(237) Clearing is of particular importance for derivatives contracts since the value and the utility of a contract depends on how that contract is cleared.109 This is because the counterparty risk needs to be managed for the lifetime of the contract which could span from a few months up to several years. This can be contrasted with cash instruments where counterparty risk usually only exists for 2-3 days between the trade date and the settlement date (which is generally on a delivery-versus-payment basis).
(238) At the current stage of market development and in the current regulatory framework, contracts traded on different derivatives trading platforms are generally not fungible110 and no cross-margining is applied between contracts traded on different platforms. In the area of derivatives, where with this market set-up, trades on one platform are not cleared by different CCPs (and contracts traded on different platforms are not concentrated on one CCP), this has led to the phenomenon of liquidity in individual asset classes tending to concentrate on one venue. This is because posting margin is a capital intensive exercise incurring an opportunity cost which incentivises derivatives traders to minimise the collateral they are required to provide by concentrating trades (in both one and the same contract and in any correlated contracts which benefit from margin offsets) on one trading venue. Simultaneously, exchanges have an incentive to offer as wide a portfolio of contracts as possible in a given asset class to attract more customers by increasing the potential of margin offsets.
(239) As a consequence, exchanges have generally historically sought to preserve, and more recently also to create, a vertical silo model whereby clearing is controlled by the exchange where the contract is traded.111
(240) As such, whilst trading and clearing could potentially be provided as separate services, many exchanges at present generally provide to users an integrated service including the
108
Netting refers to offsetting buy and sell positions over a given period of time in a given product, thus reducing the number of open positions that need to be cleared and settled. Cross margining involves calculating the amount of collateral required from a counterparty to cover the risk presented by that counterparty's portfolio. Unlike netting, which only applies to the same products, cross margining applies to a range of different products which display a degree of risk correlation.
109
See Form CO, Derivatives.
110
Fungible contracts are contracts which can be completely netted and offset against each other in the case of an equal size buy and sell position cancelling each other out so that no position remains to be cleared and settled.
111
See for instance NYX' internal document provided in response to the Commission's RFI of 1 July 2011, stating: […]*, NYSE Liffe – Global Derivatives Strategy, June 2009, p. 5; and DB's internal document provided in response to the Commission's RFI of 1 July 2011, highlighting the […]* and that )",[…]*.
trading and clearing of derivatives contracts and for which they may charge a single fee. Indeed, many derivatives exchanges (such as Eurex, CME, ICE, etc.) are vertically integrated into clearing by operating "clearing-houses" for clearing of instruments traded on their venues. Other exchanges, while not being strictly speaking vertically integrated into clearing, offer clearing services for contracts executed on their platforms through agreements with third-party clearing-houses that they select, generally on an exclusive basis (such as Liffe, etc.).112In such a scenario, customers therefore purchase an integrated service from the trading venue and have ultimately no choice of clearing services provider.113
(241) The Notifying Parties submit that because trading and clearing of derivatives are intrinsically linked and the value and the utility of a derivatives contract depends on how the contract is cleared, from a derivatives trader's perspective (customer of the exchanges), clearing of exchange traded derivatives cannot be considered on a separate basis from trading of exchange traded derivatives.114This claim of the Notifying Parties is illustrated, in their view, by the fact that exchanges design the derivatives contract and determine how that contract will be cleared, clearing being one of the contract specifications.115 As a result, the Notifying Parties argue that clearing services associated with a particular derivatives contract are part of the overall service provided by the exchange and submit that there is no separate market for the provision of clearing services to derivatives traders on exchanges.116
(242) The Commission considers that while at present trading and clearing of exchange traded derivatives are provided on a bundled basis from the perspective of a derivatives trader conducting a trade on the order book of one of the Notifying Parties117, there is nonetheless already today a separate service consisting in on-exchange registration, confirmation and clearing of trades agreed away from exchange (be they block or flex trades as analysed in Sections 11.1.2 and 11.1.3).
112
Each derivatives exchange normally has only one clearing-house. See DB's internal document provided in response to the Commission's RFI of 1 July 2011, stating that: "Competitors copy Eurex model and create vertical integration (ICE Clear, Liffe Clear); vertical integration becomes standard model except for US Equity Options", .[…]*.
113
Certain trading members may not fulfil the clearing membership requirements or may elect not to be a direct or general clearing member, but to clear trades through a general clearing member.
114
Form CO, Derivatives, paragraph 6.295 states that "from the perspective of a derivatives trader, the clearing services associated with the particular contract are part of the overall service provided by the derivatives exchange or OTC trading platform. In other words, there is no separate market for the provision of clearing services to derivatives traders."
115
Form CO, Derivatives, paragraph 6.196, second bullet point.
116
Form CO, Derivatives, paragraph 6.294.
117
While, as pointed out in the decision opening the proceedings, there is no separate market for the clearing of exchange traded derivatives as from the perspective of a derivatives trader trading these contracts on the order book, there is a separate market for the provision of derivatives clearing services to third party venues and OTC trading platforms. However, this market is not affected by the proposed transaction since NYSE Liffe does not provide derivatives clearing services to third parties. The Notifying Parties in their response to the decision opening the proceedings did not contest this conclusion.
(243) Therefore, it is concluded for the purpose of this Decision that the impact of the notified transaction as regards competition in exchange traded derivatives is to be assessed on markets comprising trading and clearing together.118