Streetwise Professor

According to the FT, the UK’s Office of Fair Trading (the British antitrust authority) has apparently caught a case of the stupids from the USDOJ:

In the row over the ICE, which is planning to move clearing in-house and away from LCH, the matter is under review by the UK Office of Fair Trading. There are signs that the OFT, which has long been troubled by the competition issues raised by exchanges owning clearers, is studying the application closely. Two weeks ago, it sent out questionnaires to market participants querying the level of competition for the mostly widely traded ICE contracts in London.

If ICE forces customers to use only its own clearer, bankers say they will press the Commission to block the deal. Last week, in a separate initiative, Nymex launched a suite of products in direct competition with ICE that will clear through LCH.

Meanwhile, customers are also threatening to bring LCH to the attention of European authorities over a deal it tentatively struck with Liffe last week that would see the exchange take some of its clearing in-house but stop short of forming its own in-house operation and ending its relationship with LCH.

It would be nice, if just once, somebody, somewhere in some antitrust authority would actually step back and do a thorough analysis of economics of vertical integration in clearing and execution. The monomaniacal focus on (likely chimerical) anti-competitive effects, to the complete exclusion of any consideration of the possibility that vertical integration, might, just might, have some efficiency rationales will inevitably lead to bad policy. As I have said before, this is throwback antitrust analysis–BC, as in before Chicago.

One simple question for the OFT: if exchange control of clearing is the big obstacle to competition in execution, why hasn’t LIFFE faced competition in its products? And for that matter, why hasn’t LSE? (Okay, that’s two questions.) And who owns a big chunk of LCH? (Okay–three.) It wouldn’t happen to be the banks that are complaining about LIFFE moving clearing in-house, would it? (I know.)

On that last point, before one canonizes the poor, martyred banks who suffer at the hands of those cursed exchanges, consider the following story by the excellent Natasha (may I call you dahlink) de Terán:

LCH.Clearnet has operated SwapClear, a much used and admired swap clearing service, for nearly a decade. SwapClear has its critics and limitations but the one that could prove to be most damaging is its membership criterion.

A self-qualifying circle of dealers, OTCDerivNet, guard SwapClear’s gates. The buyside and other smaller dealer firms are kept outside. LCH.Clearnet might have wanted to roll out a similar service to that of the CME. But it has been hamstrung by OTCDerivNet.

Imagine that, a cooperative that restricts entry! Never heard of that before. (Yeah, well, except for the NYSE and pretty much every traditional US derivatives exchange and many overseas exchanges.) Think that such entry restrictions might well enhance the profitability of the members that are on the inside looking out? That certainly was the case with exchanges, as my 1999 J. Financial Markets paper showed.

Thus, perhaps the European Commission and OFT should take a break from obsessing about exchange vertical integration, and take a gander at some other possible competition issues in clearing. As I wrote in my clearing paper, disintegration combined with the formation of a cooperative clearing venture is no guarantee that a thousand competitive flowers will bloom. Execution venues that discover prices are likely to remain monopolies after disintegration; even cooperative clearers can exercise market power by restricting entry or supercompetitive pricing (and don’t be fooled by big rebates to members–that can be perfectly consistent with the exercise of market power); and the parallel operation of an exchange and a clearer both with market power can lead to inefficiencies in the form of double marginalization and higher transactions costs.