Derivatives exchanges had to face up to electronic competition last year. The Chicago Mercantile Exchange responded by reinventing itself

Last year saw the Chicago Mercantile Exchange (CME) come up with a raft of new initiatives. It rolled out a coherent demutualisation plan and a series of successful new contracts – including two new E-Mini contracts. The E-Minis have helped to attract much interest from retail investors, who chairman Scott Gordon describes as “the fastest growing part of our business”.

The CME also has an alliance with the London International Financial Futures and Options Exchange (Liffe) that will give its members access to the Liffe Connect electronic trading platform. All these activities show that the CME is facing up to the changing nature of exchanges and to the challenge that “non-traditional” exchanges and markets – the Electronic Communication Networks (ECNs) such as Island and Archipelago, and other developments such as BrokerTec – pose to conventional futures exchanges.

These are issues that many in Chicago were unwilling to address in the past, preferring to insist on the advantages of open-outcry trade and protect their membership privileges, but the CME board and membership are now facing them head-on.

The CME’s only real competition in this category was Eurex. The Swiss-German futures exchange last year became the world’s largest in terms of volumes traded, setting new records.

But Eurex has been in the ascendant since 1998, the yearit was created by the merger of Frankfurt’s Deutsche Terminbörse and the Swiss Options and Futures Exchange. That same year, Eurex wrested dominance on the benchmark 10-year German government bond (Bund) contract from Liffe. However, Eurex has since faced problems – a proposed technology alliance with the Chicago Board of Trade (CBOT) was rejected by the CBOT’s members and was only finally signed in October of last year, while its London rival fought back with Liffe Connect, which – despite teething problems – is widely regarded as one of the most advanced systems in the world.

The CME’s demutualisation plan proposes that the exchange become a for-profit stock corporation in which members will own two classes of common stock – one with trading privileges and one pure equity – and that the board be cut from the current 39 to just 19 members. The plan has yet to be approved by members, but Gordon says he is confident they will be able to vote on it by February, after approval from the Securities and Exchange Commission (SEC), and the hunt is already on for a chief executive of the new corporation. The other hurdle still to overcome is a favourable tax ruling from the US Internal Revenue Service.

The expectation that CME members will vote to go ahead with the for-profit structure has led to a sharp rise in the value of seats on the exchange, with seat prices overtaking those on the Chicago Board of Trade for the first time in October. It has also led to speculation about which outside companies might take a stake in the new corporation. Gordon, who was re-elected for a second two-year term in December, says he has held talks with numerous other exchanges, technology and information companies and members of over-the-counter markets.

There are widespread rumours that New York’s Blackstone Group, a financial institution, has been in talks to take a stake. Rupert Murdoch is also reported to have met with the CME to discuss a post-demutualisation deal, although Gordon declines to comment on specific talks.

The CME’s link with Liffe, announced in August, gives members of both exchanges electronic access to each other’s products. Gordon says they plan an innovative spread product between the CME’s Eurodollar contract and Liffe’s Euribor, which will decompose into two products and be cleared separately in Chicago and London. They also plan a for-profit electronic joint venture that will not be limited to exchange use, but will also be capable of working in OTC markets. And the CME’s Globex alliance last year got new members in the shape of the Singapore International Monetary Exchange and Brazil’s Bolsa de Mercadorias & Futuros, widening the breadth of access its members enjoy to other markets.

The future is not secured yet. Gordon says the board has identified a candidate for the post of chief executive officer, but some observers are sceptical as to whether they can appoint the right calibre of person to run the new for-profit electronic exchange (Risk December 1999, pages 38–40). There is still the possibility that members will vote to retain the existing structure, although Gordon seems confident that the demutualisation plan will be passed. And, as Liffe learnt to its cost a couple of years ago, competitors – in the form of both the conventional futures exchanges and the new electronic entities springing up to allow faster, cheaper trading – can snatch away an exchange’s franchise if it lets its guard slip. But the CME has at least started to move down the road it needs to take.

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