Ice Concepts (EU:ICE)
Historical Stock Chart

From Dec 2019 to Dec 2024

The top executive of CME Group Inc. (CME) defended in Washington on Wednesday the U.S. market structure for futures trading, a structure that critics said gives the world's biggest futures exchange an unfair advantage over rivals.

Craig Donohue, chief executive of CME, told regulators that U.S. futures exchanges must be allowed to both trade and centrally clear contracts to compete against foreign-based rivals that operate in a similar fashion.

"We're competing on a global basis," Donohue said, testifying before regulators in a hearing on regulatory harmonization. "Ninety percent of the exchanges we compete with are clearing their products in vertically integrated structures."

So-called vertical integration of clearing, which is not allowed in U.S. securities and options markets, is a key profit center for futures exchanges like CME, because it requires traders to buy and sell contracts on the same venue.

In securities and options markets, investors can put on a position at one exchange and take it off at another, a practice known as fungibility.

Wednesday's hearing saw several experts call on the Commodity Futures Trading Commission to revisit the issue of fungibility in futures markets, as futures and securities authorities sounded out the industry on how regulators might reconcile their respective oversight functions.

"In options, the common clearing mechanism has resulted in multiple competing markets," said Annette Nazareth, a former SEC commissioner who also testified Wednesday. "What we see in the futures markets, in my view, is quite different."

Regulators on both sides of the Atlantic have previously examined the competitive impact of vertical integration in the derivatives sector.

CME's share price fell heavily in January last year when a leaked Justice Department memo suggested that the issue be reopened, while Deutsche Borse (DB1.XE) has also lobbied hard against concerns raised by the European Commission about combining clearing and trading.

However, regulators' focus on reforming over-the-counter derivatives markets has revived the fungibility issue in Washington, as authorities seek to standardize swaps so that they can be cleared at multiple clearinghouses in a bid to mitigate systemic risk.

Lawrence Harris, a professor at the University of Southern California who also testified Wednesday, said fungibility would improve prices for futures investors by fostering more intense competition among exchanges.

Neal Wolkoff, CEO of New York-based ELX Futures, which is challenging CME's dominance of Treasury futures markets, has also joined those calling for regulators to reexamine vertical integration of clearing in the U.S.

But CME's Donohue stressed that more innovation and research goes into developing exchanges' proprietary contracts, as opposed to vanilla cash equities and options contracts.

He added that systemic risk could rise if regulators try to reconcile credit profile differences across different futures clearinghouses, along with the operational risks involved in transferring positions and customer funds.

Anthony Leitner, managing member of AJ Leitner and Associaties LLC, agreed on this point.

"How do you unwind and take out those positions in two clearinghouses?" he asked regulators.

Jonathan Short, general counsel for Atlanta-based IntercontinentalExchange Inc. (ICE), said authorities must keep in mind the intrinsic differences between securities and futures markets as the SEC and CFTC work to harmonize regulation.

"You could end up hurting those two markets if you try to put a square peg in a round hole," Short said.

-By Jacob Bunge, Dow Jones Newswires; (312) 750 4117; jacob.bunge@dowjones.com