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June 24 in Chicago, a very important day. The Chicago Mercantile Exchange (CME) is set to make an important announcement: the fibreglass cow recently posted outside the exchange as part of the city’s five-month “Cows on parade” art exhibit is to be given a name, chosen after a competition among the CME’s staff and members. The winner – “Moocantile”.
It is light relief for the exchange which, along with the Chicago Board of Trade, has had a hard few months during which the rationale of everything from open outcry to clearing systems has been questioned.
It began on a potentially bright note with the resignation of Brooksley Born from the chair of the Commodity Futures Trading Commission (CFTC), the federal body that regulates the exchanges. She and the exchanges had not seen eye to eye, and now there seemed to be a chance that finally the exchanges could get regulations simplified.
As the month ends, five minutes’ walk up the road from where Moocantile is being christened, the CBOT, the CME’s arch-rival, is facing a rather more crucial choice. Should the members of this predominantly open-outcry futures exchange vote for a strategic alliance with Eurex, the electronic-only futures exchange formed by the merger of German and Swiss futures exchanges?
The Eurex question has been on the table for over a year now. Indeed, it dominated the election for the post of chairman last December. Incumbent Pat Arbor had proposed the link, whereas the challenger, David Brennan, was sceptical, especially about costs. Brennan won, and went on to champion the cause of ditching the proposed link. In a referendum of members in January, Brennan’s views held sway, and the Eurex link was rejected by a vote of 450 to 390. A couple of weeks later in London, Brennan announced that the era of exchanges cooperating or merging was over. The CBOT, he insisted, could go it alone.
What changed? For one thing, Eurex was beginning to overtake the CBOT’s volume in several key contracts. For the world’s largest futures exchange, being usurped by the bride it had jilted at the altar was a nasty jolt.
Second, at the start of June, as an indirect result of Born’s resignation, Liffe and other non-US futures exchanges were finally given the go-ahead to install a limited number of trading screens in the US. (Only Eurex had been allowed to install any before the CFTC imposed a moratorium.) The increased competition for US investors’ business which this will eventually bring was another factor in Brennan’s conversion.
Nor are the foreign derivatives exchanges likely to be the only new rivals. Cantor Fitzgerald last autumn started up a screen-based futures exchange.
Brennan claims that it was only after four months of examining all possibilities – including going it alone with the CBOT’s Project A system – that he realized that Eurex offered the best option.
The first few months of his tenure have been an eye-opener for Brennan. The futures commission merchants, or FCMs, essentially the big securities firms, which he visited almost as soon as he was elected, gave him his biggest shock. “I think he was rather taken aback when he realized the strength of feeling against the exchanges,” says an FCM at a major Wall Street firm. “He seemed to have no idea that the wrangling over common clearing last year had caused such resentment.”
The FCMs viewed last year’s attempts at establishing common clearing of CBOT- and CME-traded products as the crucial test of the exchanges’ ability to cooperate for the good of the market. The CBOT pulled out of the deal, and the FCMs suspended talks with the exchanges for nearly two months. In April, a common margining policy was agreed, but the FCMs are now at best indifferent. “We don’t really care what they do now,” says one. “As we told them at the time the agreement first fell through, we consider it our duty to look for our own solutions.”
And that they have. On the same day as the Eurex vote was being held, seven of the largest bond-trading houses announced a link-up with BrokerTec to provide electronic broking in US and European sovereign debt. Worryingly for the CBOT, BrokerTec intends to undertake futures-related initiatives soon. For the FCMs, the argument is simple. “If we’re going to be disintermediated by technology, the way to go forward is to have an equity stake in those disintermediators,” says one.
This poses a much greater threat to the CBOT than the Cantor Futures Exchange; most of the FCMs have kept their business from Cantor Fitzgerald, in part because they see it as a major competitor in bond trading. But Cantor’s decision to take on the CBOT has acted as a boon to others, proving that the time has arrived where the lack of a massive trading floor no longer prevents entry into the market. If BrokerTec were now to offer futures contracts, it would make sense for the FCMs to route more and more of the business through there.
A deal with another exchange was crucial to the CBOT’s future, and it is ironic that the soybean trader who many FCMs thought would be a disaster as chairman is the one who has managed to convince members of the merits of the deal.
But it is a deal that ought to have been concluded last summer. Brennan’s initial stance on Eurex and the previous political machinations last year over common clearing have all damaged the CBOT’s reputation.
The challenge now is to recognize that the Eurex deal is just a stepping stone. What it needs is something suggested to the exchange in recent months by IBM: an electronic trading platform combined with full internet capability. The banks aren’t waiting, so the exchanges certainly can’t afford to. The idea of becoming a for-profit organization, reawakened by Brennan in April, should help, and the CBOT is now discussing linking IBM’s internet ideas with the Eurex technology.
But if they go at the same excruciatingly slow pace as in the last 12 months, they will simply fall farther and farther behind.
