The New York Mercantile Exchange took two giant steps forwardyesterday, announcing plans to become a for-profit organization andto launch a global electronic exchange for over-the-counter forwardtrading and clearing of a wide range of standardized physicalcommodity contracts.

The exchange plans to launch the first phase of the e-commerceexchange in October. It will use its existing clearinginfrastructure to introduce complete counter-party risk managementfor OTC trading, and will create net margining with futures marketsby calculating a consolidated clearing position.

The new eNYMEX will provide a single, Internet-based interfaceto both the OTC markets and the futures market by routing futuresorders to the trading floor and the Nymex ACCESS electronic tradingsystem, depending on the session.

The range of OTC products offered initially will focus on swapcontracts in crude oil, petroleum products, natural gas, andelectricity, with some spot cash market products also offered,Nymex said. Over time, this would be expanded to include preciousand base metals, coal, and, potentially, bandwidth, weather, andemissions. Although the initial geographic focus will be on NorthAmerica, contracts also may be offered for some European and Asianlocations.

“The global energy and metals community has expressed a strongneed for an electronic OTC platform that provides an open,independent, and neutral marketplace for trading by allparticipants, price transparency, counter-party credit riskmanagement, and the liquidity created by simple standardizedcontracts,” said Nymex Chairman Daniel Rappaport.

Nymex plans to launch OTC trading first, followed byInternet-based order routing for futures trading. It also isactively looking for joint venture partners. “We’re sifting throughthe many offers we have on the table right now,” said a Nymexspokeswoman.

There have been numerous announcements over just the last fewmonths of energy companies and others launching and taking equitypositions in new energy e-commerce sites. The big questions forNymex are: how will its new system fare against the heavycompetition that’s already out there, and why should the industryput its faith and its money into another new e-commerce site whenNymex’s last electronic trading venture failed.

According to exchange Executive Vice President Neal Wolkoff,there are many factors that will distinguish eNYMEX from the crowd.”Nymex can tie together an existing liquid market and an existingcustomer base, use our experience, use the people and theintellectual capital that we’ve developed over the years in thisarea and bring the benefits of that into e-commerce on the OTCside,” he said. “There are economic benefits, there’s clearing,there’s bookkeeping, there’s non-clearing risk management andthere’s a level of market knowledge and market management that wewould anticipate bringing and that others frankly don’t have.”

Wolkoff predicts that it won’t take long for the many energye-commerce sites to consolidate. “It’s unfortunate to be talkingabout consolidation prelaunch of so many systems, but it seemsinevitable and not just in energy [e-commerce],” he added. “Thesame things are happening in so many other industries. There’s justnot going to be room for 15 sites. My guess would be over the nexttwo years, perhaps three,” consolidation will begin in earnest.

Many observers might question Nymex’s chances given the launchand subsequent shelving of its previous energy electronic tradingsystem, Channel 4. But Wolkoff noted e-commerce has come a long wayin the last few years. “Channel 4 predated a lot of the interestthat companies were having in the use of electronic systems to getefficiencies, transparencies and cost reductions on theirtransactions,” he said. “I also want to say that Channel 4 —although we had some fairly clever credit protections — didn’toffer the full range of risk management tools that we are planningto have as part of this [eNYMEX product].”

The new system will be more comprehensive, he said. It will tiethe business done on the new e-commerce system with the businessdone on the regulated futures and options markets. “Companies thathave a portfolio of gas positions, some on Nymex and some on thee-commerce platform, to the extent they are offsetting, we wouldtake into account the entire risk in determining the marginrequirements on the regulated positions,” said Wolkoff. “So thereare cost savings that we’re talking about here that weren’tpossible because of the regulatory world when the Channel 4 systemwas done.

“And we also try to learn,” he added. “We have launched NymexAccess for example, which does trade. It’s been an electronictrading system online for seven years. It doesn’t do the kind ofvolumes we do during the day but it does significant volumes. It’sbeen a productive system.”

Regarding the potential for margins for OTC trading on the newsystem, Wolkoff said, Nymex is not interested in changing the coststructure of the OTC market. It would “rather allow some of thebenefits from having OTC positions [to carry over into] the futuresmarket. We’ll come up with whatever the appropriate mechanisms,risk protections are. We’re certainly very mindful about keepingcosts as low as possible. I’m looking at this more as a means ofproviding benefits because we have the half of the equation thatnobody else does, namely futures and options,” he said.

The exchange board has retained the services of AndersenConsulting, L.L.P., to work further on the venture. eNYMEX isexpected to be a wholly owned, for-profit subsidiary of the NewYork Mercantile Exchange.

The subject of the other major announcement by Nymex yesterdaywas its plan to hold a membership vote June 20 on a”demutualization” plan, which would convert the exchange from anot-for-profit membership structure to a for-profit organizationunder Delaware law, pending approval of the Securities and ExchangeCommission, the Commodity Futures Trading Commission and theInternal Revenue Service. Each Nymex Division membership would beconverted into one share of common stock in a new holding companyfor the entire organization.

“Restructuring the exchange into a for-profit entity willprovide us with the opportunity to create new business ventures,react rapidly and decisively in an increasingly competitivemarketplace, and explore interest by outside investors” saidRappaport.

Wolkoff also said there actually is a “very close tie” betweenlaunching the new e-commerce site and becoming a for-profit entity.”The members of the exchange right now typically earn theirlivelihood through trading and brokerage opportunities. The factthat there has been a wonderful equity appreciation in the exchangeis a very big benefit, but it’s not the way in which people receivethe benefits of membership. When you enter into these alternativebusinesses, which do leverage your existing business knowledge,your existing business assets, it’s not so much that the members orthe owners of the institution will be receiving trading andbrokerage benefits, but we want them to be able to receive thebenefits of the exchange through transaction revenue and othernormal for-profit activities. The exchange will enter intofor-profit mode and will be able to have its equity realizedthrough appreciation from these successful business ventures.”

In addition to Nymex, several other exchanges in Chicago and NewYork are for the first time attempting to become for-profitentities. The reasons, according to Wolkoff, are technological andregulatory changes and new business opportunities. “I think thetechnology has made it such that customers are looking to theexchange model in getting different parts of their businessfunctions made transparent and made competitive. And the exchangesare really in a very good position given their expertise and theirhistory to be able to fulfill a lot of these needs.

“I think the fact that the regulators have been more willing toallow the exchanges to offer a more complete slate of instrumentsfor customers, both that are traditional regulated instruments plusnontraditional, nonregulated instruments also is helping to drivethis,” he added. “And I think that the exchanges, with the wholeadvent of technology and Internet businesses, realize that giventheir assets they have business opportunities here.

“We look on it as an expansion of our business with nothingnegative or bad about it. This is definitely a plus for thecustomer community.”

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