DoJ challenges ownership of clearing

DoJ challenges ownership of clearing houses

By Jeremy Grant in Washington

Published: February 5 2008 20:04 | Last updated: February 5 2008 23:37

The US Department of Justice has called for clearing houses to be broken off from the futures exchanges that own them, throwing down a challenge to the business model that has propelled the CME Group to become the world’s largest futures exchange.

The move raises questions about the approval given by US antitrust authorities last year for the almost $12bn takeover by the CME Group of cross-town rival the Chicago Board of Trade.

It also comes as futures exchanges’ ownership of clearing has become a flashpoint between exchanges and their biggest users, banks and hedge funds.

The users say ownership of clearing allows an exchange to ensure that liquidity is virtually impossible to shift to a competing platform – and locks users into high fees.

The Justice Department’s latest position, in a letter to the US Treasury department, appears to contradict some of the rationale that underpinned the Department’s decision to approve the CME-CBOT deal, without any conditions, last year.

At the time, the antitrust authority argued there was no evidence that the CME’s control of clearing would keep competitors out of the futures business – a key complaint of banks and hedge funds.

In a June 11 statement, the antitrust watchdog said it had determined that “evidence does not indicate that either the transaction or the clearing agreement is likely to reduce competition substantially”.

However, some of the same officials involved said in the letter that the department now believed that “the control exercised by futures exchanges over clearing services…has made it difficult for exchanges to enter and compete in the trading of financial futures contracts.”

They recommended that Treasury “propose a thorough review of futures clearing and its alternatives”.

“We would expect that a change in the regulatory regime that eliminated exchange control of the clearing function would facilitate the emergence of greater competition between exchanges,” the letter, signed by Thomas Barrett, assistant attorney general in the antitrust division, said.

The department highlighted provisions in a law governing the futures regulator, the Commodity Futures Trading Commission, preventing the adoption of exchange or clearing house rules that “unreasonably restrain trade or impose a material anticompetitive burden on the markets”.

“In the Department’s view, these provisions reflect Congress’s desire to stimulate competition between exchanges and between clearing organisations,” it said.

The FIA, an industry body representing the biggest users of futures exchanges, welcomed the Justice Department’s call.

“The FIA has consistently supported polices that promote competition in the futures industry,” said John Damgard, president. “We agree with the Justice Department’s recommendation that the Treasury Department review whether exchange-controlled clearing of financial futures best serves market participants and the overall competitiveness of our financial markets.”

The scope of last year’s probe into the CME-CBOT merger was, among other things, to establish whether the combination – including the clearing arrangement - would unfairly shut out competitors. It did not address general reform of clearing in the futures industry.

However, the conclusions and timing of the letter suggests that some in the Justice Department have long been uneasy about the way clearing is organised in the US.

In contrast to the futures markets, clearing in the world of stocks and options is more commonly done by clearers that are independent, quasi-utilities, or partly owned by multiple exchanges.

The CME lobbied heavily in Washington, arguing that its purchase of the CBOT posed no problems on antitrust grounds. Market users argued that the Department of Justice should make a loosening of the CME’s ownership of its clearing house a condition of approval – and were disappointed when this did not happen.

About 70 per cent of CME Group’s revenue derives from trading and clearing fees.

Terry Duffy, CME chairman, said on Tuesday that separating clearing from exchanges made little sense. “It has created nothing but efficiencies for the end-user customer and has had a zero default in its hundred-plus year system,” he told the FT. “Why anybody would think it’s a good idea to spin that out would be beyond me.”

The CME on Tuesday reported a 96 per cent rise in net income for the fourth quarter.

In Europe, moves are already under way to prise clearing and settlement away from exchanges in order to offer customers the ability to pick and choose among post-trade service providers.

To back up its recommendations, the Justice Department cited two failed recent attempts by European exchanges - Eurex, the derivatives arm of Deutsche Boerse, and Euronext-Liffe - to prise business in some of the largest futures contracts away from Chicago’s exchanges as evidence that control of clearing unfairly shuts rivals out.

