exchange's Italian clearing house CC&G, like other clearing providers, makes short-term deposits with clients, typically overnight.

This unit has benefited from increased demand for cash from Italian banks, whose borrowing costs in general have increased because lenders see them as more risky.

The LSE has been able to charge higher margins on these short-term deposits because of the risk that a bank could default.

NYSE EURONEXT PLAN B

Lenardos also cast doubt over the LSE's efforts to convince LCH.Clearnet shareholders to back that firm's 1 billion pounds sale to the British exchange group, citing confusion over the fate of NYSE Euronext.

One negative hanging over the share price is the deal with LCH.Clearnet, which seems to have stalled, pending the outcome of the Deutsche Boerse/ NYSE Euronext deal, Lenardos said.

Deutsche Boerse and NYSE Euronext, which agreed a $9 billion merger in February, are awaiting a decision from the European Commission Wednesday that will determine whether the deal goes ahead or has to be scrapped.

NYSE Euronext has said that it wants to own a clearing house and part of the rationale for the Deutsche Boerse merger is that the German group owns Eurex Clearing.

The collapse of NYSE Euronext's merger plan with Deutsche Boerse could then see the New York-based exchange lining up a bid for LCH.Clearnet, to rival the takeover by the LSE.

If I were a LCH.Clearnet shareholder I'd want to wait a couple of weeks to see if NYSE Euronext came in with a rival bid, said Lenardos.

The LCH deal is crucial to Rolet's reputation after his first major foray into the mergers and acquisitions market failed when Canadian exchange TMX Group shareholders rejected his 2.3 billion pounds takeover in June.

($1 = 0.6370 pound)

(Editing by Erica Billingham, Dan Lalor and Jodie Ginsberg)