Windy City exchanges wake up with the blues

The weather, of course, is less balanced: in the summer the heat can be unbearable, and in winter they don’t call it the Windy City for nothing. What’s more it takes a lot of cold to freeze a mass of water the size of Lake Michigan.

All in all it’s a good venue to balance work with play, which makes it all the more surprising that most non-Chicago residents working in finance speak about the city with a degree of invective bordering on the obsessed.

For, despite its attractions, Chicago is not a happy city. That much was evident at the latest Futures Industry Association meeting at the start of November. An article in BusinessWeek from a few weeks before dominated many early discussions: it had branded Chicago as in near terminal decline, unable to keep, let alone extend, its earlier dominance in banking and derivatives. It was also suggested that the city was unable to develop enough to offer a suitable home for the entrepreneurs in the tech sector now sitting on the west coast or in New York.

These aspersions weren’t the only topic of discussion. As usual the weather provided ample fodder for small talk: torrential storms hit Chicago late Monday afternoon, the day before the meetings started, leaving many stranded at airports around the US. Tuesday was a day for foul moods. But it was also election day, and there were at times nearly as many delegates crowded round the TV to watch CNN’s coverage as there were in some of the seminars.

But Chicago has its own brand of politics, and that’s not pretty either. It’s local, internecine, and utterly destructive, and has played a large part in bringing the city to the point where magazines can write about its decline.

It’s not a new story, certainly as far as the exchanges go. Seat prices on the exchanges have been dropping for years, from their peaks at or above $1 million in the early 1990s to just $300,000 for the Chicago Board of Trade.

The only prices going up are those for hotel rooms. The CBOT lost its position as the world’s largest futures exchange to Eurex last year, and volumes are down over 10%. It’s getting so bad that even Miami can lay claim to being a larger financial centre in gross dollar terms.

But it is easy to underestimate Chicago. Its residents are proud of their city, and many of them are native Chicagoans, not transient job hunters as in New York. They are therefore arguably more committed to making the city a success in the longer term.

That might not be enough to save the exchanges, though. The CBOT, the Chicago Mercantile Exchange and the Chicago Board Options Exchange are all facing threats from new electronic platforms with a lot of capital and a good deal of commitment from their backers, yet all the while they are still arguing among themselves.

At the moment the spat of choice is between the CBOT and the CBOE. The CBOE was spun out of the CBOT in the 1970s, and still allows members on its parent’s floor to trade on its exchange across the street at no extra charge.

But the CBOE has been more successful, as its higher seat price implies, growing volumes and maintaining a 50% or more share in the options markets.

The CBOT, though, is now looking to demutualize, yet wants to retain the exercise right for its members to trade for free across the street. Unsurprisingly, the CBOE is protesting, as it fears lower volumes on the floor of the CBOT will force more members across to them, for free, taking up space and resources.

The CBOT is taking the matter to court, a move that CBOE chairman Bill Brodsky tersely calls “divisive, costly and inefficient”. Why is the parent so determined to proceed? Simply because as its floor trading volume drops, so will its membership, unless the exchange can offer them something else. And free rights to trade on the floor of another exchange is just the ticket. Otherwise the members may well simply leave to trade electronically or not at all, and the CBOT literally cannot afford it.

In the nine months to September the CBOT had a net loss of $5.4 million, more than double its loss in the same period last year on almost identical revenues ($146.6 million this year, $144 million last year). It is still paying the mortgage on its trading floor, and has the expense of both the floor and an electronic system running side by side. And its options are limited because all the ventures of value it is involved in are beyond its control: the Board of Trade Clearing Corporation is a separate entity, as is the CBOE, and the trading system, Ace, is essentially a Eurex product. Hence the battle over trading rights at the CBOE.

Things got so desperate, so rumour has it, that the CBOT management even considered selling the floor equipment to banks, and then leasing it back, as a way of raising cash fast. But that stopped once they discovered that the fixtures and fittings were not worth anything near the rather high price they initially put on them (which, some floor traders say, was over $100 million).

It’s not an enviable position for what was once one of the world’s most respected exchanges. Having looked to London and Frankfurt for inspiration – or was it salvation? – on business strategy, perhaps it’s time to look across the pond once more, this time to emulate the London Stock Exchange. Rather than let its old floor, abandoned in 1986, stand idle, the LSE makes it available for football matches and the like. With a bit of ingenious planning, perhaps the CBOT could turn its floor pits into a giant skateboard park.