Rumblings and Mumblings at the FIA Expo

By Jessica Titlebaum (Chicago)

Mere days before the 25th Annual Futures & Options Expo began on October 21st, the Chicago derivatives market was all abuzz. The cause: the report last week by Crain’s Chicago Business that the CME Group was considering an acquisition of the Chicago Board Options Exchange (CBOE). Whether the acquisition will come to fruition is still in question, dependent on a resolution of a lawsuit between the CBOE and the Chicago Board of Trade (owned by the CME Group) concerning the ownership of CBOE. But that didn’t stop speculation about the potential acquisition from making its way through the Expo.

John Lothian, the publisher of the John Lothian Newsletters, believes that this is a ploy to put a price on the options exchange. “CBOE knows that to realize the value of their franchise they need to demutualize and conduct a public offering. It is only for that price information that they will be able to entertain any potential deals,” said Lothian.

But the Expo was about so much more than the rumored acquisition. In fact, many of the presentations and panels were focused on the clearing of Over–the-Counter (OTC) trades, the controversial privately negotiated transactions that take place outside of a financial exchange. The market—and the use of Credit Default Swaps (CDS) in particular— has been under heavy scrutiny, due to the role CDS contracts played in the financial decline of AIG and Lehman Brothers. However, mumblings in the industry reveal that more attention is starting to be paid instead to the growing Interest Rate Swaps (IRS) market.

According to the Bank for International Settlements, the IRS market is ten times the size of the CDS market. Statistics show that in December 2008 there was an outstanding notional amount of $418 trillion in interest rate contracts in comparison to the $41 trillion owed in credit default swaps. As of right now, LCH.Clearnet and the International Derivatives Clearing Group (IDCG) are the only two houses clearing Interest Rate Swaps. However, the CME Group is also building an IRS clearing solution.

Some of the other rumblings at the Expo arose around comments made by Neal Wolkoff, the CEO of the Electronic Liquidity Exchange (ELX), which launched in June with Treasury products and was designed to compete with the CME Group. The Commodity Futures Trading Commission (CFTC) recently approved ELX’s request to offer the Exchange of Futures for Futures (EFF), saying that the transaction does not violate the Commodity Exchange Act (CEA). An EFF is an off-exchange rule that permits market participants to buy and sell two futures contracts from two different exchanges offering the same product. In other words, someone could privately negotiate the sale of a futures contract on ELX and swap that position by buying or selling the same product at the CME Group. ELX clears through the Options Clearing Corporation so the trader would be closing a position at the OCC and establishing the same position at the CME Group. Wolkoff believes that the move will improve liquidity on the ELX market and provide market participants with clearing flexibility.

However, even with CFTC approval, the CME Group has issued a statement saying that they will not recognize the EFF rule. “CME rules already permit a firm or customer with an open position to liquidate that position by means of a legitimate block trade. However, in each case CME rules require, in accordance with the requirements of the CEA, that the block trade be a ‘legitimate’ rather than a ‘fictitious’ trade. The approval that was given to ELX does not impact how we operate our markets.”

“The CME Group is not used to competition,” Wolkoff retorted.

The CME Group isn’t ELX’s only competitor in this arena. NYSE Euronext struck an exclusive deal with the Depository Trust and Clearing Corporation (DTCC) to launch the joint clearing venture New York Portfolio Clearing. The initiative will bring together cash and futures contracts, something ELX is also looking to do. Since securities firms are obligated to clear Treasury notes and bonds through the DTCC, ELX finds it unfair for the DTCC to lock out other contenders with NYSE Euronext exclusivity.

“We are creating something that will be open to the markets,” said Lynn Martin, Senior Vice President and Head of Exchange Member Services at NYSE Euronext.

Martin said that Wolkoff does not understand the big picture. She explained that the Exchange was making a significant investment and exclusivity was important until they could streamline operations. New York Portfolio Clearing is awaiting regulatory approval by the Securities and Exchange Commission (SEC).

At the end of the week-long conference, there was, true to form, one last rumble in the derivatives market. A contrast to the friendly competition growing in the exchange arena, there seemed to be a coming together of a certain population – an underground gathering of 30 women in listed derivatives to discuss the initiative behind Women in Listed Derivatives (WILD). Lisa Causarano, from the International Derivatives Clearing Group, confirmed the group exists, adding that they will continue to reach out to influential women in the derivatives industry. What a fitting way to end a fascinating week!