By David Greising
Tribune chief business correspondent
July 10, 2007
They did it the Chicago way,
two burly exchanges represented by two old-time pit traders, hustling
and muscling their way into a cutthroat new world where electrons and
algorithms are more important to success than hoarse voices or flashy
trading jackets.
The Chicago Mercantile Exchange won the monthslong battle to acquire
the Chicago Board of Trade, the world's oldest futures exchange, in an
$11.8 billion deal. The Merc's last offer ended a see-you,
then-raise-you bidding war with the IntercontinentalExchange, a
7-year-old, all-electronic market based in Atlanta.
"I was told
it was going to be a game of Texas Hold 'Em," said Charlie Carey, a
third-generation pit trader who brought the Board of Trade into a
merger pact with the Merc in October. As the CBOT's chairman, Carey
stuck with the deal, riding out months of loud objections from CBOT
members, all the way to the end.
"Everybody around here was holding back, waiting to see if the ICE or the Merc would improve their offer," he said.
The Merc did just that. At 2 a.m. Friday, after meeting for four hours,
the Merc's board boosted its offer by 7 percent. With the bid up $3
billion from the price the Merc first offered, CBOT shareholders Monday
finally approved the deal.
Carey and his counterpart at the
Merc, Executive Chairman Terrence Duffy, have earned a moment of
elation. But just a moment. Because the world is changing fast, and
competitors are charging hard.
First up: The New York Stock Exchange.
For generations, the NYSE was content to watch the Chicago exchanges
build a tidy business trading contracts on corn and soybeans, live
cattle and frozen pork bellies. When Chicago moved into financial
futures in the 1970s and 1980s, trading Treasury bonds, stock indexes,
currencies and eurobonds, New York didn't like it but didn't do much
about it.
But now, with financial markets converging and all
players eyeing the same turf, the combined Merc and CBOT is a potential
rival, one the NYSE can't afford to ignore. It wants in on their turf,
and as all exchanges look to expand, their eyes wander into the same
places.
Ever since the NYSE converted from a private club to a
publicly traded company in 2006, it has been on the prowl for market
share and market power. Its big deal earlier this year, acquiring
Euronext NV for $13 billion, besting Germany's aggressive Deutsche
Bourse to boot, was its first major foray into exchange-traded
derivatives.
Overnight, the NYSE had taken its long history in
securities trading and tacked on a major presence in derivatives in the
form of LIFFE. That London-based exchange trades futures and options on
everything from stocks to financial instruments to agricultural
commodities.
Thanks to the Euronext deal, derivatives account
for 22 percent of the revenue of the newly anointed NYSE Euronext. And
the New York giant is motivated to grow that business, thanks to the
rich 54 percent profit it earns on derivatives.
NYSE Chief
Executive John Thain has made it clear he does not plan to cede the
futures arena to the pit traders of Chicago. He plans to grow market
share with a quick strike.
"It's very difficult to compete head
to head in existing contracts, so I think if we're going to develop a
bigger presence in the U.S. in the areas that are currently in
existence, I think it has to be by acquisition," Thain said at an
analyst briefing last month.
Talk has run rampant that Thain
might acquire the New York Mercantile Exchange. That exchange's
strength in energy contracts would be attractive at a time of
$70-a-barrel oil. Now that ICE's Board of Trade foray is over, Thain
might bid for ICE itself, where an impressive stable of smaller
exchanges around the world might appeal to Thain's global thinking.
Still, NYSE Euronext faces an uphill battle in exchange-traded contracts.
"Thain realizes how tough it is to go after the big, exchange-traded
contracts," said William Blair & Co. analyst Mark Lane. "To just
look at the areas where the CME and the CBOT don't have products, it's
pretty much just the crumbs."
The upshot of all this is that
the competition between Chicago and New York likely will veer in
different directions. For starters, the combined Merc-CBOT might
consider bidding for the Chicago Board Options Exchange, a move that
would give a burgeoning Chicago markets complex a strong footprint in a
fast-growing and profitable sector.
Duffy on Monday declined to comment on any potential CBOE hookup.
