From the February 01, 2008 issue of Futures Magazine • Subscribe!

LCH, ICE dispute leaves ECX cold

The European Climate Exchange (ECX) could lose its hard-earned position as the world’s leader in carbon emission reduction trading, thanks to a dispute between the Intercontinental Exchange (ICE) and its clearing and settlement house, LCH.Clearnet. That’s partly because ECX, which is a subsidiary of London-based Climate Exchange Group, isn’t a recognized investment exchange, but rather a brain trust with good ideas whose products — both exchange-traded and over-the-counter (OTC) — are regulated as ICE products and cleared through LCH.Clearnet.

Until recently, it seemed a match made in heaven, especially with emission reduction products increasingly being seen as part of the energy sector, which is ICE’s stock in trade.

But last July, ICE told LCH. Clearnet it would move its clearing and settlement business to its own clearing operation, ICE Clear Europe, effective July 18, 2008. Attention quickly focused on what would happen to any positions open at that time, with ICE assuming that member firms would transfer the positions to the new clearing house, and LCH.Clearnet requesting that ICE keep providing settlement prices so it can manage the positions that don’t transfer.

When ICE balked at that, LCH.Clearnet said it would not launch clearing for any new ICE products.

Meanwhile, ECX had been negotiating with LCH.Clearnet to develop futures on Certified Emission Reduction certificates (CERs), which are earned by companies in the developed world as carbon offsets by funding clean development projects in the developing world. ECX’s sister company, the Chicago Climate Exchange, launched CER futures in 2007, and ECX’s product was set to launch in September. Instead, it ran smack into the LCH-ICE dispute, much to the chagrin of ECX boss Patrick Birley, himself a former LCH boss.

“The development work on our CER products pre-dates ICE serving notice on LCH,” he says. “In fact, we’d all agreed to a September launch of CERs, but then LCH said we’re not going to carry on with that.”

The issue was put on hold in September, but complicated in December, when a group of London energy brokers, led by CantorCO2e and Spectron, asked LCH.Clearnet to clear their OTC contracts – some of which are essentially OTC CER futures look-alikes. LCH.Clearnet accepted the offer, and now says it’s in direct competition with ICE and thus ECX.

Birley, however, says ECX is not only still in talks with LCH.Clearnet, but is willing to let LCH.Clearnet offset any similar positions against ECX products, an offer ICE may have to sign off on.

Barring a breakthrough, ECX will have to sit tight on its CER futures as other exchanges launch clones.

In the long run, that may do little damage to ECX. The market for CERs is just now coming into existence, as projects that generate them begin to deliver quantifiable offsets. The cash market is using ECX’s prices for the European Union Emissions Trading Scheme (EU ETS), dubbed European Union Allowances (EUAs), as a benchmark for CERs.

“The number of CERs that have been issued is still small, and a number of people are using EUAs as a dirty hedge against CER portfolios,” says Birley. We’re encouraging members to continue using the EUA as a benchmark, or consider using the offering that we have in Chicago, but if there’s no solution with LCH, then we’ll have to ride it out until we have a clearing offering through ICE Clear when it’s launched.”

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