CME Europe: This time it’s different

By:
Russell J. Dinnage
Published on:

In September 2011, CME Group – the world’s largest derivatives and futures exchange platform operator – moved into its plush new offices overlooking St Paul’s Cathedral in One New Change.

One year later, those offices, which can house more than 300 people, remain half empty. But the CME is thinking long-term.

A new company is close to being born – pending UK regulatory approval – in the work spaces and conference rooms of CME’s newest outpost: CME Europe.

Today, CME Europe is officially four people: CEO Robert Ray; head of strategic sales Felix Carabello; COO David Feltes; and chief compliance officer Paul Richardson. The balance of the headcount is made up of 120 CME operational staff, in sales, marketing and compliance.

By mid-2013, the company is set to open trading in 30 currency pairs as well as offer clearing services for a range of over-the-counter (OTC) FX products, making it the first Europe-based exchange to offer central and order book liquidity on exchange in the forex market.

To achieve these targets, CME will have to overcome a number of key hurdles, the most significant being FX market perception that, while competition is welcome, there is no demand for an exchange-based currencies offering in Europe.

According to one market participant spoken to by EuromoneyFXNews, Europe is where "the big boys play in FX," trading in an OTC format rather than in exchange-traded contracts. Many other of the market participants say they are skeptical that CME Europe’s contract offerings through the London-based exchange will gain critical mass in Europe.

"I don’t see where the interest will come from," says the global head of listed products at a large European bank. "It’s not something we hear from our clients: 'I would do more FX business with you if there was a listed product.’"

Moreover, argues the same source, for those clients that do want to trade listed FX contracts, they can easily access the CME’s existing US-based FX futures contract on its Globex platform 24 hours per day.

So why introduce new contracts in Europe?

In an interview with EuromoneyFXNews, Derek Sammann, CME’s head of interest rate and FX products, and Will Patrick, the exchange operator’s London-based senior director of FX products, say the company is ready to change those pessimistic perceptions once again – given that 25 years ago many participants were sceptical its US contract would ever get off the ground.

It’s now a $110 billion-per-day market.

Sammann and Patrick admit that new, incoming financial regulations – such as the US Dodd-Frank Act and the EU’s European Market Infrastructure Regulation plan, as well as, on a global level, the Basel III proposals – are driving growth and consolidation in equal measures in the exchange-traded space across the EMEA region.

 
 Derek Sammann:
 "In FX, we feel the
European market
is under-served."

However, as regulation creates a sea change in the functioning of traded markets in a range of products – both traditional voice-brokered OTC deals and electronic platforms in exchange-traded, standardized products – Sammann says fundamental demand for a new CME business in Europe comes from one place: the customer.

"As regulations come in, what we are hearing from customers is a desire to have regional solutions," he says. "CME Europe is a regional solution. It will be a UK, standalone, fully registered, on-exchange solution for customers that want to deal in the jurisdiction of their home country that is consistent with where they are already trading."

And this time it’s different.

The new iteration of CME Europe is not the first time CME Group has attempted to expand into the old world, after building a storied markets empire in Chicago.

CME first opened an office in London in 1979 with five employees, and the Chicago Board of Trade – which merged with CME in 2007 to become part of CME Group – opened an office in London in 1987 with three employees.

In 2007, CME collaborated with Reuters to launch FXMarketSpace, which was a centrally cleared, global FX platform for the OTC cash market. However, the venture failed to take off despite Reuters and CME each pumping $45 million into the platform; it was closed down in October 2008 due to a lack of liquidity.

This time around, CME Europe is benefiting for the first time from a willing customer base anxious to move pre-regulatory mandate into the exchange-traded space for a number of essential financial products like FX, says Patrick.

"We are building relationships in London that we might not have built five years ago," he says. "We are setting conversations with people that we have wanted to speak to for a long time. People here are starting to see us through a different set of eyes now – as a partner as opposed to a competitor."

At the moment, there is no direct competition for CME Europe’s plans in the FX space.

Earlier this month, the Wall Street Journal reported that futures exchange Deutsche Börse was considering launching currency futures on its platform in a bid to outmanoeuvre long-time rival CME in Europe.

But the market is still awaiting a new formal offering from the German company in the FX space.

As always, the stats don’t lie

In the FX market, 30% of CME’s global currencies volumes transacted come from European trading funnelled into Globex and cleared through CME’s clearing house.

