Commentary: The Futures Exchanges Have Learned Nothing

In March, amid the swaying royal palm trees at Florida's ritzy Boca Raton Resort & Club, leaders of some 50 global futures exchanges sat together at a giant U-shaped table, determined to show that they had learned a lesson from the 1995 disaster at Barings PLC. After all, if authorities in Japan and Singapore had compared notes on the activities of Barings trader Nick Leeson, he never would have racked up the $1.4 billion in losses that eventually brought down the venerable British bank. To prevent another such debacle, the futures executives agreed to sign a sweeping information-sharing accord, each pledging to provide key data when the next trading crisis arose.

Now, though, in the wake of Sumitomo Corp.'s copper-trading fiasco, the deal struck under the Florida sunshine looks half-baked. Both the London Metal Exchange and the New York Mercantile Exchange signed the pact on Mar. 16. But the world's two competing copper exchanges haven't shared one whit of information about Sumitomo. The LME never answered Nymex questions raised months before the crisis became public or shared data with the New York exchange after Sumitomo announced a $1.8 billion loss in its London trading on June 13.

NO REPLY. On the morning after Sumitomo's bombshell, Nymex President R. Patrick Thompson arranged a conference call with LME Chief Executive David King to ask crucial questions: How would the Japanese bank unwind its positions? Would members of Nymex who also trade in London be put in financial jeopardy? What action should be taken--or avoided--in the U.S. to maintain an orderly market?

Thompson never got any answers, and that left him to operate in the dark. Twice in three days, Nymex raised its margins--the downpayments required to trade--to curb volatility. But without communication from the LME, Nymex had no way to tell whether its margins were adequate. "We really didn't have any information. That's why we feel so frustrated," Thompson gripes.

LME's King says his duty to protect Sumitomo's privacy kept him from sharing data about the firm with Nymex. Instead, he says, he shared what he knew with London regulators, who were in touch with the U.S. Commodity Futures Trading Commission. But Thompson says key information never reached Nymex.

The halting response to Sumitomo's loss illuminates crucial weaknesses in the exchanges' March pact. For one thing, since the exchanges are the first line of defense in a market emergency, they need information right away. As Thompson says: "If anything has to be done, we are the ones who have to do it." Yet the pact leaves direct, market-to-market communication an option rather than a requirement.

Another problem: The exchanges' controls and monitoring procedures vary widely. For example, while the U.S. has strict rules requiring large traders to report positions daily, Britain does not. In practice, London exchanges collect such information by jawboning. The LME gathered "95%" of the data it sought before Sumitomo announced its loss, King says. But he's mum on details, and critics doubt that the LME was keeping adequate tabs on the bank's trading. Says one U.S. official: "A lot of business flows to the LME at the expense of Nymex because they don't have a rigid system for monitoring trades."

NO EXCUSES. Exchanges still can't rely on their counterparts for the information needed to contain risk--pact or no pact. That sets the stage for more Barings, Sumitomos, or, worse, a crisis in which no deep-pocketed savior steps forward to cover the losses.

To make the exchanges' pact work, two key reforms are necessary. First, minimum global regulatory standards must be established. For example, every exchange should require that large traders post cash margins and report their positions daily. Exchanges should make it their business to know who is making big trades. Second, legal or regulatory barriers that discourage exchanges from sharing information with each other should be eliminated. There should be no excuse for cutting off direct communication.

No doubt, implementing such steps will be difficult. But without them, the pact that the futures folks signed in Boca Raton will be about as forceful as a tropical breeze.

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