Eurex may say ‘there’s room for all’ but as it prepares to launch in Chicago, local exchanges should take a look at what they are up against. Jan Wagner reports.Beware, Chicago derivatives exchanges, Eurex is busy planning the last elements of its big push into the US market next year with the aim of ending the Chicago exchanges’ dominance of that lucrative market.

If recent history is any guide, the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME), which still rely heavily on open outcry trading, had better prepare their defences well. In 1998, Eurex forerunner Deutsche Terminbörse (DTB) won back the bulk of German Bund trading from Liffe, its London rival. The simple reason was that DTB’s electronic platform was quicker, cheaper and more efficient than Liffe’s open outcry pits. Liffe quickly went electronic and now closely jockeys with Eurex for the title of the world’s biggest exchange.

EuronextLiffe also has its sights on building its US business and launched its securities futures joint venture, NQLX, with Nasdaq in November 2002.

It is easy to appreciate why Rudolf Ferscha, chief executive of Eurex, is now setting his sights on the US. Since the beginning of the bearish equity markets three years ago, liquidity has returned to US derivatives exchanges in a big way. Trading volume at the CBOT and the CME, which, respectively, specialise in US government bond and interest rate futures, has hit record levels.

Eurex already has pretty strong foundations on which to build its US business. The exchange estimates that US investors now account for 20%-30% of trading in its top derivatives products, including futures on the German Bund and the Euro-Stoxx-50 stock index.

Eurex has also built a strong reputation for itself in the US market since agreeing to a leasing deal with CBOT in 2000. Under the deal, which expires just prior to its planned US debut (now that CBOT has switched its allegiance to EuronextLiffe’s Connect platform), Eurex has been leasing its a/c/e electronic platform to the CBOT for trading in US government bond futures.

The platform has caught on so well that it currently accounts for 80% of all trading in the benchmark product. Indeed, a/c/e’s success is a major factor in Mr Ferscha’s decision to no longer to put up with a licensing fee while the CBOT raked in handsome transaction fees.

Eurex has kept its US battle strategy under tight wraps. It says, however, that it plans to offer the full range of derivatives available in the US. “But the exact specifications of these products will be made public at a later stage,” says Mr Ferscha.

Considering its huge success, the US bond future featured on the a/c/e platform should rank as Eurex’s flagship product. But how these products will be delivered is still up in the air. Eurex has yet to make public whether it will open an exchange in Chicago or buy an existing one. Neither option should pose a problem, but many believe that cash-rich Eurex will buy a regulated onshore business. It is rumoured to be eying BrokerTec Futures, the remaining independent arm of BrokerTec – the rest of which was recently sold to interdealer brokerage firm Icap.

Plans come together

Importantly for Eurex, the first piece of the jigsaw for securing US regulatory approval has been put in place – namely its partnership with the Chicago-based Clearing Corporation, signed and sealed in May. The arrangement, which is the first ever transatlantic clearing deal, means that Eurex customers in Europe and the US will be able to trade both euro- and dollar-denominated derivatives and have the choice of clearing through the Clearing Corporation or Eurex’s in-house clearer.

Once the US exchange is in place, new and existing customers – those who use a/c/e – will be able to access Eurex’s network either by ordering a special screen and connection from the exchange or via the internet.

Track record

Mr Ferscha is highly confident that Eurex’s business model – offering a fast, efficient, and low-cost electronic platform to anyone in the world wanting to trade derivatives – will ensure the success of its US strategy. To support his claim, he cites the exchange’s recent performance vis ŕ vis the CBOT.

“Consider that in the last three years we developed our interest rate product suite from a head-to-head level with the US interest rate market to a level now double the size of the US market. We have grown our business much faster than our American competitors,” he says.

At the same time, however, Mr Ferscha doubts that the competitive threat posed by Eurex will lead to the demise of one or more of the Chicago exchanges, which in addition to the CBOT and the CME includes the Chicago Board Options Exchange (CBOE). “The world is big enough for all of us,” he says generously, “but we will grow this market much quicker than any of the existing exchanges.”

Peter Green, chief executive of the London derivatives firm Kyte Group, agrees that Eurex’s chances are very good, owing to the considerable advantages its electronic platform has over the open outcry trading at the CBOT and the CME.

“Kyte trades more efficiently and cheaply with screen trading on Eurex than with open outcry on the Chicago exchanges,” he says. “With open outcry there are too many hops to make before having a trade executed and in Chicago there are complicated transaction fee schedules. On Eurex, and on Liffe for that matter, one price fits all.”

Common clearing – too little, too late?

The introduction of a common clearing link for the two derivatives exchanges in Chicago has been under debate for almost 13 years, writes Frances Maguire. Now made possible by the Chicago Board of Trade’s (CBOT’s) decision to sever its relationship with the Board of Trade Clearing Corporation (BOTCC) and move its clearing to the Chicago Mercantile Exchange’s (CME’s) wholly-owned subsidiary, the link is expected to go live by January 2, 2004.

It is estimated that member firms will save up to 90% in collateral for interest rate and equity products. The Common Clearing Link will clear approximately 85% of US futures and options volume. Spread credits between CME and CBOT products will be recognised by the CME Clearing House in a single portfolio. The exchanges will publish inter-commodity spread credits for interest rate, equity and agricultural products shortly, which are expected to be as high as 90%.

CBOT contracts will continue to be net margined, while CME accounts will have net margining for proprietary accounts and gross margining for customer accounts. Portfolio margining will also be available for customer positions on a net and gross basis.

First step

Taking part in a panel discussion at the Futures Industry Association and the Futures and Options Association’s 10th International Derivatives conference in London last month, CME president and CEO Jim McNulty said: “Transatlantic clearing is something global clearing firms look to. The consolidation of clearing in Chicago is a first step. Who knows, the next step may be a global step.”

The catalyst for the move is often cited as the increased competition from Eurex’s plans to buy or set up a US exchange, but industry insiders say it was the vested interests at the BOTCC that held back consolidation. One source close to the deal says: “The CBOT regained control of its clearing business, deciding it was the intellectual property of the exchange not the clearing house. It had been a case of the tail wagging the dog.” Another source says that the BOTCC had wanted to clear both CBOT and Eurex contracts. Now, the BOTCC will clear any Eurex US venture.

Unresolved issues

But there are still key issues to be resolved in the next six months. Nothing like this has been attempted before, on this scale. The relevant expiry date for moving CBOT clearing will be December 19 and it is presumed that the transfer will have to take place within banking hours, over the holiday period.

Then there is the question of who owns the open interest. Technically it belongs to the clearing firms but, as it cannot be divided up and given back to them, the exchange will take ownership of the outstanding positions to move it in one block. And there is the question of the guarantee, or default, fund. The fund for the CME clearing is not big enough to guarantee obligations of the CBOT contracts. While it would be quicker to increase the obligation from CME members, they would not accept this and CME has just months to process new obligations from CBOT clearing members before the link can operate.

The logistics of moving the CBOT clearing business across to the CME Clearing House will be costly and the brokers refuse to pick up the tab; they believe it should land firmly in the laps of the exchanges that took the decision.

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