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

Clearing the air

Oh to live in interesting times! With all the financial woes hitting global markets, worrying about the mechanics of clearing seems to be a low priority. But it’s not and here’s why: Last March during the Futures Industry Association’s (FIA) Boca Raton conference, the big topic was the fear of a “single silo” clearing house structure, practiced by the CME Group (and most other exchanges), and the danger it could hurt competition. The group think at the conference pushed the “multi silo” approach, that is the clearing house separated from the exchange. Examples of this could be seen in the past, such as the Chicago Board of Trade and the Board of Trade Clearing Corp.

During one panel with all the heads of exchanges under fire from two futures commission merchant (FCM) heads, the question was: how can you defend the single silo approach? How can you promise fees won’t go up arbitrarily? And almost to a person, each exchange head said not only did the single silo approach save money due to efficiencies, it also expedited the launch of product, a key in today’s fast moving environment. Even one of the last visages of the multi silo approach, Euronext Liffe, was moving toward a single silo approach. Nevertheless, as if to send the exchanges a warning, during the conference there was the “coming out” party for the new Electronic Liquidity Exchange (ELX) that would be a perfect example of an exchange the FCMs could love. After all, many were ELX shareholders, and thus wouldn’t be beholden to the whims of the CME Group et al.

The irony, of course, is during the crisis on Wall Street these last few months, as investment banks fell or were bought, it was the futures and options exchanges that have been beacons of stability and safe havens. Many firms moved trading to the exchanges to take advantage of the segregated funds and other safety nets and transparencies that are part of what makes the derivatives exchanges tick.

Further, the Wall Street debacle has accelerated the push to revamp the over-the-counter contract system and find ways to place some of the risky products that caused the financial problems occurring today to be cleared on-exchange. The famous credit default swaps (CDS), which seemingly all parties want cleared centrally, may finally find a place at one of the exchanges, most notably, the CME Group or Intercontinental Exchange (ICE). What’s a bit strange, as you’ll see in our Top 50 Brokers story by Managing Editor Dan Collins, is some exchange members are fine with CDSs being brought into the clearinghouse, but want them segregated from normal futures and options business. Seeing the toxic effect CDS products have had on huge investment houses, clearing members don’t want to “jeopardize” their funds on a product that is neither fish nor fowl. For the exchanges that need to publish new products or perish, this will be tricky. Yet it could mean a whole new world for on-exchange players, Wall Street mega firms and traders in general.

Although many FCMs quoted predicted a drop in on-exchange volumes next year, the speed of getting new and different products to market might change that view. A year is a long time in the markets; just look at how much the Top 50 Brokers landscape has changed in 12 months. Once again it goes to show that in a business that focuses on risk transference, change is the only thing that is certain.

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