Select Committee on Treasury Minutes of Evidence

Letter from Sir Brian Williamson to Mr Jim Cousins MP (29 October 1999)

  When you and your colleagues from the Treasury Committee visited the Exchange during the summer, you asked to be kept informed about three key challenges facing LIFFE. The first concerned LIFFE's efforts to obtain approval from the US Commodity Futures Trading Commission for the Exchange's electronic trading system, LIFFE CONNECTTM, to be made available in the United States. The second involved our attempts to tailor regulation to the changing needs of the wholesale market and to create a more level playing field in regulatory terms between LIFFE and its main competitor, the Eurex exchange, based in Frankfurt. The third was the need successfully to transfer LIFFE's main products from the trading floor to LIFFE CONNECTTM. I am pleased to report that all three issues have now been substantially resolved.

  Beginning with access to the United States, LIFFE received a so-called "no-action letter" from the CFTC at the end of July which permits the Exchange to make LIFFE CONNECTTM available to its members and their affiliated companies in the US. As you know, LIFFE had been actively seeking such approval for well over a year and for most of that time our plans were frustrated by the US regulator's inability or unwillingness to act quickly enough. During this time, our major European competitors, Eurex and MATIF the French exchange, continued to enjoy direct screen access to the United States. The CFTC's decision to grant LIFFE a no-action letter removed this discrimination and created a fairer basis on which we can compete.

  Nevertheless, we suffered some delay and as a consequence our competitors are well placed to expand further their facilities in the United States whereas we are just beginning to connect members to our system—and, of course, we are subject to Y2K freezes on the provision of new technology.

  There remains only one aspect of the no-action letters themselves which have been granted to LIFFE and other non-US exchanges with which we are not content. This concerns the need for such exchanges to apply to the CFTC whenever they wish to make a new product available for trading on screens in the United States. However, we are working with the other exchanges to persuade the CFTC to lift this requirement and we are reasonably confident of success. We raised this point with the European Commission in Brussels earlier this week and with the US Mission to the European Union and the former have pledged their support for our case.

  The second major challenge facing the Exchange, which interested your colleagues, concerned regulation. LIFFE was particularly anxious that it was being prevented from changing its rules on so-called "cross trades". As a result, we were unable adequately to meet the needs of wholesale customers at a time when the Over The Counter market and Eurex were able to meet those needs. The rule changes required may seem esoteric, but they were nonetheless of vital importance to us.

  Cross trades involve an exchange member submitting corresponding buy and sell orders to the central market from two separate customers or a member submitting a buy order from a customer and a corresponding sell order for the member's own account or vice versa.

  Futures exchanges have traditionally permitted cross trades as a means of facilitating the execution of customers' business. Such trades have been particularly useful in the case of less active exchange products, where simply entering the customer's order into the central order book might very well result in the order not being completed. The use of cross trades has been further facilitated by exchanges permitting their members—before they submit an order to the central order book—to try and find a counterparty for that order from among their customer base, from other members, or from other trading desks within the same firm.

  For electronic trading, futures exchanges have typically required their members to observe a time delay between submitting the first and the second of the corresponding orders of a cross trade to the central order book. The rationale for this requirement was to give other market participants an opportunity to participate and to ensure that business was done at the best price. However, this delay was undermining the primary desire of our wholesale customers for certainty and speed of execution, and of price. Indeed this delay, and the resulting lack of certainty, was frustrating the process of finding counterparties for incomplete business and thus of cross trading itself. At the same time, there has been a growing feeling within the Exchange and among members that it was feasible to liberalise crossing rules in a way which would not damage market quality.

  Earlier this month, LIFFE therefore amended its rules on cross trades and the Financial Services Authority are content with the changes. We regard the new rules as vital to our ability to prevent business being lost to the Over The Counter market. The changes have been welcomed by members and customers, and market quality has improved.

  The final issue, and also one which was of key importance to LIFFE, was the successful transfer of the Exchange's main products from the trading floor to LIFFE CONNECTTM. Those products—LIFFE's short term interest rate futures, which are used by wholesale customers to manage their exposure to euro, UK and Swiss interest rates—have been trading in parallel in the pits on the market floor and on LIFFE CONNECTTM for a transitional period. Since the beginning of parallel trading, business has increasingly migrated from floor to screen and by the end of last week more than half of such business was being transacted on LIFFE CONNECTTM.

  Earlier this week, the Exchange announced that LIFFE's short term interest rate futures would be traded exclusively on LIFFE CONNECTTM from 22 November 1999. Since we made the announcement, over 90 per cent of business on LIFFE in short term interest rate futures has been transacted on LIFFE CONNECTTM.

  The Exchange's Board decided to close the pits for two reasons. First, because LIFFE CONNECTTM had clearly demonstrated that it could deliver the functionality, speed and robustness that members and their customers required. Secondly, in order to respond to demands for a single LIFFE trading platform for short term interest rate futures. Moving to a single platform will enable members to plan ahead with greater ease. It will also avoid a split in liquidity at a time when trading activity generally is likely to reduce as market participants' attention turns to Year 2000 preparations.

  Though we believe it premature to make any statements, it looks as if we have a technology which can cope well with trading short term interest rates on a screen. This would clearly make LIFFE's system, LIFFE CONNECTTM, a world leader.

  I apologise for writing at such length, but I thought it important to explain how the three key issues which we discussed with you during the summer had now been substantially resolved. I also wanted to thank you once again for the interest that you and other Members have shown in the Exchange. It goes without saying that we are at your disposal should you or other Members of the Treasury Committee wish to visit LIFFE in the future.


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