When IntercontinentalExchange begins to transition its cleared energy swaps products to futures next month, it could mark the beginning of the end for cleared energy swaps, make many US derivatives reforms moot, and trigger a fundamental change in derivatives markets.
Or could it be a mere technical change that will have an imperceptible impact on global energy markets?
Of course, no one really knows what the effect of ICE’s plan to shift its swaps to futures will ultimately be, since so much hinges on still-developing regulations and an ever-evolving derivatives market.
But it is telling how wildly divergent the views are of the impact of swaps-to-futures.
On the sidelines of an Information Management Network derivatives trading conference in New York this past week, Gary DeWaal, senior managing director and general counsel with brokerage Newedge, said within a decade cleared energy swaps may no longer exist. There still will be customized, uncleared swaps between parties, but most swaps would just be cleared futures.
Charles Reyl, president and CEO of Parity Energy, which plans to launch an energy-focused swap execution facility, called DeWaal’s view a “bit extreme,” and said they ignore the benefits of cleared swaps, including customer clearinghouse choice, and preferences of brokers who may be unwilling to lose fees under a move to futures. Reyl said it “remains to be seen” what impact ICE’s planned transition may have.
The potentially larger issue, and what many see as the key motivation behind ICE’s swaps-to-futures plan, is the new swaps reforms within the Dodd-Frank Wall Street Reform and Consumer Protection Act. ICE’s plans could make many of these reforms meaningless, DeWaal said. “We’re going to remember [Dodd-Frank] as a deviation that lasted for four or five years,” DeWaal said.
DeWaal called ICE’s planned transition “a remarkable vote of no confidence” and a “major pushback” to rules the Commodity Futures Trading Commission has been working on since Dodd-Frank became law in 2010. “They’re trying to totally get out of the Dodd-Frank regime,” DeWaal said. “They don’t even want to deal with these new requirements for cleared swaps. I think that’s a dramatic statement.”
Under ICE’s plan, cleared North American natural gas, electric power and environmental products swaps will be listed as futures on the energy division of ICE Futures US, while cleared oil products, natural gas liquids, freight and iron ore swaps, will be listed as futures on ICE Futures Europe.
ICE in July said it would transition its cleared swaps products to futures by January. This week it announced that it was advancing the schedule to October 15, when other Dodd-Frank rules are scheduled to take root.
Brookly McLaughlin, an ICE spokeswoman, said Friday that the swaps-to-futures plan was motivated by customer requests. “They are seeking regulatory certainty amid the continued evolution of new swap rules and how those rules might impact their operations,” McLaughlin said. “They have strong familiarity with operating in the futures markets in their risk management and hedging activities, and have expressed a preference for a timely transition to gain operational and regulatory certainty.”
According to Paul Cusenza, CEO of Nodal Exchange, ICE’s transition to futures may signal that the exchange is less worried about a controversial CFTC rule that may have forced them to delist a majority of their listed contracts. That rule, known as Core Principle 9, would require 85% of a contract’s trades to be executed on an electronic exchange in an effort to boost price transparency.
In May, the CFTC approved a final set of rules for designated contract markets, but delayed action of that 85% rule in light of industry opposition. The rule, which Commissioner Jill Sommers has called “an unnecessary solution in search of a problem,” was expected to be considered sometime this summer.
Cusenza said ICE’s plan indicates that the exchange believes the 85% rule “will be decided in a way that will be less restrictive than proposed,” since ICE believes it will not have to route all of its swaps trading through a swap execution facility.
According to Neal Wolkoff, CEO of Wolkoff Consulting Services and the former chairman and CEO of the American Stock Exchange, if the 85% rule was finalized as proposed, it would undo ICE’s swaps-to-futures plans as well as a similar structure CME has in Clearport.
“If a swap can be a future and a future can be a swap then it’s hard to really justify having this very disparate regulatory and clearing treatment,” Wolkoff said on the sidelines of Thursday’s conference.
McLaughlin said Friday that ICE would not abandon its proposal if the 85% rule was finalized as proposed. “ICE’s markets offer the key benefit of a liquid central limit order book for all of its major contracts,” she said.
This is a difference between ICE’s proposal and CME’s Clearport, where so-called swap futures do not trade on a central limit order book and has most of its volume executed by brokers off-exchange.