BusinessDay 30 Mar 2018

A4 BUSINESS DAY
C002D5556 Friday 30 March 2018
FT
CME’s hard-charging chief executive Terry Duffy has made an audacious approach for Nex
Chicago’s CME eyes pole position
in biggest bond market
Deal for UK’s Nex Group would bring together cash and futures trading in US sovereign debt
PHILIP STAFFORD
Shake-ups are rare in the
world’s largest government
bond market. But a successful
bid from Chicago’s CME for
London’s Nex Group could herald
the biggest change in the trading
of US government debt in a decade.
The audacious approach by
the CME’s hard-charging chief
executive Terry Duffy for Nex, run
by veteran City entrepreneur Michael
Spencer, would for the first
time unite the trading of the cash
bonds — dominated by Nex’s BrokerTec
platform — with an interest
rate futures market that is in the
CME’s grip.
Analysts say the CME’s contemplation
of a takeover underlines
how the post-financial crisis landscape
has forced banks — who have
long favoured keeping the two pools
of trading separate — to recognise
the cost benefits of a common
platform.
For most of its history BrokerTec,
the crown jewel in Nex, only handled
trading by banks before more recently
allowing nimble, electronic firms
like Citadel Securities, Virtu Finan-
PEGGY HOLLINGER
Airbus has slammed attempts
by Brussels to freeze the UK
out of the EU’s €10bn Galileo
navigation project after Brexit, warning
that British participation in European
space programmes is critical to
partnership on security and defence.
Tom Enders, Airbus chief executive,
has urged the European Commission
to rethink its proposal to
exclude the UK from access to Galileo’s
encrypted services or industrial
participation after March 2019. He
called on both sides to find a longterm
solution to retain Britain’s participation
in all space programmes.
“The UK’s continued participation
in the EU Galileo programme
will ensure security and defence ties
are strengthened for the benefit of
Europe as a whole, during a period
of increasing threats to our security
cial and DRW to use the platform. In
contrast, the CME has for decades
catered to a broader spectrum of
traders and institutional investors
who use futures contracts to hedge
and take advantage of price swings
in bonds.
“There are a lot of buyside firms
who trade derivatives with CME. If
BrokerTec were to ever open up to
the buyside, CME could provide institutions
with seamless clearing and
settlement for cash Treasuries,” said
Jim Greco, co-founder of Direct Match,
a start-up trading venue that failed to
break into the Treasury market.
Banks and high-frequency trading
firms say a combination of the
two companies should lower their
overall trading costs as they will be
able to make more efficient use of
the capital that regulations require
them to back their bond and futures
trades with.
According to a person close to the
deal, the rationale for the acquisition
lies in the tougher capital requirements
banks face, their inability to
offer market financing and the savings
they can make from processing
deals through clearing houses. Under
UK takeover rules, the Chicago
and geopolitical instability,” he said
in a statement to the Financial Times.
Describing the UK as “one of only
two serious powers in Europe” on
defence alongside France, Mr Enders
insisted: “Maintaining and enhancing
security and defence ties across
Europe is vital for all citizens across
the continent. Irrespective of the UK’s
membership or not of the European
Union, the UK is an important part
of Europe geographically, economically
and culturally, and must play an
integral role for our mutual security.
“The UK needs to be able to continue
in current and future European
security and defence programmes to
strengthen the successful partnership
that already exists.”
Mr Enders comments come as
London and Brussels are locked in
a dispute over UK participation in
Galileo.
The row follows a letter to the
ANALYSIS
group has until April 12 to firm up
its interest in Nex.
If it does it will be the CME’s first
overseas acquisition, its first major
deal since it paid almost $10bn
for Nymex, the commodities and
metals exchange, in 2008 and only
strengthen Mr Duffy’s position as
one of the most powerful executives
in financial markets.
Banks and traders will be hoping
a deal improves a market that even
the US Treasury admits is inefficient
and presents potential risks, such as
non-settlement of bonds.
A reshaping of the plumbing
of the Treasury market comes at a
pivotal time. The Federal Reserve is
raising interest rates and shrinking
its balance sheet, increasing the
chance of divergences in the value
of futures contracts and cash bonds.
Many banks still perform the
crucial role of underwriting the US
national debt via huge and growing
sales of Treasury bonds each
month. But Kevin McPartland, an
analyst at Greenwich Associates, a
consultancy, points out that banks
have also adapted their trading, and
are as likely to trade futures as they
are the cash market.
Airbus says UK participation in Galileo project post-Brexit is critical
Europe’s biggest satellite maker urges Brussels to rethink plans to kick Britain out of space programmes
UK from the European Commission
in January which explained that it
would be inappropriate to divulge
highly sensitive information about
post-2019 plans for Galileo’s highly
encrypted public regulated service to
a departing member state. Without a
security agreement allowing for the
exchange of highly sensitive information
this would be against EU rules,
according to EU officials.
The PRS which has an added layer
of security, is designed to be able to
function when all other navigation
services are being jammed.
