Crunch time at CME
By: Ann Saphir Nov. 01, 2008
The financial crisis that has blunted growth in CME Group Inc.'s futures business also presents CEO Craig Donohue with the opportunity to seize a market worth up to $400 million a year in new revenue — but he'll have to outfox a powerful rival, overcome Wall Street distrust of Chicago exchanges and perform a nifty dance step with resurgent regulators.
He'll also have to be quick. Just last week, New York Federal Reserve officials were in Chicago checking CME's progress in creating a new fund to guarantee trading in credit-default swaps, the insurance-like contracts that emerged as prime culprits in the credit meltdown. Fed officials also met with CME's chief competitor for the swap market, IntercontinentalExchange Inc.
Mr. Donohue and Kenneth Griffin, CEO of CME's partner, Citadel Investment Group, expect their platform to be operational this week.
Mr. Donohue badly needs the new business. Trading at his firm's two Chicago exchanges has grown only 17% this year, the slowest pace since at least 2002, and some analysts forecast declines next year. Third-quarter profit rose 3%, to $278 million. Meanwhile, shares of CME swung widely last month as investors tried to gauge its chances of success in the swaps business; starting Oct. 13, the stock slumped 43%, hitting a three-year low of $233.19 a share on Oct. 27 before recovering slightly to $282.15 on Friday.
The challenge is unprecedented for CME, which has increased its profits and share price since its public offering in December 2002. It also comes at an important time for Mr. Donohue, 47, a dapper lawyer who drives a Bentley convertible. His employment contract is up at the end of next year.
Mr. Donohue faces a familiar foe: Intercontinental CEO Jeffrey Sprecher challenged CME in its bid to acquire the Chicago Board of Trade last year. Mr. Donohue won, thanks in part to CME's ties with its crosstown counterpart.
But now, Mr. Sprecher has the connections. He formed Intercontinental eight years ago with the backing of Wall Street trading houses — the very firms that control the $47-trillion credit-default swaps market — and in the wake of Enron Corp.'s demise, when energy traders sought a safer platform for oil and gas contracts. That's exactly what credit traders and regulators want today.
Last week, Goldman Sachs, Citigroup Inc. and seven other firms signaled their support for Mr. Sprecher's plan when they agreed to allow the Atlanta-based exchange to acquire their clearinghouse, Chicago-based Clearing Corp.
The Wall Street firms have chafed at CME's dominance in U.S. futures trading — it controls 98% of that business — since it acquired the Board of Trade, and they fear its ability to raise trading fees. Mr. Donohue "faces an uphill fight" against Intercontinental, says Craig Pirrong, a finance professor at the University of Houston who studies exchanges.
Mr. Donohue says CME's position as the biggest U.S. exchange and clearinghouse gives it a huge advantage. "We're entering a new time in financial markets," he says.
Meanwhile, he says, the loss of business in CME's biggest contracts — futures and options tied to interest rates — will be temporary. He expects trading to pick up as credit markets loosen and as the federal government issues more debt to pay for its bailout. CME also hopes to fuel growth through international expansion and increased services to other over-the-counter markets, such as energy and interest-rate swaps.
But none of those markets would approach the $150 million to $400 million in revenue that Niamh Alexander, a New York-based analyst for Keefe Bruyette & Woods Inc., estimates could come from clearing credit-default swaps. CME also could generate fee revenue if the swap contracts were traded on its platform, as it is proposing.
To win the clearing business, Mr. Donohue and his team argue, CME can leverage the $1.7-billion guarantee fund it manages for futures. Kim Taylor, president of CME's clearinghouse, says that fund can be augmented by raising several hundred million dollars in additional capital from trading firms, meaning swaps traders wouldn't have to fund a new multibillion-dollar guarantee account from scratch.
Mr. Sprecher is asking traders to do just that for Intercontinental's fund. He says his approach is safer because it doesn't expose futures traders to the risk of default from credit contracts.
Intercontinental may have a slight advantage with the New York Fed, which is taking a heavy interest in swaps clearing in the wake of the credit meltdown. Mr. Sprecher plans to set up his guarantee fund as a trust bank in New York, under the Fed's authority. Mr. Donohue and CME prefer that swaps trading be regulated by the Commodity Futures Trading Commission, the federal body that regulates other exchange-traded derivatives.
But who regulates the contracts won't matter to CME unless it can capture a large portion of the market. "To really get the volume going, you need to get the dealers on board," Ms. Alexander of Keefe Bruyette says.
And soon. On Friday, the biggest swaps dealers, including the nine backing Intercontinental, promised the Fed that they would use a clearinghouse for credit contracts beginning Nov. 30.
Ms. Alexander, like many analysts, believes Intercontinental has the edge, but she isn't counting out Mr. Donohue and CME. "There has never been a better time for them to get some traction in the over-the-counter markets, and they are doing everything they can to try and accomplish that." |
