July 21, 2003

Reactions to CBOT/CME Common Clearing

CHICAGO (HedgeWorld.com)--Despite concerns over the very brief comment period and arguments over the anti-competitive effects of one aspect of the new linkage, the Commodity Futures Trading Commission voted to approve the rules submitted by the two Chicago-based futures exchanges under which the Chicago Mercantile Exchange will provide clearing services for the Chicago Board of Trade.

The president of the Futures Industry Association had been among those who complained that the CFTC should have allowed more time for public comment on these rules.

John Damgard, in a statement July 11, objected that the CFTC announced its plan to approve of these rule changes on July 8 and only allowed concerned parties until noon July 14 to comment, a period of only three business days Previous HedgeWorld Story.

"We recognize the desire to proceed in a fashion that does not delay the implementation of the CBOT-CME clearing link," he said. "We certainly see a number of positive aspects to this link, such as the potential cost savings. However, we believe it is important for the CFTC to carefully consider the implications of determining that the implementing rules comply with the Commodity Exchange Act."

Notwithstanding the time pressure, the FIA did submit comments by the deadline. Its comments focused on the proposed new CBOT regulation 701.01, which requires each member of that exchange to "comply in all respects with any statement of policy or other notice issued by an exchange relating to the procedures and processes that must be followed to effectuate the transfer of open positions to any clearing services provider."

This is troublesome because the language is not limited to the CBOT/CME link. The language appears to authorize the CBOT's board of directors, simply by issuing a new statement of policy, to direct its clearing members to transfer all open positions to any other derivatives clearing organization it might select, thereby abrogating existing contractual relations to which the CBOT itself is not a party.

The FIA also expressed concern about the clearing services agreement between the CBOT and the CME.

"Although this agreement is apparently on file with the Securities and Exchange Commission, we understand that it has not been filed with the [CFTC]. Our initial review of this agreement has raised a number of questions that we believe the [CFTC] should address before the link receives final approval."

The CFTC received other comments, two of them from the Board of Trade Clearing Corp., Chicago. The BOTCC itself filed a brief reaction, and its outside counsel filed a more detailed argument. That longer comment was prepared by Kenneth M. Rosenzweig, a partner with Mayer, Brown, Rowe & Maw LLP, and it too focuses on 701.01. Mr. Rosenzweig contends that this provision, which he calls the follow-the-shepherd rule, is inconsistent with the CFTC's statutory mandate to avoid adopting any rules or taking any actions that result in any unreasonable restraints of trade.

For 78 years, the BOTCC had cleared trades for the CBOT Previous HedgeWorld Story. This spring, that long relationship broke asunder. The CBOT sought to acquire the BOTCC, but the terms it offered proved unacceptable and the two firms have gone their separate ways--CBOT into its link with CME and BOTCC toward a relationship with Eurex, which will likely open a U.S. operation early next year.

Under those circumstances, Mr. Rosenzweig's concerns were somewhat different from those of the FIA--less prospect, more retrospect.

"The CBOT's designation of the CME as its new clearinghouse on a going-forward basis is not the subject of this letter. In other words, we express no view as to whether the CBOT should instruct its members that trades made on or after a given date must be submitted to the CME. Rather, we wish to focus the Commission's attention on whether an exchange may require its members ... to terminate their existing clearinghouse contracts, against their will and without the permission or consent of that clearinghouse."

Mr. Rosenzweig is a former chairman of the futures and derivatives law committee of the Chicago Bar Association. His comment, like the FIA's, lamented the quickness of the comment deadline. He said that the BOTCC would have been likely to comment on "the other rules that have been submitted by the CBOT and CME" beyond 701.01, had it not been for the "limited opportunity that has been provided for public comment."

The CFTC replied to concerns about timing that it struck the best balance it could. "Given the fact that the commission is not obligated to post this rule for comment, our goal was to balance the opportunity for public comment with the timeline in the [two exchanges'] agreement."

When it announced its approval of the rules late Tuesday afternoon, the CFTC also hinted that it is open to modification of 701.01. "The Commission is aware of public and industry interest in related policy issues regarding market structure and competition, and looks forward to hearing more on these issues," the statement said. "The Commission believes, however, that this broader dialogue should not impede the planning necessary to move forward to implement the link in an orderly manner. The Commission believes that it is of paramount importance to enhance legal certainty concerning the procedures to implement the link so that all affected parties may make plans as necessary for a smooth and orderly transition beginning in November."

CFaille@HedgeWorld.com

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