July 31, 2012 / 8:35 PM / 5 years ago

Back to the futures: ICE swap switch offers boon to big traders

* ICE to move all cleared over-the-counter energy products to futures

* Could avoid large traders being designated as swap dealers

* ICE move could be attempt to compete with NYMEX for deals

By Chris Baltimore and David Sheppard

HOUSTON/NEW YORK, July 31 (Reuters) - I ntercontinentalExchange Inc’s plan to switch all of its cleared over-the-counter (OTC) energy products to futures contracts could be a boon to large merchants looking to reduce their exposure to potentially costly new rules.

The move, announced by ICE on Monday, will see the exchange switch the designation of all of its cleared OTC swaps for crude, refined products, natural gas, electric power and natural gas liquids to futures contracts in January 2013.

Large traders said the move would be beneficial as they look to reduce their exposure to looming new rules imposed on the $650 trillion swap market by the Commodity Futures Trading Commission (CFTC) as part of the 2010 Dodd-Frank law.

The move may also make sense now that swap deals will count toward new federal “position limits,” which will set a maximum number of contracts that any one trader can hold.

“The key detriment to swaps versus futures in the past was position limits,” said a senior regulatory official with a major energy merchant, speaking on condition of anonymity.

“Now that they’re on a level playing field there’s no reason not to be a futures contract.”

In the past, position limits were set by the exchanges and applied only to futures, allowing traders to amass much larger positions in the opaque swaps arena.

ICE’s largest customers could also avoid being defined as swap dealers or major swap participants, a designation that brings new costly regulatory burdens, said Craig Pirrong, a finance professor at the University of Houston, who is a futures market expert.

“Why not?” said Pirrong, who has dubbed the rules as “Franken-Dodd” due to their complexity and occasional unintended consequences.

“You can do the same thing and change the name and you are under a totally different regulatory regime.”

Futures dealing does not carry the same burdensome reporting requirements as similar cleared OTC swaps deals.

Prior to the planned January change, trading ICE swap contracts could count against a “de minimis swap” dealer exemption, while futures contracts do not.

Chuck Vice, ICE president and chief operating officer, said in a statement on Monday that the new swap rules would “increase the cost and complexity for swaps market participants ... relative to that of futures market participants.”


Energy swaps trading has surged over the past decade, both because of the lower regulatory burden and lesser margin requirements compared to futures.

But the Dodd-Frank reforms have changed that, bringing oversight to the $650 trillion over-the-counter swaps market and increasing both the compliance and capital burden on companies.

Commissioner Bart Chilton at the CFTC said his agency will address any potential for regulatory arbitrage through its ongoing rule-making process.

“I don’t believe their (ICE) move is an effort to get out of regulation,” Chilton said. “The simple fact is this: we haven’t completed the rules, so we will certainly be aware of what we are doing and all the myriad complexities.”

The ICE move could also be an attempt to compete with the CME Group, owner and operator of the New York Mercantile Exchange (NYMEX), which already offers a clearing mechanism to replace swaps with futures.

“Trading OTC swaps on NYMEX’s ClearPort platform, you already have the option of switching them to futures,” said one New Jersey based options broker.

Some market players urged caution, however, saying that switching longer term swaps to futures is not always straightforward.

“You can’t just flip the switch overnight and say ‘Okay, now all these things are now futures,'” said Mike Corley, president of Mercatus Energy Advisors, a Houston-based consultancy that advises companies on fuel hedging.

“From a risk management standpoint, moving all these products and exposures that have historically been over the counter onto an exchange overnight is not an easy task,” Corley said.

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