The Commodity Exchange Arena Shifts to ‘Swaps’

October 12, 2012

The global commodity exchange is buzzing with activity. The world’s largest commodity exchange prerogatives are hustling forward to use the newly formed regulations to their benefit. The clearing and trading of energy swaps is the target.

The Chicago based CME has fallen further behind with the approximated yearly business of securing £747.8 million over the counter swaps to its arch nemesis ICE. Both Intercontinental Exchange (ICE) and the CME Group Inc. are now scurrying to cleave an upper hand by modifying most of the cleared energy swaps into futures. Thus the swaps will be absolved from Commodity Trading Commission regulations that come into force today.

The switch seems to be perfectly logical as oil and natural gas futures contracts that were recently renamed are very similar to swaps that many companies such as Glencore or BP have been using constantly. To the energy industry, clearing has always been the backbone since the Enron meltdown back in 2001. The energy industry is benefitting hugely with the switch to futures.

Commodity Futures Trading Commission’s new rules have made swapping much more stringent. The rules warrant for a higher capital if the trade involves more than $8 billion in swaps annually. The exchange that offers the most hassle free transition is bound to win a larger volume. Stakes are high for both the exchanges. OTC energy clearing consisted of around 30 percent of ICE’s revenue in 2011 and 9 percent of CME’s revenue.

ICE has been predominating with its business since the past few years. Its volume has doubled and that of CME has slipped considerably. Last year alone saw ICE conduct energy swap contracts as much as four times more than CME and this year also ICE is going strong, with volumes about five times larger than CME.

Energy swaps being policed

The change in the rules is aimed at the Dodd-Frank reforms that are meant to restrict the OTC derivative market, which was blamed for the 2007-2008 economic downfall. The switch ensures more money for the clearinghouses. A major portion of the swap trading currently occurs over the counter. With the new rules in place, the revenue for clearing houses can skyrocket to about $2.1billion in 2 years from now.

A swap generally involves a trader on one side to pay a fixed price for a commodity periodically while the trader on the other side pays the market price of the commodity. It is similar to a futures contract which is aimed at selling or buying a pre determined amount of a particular commodity at a date in the future. Swaps were usually traded far away from the exchanges and were never in the crossfire like now.

The future market

ICE has responded firmly to the change in regulations by stating that it will be changing all of the energy swaps it owns to futures over the weekend. The CFTC has also approved the move. The transaction for ICE is very simple as most of its liquid swaps are traded on its electronic platform. The transition from swaps to futures also ensures that the markets remain transparent.

The CME on the other hand has a somewhat complicated pathway. It will pass a set of new rules to enable easier replacement of swaps with futures for its traders. CME’s Clearport contracts start as swaps and end as futures during clearing. It will be allowing its users to continue this affair away from the exchange. CME also does not have any liquid trading avenue which is bound to make the transition slightly problematic.

Binary options today

Both ICE and CME are neck to neck with natural gas swaps that comprise a whooping 81% of the OTC energy volume of ICE and 57% cleared energy swaps as per CME’s Clearport data from both the exchanges.

The ICE is going strong this year. It has successfully cleared around 2 million over the counter energy contracts on a daily basis for half of this year. The clearing percentage has spiralled up to 25 percent from its average for the previous year and doubled since 2009.

CME on the other hand has cleared around 440,000 contracts on a daily basis this year, which is close to its last year’s average and has slumped by 10 percent since 2009.

If anything the new regulations are likely to bring about more stability to the dwindling market. By bringing the swaps under the safe havens of clearing houses, traders are likely to gain confidence as they are assured of some guarantee from the clearing houses. Hopefully the new rules will bring about a bullish trend in the days to come as opposed to the bearish market of today.

Bank your options on Call towards any bullish trends after the new regulations come into force today. The commodity market is likely to go bullish as the CFTC enforces the new reforms.