“If the commission shared this
information with the UK (which will
become a third country) it would irretrievably
compromise the integrity
of certain elements of these systems
for many years after the withdrawal
of the UK,” the commission said, according
to an official who had seen
the letter.
Who will fare worse in a
China-US trade war?
China seen as vulnerable, but critics say Trump has squandered a strong hand
GABRIEL WILDAU
Donald Trump earned ridicule
for declaring on Twitter
that for the US, a trade war
would be “easy to win”. But economists
say there is some truth to the
observation that in a trade war, deficit
countries hold an advantage over
those with trade surpluses.
China’s trade surplus swells its
economy each year, while net imports
subtract from the US growth.
From this perspective, economists
say Mr Trump is correct that he
has less to fear from a decrease in
trade with China than President Xi
Jinping.
However, White House actions
to date have offered little reason
to believe that Mr Trump and his
advisers understand how to play to
their own advantage.
“In principle, trade war is something
that deficit countries with
diversified economies should win
and surplus countries always lose.
So it’s not really an even battle,” says
Michael Pettis, finance professor
at Peking University’s Guanghua
School of Management.
“That’s not to say that deficit
countries can’t screw up, and unfortunately,
the approach that the US is
taking isn’t really going to address
the deficit.”
Understanding why surplus
countries typically fare worse requires
stepping back from a focus on
specific products such as soyabeans
or steel and understanding the macroeconomic
forces that create trade
surpluses and deficits.
A basic economic principle states
that the balance between exports
and imports corresponds to the difference
between national savings
and investment. Economists generally
see the latter balance as more
significant: the savings-investment
gap determines the trade balance,
rather than vice versa.
On this view, specific trade policy
measures are mostly distractions. A
steel tariff will cut steel imports, but
if the savings-investment balance
cannot adjust, other imports will
rise correspondingly, leaving the
overall trade balance unchanged.
For the US, closing the trade
gap requires more savings relative
to its level of investment. Fiscal
policies designed to increase US
savings would help, though recent
deficit-financed tax cuts and
spending increases push in the
opposite direction.
“Tariffs won’t have much impact
on a country’s overall trade
balance. As long as US demand is
rising while the economy is near
full capacity, we’re going to be
importing from somebody,” says
David Loevinger, former senior
co-ordinator for China affairs at
the US Treasury and now managing
director of emerging markets
sovereign research at TCW Group.
“It’s like a water balloon. If you
restrict one end it just flows somewhere
else.”
Beyond fiscal policy, the US
could restrict the ability of China
and other surplus countries to
finance American deficits through
purchases of US Treasuries and
other dollar assets.
The imposition of capital controls
would be a fundamental
repudiation of the US commitment
to financial openness and liberalised
capital flows, which underpin
the dollar as a global reserve currency.
Yet there are few signs that
Mr Trump or advisers care about
such things, especially now that
globalists led by Gary Cohn have
been sent packing.
A trade war fought this way
would inflict significant pain on
China and bring some benefits to
the US.
Wei Li, senior China economist
at Standard Chartered in Shanghai,
estimates that a broad-based trade
war between the US and China
would cost China 1.3 per cent to
3.2 per cent of GDP, with the latter
estimate representing an extreme
scenario in which the US bans all
Chinese imports. For the US, the
comparable loss would be 0.2 per
cent to 0.9 per cent.
For an example of how a trade
war using capital controls might be
fought, one need look no further
than China in the 2000s.
Chinese foreign exchange controls
are designed to restrict capital
flight, while the country increasingly
opens up to foreign inflows
through its stock and bond markets.
But when China’s surpluses were at
their peak a decade ago — the current
account surplus hit nearly 10
per cent in 2007 before falling to 1.4
per cent by 2017 — China blocked
financial inflows to domestic financial
markets.
“Any kind of capital flow restriction
is ultimately a way of managing
trade imbalances,” says Mr Pettis.
The difficulty for the US is that
capital controls cannot feasibly
be deployed only against “strategic
competitors” such as China.
Military allies Germany and South
Korea are also big contributors to
the US current account deficit.
This is where China sees its
protection from the ravages of
global trade war. Arthur Kroeber of
Gavekal-Dragonomics, a Beijingbased
research group, says China’s
focus is to isolate the US to prevent
allies such as the EU and Japan from
entering the fray.
“China knows it can hold its
own in a commercial conflict with
any individual rival, including the
US. But a concerted effort by the
industrial democracies to constrain
China’s mercantilist development
programme would cause it much
more pain,” he wrote last week.
Mr Kroeber saw German Chancellor
Angela Merkel’s recent agreement
with Mr Xi to co-operate on
steel overcapacity as a “German
rejection of US efforts to bully it into
an anti-China alliance”.
China’s other main point of
leverage is the reliance of US companies
and China’s huge domestic
market. Such dependence does
not show up primarily in figures on
goods trade but rather in services
as well as corporate earnings by
the local units of US companies
such as Apple, General Motors and
Caterpillar.
US businesses are vulnerable to
myriad forms of disruption, much
of which would likely occur through
regulatory harassment. China Inc, by
contrast, remains more domestically
focused, despite a recent wave of
outbound investment.