Exchange Mergers May Concentrate Risk, Australia’s Medcraft Says
Mergers between exchange companies around the world may increase risks for investors as fewer companies handle derivatives trading and clearing, said the head of Australia’s securities regulator.
“It’s a logical conclusion, that if everything’s going through two clearinghouses there’s a concentration of risk,” Greg Medcraft, 56, chairman of the Australian Securities and Investments Commission, said in an interview yesterday. “You have to be careful about the unintended consequences of innovation.”
Global regulators are requiring more transactions to be processed through clearinghouses after the U.S. financial crisis triggered a $182 billion bailout of American International Group Inc. (AIG) when the insurer couldn’t make good on its trades. Exchanges have been the subject of $50 billion in attempted deals in the past three years, including Intercontinental (ICE) Exchange Inc.’s offer buy NYSE Euronext in December. CME Group Inc. approached Deutsche Boerse AG (DB1) to consider beginning talks on a merger, people familiar with the matter said last month.
Medcraft did not specifically identify any mergers. Richard Adamonis, a spokesman for NYSE Euronext, said the exchange had no comment on Medcraft’s statements, as did CME’s Laurie Bischel. Intercontinental’s spokeswoman Brookly McLaughlin declined to comment. Naomi Kim, a spokeswoman for Deutsche Boerse, did not respond to e-mails and a phone call.
Clearing in most Asia-Pacific countries with the exception of Japan is conducted by the dominant exchange operator. Hong Kong and Singapore are in the process of drafting rules for the clearing of over-the-counter derivatives.
Australia last month blocked plans to allow competition in equity clearing. LCH.Clearnet, the world’s largest clearinghouse for interest-rate swaps, will press ahead with an Australian application to process over-the-counter interest-rate swaps, the company said on Feb. 11.
ASX Ltd. (ASX)’s monopoly on clearing and settlement services was cited by Treasurer Wayne Swan as a reason for him rejecting a takeover bid in 2011 from Singapore Exchange Ltd., concerned that collateral would be held overseas.
Intercontinental offers trading in futures based on crude oil, natural gas, electricity, sugar, cocoa and financial products such as currencies and equity indexes. It owns the world’s largest clearinghouse for credit-default swaps.
The NYSE purchase would give Intercontinental futures based on interest rates that trade on the Liffe exchange in London. The company will also pursue opportunities to offer clearing for interest-rate swaps, the biggest part of the $639 trillion over- the-counter derivatives market, Sprecher said last month on a conference call with analysts.
Acquiring Deutsche Boerse would give CME the Eurex futures exchange, the continent’s largest by number of contracts traded. Deutsche Boerse has said it’s not in merger talks. A deal between the two companies may yield “significant cost savings” through shared systems for trading and clearing, Niamh Alexander, an analyst at KBW Inc., said in a report last month.
Antitrust concerns may not hinder a combination unless the so-called vertical model of futures exchanges, in which the market operator owns both the trading platform and clearing operation, prompt regulators to condition approval on a remedy such as spinning off a clearing business, Bruce Weber, dean of the Alfred Lerner College of Business and Economics at the University of Delaware, said in a February phone interview.
The European Commission blocked Deutsche Boerse’s takeover of NYSE Euronext in February 2012 because a combination would have put 90 percent of European exchange-listed derivatives trading in the hands of one company. Since then, several companies, including CME and New York-based Nasdaq OMX, have said they plan to introduce new markets to trade futures in Europe.
Companies from JPMorgan Chase & Co. to BlackRock Inc. are now required under the 2010 Dodd-Frank Act to have most of their privately negotiated swaps trades backed by a clearinghouse that’s capitalized by the world’s largest banks. That means dealers and their customers have to post upfront collateral to absorb losses if a firm defaults and settle daily losses.
Executives, traders and regulators are grappling over whether the shift in some swaps to futures contracts, known as futurization, constitutes a grab for market share by exchange owners such as CME or is a natural progression in the market as rules mandated by the Dodd-Frank Act take effect. Futures are agreements to buy or sell an asset or commodity at a specific price and time.
The U.S. Commodity Futures Trading Commission, which has regulated futures contracts since its creation in 1974, won authority under the act to oversee swaps, which had been largely unregulated since their development in the early 1980s.
A lobbying group, Companies Supporting Competitive Derivatives Markets, told a House Financial Services Committee hearing in December that the shift to futures was a consequence of the CFTC’s regulations. The agency should re-examine its rules because conversions could reduce transparency and competition in swaps, the group said in its testimony.
The coalition includes interdealer brokers and companies with trading platforms, including GFI Group Inc., Icap Plc, Thomson Reuters Corp. (TRI) and Bloomberg LP, the parent of Bloomberg News.
“You’ve got to make sure that counterparty risk is managed,” said Medcraft. “You can have alternative ways of making sure that the risk of counterparties is mitigated. You can incentivize them through capital requirements or you can just make sure margin requirements in OTC markets are appropriately targeted.”
The London Metal Exchange, owned since December by Hong Kong Exchanges & Clearing Ltd., plans to start its own clearinghouse next year, according to a statement from the company last month.
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