They said that eliminating “exchange control of the clearing function would facilitate the emergence of greater competition between exchanges”.

A clearing house guarantees that payments to be made under trades agreed by two parties are made, using collateral posted by the parties. Clearers make money by charging clearing fees, but also on the vast deposits lodged with them.

The department’s letter was sent in response to Treasury’s request for public comment on a planned “blueprint” for reform of the US financial regulatory system.

Robert Steel, undersecretary for domestic finance, will on Thursday update Wall Street on Treasury’s thinking in a speech in New York.

While the justice department’s letter has no effect on last year’s approval of the CME-CBOT deal, it re-opens the sensitive issue of clearing ownership just as the CME is poised to acquire the New York Mercantile Exchange, further bolstering the CME’s dominance.

However, the signatories to the letter - including George Baranko, an attorney central to last years’s CME-CBOT probe - said their comments did not apply to “energy futures markets” – a move apparently designed to indicate that the department was not prejudging the outcome of any probe into a CME-Nymex merger.

Commenting on Tuesday’s letter, a spokesman for the Justice Department said: ”In its comments to the Treasury, the Antitrust Division recommended a study to determine whether the current regulatory structure for interest rate futures transactions could be improved in a manner that would make entry easier. In the CME-CBOT transaction, the Division investigated whether the transaction would substantially lessen competition, which involved a range of issues. Among other things, the Division noted that the CME’s products and CBOT’s products were not close substitutes and that neither firm was likely to introduce products directly competitive with the other’s established products. In connection with one issue, entry, the Division noted that, given the announced intentions of two exchanges to offer interest rate futures products, the evidence indicated that entry would not be foreclosed by the transaction under the current regulatory structure. The Division did not comment on the separate issue of whether the regulatory structure could be improved.”

Additional reporting by Hal Weitzman in Chicago

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Top intelligence official revives Iran doubts

By Demetri Sevastopulo in Washington

Published: February 6 2008 03:05 | Last updated: February 6 2008 03:05

The senior US intelligence official on Tuesday stressed that a recent report on Iran had concluded that Tehran had halted only one part of its alleged nuclear weapons programme.

Admiral Michael McConnell, director of national intelligence, said the November national intelligence estimate had concluded that Tehran had ceased only efforts to covertly enrich uranium and design nuclear warheads. “The only thing that they’ve halted was nuclear weapons design, which is probably the least significant part of the programme,” he told the Senate intelligence committee.

Adm McConnell said Iran continued to develop uranium enrichment technology and longer-range ballistic missiles.

Critics of the US administration’s approach on Iran had seized on the NIE as evidence that the US had exaggerated the threat. In response, Robert Gates, defence secretary, gave a tough speech on Iran a few days later, stressing that the report had confirmed for the first time that Tehran had established a nuclear weapons programme.

A spokesman for Adm McConnell said on Tuesday he was not backing away from the NIE’s conclusions but simply concerned that there had been too much focus on one element of the report.

Adm McConnell was giving Congress his annual assessment of threats to the US. He also raised concerns about North Korea’s nuclear activities.

“While Pyongyang denies a programme for uranium enrichment, and they deny their proliferation activities, we believe North Korea ­continues to engage in both,” he said.

The US is trying to convince Pyongyang to provide a full declaration of its nuclear activities as part of a deal reached in six-party talks aimed at denuclearising the Korean peninsula. North Korea has already missed the deadline of the end of last year to provide the declaration.

Adm McConnell expressed concern about the increased ability of al-Qaeda to operate in the border area of Pakistan and Afghanistan, and said the organisation was improving its ability to attack the US.

He also raised concerns about a growing influx of “western recruits” into the tribal areas of the Pakistan-Afghanistan border since mid-2006.

At the same hearing, General Michael Hayden, director of the Central Intelligence Agency, confirmed publicly for the first time that the US had used the interrogation technique of waterboarding – or simulated drowning – on three detainees captured since the 9/11 attacks.

Gen Hayden said the CIA used the technique on Khaled Sheik Mohammed, the alleged mastermind of the attacks, and two other detainees. He said the CIA had not used waterboarding for almost five years.