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Industry Spotlight > Clearing and Custodial Firms

House Ag Committee Hears Objections to Eurex U.S.

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WASHINGTON (–The Agriculture Committee of the House of Representatives held its long-awaited hearing on the Eurex U.S. application for designated market status.

The chairmen of each of the Chicago futures exchanges testified on Nov. 6 to set out their common objections to the granting of this designation, at least on the basis of the existing application.

Charles P. Casey, chairman of the Chicago Board of Trade, charged that Eurex is not the “fully electronic” marketplace it presents itself to be. Eurex in Europe relies (and the U.S. version presumably will also rely in some part) upon a call-around telephone dealer market, one that he said “allows dealers to quote opaque prices to customers and to internalize order flow.”

Terrence A. Duffy, chairman of Chicago Mercantile Exchange Inc., said that the established exchanges are concerned that Eurex U.S., more formally the U.S. Futures Exchange LLC, plans to pay for order flow in what he called a “survival of the fittest” game to reward fiduciaries who direct their customers’ orders to the Eurex platform.

Although the Securities and Exchange Commission has long been critical of payment for order flow, the Commodity Futures Trading Commission, which must act on the Eurex U.S. application, has not previously considered the issue.

Mr. Duffy also referred to public reports that there have been several squeezes involving German debt at Eurex. Also, an international link that will allow the trading of the same contract in two jurisdictions with different regulatory requirements raises concerns that practices allowed in Germany but disallowed in the United States will directly affect the U.S. market. Such arrangements “present significant cross-border bankruptcy and other legal risks” Mr. Duffy said.

As to the application itself, Mr. Duffy called it an “empty shell,” omitting crucial facts concerning its regulatory, clearing, settlement and financial responsibilities.

CFTC Chairman James E. Newsome spoke to many of these points in his testimony. As to the linkage with Europe, he also is aware of public statements by Eurex US that it intends to offer a link with Eurex Clearing at some future time, but that isn’t in the pending application, and neither the underlying statute nor the CFTC’s regulations require that “an application for designation as a contract market include all future clearing plans that may be contemplated, or future plans in general.”

Any proposal that would permit a cross-border clearing link, Mr. Newsome said, would require additional CFTC action and additional opportunities for public comment.

On the subject of incentives for volume, Mr. Newsome said that certain forms of incentive, such as fee holidays for new products or reduced fees for market makers, have long been deemed acceptable within the established exchanges. He assured the committee that the CFTC would not allow Eurex U.S. to offer any incentive program that the established exchanges also are not allowed to offer.

This hearing had been scheduled before a subcommittee on Oct. 16 but was postponed after the CFTC announced it was taking the application off the fast track Previous HedgeWorld Story. Although Thursday’s hearing took place before the full committee, the acting chair was the chair of the responsible subcommittee, Jerry Moran (R-Kan), of the General Farm Commodities and Risk Management panel. Sen. Moran used the occasion to note the death this week of a former chairman of the CFTC (1982-1991) and a fellow Kansan, Kalo A. Hineman.

McErlean Replies

Michael McErlean, director of the proposed Eurex U.S. exchange, also testified, accompanied by Ed Rosin, an attorney with Cleary Gottlieb, Steen & Hamilton, New York. His opening statement was quite general in its discussion of the Eurex position, explaining for example that the U.S. Futures Exchange will “operate as a U.S. company, located in the U.S., staffed by U.S. employees, acquiring services from U.S. service providers, and subject–in all respects–to the same U.S. regulatory framework that is applicable to all U.S. futures exchanges.”

During the question-and-answer period, Mr. McErlean responded to the specific charges, such as the contention that the application was an “empty shell.”

“Our application was over 2,000 pages that we did submit to the CFTC,” he said, although much of that has not been disclosed because it is competitively sensitive.

Asked whether payment for order flow was in the best interests of the customers of the proposed exchange, he said it was in their best interest to have an efficient and liquid marketplace, which the proposed fee structure would accomplish.

Asked about telephone call-around, he did not speak to the situation in Europe, but said that the American system would be fully electronic.

Asked about a trans-Atlantic clearing link, Mr. McErlean acknowledged that there are such plans but said the German side of the link will have to be recognized as a derivatives clearing organization under U.S. law before it can become effective. “We’re getting feedback from our market participants” to produce the system of clearing that the market wants to use.

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