Regulatory rumble

Futures, Mar 2008 by McMahon, Chris, Collins, Daniel P

DOH! J

Three days after the Department of Justice dropped a bombshell on the U.S. futures industry in a comment letter to the Treasury Department on regulatory structure, it denied the content plainly expressed in the letter.

In the comment letter, the DoJ stated it "believes that significant benefits might be achieved if regulatory policy were changed so as to foster exchange competition by, inter alia, ending exchange control of clearing (in conjunction with appropriate regulation to ensure that clearinghouses could not in turn exercise market power)." In the press statement that followed, the DoJ says "...comments did not take a position on what action, if any, that should result from such a study and contemplated that Treasury would take into account a range of considerations."

The DoJ letter created a firestorm and drew anger from commercial end users, a Commodity Futures Trading Commissioner and members of Congress and more importantly erased billions of dollars in market capitalization and shareholder value from U.S. futures exchanges.

The letter was sent in response to the Treasury's request for comments on the "Regulatory Structure of Financial Institutions," and was posted two months after the deadline for submissions.

Craig Donohue, CME CEO, said in a presentation to analysts the day after the letter was released, that the idea of adopting a securities style clearing utility for the futures industry is something that has been debated for some time and any change would require action from the CFTC and Congress. He referred to the DoJ letter as simply "one opinion" on the matter.

Donohue said during the presentation that for futures, vertical clearing is the industry standard, that horizontal clearing does not permit contract fungibility and that futures, which are designed by the exchange, are inherently different from equities, where utility clearing is the norm.

CME outside council Jerrold Salzman, of Skadden, Arps, Slate, Meagher & Flom LLP, noted during the presentation that the comments seemed to come out of the blue and that none of the other comments to Treasury addressed the clearing structure of futures.

"We take it seriously that somebody in the Department of Justice thinks that their job extends beyond enforcing the anti-trust laws and into making social policy in contravention to the findings of the Congress," says Salzman.

CFTC Commissioner Bart Chilton responded that the letter was more an editorial on futures industry practices than regulation and questioned the timing of the letter, which came out a week after the CME and Nymex Inc. announced that they were in merger negotiations. "The letter has, unfortunately, roiled the markets; this is precisely the kind of behavior that government regulators are supposed to take ordinary care and attention to avoid," Chilton noted.

In a letter to Treasury secretary Hank Paulson and Attorney General Michael Mukasey, Sen. Richard J. Durbin (D-IIl.) and Rep. Rahm Emanuel (D-IIl., and a former CME board member) objected to the letter and pointed out the immediate negative effect on CME stock, which lost more than $103 per share and $5.5 billion in market capitalization.

The Futures Industry Association (FIA), a longtime advocate of delinked clearing, issued a statement in support of the DoJ recommendation. "We agree with the [DOJ 's] recommendation that the Treasury Department review whether exchange-controlled clearing of financial futures best serves market participants," stated FIA President John Damgard. "A case can be made that people are paying more than they should for clearing and maybe if they introduced competition in clearing and execution it would benefit the end users," he later added.

By Chris McMahon and Daniel P. Collins