MiFID, Moats and Market Structure

The first analyst question out of the gate on the CME Group’s quarterly earnings call this morning touched on a nagging concern: What about European regulators’ call for “open access” to derivatives trading venues and clearers, part of the EU’s January 14 informal agreement on the market structure directive known as MiFID 2?

The caller wondered: What does this mean for CME and other derivatives exchanges with “vertical” business models that don’t allow other exchanges to trade or clear their products? If “open access” takes hold in Europe, could it “creep over to the U.S.?” Two other callers posed questions touching on the same theme.

Seasoned observers of the U.S. regulatory scene have seen this movie before, exactly six years ago. On February 6, 2008, just a little over a month before CME Group announced plans to acquire NYMEX, the U.S. Treasury released a report from the Justice Department concluding that the “vertical” model was anticompetitive. (See the report here.)

CME’s stock dived after the Justice Department view was made public, though it’s hard to sort out the letter’s effect from that of the barrage of bad news about the financial system in that period. In retrospect, given the huge systemic challenges the world financial system was facing in early 2008, the timing of the letter’s release seems almost reckless. Compared with the OTC markets, exchange-traded derivatives markets were functioning relatively smoothly despite the crisis atmosphere of early 2008.

Several members of Congress scoffed at the Justice Department’s conclusions. And global regulators’ attention was quickly consumed by efforts to save the global banking system from the near catastrophic effects of Bear Stearns’s collapse in March and Lehman’s bankruptcy in September.

It’s not surprising that the “open access” issue would be revisited post crisis. But the moats around the business models of the derivatives exchanges may not be as deep as some believe. Paradoxically, there’s a good argument that competition among futures exchanges and clearers is pretty robust despite the consolidation of recent years. And maybe it’s not a bad thing if it takes substantial resources and expertise to enter into these systemically important businesses.

As for MiFID 2, CME officials noted on the call that the proposed language is broad, and the rules would not take effect until 2016. In the meantime, the CME is seeking clarification. CME Chairman Terry Duffy said on the call that U.S. Dodd Frank legislation rules out requiring one clearinghouse to take on the risks of another clearer. Changing that provision would “take an act of Congress,” he added.

It will now be up to the European Securities and Markets Authority to define “access.” Should futures products be fungible among major exchanges? To what extent can customers open a swap or establish a position at one clearing house and close it at another?

A CME competitor recently suggested that the notion of forcing the exchanges and their clearing operations into “open access” runs counter to regulators’ expressed goals. As Jeff Sprecher of IntercontinentalExchange told the Financial Times last week:

“What I don’t understand is why any regulator would want to now interconnect a bunch of clearing houses and re-link the very risk that they asked us to take on. It makes no sense to me from a risk standpoint. And if you’re going to do that, I don’t know why there should be a clearing mandate imposed on an industry. Because I’m not sure that the industry is going into a less risky environment than it would be if you just did everything bilateral.”

Bill McBride
February 4, 2014

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