CME’s London Futures Exchange Launch Delay Is Nothing To Worry About
The CME Group (NASDAQ:CME) announced recently that it would launch its London-based futures exchange on September 26, instead of September 9 as previously planned, due to regulatory reasons. Although launching on the earlier date would have been symbolic for the firm, we believe that the delay is not material. The global derivatives market is set to grow in the next few years, and the CME Group seems to be well positioned to benefit from this opportunity.
However, we would start to get worried if the launch of the new exchange were to be delayed substantially in the future. In that scenario, the CME Group is likely to fall behind its competitors in capturing the growing European derivatives market.
See our full analysis for the CME Group
What Is So Special About September 9?
Starting September 9, 2013, the Dodd-Frank Act mandates all “category 3 entities” to start clearing swaps on centrally cleared platforms. Category 3 entities include ERISA plans, and are the last set of U.S. based market participants to come under the purview of this mandate. [1]
With all U.S. market participants now obliged to clear OTC derivatives on centrally cleared platforms, the global derivatives clearing industry is expected to experience a significant boost in the coming months. The impact is likely to be highest in London, which is one of the world’s largest hubs for trading OTC derivative products. The launch of CME’s London-based futures exchange would have coincided with this historic event if it had launched on September 9.
Why Doesn’t The Delay Matter Much?
Firstly, the delay in launching the London-based futures exchange is not too long. The new exchange would be only a couple of weeks behind schedule if it is launched on September 26.
Secondly, the CME Group already has a growing derivatives clearing business in Europe since mid-2011. The unit recently expanded into multiple products such as interest rate swaps, and we do not expect the growth to stymie because of a short delay in the launch of CME’s London-based futures exchange.
Lastly, September 9 does not mark the end of the growth opportunity. Similar to the Dodd-Frank Act in the U.S., the European Market Infrastructure Regulation (EMIR) is likely to push all European market participants onto the centrally cleared channel sometime in Q2/ Q3 2014. [2] The CME Group is unlikely to miss out on that occasion unless the launch of its London-based futures exchange is substantially delayed.
What If the Launch Is Delayed Further?
Although the chances of this happening are slim, a significant delay in launching a futures exchange is likely to leave the CME Group incapable of capturing the high initial growth in the European derivatives market. While its clearing business is likely to offset the impact, we believe that running a futures exchange in conjunction with the clearing business is crucial for CME’s longer term prospects.
A futures exchange and a clearing firm can together reduce clients’ margin requirements substantially by a process called “cross-margining”. The combination is also better positioned to launch innovative products that can meet the needs of clients who switch over from over-the-counter (OTC) markets to the centrally cleared channel. Due to these reasons, clients are likely to eventually gravitate towards clearing firms that have an affiliated futures exchange.
Almost all dominant derivatives clearing firms in Europe are in the process of starting, acquiring or collaborating with a London-based futures exchange. The IntercontinentalExchange (NYSE:ICE) is in the process of acquiring NYSE LIFFE, and LCH.Clearnet has collaborated with NASDAQ NLX. We believe that a significant delay in launching its London-based futures exchange is likely to allow CME’s competitors to cement their positions in Europe.
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Notes:
- Implementing the Mandatory clearing of swaps under Dodd frank Act, Northern Trust [↩]
- US CFTC and EU Regulators Provide Guidance on Deadlines for New Swap Regulations, Latham & Watkins [↩]