'Blackbird' Trading System Criticized at Hearing

September 24, 1999

The chairman emeritus of the Chicago Mercantile Exchange told the Senate Agriculture Committee yesterday that a new electronic communications system used to trade derivatives operates free of government regulation. There is "no justification" for regulating one type of system only to exclude another, says Leo Melamed.

The "Blackbird" system "appears to be a multilateral transaction execution facility for swaps and other financial instruments," Melamed said. "Each member's bids and offers are live and available to every other participant that passes the automatic credit screen. The contracts traded are highly standardized. No legislation or regulation seems to exempt Blackbird from (Commodity Futures Trading Commission) registration, yet it has apparently gone live."

Melamed added, "There is no justification for regulating agency systems like designated contract markets and excluding principal to principal systems like Blackbird. In fact, ultimate customers in agency systems have a much greater degree of protection under a wide range of federal and state laws."

David Brennan, chairman, Chicago Board of Trade, also had some comments on Blackbird for the committee. Competition that exists for U.S. exchanges is "very, very real," he said. "One new competitor has already cloned our most successful contracts and seeks to cream skim our best customers. Others maintain that many instruments currently being traded as government security forwards or when-issued contracts already compete with our most successful contracts.

"Other new competitors can clearly be seen on the horizon...Derivatives Net's Blackbird system has commenced or could commence any day electronic trading in interest rate swaps and other products that may be indistinguishable as a practical matter from already exchange-traded products but without any form of CFTC regulation," said Brennan.

A Blackbird official testifying at the hearing denied that the system amounts to a futures exchange. He said Blackbird is no different from the trading that takes place over telephones among derivatives dealers today, but is lower-cost because it is electronic.