Ultimately, leaders at the NYSE, the Merc and the CBOT all realize that
one of the ultimate battlegrounds might be in an area of highly
technical but hugely lucrative trading called swaps.
Big
financial institutions and corporations seek to guard against changes
in the direction of interest rates, exchange rates or other financial
risks by entering into complex financial contracts. In essence, they
"swap" the risk they have with an institution that has an opposite risk
profile. The numbers are so big that the swaps market is estimated to
be valued beyond $300 trillion in notional value.
By their
nature, swaps contracts are custom fit to the needs of the institutions
that trade them. And the private firms and investment banks that set up
the swaps jealously guard their highly lucrative footholds. Indeed,
some Chicago exchange leaders believed that New York banks supported
the ICE bid in part to prevent Chicago from competing in the swaps
arena.
More and more, exchanges such as the Board of Trade and
Merc have argued that some so-called plain-vanilla swaps could be
listed on exchanges. Customers would be attracted to the exchanges'
ability to clear trades, eliminating the considerable risk that the
other side of a swaps contract might not meet all its obligations.
"Everybody is looking at swaps longingly," said Gilbert Bassett,
director of the International Center for Futures and Derivatives at the
University of Illinois at Chicago. "They want to get a piece of that
business onto the exchanges."
Potentially, swaps could mean
hundreds of millions of dollars in new revenue for exchanges. But for
now, the business is quite small. Last month, the Merc and CBOT both
introduced exchange-traded swaps-like contracts, but have yet to report
their first trades. The NYSE hasn't introduced a contract yet.
For the CBOT's Carey, the potential in swaps is part of a bigger picture that made sense for his exchange.
"We've cemented Chicago's position as the derivatives capital of the
world," Carey said. "With the cost of technology, the cost of a global
network, the cost of distributing your products, you've got to have
scale."
Carey grew up trading in Chicago's grain pits. Today,
the future of the markets is found in fancy mathematical algorithms and
lightning-fast computing power.
The Merc's Duffy knows things
will move quickly from here on out. He seems glad to be moving to the
next phase after a deal that took nearly 10 months to play out.
The end game was particularly rough. After raising the Merc's bid,
Duffy spent an anxious weekend waiting to see if ICE would try to top
it. Between attending Friday's Police concert at Wrigley Field, a round
of golf with friends Saturday and time with his twin children Sunday,
Duffy recalled, he twitched every time the phone rang.
"This
has been a very anxiety-ridden process we've been going through," Duffy
said Monday. "It has taken its toll on a lot of us."
Duffy's
cell phone rang almost the moment those words came from his mouth. On
the other line was one of the deal's biggest fans: Mayor Richard M.
Daley.
"It's been a long road," Duffy told Daley. "It's huge for Chicago, and your support helped solidify it for us."
Now it is up to Carey, Duffy and the other leaders make certain the
deal solidifies Chicago's position in the fast-changing world of global
finance.
- - -
Consolidating futures
2000
Exchanges in Amsterdam, Brussels and Paris merge to form Euronext.
2001
Atlanta-based IntercontinentalExchange buys London's International Petroleum Exchange.
2002 Euronext acquires the London Financial Futures Exchange and the
Portugal-based exchange Bolsa de Valores de Lisbon e Porto.
2003
Stockholm Stock Exchange owner OM merges with the Helsinki Exchange to form the OMX group.
2004
Eurex acquires U.S.-based Brokertec Futures and creates Eurex U.S. in Chicago
2006
IntercontinentalExchange purchases 8 percent of India's National Commodity and Derivatives Exchange.
2007
April: The New York Stock Exchange parent buys Euronext
April: Deutsche Boerse offers to buy the New York-based International Securities Exchange.
May: Nasdaq parent buys OMX.
June: Borsa Italiana and the London Stock Exchange agree to merge
Monday: Chicago Board of Trade shareholders approve merger with the Chicago Mercantile Exchange.
Source: Futures Industry Association, news reports Chicago Tribune
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dgreising@tribune.com
In the Web edition: Tribune senior correspondent Greg Burns analyzes
the merger of the two exchanges in a video report at
chicagotribune.com/marketsmerger.
