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CME, ICE Evolve Ahead of Dodd-Frank Implementation

Joining the race to transition a fair amount of swaps and over the counter (OTC) business to a cleared futures model before more rules under the Dodd-Frank Wall Street Reform Act take hold in the coming months, CME Group last week launched a broad suite of new natural gas and power contracts that will be listed as futures on CME Globex, the New York Mercantile Exchange (Nymex) trading floor and CME ClearPort, and will be available for trading on CME Direct, a platform offering side-by-side trading and straight-through processing and clearing of exchange-listed and OTC energy markets.

The move follows rival IntercontinentalExchange's (ICE) announcement in late July that all cleared OTC products listed on its OTC energy market will be transitioned to futures products (see NGI, Aug. 6). Cleared North American natural gas, electric power, environmental products and natural gas liquids swaps will be listed as futures on the energy division of ICE Futures U.S. Cleared oil products, freight and iron ore swaps will be listed as futures on ICE Futures Europe.

The clock continues to wind down on the deadlines to comply with the Dodd-Frank Wall Street reform act as rules continue to come online following the legislation's enactment in 2010. The exchange-tweaking moves in recent weeks by ICE and CME would appear to be a way for the exchanges to minimize the impacts or work around the new rules.

The Commodity Futures Trading Commission (CFTC) last week clarified its regulations with respect to when a swap dealer will be required to register with the agency under the new Dodd-Frank Wall Street reforms (see related story).

"CME's move...to list more natural gas and power contracts as futures contracts comes as no surprise," said Steve Blair, a technical analyst with Rafferty Technical Research in New York. "Ever since ICE announced their plans in July, everyone expected CME to follow suit, and that's what we saw... I don't think it is so much an attempt to manipulate or get around Dodd-Frank; I think it is an attempt to make it easier for all parties involved to stay in compliance and work within the limits that are being imposed on them. I'm also not sure that these actions will completely get rid of the traditional swaps market. It might just tone it down a bit."

Thanks to the Dodd-Frank rules, Blair said one of his hedge fund customers told him they were expecting to do more business via ClearPort than they had been doing bilaterally. "But the switch isn't really coming from the customer or hedge fund side, it has more to do with the swap dealer side, like the big banks, which are struggling with the new regulations, especially position limits," he told NGI. "These recent moves by the exchanges will likely make things much easier for the banks because they will be doing business on an exchange cleared level rather than bilaterally. In my opinion the banks likely approached the exchanges about this problem, and the exchanges see this as a way to bring more business through their exchanges. This is why they are eager to change a lot of their swaps contracts into swaps futures contracts."

However, a California-based broker said the moves by the exchanges would likely impair the big banks, because it is going to bring everything into the open. "I view [last] Monday's CME action as following the footsteps of ICE in moving present OTC products into a cleared futures environment," the broker told NGI. "That is the thrust of Dodd-Frank. Get all of these contracts onto an exchange so they can be margined, marked to market and nothing gets out of control. This has been coming for the last three years.

"Big speculative accounts like banks and hedge funds aren't going to like it because of those requirements," he added. "It's my understanding that even now large traders can do deals using ICE pricing in a noncleared format between themselves without adhering to the clearing requirements and margining of an exchange. Dodd-Frank brings, or attempts to bring, everything onto exchanges. If these banks and hedge funds are going to do these mega deals between themselves, bring it out into the open."

CME's announcement follows the May introduction of CME Direct, which offered industry participants access to CME Group's suite of global benchmark energy products, including Henry Hub Natural Gas. CME Direct launched in May 2012 supporting trading for CME Group's energy complex, which has average daily trading volumes of approximately 1.9 million contracts.

"The addition of these contracts vastly expands the breadth of listed products offered on CME Direct and offers our customers in the natural gas and power markets new trading strategies that better meet their needs," said Gary Morsches, managing director of Global Energy at CME Group. "This offers a fuller, more robust trading and clearing solution for our customers as they manage risk in the energy markets."

The new natural gas and power product suite includes 164 natural gas contracts available at 52 trading hubs and 48 power contracts for the four most liquid North American independent system operators. CME said it also offers market participants several new trading strategies, including calendar strip and strip spread pricing, intra-month calendar strip trade pricing, cross basis swaps, and ISO and DART spreads for the power markets. All of these contracts are listed by and subject to the rules of Nymex.

"With unparalleled access to CME Group's listed and aggregated OTC markets, CME Direct provides a highly automated, sophisticated new way for the natural gas and power industry to execute their trading strategies," said Michel Everaert, managing director of OTC Solutions. "CME Direct's global distribution and real-time access allows market participants who have never used our services to access our markets and benefit from our risk management products."

Recently, ICE announced that it was moving up the roll-out date for its OTC-to-futures conversion from January 2013 to Oct. 15, 2012 due to "the strong preference of our customer base to trade futures as soon as practical."

"After further consultation with customers we determined that it was best to move this transition to October in order to support the daily hedging and risk management requirements of commercial participants," said Charles A. Vice, president of ICE.

As previously announced, these products would continue to be listed and traded on the ICE platform and cleared at ICE Clear Europe, and block trades would continue to be available subject to applicable requirements. ICE Clear Europe was approved as a CFTC-regulated derivatives clearing organization in 2010. All uncleared swaps would continue to be listed on ICE's OTC platform, which would register as a swap execution facility (SEF) when the SEF rules are finalized.

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