Panels on clearing have never been the most well attended panels during the annual Futures Industry Association (FIA) conference in Boca Raton FL. but clearing was the theme of much of the discussion during the recently concluded 2008 conference.
While the biggest news item may have been the announcement by the International Securities Exchange (ISE), Eurex and the Option Clearing Corporation (OCC) that they planned to create a transatlantic trading and clearing link that will allow Eurex customers to access ISE's options market using their existing Eurex connections, more interesting though was the unanimity of support for the vertical clearing model during a panel of exchange leaders. What used to be a vigorous debate regarding the pros and cons of the vertical vs. horizontal clearing model became an acknowledgement of the ascendancy of the vertical model.
Richard Sandor, chairman of Climate Exchange Plc., which owns the European Climate Exchange (ECX) and Chicago Climate Exchange (CCX), is warming to the vertical model.
Sandor said that outsourcing clearing to a utility clearinghouse makes sense for a start-up exchange but that model runs into problems as the exchange matures. Sandor commented on the difficulty of outsourcing clearing when your partner can turn around and compete with you as LCH.Clearnet has attempted to do with the ECX. “Is it rational to do business with an independent provider of clearing services now becoming your competitor,” Sandor asked.
New York Mercantile Exchange (Nymex) President and CEO Jim Newsome, who moved from regulator to exchange leader, pointed out that the Commodity Futures Modernization Act of 2000 did not “provide a right to be successful, just to compete.” The FIA and many of its large investment bank members noted shortly after its passage that it mandated competition in clearing, which they interpreted as giving FCMs the ability to select their clearing house.
The recent Department of Justice letter calling for a study of the Futures industry clearing practices comes at a time when the vertical model has emerged as the industry standard. CME Group CEO Craig Donohue concluded that the free market is saying that the horizontal model is not efficient. “It makes it harder to innovate.”
Intercontinental Exchange Chairman and CEO Jeff Sprecher said that their failure to have an in house clearinghouse has harmed its ability to innovate and get new products launched in a timely manner. ICE is in the process of moving clearing to its three clearing operations, transitioning from a model where they outsourced clearing to LCH.Clearnet.
Even Hugh Freeburg, chief executive at Euronext Liffe, a long time proponent of the horizontal model commented on how their model may have put them at a competitive disadvantage. “We want to be on a level playing field,” Freeburg said.
While the exchange leaders concentrated on how the vertical model allowed for greater innovation and market integrity, for others it was simply a matter of dollars and cents.
Richard Berliand outgoing chairman of the FIA who moderated the panel of exchange leaders said, “The rise of shareholder interest has produced this kind of consensus.”
Ron Filler, managing director for Lehman Bros. during another clearing panel, said, “Industry consolidation is being driven by revenues that can come from clearing.”
The one dissenting voice was Michael Cahill the president of the OCC, which clears for 10 active exchanges. He said that all of them would like to have a vertical silo but points out that the cost of OCC clearing to end users is 1.7¢ per contract. “Customers want us to operate as the low cost provider.”
One expert concluded, “The clearing space is where all of the entertainment will be.”
The reason for this is because as some exchanges transition to in house clearing operations, there will undoubtedly be a battle for the existing open interest. And while there is some precedent to this (the Chicago Board of Trade moving its open interest to the CME clearinghouse) few experts are willing to say that there is definitive legal ground as to how such transitions will unfold. One Eurex official told us that if they knew the open interest could unilaterally be moved from the former Board of Trade Clearing Corporation to the CME, their strategy for Eurex US may have been different.
Newsome pointed out that Nymex’s recent agreement with LCH.Clearnet will allow customers with open interest in ICE energy contracts at LCH to keep those contracts at LCH and trade identical contracts that will be listed at Nymex. “The end user community will have the opportunity to keep the open interest in the ICE products at the LCH.”
Sprecher seemed to acknowledge that he won’t have the ability to unilaterally move the open interest of ICE Europe products ala CME/CBOT; “My goal is that everyone has a consensus view.”
With a lot of transition in clearing services expected in 2008 it will be the space to watch.