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DERIVATIVES REPORT: CME 72 silo created at the CME. However Eurex did not take the measure of the ruthless drive of the US exchanges to undercut any market solutions that Eurex was touting. The CME and the CBOT clearly understood their own turf and what they could and could not do to withstand any assault on their market. But, stresses Donohue, the picture is greyer than market watchers often paint it. Developments in the market have been utilised to cooperate with other exchanges as well as compete with them. Recognising, for instance, that demands for greater efficiency have a wider application that the CME can also leverage to mutual advantage, Donohue claims that the exchange has led the trend toward standardisation and consolidation. “For example, Euronext.liffe uses CME’s Clearing 21 System to clear and process the majority of their securities and derivatives products. In the area of risk management CME literally created the industry standards when it developed its proprietary SPAN Margining System,” he recounts. SPAN, which allows exchanges to monitor risk exposure, has now been licensed to some 47 exchanges and clearing houses, including the Shanghai Futures Exchange. It is, says Donohue “an important step for China in the process of moving toward global industry standards.”Not least, he points to the “historic clearing processing agreement with CBOT,” as an “example of our willingness to seek standardisation and consolidation benefits that have reduced performance bond requirements for market users by more than $2bn and has saved our joint clearing member firms more than $200m in capital”. Utilising CME’s own clearing house, it was officially launched at 7:00 p.m. on Sunday, November 23, 2003 when CME began providing clearing and settlement services for a number of CBOT products, including agricultural, Federal Reserve funds, swap, municipal and Dow futures and options on futures contracts. The CME clearing house is now the world’s largest derivatives clearing organisation. “The funds we hold in custody dwarf anything held by any of our nearest competitors by a wide margin,” claims Donohue.“We hold about $40bn in collateral, and we move about $1.5bn to $6bn of collateral each day. I am confident that the $2bn savings that we provide dwarfs what can be offered by our competitors.” It was an imperative for the CME to achieve vertical integration, for four elemental reasons: It creates value, maintains Donohue, “and the ability to manage every aspect of how we deliver value to our customers. The CME can now manage all elements without being dependent on third party partners or service providers,” he explains. Equally, he expands, “I do not want to see us outsource critical functions because we would deprive ourselves of the opportunity to create and leverage our intellectual capital and lose our innovator’s advantage.” Three, Donohue is content that the Clearing House means that “we now have every major financial futures and options product cleared in a single clearing facility.” Last but not least, it was an effective nuclear deterrent. Two exchanges that would rather cheerfully run over each other suddenly began talking and acting like long lost friends. Had they been to Damascus? Or had they realised either by luck or by judgement that the initiative was a highly effective counterpunch to Eurex’s planned product launch at the beginning of 2004? Donohue answers indirectly,“both the CBOT and the CME have increased market share at the expense of the European exchanges. There has been a sea change. We are now seen as setting the pace of growth.” Perhaps the clearest indication of the direction of the CME’s near term strategy came in mid-April of this year when it announced that it was enhancing its strategic planning and corporate development capabilities and appointing Ann Shuman and Kendal Vroman as co-heads of corporate development. The appointment of two heads, rather than one to replace the work of outgoing managing director Scott Robinson indicated that the CME was bringing strategy into greater focus. Both Shuman and Vroman played key roles in the clearing agreement with the CBOT and the distribution partnership to provide CME FX on Reuters, Donohue explained at the time. The announcement was given additional piquancy when the same release mentioned the appointment of Johannes Zhou, as director of Asian business development. Zhou previously served in high executive positions in the Hong Kong Futures Exchange. Undoubtedly his experience of the operation of Chinese markets and his contact book will come in very handy for the CME. Just how handy became clear last year as the CME began to establish a bridgehead in the all-important China market. A Memorandum of Understanding (MOU) was signed in June last year with China Foreign Exchange Trading System and National Interbank Funding Centre (CFETS), a subsidiary of the People’s Bank of China, the central bank. It was a canny move. Regulated by China’s State Administration of Foreign Exchange, CFETS already provides an electronic bidding system for matching spot trading of the Renminbi (RMB) against the world’s main currencies and also operates markets for RMB interbank lending and RMB bond trading. Under the MOU, CFETS provides CME with local market intelligence and in turn the CME helps CFETS become “more familiar with the international FX derivatives markets practices”, products and regulations, according to the CME’s press blurb. “Expanding global distribution of our products and adding new customers in Asia is part of CME’s long-term growth strategy,”explains Donohue. Another similar MOU, this time with the Shanghai Stock Exchange (SSE) followed in March this year. “China’s exchanges can gain enormous growth and acceleration benefits by collaborating with global exchanges like CME to utilise its extensive infrastructure, trading and clearing platforms, and industry standardised business practices,”says Donohue, acknowledging that the CME’s long-term growth strategy is to expand global distribution of its products and to add new customers throughout Asia. He adds “We had introduced an Asian JULY/AUGUST 2005 • <strong>FTSE</strong> GLOBAL MARKETS
Incentive Plan to make our products more attractive to new customers from the Pacific Rim. We also launched a telecommunications hub in Singapore designed to make our markets more cost-effective and accessible.” To unseasoned observers, these appear small steps to cross huge chasms. But the significance of the relationships has not been lost in the region itself, which has been awash with a growing network of strategic alliances including not only exchanges but also regulators and governments. It indicates that the CME is playing for big stakes in a politically very savvy regional league. Just a few examples of extant market-to-market arrangements are the MOU between the Online Commodity Exchange of India and Malaysia Derivatives Exchange, the strategic partnering arrangements between Singapore Exchange and Bursa Malaysia, and the understanding between Sydney Futures Exchange and Hong Kong Exchanges and Clearing Ltd. Each relationship sees itself as a major power hub with much broader regional pretensions. One of the forces driving this interest in regional agreements has been structural change in the exchanges. More and more institutions in the region have taken the demutualisation route and, at the same time, derivatives and securities businesses have been rationalised. Everyone in the Asia Pacific region, it seems, is learning to play the CME’s game. In Singapore, Hong Kong and Korea, for example, the separate exchanges have been combined into a single market operator. A similar example is the Australian Stock Exchange, which recently announced plans to move its futures, options and stocks products onto a single technology platform by 2006. This trend has encouraged these consolidated, for-profit entities to focus on the opportunity to grow their share of regional and indeed world trading. For the time being, in Asia, the CME is playing the role of learned benefactor. In a speech earlier in the year to the SSE, for example, Donohue had stated that the CME’s purpose “is not to threaten or overtake the internal development of China’s emerging futures markets.”Just so. It is an unusually benign statement from a highly competitive operator and most people agree that competition made the CME. The exchange’s ability to successfully respond to the challenge from its European competitors; its willingness to ruthlessly cut costs so that it could equally ruthlessly cut prices; and its single minded focus on global expansion, has forged the successful entity that it is today. A number of questions however, still hang over the exchange. Will it merge with the CBOT? Will it acquire in Europe or Asia, and if it does acquire, will it buy another derivative exchange? Donohue is not drawn on specifics and instead emphasises that the CME’s merger and acquisition strategy is not limited to exchanges, securities or otherwise.“We have a well thought out strategy and if we were to do something it would be to create shareholder value, not because of someone’s idea of what we should be.”That’s telling us. <strong>FTSE</strong> GLOBAL MARKETS • JULY/AUGUST 2005 Looking South on Madison, Chicago 73
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