The Chicago Mercantile Exchange Intends to Purchase the Chicago Board of Trade, Creating One of the Largest Derivatives Markets

As exchanges vie for revenue in an increasingly competitive marketplace, few people were surprised when the Chicago Mercantile Exchange (CME) last month announced its intent to purchase cross-town rival the Chicago Board of Trade (CBOT) for $8 billion. The newly formed CME Group would be one of the world's largest derivatives markets, with average daily trading volume at nearly 9 million contracts per day, equal to $4.2 trillion. Cost savings, according to the companies, will top $125 million in the second year after the deal's closing.

In an increasingly electronic marketplace, technology is at the core of the exchanges' merger. "This is about technology and nothing else," says Octavio Marenzi, founder and CEO of Celent Communications. "The whole and only rationale for the merger is about migrating to a single technology platform."

According to the exchanges' executives, that platform will be the CME's Globex, to which the CBOT users likely will begin to transfer once the merger is cleared by regulators. The CBOT's current trading platform, Liffe Connect, is licensed from London-based Euronext.liffe. "The systems are pretty straightforward" in terms of ease of use, explains Marenzi. "The real trick will be migrating users without them even knowing it."

Leslie Sutphen, global head of eBrokerage strategy and implementation at Chicago-based broker Calyon Financial, believes the differences in the technology will be negligible. The platforms of both the CME and the CBOT have their own sets of benefits and challenges, relates Sutphen, whose firm trades on both exchanges. "Either is acceptable for us," she says. "But this will simplify life a bit. There will be one less platform to worry about. You only have to deal with one help desk."

Sutphen's hope is that the cost savings associated with the merger will benefit the markets' participants, as was the case in the CME/CBOT's back-office merger in 2003. "When they combined back-office functions, we saw more savings," she says. "The greatest benefit [of the merger] would be cost efficiencies. We hope they'll pass those efficiencies on to the end user."

Michael Buek, a principal and portfolio manager in Vanguard Financial's quantitative equity group, also sees the merger as a nonissue from a technical standpoint. "As an investor, I'd care a lot, but I don't think the exchanges are merging to satisfy a core equity client need," contends Buek, who trades S&P futures on the CME. "If I have a consolidated trading front end that lets me get to fair and fast market centers, then I don't care what they're called."

The 'Electronic Age'

Although the CME and the CBOT have declined to tally up potential layoffs, Peter Horowitz, managing director and leader of the Capital Markets practice at BearingPoint Financial Services, predicts the impact will be nominal. "Marginal players" with specific niches might get "pushed aside" during the merger, he says, as will many floor brokers, considering the CME's overwhelmingly electronic model.

CME CEO Craig Donohue said earlier this year that by the beginning of 2007, the exchange will be nearly 70 percent electronic. The new merger proposes a move of the smaller open-outcry business of both exchanges to the CBOT's trading pits nearby.

BearingPoint's Horowitz cites the New York Stock Exchange's hybrid of electronic and floor trading as a likely model for the new CME Group. "It will be interesting to see if that approach survives," he says. "As things evolve in Chicago, they might accept the conventional wisdom that everything is going electronic."

The electronic age is "right around the corner," adds Celent's Marenzi. But, he notes, "I've been saying that for a long time. The longevity of the open-outcry system never ceases to amaze me. There's just no reason for it."

Beyond the extent of its electronic status, other questions remain about the benefits of the merger to the CME Group's participants. Vanguard's Buek worries that with all of its focus on increasing investor returns, "They may take their eye off the ball in terms of servicing my needs." And with fewer games in town, he continues, "They might start charging higher prices."

But Buek is comforted by the nature of capital markets. "There aren't a lot of barriers to entry for exchanges," he says. "If they do take their eye off the ball, someone else will provide what I'm looking for."