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“It’s fragmentation, Jim, but not as we know it” – why Dodd-Frank won’t work

Interesting last week to see that GFI has applied to the CFTC to become a futures exchange. This follows on from ICAP’s purchase of Plus Markets (now ISDX) and so it surely can’t be too long before the other IDBs follow suit and execute their own regulatory hedges too. What they are worried about is that the regulatory regime around swaps seems to favour futurisation rather than SEFs and so will hand the keys to the kingdom over to the likes of the CME, ICE and other derivatives exchanges. This is leading to a headlong rush to set up futures exchanges and so we may see a similar type of market fragmentation that equity markets experienced thanks to RegNMS and MiFID. But, because derivatives contracts are specified (and owned) by their parent venue, they are tied to that venue alone. This lack of fungibility will do nothing for transparency (other than make it worse), and even less for liquidity. Imagine if you could only sell the Microsoft or Vodafone shares you own back at the same venue where you bought them. So, hardly a recipe for best execution either then.

Maybe we can learn a lesson from US equity options markets which operate a multi-market structure (11 at last count, soon to be 12) and yet standardise all contract specifications through one central body, the OCC. This provides the trading community with choice and allows market operators to experiment with different business models too. Even better, there is one standard record of what actually happened in the OPRA time and sales feed. Simple, transparent, competitive – now, what was it again that Dodd-Frank was supposed to be about?

Comments
One Response to ““It’s fragmentation, Jim, but not as we know it” – why Dodd-Frank won’t work”
  1. Mark Brennan says:

    Steve – excellent piece and, as we discussed, a fairly compelling idea. However, I still maintain the vertical juggernauts (read, CME) will not willingly cede their IP (i.e., open interest) to a truly centralized clearing model unless the CFTC steps in and wrests control from the vertically aligned DCOs and moves clearing to a truly centralized, utilitarian organization – as the SEC did with the OCC in the early 70s.

    But there’s no question that the potential proliferation of futures exchanges will not necessarily help end users and indeed calls into question the unintended consequences of Dodd Frank.

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