2002 winner | DERIVATIVES EXCHANGE OF THE YEAR Intercontinental Exchange

Intercontinental Exchange (ICE) exceeded all its internal growth expectations last year. It now has 8,000 registered users from 450 firms, who can trade in more than 600 types of listed commodity and over-the-counter derivatives contracts.

The commodities range from crude oil, refined oil products, natural gas, power and precious metals to weather derivatives and emissions allowances, and new products are continually being introduced. UK natural gas was added on December 6, attracting 115 trades and a volume of 205 million therms in just two days.

In 1995, Jeffrey Sprecher, the exchange’s founder and chief executive officer, got the inspiration for the ICE while president of Western Power Group, when he was involved in negotiations to create a Californian energy exchange as part of the state’s deregulation process.

Sprecher was disappointed with the quasi-governmental structure of the resulting exchange, but felt there would be an opportunity to create an independent exchange after the energy companies’ five-year commitment to the governmental exchange expired. “In the business plan we had aimed for 600 users in the first year, and a total of 2,000,” says Sprecher. “I never realised how big the commodity market was. I thought we would end up as a small US-based power, and maybe US natural gas, brokerage system.”

Sprecher bought Atlanta-based Continental Power Exchange in 1997, after realising its private electronic trading network of 62 electric utilities had a suitable infrastructure for developing his electronic exchange.

Sprecher attributes the ICE’s success to the core emphasis of generating trading volumes from committed users. “I was very interested in trying to offer equity as compensation for bringing business to the system,” he says.

The result was a consortium of financial institutions and energy companies committed to supporting online trade volumes when the ICE went live in August 2000. The launch partners are BP Amoco, Deutsche Bank, Goldman Sachs, Morgan Stanley, Royal Dutch/Shell Group, Société Générale and TotalfinaElf. Additional equity partners shortly followed (American Electric Power, Aquila, Duke, El Paso, Mirant and Reliant Energy) and ensured the ICE had large firms to support active trading.

The ICE’s growth has accelerated since Enron’s collapse in November, which forced the closure of its once-domineering digital trading platform EnronOnline. It has now reached 4,000 trades a day with a notional value of $2.5 billion.

The ICE had trouble keeping up with the soaring demand after Enron’s collapse, which created a backlog of user requests. Sprecher acknowledges that heavy traffic caused occasional network failure: “We doubled [the number of users] in two weeks and we were already growing at an unbelievable rate, so we definitely had hiccups. But the liquidity has been so great that people have been relatively patient.”

All bids and offers on the ICE are anonymous, but it runs all trades through a counterparty credit exposure matrix, which allows traders to set personal credit limits, both in terms of tenor and value, with all listed traders. The ICE will not list potential trades on a trader’s screen if execution would break either preset credit limits.

The ICE is launching daily clearing in a joint venture with the London Clearing House, to further lessen counterparty credit risk. Its commodities with the greatest liquidity – US oil and natural gas swaps – will be settled daily beginning this month. The ICE plans to roll out the clearing system to its other OTC contracts over the course of the year.

The ICE also has operational advantages over EnronOnline, says Matthew Hogan, natural gas trader at commodities trading firm, Phibro, based in Connecticut. “I can post my bids and offers, so it is more flexible. Everyone got lazy using EnronOnline because they knew Enron would post the price, but now it is an open field. It’s good for me because now I am seeing a lot more numbers.”

The ICE’s acquisition of London-based IPE in July 2001 has facilitated the development of its clearing system. The takeover was ambitious, but ultimately successful through a stock swap. The ICE swapped 10% of its shares for 100% of IPE shares. At that time the ICE was valued at $1.3 billion, making the IPE worth $130 million.

“We will integrate our OTC business into their clearing system [provided by London Clearing House] and we want to put IPE contracts on the ICE screen,” says Sprecher.

IPE is open-outcry, and Sprecher says its traders will determine to what extent it becomes electronically traded.

Enron’s demise also led to a growth in the number of market participants who want to use the ICE for price transparency – not for trading. The number of view-only users has grown rapidly over the past two months, and Sprecher is carefully reviewing the ICE’s fee policy for view-only accounts. “We charge a commission on every trade, so we are probably going to have to change the revenue model to try and amortise the overhead we have in maintaining all those view-only accounts,” he says.

Still, the business is profitable. “We are running at about 40% pre-tax profit on revenues of about $120 million, but those revenues are growing fast,” says Sprecher.
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