Common clearing link and the ultimate game of poker

August 5, 2014 09:00 AM
Chicago vs. New York, and Frankfurt

Note: August represents the 500th issue of Futures magazine dating back to its origin as Commodities magazine in February 1972. As part of that celebration we have digitized some important stories from the past and are presenting some of the major events in the industry. Here we recount the Common Clearing Link between the CBOT and CME. It came during a historic period in the industry when exchanges and FCMs battled over who would control clearing. The Future of the CBOT literally hung in the balance as it faced down its greatest challenge. 

Common clearing link

The CFMA meant different things to different groups and to the Futures Industry Association (FIA) and the large bank future commission merchants (FCMs) that had come to dominate its leadership, it meant the potential of delinking clearing from exchanges.

In Chicago, the Board of Trade Clearing Corporation (BOTCC), which cleared all CBOT trades, was owned by clearing member firms. CME on the other hand owned its own clearinghouse. This was a bone of contention for large clearing member firms who wanted more control over the cost of clearing as they had with BOTCC. The FCM community also had for years pushed for cross margining at the two major clearinghouses, or better yet a merger. This blew up at a Commodity Futures Trading Commission (CFTC) forum in the summer of 2002, where the FIA would argue that language in the CFMA allowed FCMs to take their clearing business to the clearinghouse of their choice and perhaps provided a mandate to make futures contracts fungible.

This led arguably to the low point in broker/exchange relations in the history of the industry. The coming demutualization of exchanges had brokers worried that an exchange with its own clearinghouse would create a powerful monopoly and have enormous pricing power.

They would not stand for it. Many of the largest brokers would back a string on potential competitors, mainly to the CBOT bond complex. There was Brokertec, ELX, NYSE Liffe US and of course Eurex US, which perhpas offered the strongest challenge. None have been successful in gaining significant market share but the idea was to keep price pressure on the soon to be (or recently) for-profit exchanges. The CFTC did not accept the FIA’s argument and did not argue in favor of brokers moving margin and open interest to a clearer of their choice.

In a tactical coup the CME and CBOT announced the common clearing link in April 2003. It had delivered to the FCM world what they had been clamoring for but not quite in the way they envisioned it. FCMs would get the clearing efficiencies and margin offsets they had called for but would lose the control they desperately wanted. It would also serve as a forerunner to an eventual merger.

Around the same time, the CBOT had been looking for a new technology partner to host it electronic trading platform. Its existing deal with Eurex was troubled as it was signed in haste after the CBOT pulled out of the Globex arrangement and had to be reworked as the two exchanges disagreed as to what each side were to deliver. CBOT had to decide to stay with Eurex or choose Lifffe’s new electronic platform. Complicating matters was the knowledge that CBOT’s clearinghouse (BOTCC) had been separately negotiating with Eurex and that Eurex would likely launch competing interest rates contracts if CBOT chose Liffe.

CBOT went with Liffe. Eurex geared up to make a huge splash with its launch of its interest rate complex in direct competition with the CBOT.  The launch went well  as they had lined up professional traders and market makers. BOTCC agree to be the clearinghouse for Eurex US, changing its name to The Clearing Corporation. But when it was time for the first roll, the CFTC allowed the CBOT to seamlessly move its open interest from the former BOTCC to the CME clearinghouse. This was game, set and match.

Later a Eurex official confided that they would not have gone to the trouble if they believed the CBOT could simply transfer the open interest over.


About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.