Around 40% of CME’s spot market FX trading volumes globally originate in London, according to the Bank for International Settlements.

Five years ago, CME was seeing around $10 billion per day in average notional turnover volumes for FX products through its exchange offerings housed in the US. This year, the company is seeing an average of $110 billion per day in total notional turnover in FX products in that US-based market.

As a result, the company’s footprint in the FX market has grown.

Five years ago, CME transacted the USD equivalent of 10% of the average daily FX currencies volumes recorded by Icap-owned FX broker-dealer platform EBS, which CME uses as a benchmark for volumes levels within the segments of the market that its products trade in.

In September, CME surpassed EBS for the first time in average daily FX volumes in that market segment, growing turnover by 115% in the exchange-listed and cleared currencies derivatives markets it shares with the Icap platform.

Marrying the markets

CME Europe is betting long-term that, as new financial regulations tighten the shrinking market for credit ever further while raising credit risks tied to counterparty interactions, clients will develop bespoke trading methods that marry unregulated transactions with regulated ones, says Sammann.

"Asset managers, regional banks and hedge funds are the three primary client segments that have said they want to augment their liquidity in Europe," he says, adding that traditional prop traders say they are also intending on becoming participants in the European exchange.

As a result, Patrick says CME Europe will become a venue where the best parts of the exchange-traded model can be siphoned off by the market and rolled into an OTC product that can then be funnelled back to the exchange for central clearing.

"Traditionally, the only difference between the OTC and listed derivatives world was exchange-for-physical (EFP) trading," says Patrick. "Now we are finding that markets are touching and the first place they touch, other than in the EFPs … is OTC clearing."

However, Sammann acknowledges that traded markets in FX and other products in Europe and globally will ultimately decide how and when it wants to conjoin bilateral OTC trading methods with the regulated exchange space.

"We’ll be agnostic on where and how business comes into CME Group," he says. "But when seeking to meet compliance mandates outside of the US, the one thing customers consistently tell us is that they need a clearing solution, which is why we launched our European clearing house in May 2011."

FX clearing: If you build it, they will come

In September, CME Group revealed it has cleared $9 million in notional OTC FX volumes since it launched its clearing service for products through CME ClearPort in April.

Compared with LCH.Clearnet, which in September had cleared more than $210 billion in notional FX volumes since March, Sammann admits that CME has substantial work to do in Europe before it can convince the currencies market that the company’s London-based clearing house – CME Clearing Europe – can become a clearing venue of choice.

Specifically, Sammann says CME Europe must convince the bank-dealer segment of the FX market – which he says LCH.Clearnet has a lock on at the moment – to become direct clearing members with CME Clearing Europe.

However, it might take anywhere from six to 24 months for uptake of CME Europe’s FX clearing offerings to become widely used by the market, he says.

"We have got our value proposition – it’s interesting to some, not interesting to everybody," says Sammann. "LCH has their value proposition, interesting to some, not interesting to everybody. We have got the pipeline of clients, we’ve got the multi-asset class, the clearing story we have to tell is significant, but there’s a big chunk of our client base saying they will test, send in FX portfolios, get connected and be ready to clear through CME Clearing Europe when there’s more regulatory clarity."

Patrick adds that the size of some of the FX portfolios CME Europe is being sent on a daily basis means that – once CME Clearing Europe reaches certain targets – the business will "quickly scale up".

"While those numbers out there might seem like LCH has a head start, looking at the size of the portfolios we get sent in, that goes away very quickly," says Patrick.

Starting with FX: the changing culture

Sammann says CME Europe’s launch represents a change within the culture of CME Group overall, which was, until about five years ago, "a very Chicago-centric firm".

"I would posit that a lot of the outperforming growth rates we have seen in our FX business [in the US] in the last few years isn’t because we are smarter than everyone else," says Sammann. "I would say that we’ve done a lot better job listening to our clients."

As such, CME Europe will benefit from a level of expertise in the FX space from CME Group’s 40 years of presence in the market – spanning a multi-asset spectrum of products – where Sammann says the company is already the leader in exchange-trading and OTC clearing.

"In FX, we feel the European market is under-served," says Sammann. "With the pending implications from regulation at hand, FX is a place where people are coming to us more than ever and asking how to connect in a non-US solution."