It's gut-check time on La Salle Street
February 5, 2004
BY DAVID ROEDER Business Reporter Advertisement
The day for which the Chicago Board of Trade has been preparing with dread and determination is at last imminent.
It will arrive Sunday night, when worldwide financial markets open, and Eurex U.S. goes live. With its headquarters in the Sears Tower, the new electronic exchange is primarily owned by Eurex AG of Frankfurt, the busiest futures exchange in the world.
Its mission is to bring the Board of Trade to its knees. It won't be easy. It could be foolhardy. And it will cost all sides millions of dollars.
Eurex wants to parlay its international status and its dominance of trading in German Bund futures into a new market: exchange trading of U.S. Treasury debt. That's where the Board of Trade has a monopoly.
Commission's analysis counters objections to Eurex U.S.
In approving the Eurex U.S. application to go head-to-head with the Chicago Board of Trade, the Commodity Futures Trading Commission said it was upholding fair competition and market innovation.
The 142-page analysis by CFTC staff rebutted specific objections to the Eurex plan. Chicago exchanges and some local traders filed objections, while other traders and large investment banks supported the application.
Among the points the CFTC dealt with:
**That Eurex's foreign ownership places it beyond the reach of U.S. laws on market manipulation.
The CFTC held that the Eurex U.S.' status as a Delaware-registered corporation and its domestic operations ensure it must comply with U.S. laws.
* That a Eurex plan to reduce fees for large-volume trading firms is an illegal incentive.
The CFTC said such incentives are legal and don't differ from preferential pricing the Chicago markets use.
* That the Eurex stake owned by investment banks means they'll take their trades there.
The CFTC said all those banks also own seats at the Chicago Board of Trade and the Chicago Mercantile Exchange. If the Chicago markets lose business, those seats decline in value.
* That the Eurex application is incomplete because it failed to specify the contracts to be traded.
The CFTC said an overhaul of commodity trading laws in 2000 removed a requirement for advance approval of contracts. The Chicago exchange supported that overhaul, the agency noted archly.
David Roeder
The Treasury complex in January accounted for 78 percent of all business at the CBOT, currently the fourth-busiest futures exchange in the world. So it would seem the CBOT could afford to share a little market.
But futures trading doesn't admit such generosity. The history of futures demonstrates that volume in particular types of contracts, such as for gold, crops or stock indexes, tends to concentrate at one exchange. In turn, that creates the liquidity that draws new users to the same location.
So the CBOT is afraid that even a small success by Eurex could become a big one. The CBOT could lose its biggest revenue producer and its primary claim to the global financial stage.
Longer term, a loss for the CBOT hurts Chicago's prestige in financial services. The city's futures and stock exchanges are an anchor for the Loop, symbolized by the majestic Board of Trade skyscraper at the foot of La Salle Street.
If the business goes elsewhere, there's doubt that Chicago can keep its large community of traders and trading firms.
Eurex obtained approval for its U.S. plans Wednesday from the Commodity Futures Trading Commission, the federal regulator of the futures markets. The CFTC said authorizing the market benefits traders by encouraging competition.
In response, Eurex U.S. said it would debut at 7 p.m. Sunday. The exchange, 20 percent of which is owned by mega-firms such as Deutsche Bank and Goldman Sachs, said more than 100 customers have participated in trading simulations, and 36 have agreed to be market makers.
"When an exchange goes after another one with an established hold on a market, they're going for the home run. You either get that or the strikeout,'' said Craig Pirrong, finance professor at the University of Houston and an authority on futures exchanges.
He said Eurex has a formidable track record, but the CBOT has substantial advantages as the incumbent market. "Either way it goes, it's not going to be a cheap fight,'' Pirrong said.
The CBOT has squelched two well-pedigreed, well-funded challenge to its Treasury dominance. One, a computer trading system called BrokerTec, gave up the ghost last year after getting less than 1 percent of the trading. The investment banks that backed it are now shareholders in Eurex U.S.
Eurex, however, has hit a home run before. In 1997, it set out to grab the Bund contract, representing German government debt, from London's futures exchange using what was then a radical idea -- an all-electronic market that wouldn't require a physical trading floor. London's exchange, which had a floor, reacted slowly, and lost the contract in a matter of months.
The experience pushed worldwide markets toward electronic trading and away from the "Chicago model'' of business conducted amid the shouting of trading pits. The CBOT and the larger Chicago Mercantile Exchange have responded by developing computer trading systems while maintaining their pits, arguing that customers will decide which is preferable.
Last month, 90 percent of the CBOT's Treasury trading occurred electronically. Overall, more than 40 percent of volume at the CBOT and Merc takes place via the computer, and it's the fastest growing part of the business.
Some experts believe that by saddling themselves with the expense of the pits, the Chicago markets have made themselves vulnerable to Eurex-like challenges. The same London market that lost out to Eurex has reconstituted itself as an electronic exchange, and plans to start listing the Merc's most lucrative contracts, Eurodollar futures and options, on March 18.
"The Chicago markets are in peril because of small-mindedness,'' said a prominent academic expert in futures trading who asked that his name not be used. He said the local exchanges resisted electronic trading out of loyalty to the idea "that the best way to clear a market was to have the biggest and heaviest guy elbow his way to the best place in the pit.''
In preparation for the competition from overseas, the Board of Trade and Merc have slashed fees and improved their computer technology. Tuesday, the Board of Trade tried the tit-for-tat approach, announcing it would start listing the German contracts that are Eurex's mainstays.
Futures trading is changing fast enough, with or without Eurex's arrival in the United States. But its upcoming fight with the Board of Trade will say a lot about how the industry looks from La Salle Street. |
