As they watched their respective share values plummet last Wednesday as a result of the Department of Justice's (DOJ) findings that financial futures exchanges that also act as clearinghouses are barriers to competition, the New York Mercantile Exchange (Nymex) and the Chicago Mercantile Exchange (CME) -- which are currently in talks for an $11 billion merger -- fired back.
The DOJ's concerns were made public on Feb. 5 when Thomas Barnett, assistant attorney general of the DOJ's antitrust division, argued in a letter to the Treasury Department that exchanges that also clear deals are bad for competition and are likely holding back innovation, noting that the operations might need to be separated.
In response, the Commodity Futures Trading Commission (CFTC), U.S. politicians, CME, Nymex and futures market participants rejected the DOJ's comments, while some also questioned the timing of the letter.
"I think separating clearing from the exchanges is the dumbest thing I have ever heard," said Ed Kennedy, a broker with Commercial Brokerage Corp. in Miami. "CME and Nymex are the two largest clearing entities in the United States and the clearing function is part and parcel of their exchanges."
Kennedy said he believes the DOJ's aim is misguided. "The big problem with the subprime financial crisis has to do with all of the swaps that were written where the counterparty was worth absolutely nothing," he said. "You don't have that with the regulated exchanges because the counterparty risk is handled by the clearinghouse. It is an entity that has full transparency and works. While we don't even know how big the problem is with the swaps written against the subprime mortgages due to the lack of transparency in that arena, the DOJ actually wants to focus on the regulated exchanges and screw up a model that works. It really is mind-boggling."
The CFTC chimed in on Friday in support of the current exchange clearing practices. "As the regulator of the futures markets, the CFTC is confident that the U.S. futures exchanges and clearinghouses are functioning well, especially during these turbulent economic times," said CFTC Acting Chairman Walter Lukken. "The CFTC continues to examine the industry's clearing structure as part of our broader mission. While recent Department of Justice comments on clearing deserve thoughtful analysis, we believe that the various clearing models that have developed in the U.S. meet the standards established by the Commodity Exchange Act."
Following the DOJ comments, shares of CME and Nymex spiraled lower on Feb. 6. CME shares closed at $485.25, down $103.55, or more than 17% on the day, while Nymex shares finished at $87.88, down $18.78, which also equaled more than a 17% drop on the day. To finish the week the shares of both companies made partial rebounds with CME closing Friday at $517.00 and Nymex closing at $95.87.
Nymex confirmed in late January that it was in talks to be acquired by the CME Group, owner of CME, in what would be an $11 billion cash and stock deal (see NGI, Feb. 4). The companies said they are engaged in preliminary discussions and have agreed to a 30-day exclusive negotiating period. Under the terms being discussed, shareholders of Nymex would receive $36 in cash and 0.1323 of a share of CME's common stock (the exchange ratio) in exchange for each Nymex share.
"The DOJ's comments are not a function of this merger proposal, but they are definitely coming up at an inopportune time for Nymex and CME," a New York analyst said. "This is a case of a DOJ attorney, who has perhaps been working in another area, looking into commodity trading and raising questions. I don't think it is something that has been an ongoing issue. We will have to see what the DOJ decides to do here."
Responding to Barnett's comments, Nymex last week said it believes that a market-driven regulatory structure can most efficiently and safely meet the needs of a broad array of derivatives market users, particularly during dynamic periods of growth and volatility. "The vertically integrated clearing model has stood the test of time for more than a century, including more than 80 years of federal regulation and Congressional oversight," the company stated.
Nymex added that by passing into law the Commodity Futures Modernization Act of 2000, Congress once again rejected an approach under which market structure would be "dictated by government fiat. By avoiding a 'one-size-fits-all' model, Congress has instead provided for substantial flexibility in how companies may organize their businesses and still comply with regulatory requirements. We continue to believe that Congress made the appropriate choice by focusing upon a free market solution that also involves both self-regulation as well as direct oversight by the Commodity Futures Trading Commission."
Nymex contends that any "mandate or fiat" that clearing of a given product must occur on numerous clearing organizations would actually "increase systemic risk and default risk" and also would "seriously undermine the ability of a proactive clearing organization such as Nymex to manage market risk."
CME similarly rebuked the comments by Barnett. "CME Group welcomes the opportunity to participate in industry discussions concerning market structure and the organization of clearing and settlement services, the company said Wednesday. "CME Group believes that market driven solutions and a range of choice in execution and clearing services best serves the interests of market participants."
CME also cited the Commodity Futures Modernization Act of 2000, noting that Congress "appreciated the merits" of a free market solution to the organization and ownership of clearing houses. "[Congress] rejected suggestions that clearing houses be taken from exchanges and converted into user owned utilities," CME said. "Congress adopted an extremely flexible approach to regulation that promoted innovation and competition by avoiding a one-size-fits-all model."
Late last week, CME posted a supportive letter on its website that U.S. Sen. Dick Durbin (D-IL) and Rep. Rahm Emanuel (D-IL) sent to the DOJ and Treasury Department. "We are writing to express our strong objections to Department of Justice's (DOJ) recent letter concerning its opinions on the structure of clearing and settlement services in the U.S. futures industry," Durbin and Emanuel wrote.
The lawmakers found the timing of the DOJ comments to be suspect, noting that they came more than six months after the DOJ cleared the CME merger with the Chicago Board of Trade and more than two months after Treasury's comment period regarding a financial market competitiveness initiative ended. The filing at Treasury is "an approach that raises concerns about both the substance of the letter and the manner in which it was filed." The lawmakers noted that the opinions in the DOJ's comment letter "are inconsistent" with its earlier determination to approve the CME/CBOT merger.
Durbin and Emanuel also took issue with the effect on CME's share prices on Wednesday, noting that the market capitalization of CME's shareholders was reduced by $5.5 billion in one day. The lawmakers quoted one Commodity Futures trading Commission member as saying, "The DOJ staff 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."
Durbin and Emanuel requested clarification of the content of the comment letter and the reasoning behind it being filed two months after deadline. They also seek to find out whether the DOJ considered the letter's influence on the markets prior to sending it.
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