Too Big To Fail?

On a wet day last week I was taken by a former colleague for lunch. in a basement restaurant that I picked because it brought back memories

of most agreeable lunches, decades ago now, with my friend Robin. Three pints of Wallop and a ham sandwich were our usual fare, I recall. We had lunch. there on 9/11 as it happens.

But back to the present. Afterwards I went back to my host’s office, a new glass-fronted building and though only on the sixth floor the views are great. In all my working life I never enjoyed views like that in London; a worthwhile price to protect the City’s architectural heritage. I worked in New York and Singapore and the views from both offices were excellent. In the latter I kept by me binoculars and a copy of Birds of South East Asia (no sniggering at the back, please).

In a previous post, augmented by a comment from Sarah, I mentioned that banks in New York work Summer Hours on Fridays, closing at 2.00. Well, this American-owned firm has a generous Friday dispensation for its staff in London. The bar opens at 3.00 and wine, beer and soft drinks are on tap.

Over a glass of chilled Rosé, concerns were raised that an Exchange might fail and what might the consequences be. The background to this is that over the last 25 years Exchanges around the world have consolidated so that now two of the biggest are the venerable Chicago Mercantile Exchange (CME) and the upstart Intercontinental Exchange (ICE). If one or both of these Exchanges were to fail it would catastrophically disrupt trading in currencies, commodities and interest rates around the world. The Exchanges would say that their very size is their protection from default and that a default in one of their markets would not be contagious. But what if failure were to arise because of a cyber-attack? A chilling prospect.

In the old days Exchanges did go bust. In the 1970s The New York Mercantile Exchange defaulted on a delivery in their Potato Futures contract, which put that Exchange out of business effectively until they launched a Heating Oil Futures contract in 1978. This was the first successful energy futures contract. In London, in 1981, The International Petroleum Exchange started a similar Gas Oil Futures contract.

In 1974, the Paris White Sugar market went bust. There was a sharp fall in prices and the speculators holding long positions did not pay their margin calls. Something similar happened in 1983 in Kuala Lumpur when palm oil prices fell steeply.

CME and ICE both have a rigorous and robust financial framework now. The most important safety features at these behemoth Exchanges are gross margining and capital adequacy rules but the risks they face are to their electronic trading platforms as well as their financial integrity.

All unsettling food for thought for the large number of businesses and people around the world who depend on these Exchanges.