IFR-ELX ups pressure on CFTC over portfolio margining

LONDON, Nov 1 (IFR) – Start-up exchange ELX Futures is
slowly bringing the market’s attention to the CME’s monopoly of
futures clearing in the US. By raising the question of whether
current portfolio margining arrangements are anti-competitive,
it has given more formality to previously closed-door

ELX sent a letter to the Commodity and Futures Trading
Commission last week in an attempt to promote awareness of the
potential that portfolio margining, or the ability to post cash
for a total cross-asset derivatives position, can have in
limiting competition between execution venues that own and
control their own clearing houses and those that do not.

ELX wanted to affect both the informal and the formal
discussions taking place ahead of any forthcoming rule-making on
portfolio margining procedures.

The CFTC has not put the issue out for public comment yet.
If the Commission publishes a notice of proposed rule-making or
an advanced notice of proposed rule-making on portfolio
margining, then an official public comment period would
commence, but that is still being decided, according to a CFTC

At issue is whether or not it should be accepted practice
for instruments other than those already traded and cleared on
the CME to enjoy the benefits of portfolio margining.

The CME garners the bulk of trading in regulated futures and
in options on futures. But while it permits the clearing of
off-exchange swaps, particularly within the energy and metals
space, it draws the line when it comes to interest rate
instruments that are executed other than on its own platform.

Since the off-exchange swaps are converted to futures for
clearing purposes, they enjoy the benefits of cross-margining in
a single pool with associated futures contracts. “We’re not
saying that there should not be portfolio margining, we’re just
saying if they [CME] receive portfolio margining on futures and
swaps, that it be done by an open process and not by a 4-d
process,” said Neal Wolkoff, CEO of ELX Futures.

“Any kind of favourable relief like that should be
conditioned on the CME agreeing essentially to position
transfers so that others can benefit from these swaps as well.

It shouldn’t just simply allow them to say ‘well, we have a
monopoly on futures’,” he said.

The issue of portfolio margining follows another bone of
contention between the exchanges, which flared up last August
over the fungibility of contracts known as exchange of futures
for futures (EFF), or the process of establishing futures
positions on one exchange while at the same time liquidating
futures positions on another.

In contrast to the views held by the CME and CBOT, the
Commission clearly stated that EFF trades, when solely used to
liquidate and establish similar positions on different
designated contract markets, were not fictitious. It did,
however, keep the door open for the CME to block the
transactions. As it stands, CBOT’s rules do not allow the
execution of EFFs.

Though portfolio margining is not high on the regulatory
agenda at the moment, Wolkoff noted that even a “behind the
scenes” discretionary action could lead to tremendous fallout as
far as making the future market for clearing services less
competitive was concerned. “We think the CME should be required
to allow position transfers to facilitate competition,” he said.
If the issue was not resolved, Wolkoff likened it to a de facto
order prohibiting competition in swaps clearing since it would
all be cleared at the CME. “It’s like saying let’s just have one
clearing house. That of course puts a tremendous amount of
additional power in the hands of a single entity.”

Other participants believe the discussions could get uglier.
“From a legal basis, ELX is a thorn in CME’s side. That pressure
is not going away,” said Ed Ditmire, market structure analyst at
Macquarie Research. “On the other hand, it’s not as if
regulators have responded to the ELX in any real material way so
far,” he added.

ELX, which was founded by various bank institutions, was
designated as a contract market (DCM) in May last year.

“From the ELX perspective, this is taking a very long time.
For the CME, if there was going to be a ‘not guilty’ verdict,
they would like to have it resolved quickly. If it is more
complicated than that, they are probably fine with it taking a
very long time,” Ditmire said. Allowing customers to
cross-margin their interest rate swap positions against their
interest rate futures positions should in theory drive better
capital efficiencies for customers. “If the CFTC rules in ELX’s
favour, CME’s competitive challenges could be materially higher,
as a key barrier to competition would be weakened,” added

The CME has maintained in its discussions with regulators
that futures are a different animal to other securities, and
that the fungibility that existed between exchanges in the
options markets should not be adapted to the trading and
clearing of futures. Futures dealers, while not averse to
competition, agree. As one head dealer notes, levelling the
playing field for cross-margining has the potential to fragment
the futures market.

“We don’t want to see what’s happened in the equity space
happen in the futures space,” he said, noting that trading
volumes had been down in Europe because of split liquidity.
“Having a secondary exchange is good, but at some point if we
open it up to everyone, you just have greater fragmentation,” he

Indeed, maintaining US competitiveness in the futures market
is a key concern.

“At the end of the day, in the global futures markets the
global standard contracts are not fungible,” said another equity
analyst. “So for a US-based regulator to change the rules
without having any other regulators change the rules, it would
put US-based exchanges at a competitive disadvantage.”

Kathleen Hoffelder

IFR-ELX ups pressure on CFTC over portfolio margining