DOJ: Futures Structure 'Anti-competitive'
CME, Nymex say vertical clearing key to global competitiveness
February 11, 2008
The U.S. Department of Justice (DOJ) last week called the vertical structure of U.S. futures exchanges anti-competitive and costly for investors. Though the statement is unlikely to result in imminent regulatory changes, it highlights the growing concerns that have prompted global banks to launch competing execution venues.
The DOJ's letter, issued on Feb. 6, was a response to the Treasury Department's request for comments, filed in October, on how best to bolster U.S. competitiveness in the capital markets. The 22-page letter cites the DOJ's experience investigating anti-competitive behavior across the U.S. financial markets and concludes that "current rules and policies related to clearing futures contracts may be unnecessarily inhibiting competition among futures exchanges in the development and trading of financial futures contracts, to the detriment of the economy and consumers."
The biggest U.S. futures market operator is CME Group, consisting of the Chicago Mercantile Exchange and Chicago Board of Trade (CBOT), which merged on Dec. 7. The group announced last month that it was in talks to buy the New York Mercantile Exchange (Nymex) for $11 billion in cash and stock. Each of those exchanges has cleared its own listed products--a vertical business structure, unlike the equity and options markets, and one that critics have long said inhibits competition and inflates fees.
The DOJ letter contains those criticisms and recommends that Treasury "undertake a careful and objective review of exchange-controlled clearing of financial futures, the regulatory structure that underlies it, and its alternatives."
Interpreting that language as a threat to CME's healthy profits, investors unloaded the exchange's stock, slashing its price 17.5 percent on Feb. 6, to $485.35 per share from $588.80. The price recovered somewhat the following day, closing at $528.01.
Richard Repetto, an analyst at Sandler O'Neill & Partners, called the letter a "non-event," adding, "No one is going to act on this DOJ letter."
Repetto said the agency may be laying the foundation for an antitrust action, in the event CME agrees to acquire Nymex. The DOJ letter is a "direct contradiction," he said, to one it issued in June supporting CME's purchase of CBOT. In that letter, the DOJ claims that neither "the transaction or the clearing agreement is likely to reduce competition substantially"; product innovation stems less from competition between the exchanges than "winning business from" the over-the-counter market; and consolidating their clearinghouses would not stop new entrants.
Still, the agency's new statement has met with some fanfare. "The DOJ's recommendation is an amazingly intelligent analysis," said a market participant who asked that his name not be disclosed. "It's extremely courageous politically because the exchanges are one of the strongest political lobbies in the U.S."
Exchanges React
In a statement issued by CME Group on Feb. 6, the company said it "welcomes the opportunity to participate in industry discussions concerning market structure and the organization of clearing and settlement services."
Calling vertical clearing the "industry standard," CME noted that, "unlike domestic stock and options exchanges, domestic futures exchanges compete directly with non-U.S. futures exchanges, where 70 percent of all futures and options contracts traded globally are cleared on or through exchange-owned or -controlled clearing facilities. Any failure to recognize that fact would create an un-level playing field for U.S. futures exchanges at a time when U.S. futures exchanges are the strongest example of how to maintain our overall competitiveness in global financial markets--a key area of concern in recent times."
