Streetwise Professor

August 20, 2012

An Option on Regulatory Uncertainty

Filed under: Commodities,Derivatives,Economics,Exchanges,Politics,Regulation — The Professor @ 7:33 pm

The CME Group has announced plans to open a European exchange, following its earlier announcement of its launch of a European clearinghouse.

Just another unintended consequence of Frankendodd.  Another bucket emptied by the Sorcerer’s Apprentice’s regulatory broomsticks.

Why do I say that, pray tell?  Because that’s what CME Group is saying, quite clearly:

The Chicago-based exchange said that as policymakers overhaul the global market infrastructure, it was becoming increasingly important for market infrastructure providers to offer a choice of regulatory regimes. Derek Sammann, managing director of CME Group’s global interest rate and FX business, told Financial News immediately after the announcement: “Clients should not have to choose to trade with us in the US regulatory environment, or not to trade with us at all. That is not a real choice.

He added: “The more we have invested in our global infrastructure, the more we have realised that there are customer acquisition opportunities by creating regional access to our services.”

. . . .

Phupinder Gill, chief executive of CME Group, in June told an international derivatives conference IDX in London that the exchange group’s non-US clients had raised concerns that they would become ensnared by the Dodd-Frank rules if they traded with the US-regulated company – a phenomenon commonly known as extraterritoriality.

He said: “The question that many of our clients ask is if they are going to get ‘Dodd-Franked’.”

No, no, no, Gill!  It’s “going to get Frankendodded.”  Get with the program!  We need to feed the meme!

The reporting has been rather unclear on what the CME Group’s plans are going forward.  The new UK-based exchange will offer FX futures contracts.  The CME press release, and the reporting, do not say explicitly, but it looks like these would be new products, distinct from the CME’s FX contracts traded on Globex.  This means that liquidity and clearing would be fragmented, so that regulatory cost savings for European customers would be offset to some degree by higher trading and clearing costs.  Great!  And regulators note: the market will become more complex and difficult to oversee, with divided jurisdiction and the consequent need for regulators to coordinate in the event of market stress.  There will be arbitrageurs-including, no doubt, those HFT demons-buying and selling between the two markets, leading to more message traffic, more complexity, and more potential for breakdowns and technological glitches.  That is, the adverse technological consequences of fragmentation that have accompanied fragmentation in equity markets may rear their ugly heads in futures as well, with the added twist of fragmentation across international jurisdictions.

Given the difficulties associated with building liquidity, it is uncertain how the CME’s UK initiative will fare: it may be the case that Europeans decide that the liquidity and clearing costs savings exceed the regulatory burdens.  But it is relatively inexpensive for CME to put its toe in the water in the way it has.  It is a cheap way to buy an option on regulatory uncertainty.  If Frankendodd turns out to be the real monster that I think it will be, European customers will be willing to incur higher liquidity and clearing costs in order to avoid the monster’s grasp.  CME Group will add more contracts that mirror its US offerings.  The market will become more fragmented, and more complex.

Exactly what Frankendodd and Gigi and Timmy! intended, surely.

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4 Comments »

  1. […] is what Dodd-Frank is bringing you. Ain’t it the bestest law […]

    Pingback by Breakfast Links | Points and Figures — August 22, 2012 @ 4:56 am

  2. […] the most transparent currency markets in Chicago, and extending them over to Europe should be easy. Craig Pirrong makes some great points about fragmentation etc. But, markets all over the world are getting […]

    Pingback by The European CME | Points and Figures — August 22, 2012 @ 8:57 am

  3. “He said: “The question that many of our clients ask is if they are going to get ‘Dodd-Franked’.” (The clients must have had bad cellphone connections- what they were asking was were they going to get butt-fucked, as in “the dog ate your segregated funds.”

    Comment by Robert — August 22, 2012 @ 10:05 pm

  4. […] the most transparent currency markets in Chicago, and extending them over to Europe should be easy. Craig Pirrong makes some great points about fragmentation etc. But, markets all over the world are getting […]

    Pingback by DoddFrank Spawns European CME - OBAMA-B-GONE — August 23, 2012 @ 6:41 am

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