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A combination of good management and exchange unity at the CME and
lagging care taker management and a multitude of problems at the CBOT
opens the door for a for-profit CME to take advantage of a weakened CBOT
and become the dominant U.S. futures exchange.
The CME is on a fast track to become a for-profit futures exchange. The
membership has approved the plan, the CFTC has approved the minor
technical rule changes and the CME just awaits a ruling from the
Internal Revenue Service before being able to proceed with the plan.
The CBOT on the other hand took the initial step to become a for-profit
corporation with the goal of splitting the exchange in two around two
different business models; open outcry trading and electronic trading.
However, the CBOT faces several other daunting challenges.
First is the question of CBOE Exercise Rights of Full CBOT members. The
CBOT has filed a lawsuit “a lawsuit seeking a declaration that the
CBOT’s re-incorporation as a Delaware not-for-profit corporation would
not extinguish the Exercise Right and asking the Court to prevent the
Chicago Board Options Exchange from taking any action to the contrary.”
This could just be the first step in a very messy and lengthy court
battle delaying the CBOT’s restructuring plan. Looking back in history,
the CBOT legal battles with Dow Jones, Inc. over use of its Industrial
Index for a futures contract back in the early 1980s opened the door for
the CME to establish the dominant U.S. stock index market with the
introduction of the lesser-known S&P 500.
The CBOT has a big debt load from the building of the huge financial
trading floor. The CBOT is also experiencing declining revenues and
declining volume. The CBOT has gone from the busiest futures exchange
in the world to the third busiest in Chicago. Throw in the fact that
the CBOT does not own the CBOT Clearing Corp, which clears its trades,
as opposed to the internal CME clearing operations, and you have a
vulnerable exchange, IMHO.
The CME has a new visionary and technology friendly CEO in place,
selected to run a for-profit CME. The CBOT has an able, but care taking
CEO in place, replacing the longtime politico CEO Thomas Donovan.
An aggressive for-profit CME could chose to list traditional CBOT
contracts on its popular Globex2 system to compete with the CBOT’s
introduction of electronic versions of its contracts on the CBOT/Eurex
alliance trading platform. The public may just choose the CME’s proven
Globex2 platform and known support system versus the CBOT’s Eurex
platform and unproven customer support. Throw in probable free quotes
from the CME for these new electronic contracts and you may have a good
start for the CME to win the electronic trading volume of the CBOT
products.
Mini contracts traded on CME have proven to be a key ingredient to the
ongoing success of the exchange and its open outcry markets. The
Globex2 stock index volume acts as a very dependable local trader where
the pit traders and the arbitrageurs know they can lay off some of their
risk, without the paper fumbling inefficiency of dealing with a broker
burdened with the one lot cancel replace business.
This is a real threat to the CBOT’s future. Two common themes of large
brokerage firms and trading houses have always been implementing cost
reducing electronic trading and common clearing of trades. The CME and
CBOT have never been able to agree on common clearing despite the
efforts of some very smart and influential exchange players to push it
through. One way to accomplish common clearing is to promote the
movement of trade to one exchange. These long time proponents of
electronic trading and common clearing may be able to kill both birds
with one stone.
The CBOT’s hopes lie in being able to dispense with the Exercise Rights
question with the CBOE and quickly wrap up merger negotiations with that
same CBOE. A combined CBOT/CBOE would be a formidable opponent for the
CME over the next battlefield; single stock futures. A lot of things
have to fall in place, but a combined CBOT/CBOE would be able to
leverage off of the liquidity and expertise offered by CBOT members
trading on the CBOE and the growing volume and popularity of the CBOE
stock option and indices products.
The ability of a combined CBOT/CBOE to clear and margin securities and
futures in a single exchange doing each already has some synergy which
could give the CBOT/CBOE an edge in the battle for single stock futures
volume. But don’t count the CME out. Their edge in electronic stock
trading and likely head start as a for-profit futures exchange may give
them the flexibility and resources to respond forcefully. I would look
for them to pursue the Chicago Stock Exchange, perhaps?
CME seat prices have recovered to the point IOM seats set new highs this
spring. CBOT seat prices are off their lows, but still in the dumps,
with the Full Seats deriving a large amount of their value from the
Exercise Rights to trade on the CBOE trading floor.
The CBOT is not dead yet, but it is bleeding red ink and vulnerable. An
aggressive for-profit CME, smelling the blood in the water, might just
decide to attempt to take a bite out of the CBOT’s market share. The
CME may just make the CBOT’s electronic markets their lunch.
Regards,
John J. Lothian
Disclosure: Futures trading involves financial risk, lots of it!
Disclosure: John J. Lothian is the President of the Electronic Trading
Division of The Price Futures Group, Inc., an Introducing Broker.
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