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March 19, 2008

OneChicago Launches ETF Futures Listings

By John Hintze

OneChicago, an electronic exchange specializing in single-stock and other securities futures, began listing in December futures on three major exchange-traded funds (ETFs). It is a move that it hopes will push clearing firms to begin clearing securities futures products.

The exchange has faced an uphill battle since it opened its doors in November 2002, mainly because the vast majority of clearing firms have yet to retool their operations to clear the products in securities accounts. Securities futures can be placed in futures accounts as well as securities accounts, such as portfolio margin accounts, where they can be used to achieve significant margin reductions.

OneChicago saw large volume increases through much of last year compared with the year before, but one major customer's trading fell off toward year-end, and volume for 2007 was only 1.9 percent higher than in 2006, compared with double-digit gains in the futures industry overall.

Despite that loss, said David Downey, CEO of the exchange, order traffic from retail customers was up 73.5 percent and orders from other brokerages increased more than 130 percent.

Currently, Downey said, trades in securities futures are cleared only by Fortis and Interactive Brokers, a joint-venture partner in OneChicago along with the Chicago Board Options Exchange and Chicago Mercantile Exchange.

That limits investors' ability to use the products in securities accounts, where, Downey said, they could provide lower financing rates than typical margin loans and an advantageous borrowing solution for equity short sellers. The exchange recently put a calculator on its Web site to demonstrate the savings.

In fact, Downey said, investors' savings come at the expense of brokers' revenues-margin and stock lending are major revenue sources-and that has inhibited bulge bracket players such as Bear Stearns, Goldman Sachs, and Merrill Lynch from offering the securities or clearing those transactions for introducing brokers.

Enter the ETF strategy. The three new listings over the last two months are futures contracts on the most active ETFs: the SPDR Trust Series I, the Nasdaq 100 Trust Series 1 and the iShare Trust, which track the S&P 500, the Nasdaq 100 and the Russell 2000 indices, respectively.

Given the popularity of ETFs, OneChicago is calculating that securities futures' ability to efficiently hedge will gain enough popularity among customers to persuade brokers to begin clearing them.

"Hopefully, we'll see two things happen: Investors will either convince their brokers to begin offering the product, or they'll move their money [to another firm], and that will convince them," Downey said.

Early indications suggest investor interest is perking up. OneChicago has listed Diamond ETFs, based on the Dow Jones Industrial Average Trust, for a while without gaining much traction. However, Downey said, those listings have been very active over the last few months, most likely because investors use them for arbitrage opportunities with the new SPDR ETF.

The bigger issue, however, is whether those securities futures are being held in futures or securities accounts. Traditional futures contracts must be held in accounts at futures commission merchants, while single-stock futures can be held in futures or securities accounts.

OneChicago began trading single-stock futures in 2002. It had 491 single-stock futures listed as of Jan. 8.

Downey said the new securities futures will be offered in multipliers of 1,000, instead of the typical 100, making it more cost-effective for large institutional funds to use them. He said that they can get further margin offsets if their securities clearing firms are able to clear them in portfolio margin accounts-only 12 broker-dealers have been approved so far to do so, including most of the largest ones. He added that OneChicago anticipates later offering the ETF listings in multipliers of 100, making them attractive to investors with less capital.

Gary Morton, a senior executive for risk and margins at Chicago-based optionsXpress, said his firm offers accounts where customers can combine futures, options and equities. However, the futures are cleared separately through a futures commission merchant, and the self-clearing broker-dealer has not yet retooled its back-office system to process securities futures in securities accounts. Before his firm does that, he said, he wants to see more volume and broader interest in the products.

"I really see a big advantage to using securities futures, and I look forward to them having more liquidity," Morton said.

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