Both Nymex and ICE launched OTC clearing in 2002, and in terms of volume they are running almost neck and neck. Their business models are very different, however, and that has some important implications for how their clearing systems operate.

ICE is essentially an electronic trading platform that operates over the Internet. After the Enron collapse, a large volume of OTC power and gas trading migrated from EnronOnline, the largest electronic trading platform at that time, to ICE, which had the significant advantage of not being tied to a single player. The burst of activity was short-lived, however, and after a few record-setting months, the level of trading at ICE, in line with the overall marketplace, fell into a deep depression. As credit concerns spread from Enron to the merchant energy sector as a whole, almost all of the main players were forced to downsize their trading operations, in some cases all the way down to zero.

ICE realized that the market was drying up, and looked to clearing as the solution. Through its ownership of IPE, ICE had a relationship with LCH, and sought out the U.K. clearinghouse as its partner. The fact that LCH was based abroad created some marketing problems, since most players in the North American power and gas markets were not familiar with the organization, but LCH was able to overcome this somewhat by gaining recognition from the Commodity Futures Trading Commission as an authorized clearinghouse.

As an electronic platform, ICE looked for a way to integrate clearing into the trading process, and rewrote its software to keep both streams of business on the same screen. Any participant on the ICE system can see the full range of bids and offers in the order book, and only after the transaction is executed does the option of clearing present itself. All participants are set up with a counterparty credit filter, and this dictates which prices on the screen are tradeable.

ICE began offering OTC clearing in March 2002 on only a few products, and gradually that list has expanded. As of November, there were 26 contracts available for clearing. That is just a tiny portion of the more than 300 contracts available for trading on the ICE system, but ICE officials claim that these are the benchmark products, with the greatest amount of trading and largest open interest. In fact, clearing is now the engine of growth at ICE. In September, the level of trading once again began setting records, and it was the cleared flow, not the bilateral flow, driving that trend.

Over at Nymex, the situation could not be more different. To start with, trading and clearing are not integrated. Most trading at Nymex still takes place on the exchange floor, while the OTC clearing business is conducted through a separate electronic facility called ClearPort. This system does have the capability to support trading, but at present only a tiny number of transactions brought through ClearPort are actually matched on that system.

Second, Nymex realized early on the benefits of working with the voice brokers in the OTC energy trading business. These brokers had strong relationships with the customers, and they had the incentive to recommend clearing as a way to restore liquidity to the marketplace. Just as important, they had a built-in bias for Nymex because of the perceived threat that ICE posed to their way of doing business. Several voice brokers, speaking on condition that they not be named, said they viewed ICE’s electronic trading model as cutting into the need for a middleman to arrange trades with their customers. Nymex therefore designed ClearPort so that the brokers could report the trades directly into the system on behalf of their customers. In effect, the brokers are a sales and distribution force for ClearPort.

Third, Nymex had the advantage of owning its own clearinghouse. This helped the exchange move quickly to expand the list of contracts available for clearing in response to customer demand. As of November, Nymex had listed 117 contracts on ClearPort, almost five times as many as on the ICE/LCH platform. Not all of them are successful; a handful dominate and more than 30 have no volume at all. But the overall impact is that a greater variety of business can be moved through ClearPort than its rival. This in turn creates more opportunity for margin offsets among related contracts, not only within the ClearPort slate, but also against the futures and options contracts traded on the floor.

Fourth, Nymex doesn’t just novate these contracts, it converts them into futures through a process somewhat similar to exchange-for-physicals or exchange-for-swaps, whereas at LCH, the contracts remain OTC instruments after clearing. For most practical purposes, this makes little difference. Both clearinghouses offer margin offsets against futures, and both clearinghouses back the contracts with the full force of their guarantee structures and financial resources. From a legal perspective, however, there are some significant differences. Once Nymex converts an OTC transaction into a future, it is held in a segregated account and it takes on some important legal protections in the event of a bankruptcy that are not available to swaps.

Both platforms are fiercely competitive and quick to match what the other is offering, and both say they have more contracts in the pipeline. But there is one area where ICE has trouble matching what Nymex offers, namely the gas basis swap business. Thanks to an exclusive relationship with Platts, the predominant pricing source for the OTC gas business, Nymex has been able to clear a large number of actively traded contracts that are based on the differential between Henry Hub and other pricing points around the country. This segment of the ClearPort business accounts for 45% of the entire volume of OTC clearing at Nymex.—Will Acworth

 

ClearPort Volume: Breakdown by Category

 

Basis Swaps

Nearly half of all OTC energy contracts cleared by the New York Mercantile Exchange are natural gas basis swaps, which are widely used to hedge forward price risk in natural gas markets across the U.S. and into Canada. The basis swaps represent the differential between Henry Hub gas futures and physical market centers around the country, which are connected by a number of pipeline networks. For example, the MichCon basis swap is derived from an index measuring prices for gas delivered to Michigan Consolidated Gas Co., a natural gas utility that serves 1.2 million customers in Michigan and delivers more than 600 billion cubic feet of gas per year to customers across North America. Similarly, the Transco Zone 3 basis swap is derived from an index of gas prices in Transco Zone 3, a major pooling point in eastern Louisiana from which a number of interconnecting pipelines feed gas to major markets on the Eastern Seaboard.  Most of the 29 basis swaps available for clearing on the Nymex ClearPort platform are derived from price indices published by Platts, a leading provider of information about the energy industry. Note: the numbers on the map represent only the approximate locations of the various market centers referenced in ClearPort basis swaps.

 

Key to Map

1          Henry Hub Basis Swap
2          CIG Basis Swap
3          Waha Basis Swap
4          Alberta Basis Swap
5          Chicago City Gate Basis Swap
6          Houston Ship Channel Basis Swap
7          San Juan Basis Swap
8          SoCal Basis Swap
9          Transco Zone 6 Basis Swap
10         Northwest Pipeline Rockies Basis Swap
11         Panhandle Basis Swap
12         MichCon Basis Swap
13         Permian Basis Swap
14         M-3 Basis Swap
15         TCO Basis Swap
16         PG&E Malin Basis Swap
17         PG&E Citygate Basis Swap
18         NGPL Texok Basis Swap
19         NGPL LA Basis Swap
20         ANR OK Basis Swap
21         Northwest Pipeline Sumas Basis Swap
22         NGPL Mid-Con Basis Swap
23         Demarc Basis Swap
24         Ventura Basis Swap
25         Dominion Appalachia Basis Swap
26         Tetco East Louisiana Basis Swap
27         Tetco South Texas Basis Swap
28         Columbia Gulf Transmission Onshore Basis Swap
29         Transco Zone 3 Basis Swap

Source: New York Mercantile Exchange. Pipeline data and map courtesy of PennWell MAPSearch.
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