Jim Kharouf explains how The Clearing Corporation lived on despite being dumped by the mighty Chicago Board of Trade.
Dennis Dutterer is seen as the gutsy player who stood up against the bullying tactics of the Chicago Board of Trade (CBOT) and helped forge a new era of US futures competition in which Eurex US began trading last month. “I don’t mind that,” chuckles Mr Dutterer, president and CEO of The Clearing Corporation (CCorp) – formerly the Board of Trade Clearing Corporation (BOTCC).
But the fact is, he says, there was nothing daring about his move to agree to clear trades for Chicago-based Eurex US in the face of hostile opposition from the CBOT. Mr Dutterer’s modesty aside, key decisions made by him and the board of directors have helped shape two major changes that have altered the competitive landscape of the US futures industry: the historic CBOT-Chicago Mercantile Exchange (CME) common clearing link was created, which now runs all trades from the CBOT through CME clearing; and the BOTCC becoming the clearing house for Eurex US, which serves as a major component of the Eurex challenge to the CBOT.
Industry shift
The seismic shift began with a surprise announcement in the industry last April, when the CBOT severed its 78-year relationship with the BOTCC, which had such a close relationship that many in the industry mistakenly believe that the CBOT owned the BOTCC.
It processed and cleared all the trades for the exchange and the clearing fees from the CBOT accounted for virtually all the BOTCC’s revenues; the snap decision could therefore have sounded the death knell for the independent clearing house.
The events of just how the CBOT cut off its relationship with the BOTCC remain muddled in the public mind, but are crystal clear to Mr Dutterer.
The BOTCC had spoken with Eurex executives rather generally about offering processing services more than a year prior to the announced Eurex US venture and saw absolutely nothing unusual about doing so. As an independent clearing house, Mr Dutterer says the BOTCC had signed agreements in the past to handle trade clearing or processing services with other exchanges, including a processing deal with BrokerTec Futures Exchange, which opened with great fanfare in November 2001 as the new electronic competitor that aimed to take serious marketshare in US interest rate futures from the CBOT.
The BOTCC also signed on with other minor exchanges to handle clearing or processing, including the Merchants’ Exchange and the Commodities Derivatives Exchange.
Meanwhile, the CBOT was in the midst of major decisions regarding its electronic trading platform, which had been licensed from and operated by Eurex under the name a/c/e. In July 2002, the CBOT and Eurex decided to shorten the a/c/e contract. With the contract reset to conclude in January 2004, the door was opened for Eurex to compete with the CBOT on its cornerstone products, US interest rate futures and options on futures. The CBOT ultimately decided to switch platforms from a/c/e to LiffeConnect, owned by EuroNext Liffe.
The imminent competition from Eurex led the CBOT and the BOTCC down opposing paths that created the backdrop for the futures industry. For the first time in their long relationship, the CBOT began to push the BOTCC for a contract, which most believe included exclusive clearing and processing for the CBOT.
“Providing services to Eurex would certainly be consistent with what we have done for the past 10 or 15 years,” Mr Dutterer says. “At the same time, the Board of Trade wanted a contract with us and we never had a contract with them for clearing and processing. And we had discussions about what we wanted in the contract and what they wanted.”
The divorce
Then came the April 16, 2003 BOTCC board meeting. In the middle of the meeting, which was focused on the CBOT contract, he got the news that the CBOT and CME has struck a common clearing deal.
“We never left the Board of Trade,” Mr Dutterer stresses. “They did it without any notice to us. They never had a contract so that gave them flexibility.”
The CBOT also followed with an offer to buy the BOTCC for $207m, which amounted to a $5m bid over the liquidation price of the BOTCC. The CBOT gave the BOTCC seven days to accept the offer, but the clearing firm essentially turned it down by letting the offer period expire. A second, less lucrative, offer from the CBOT was also left unanswered.
Mr Dutterer is not the kind of executive to tip his hand emotionally in business decisions. Asked how he handled losing CBOT business in that manner, he will only say it came down to accepting the CBOT’s decision and moving on.
Some board members who were told by CBOT officials that the clearing house would have more time to work out a contract, were surprised by the CBOT’s announcement; but if the perception from the outside is that the atmosphere in the board room must have been hotter than hell and the relationship between the two organisations bitter and twisted, then Mr Dutterer is not admitting it. “No one jumped up and down and yelled obscenities,” he says.
The only thing for Mr Dutterer and the board to do was unsentimentally examine their options. With the loss of the CBOT and therefore most of the BOTCC’s revenues, Mr Dutterer says many scenarios were considered, including liquidating the company and giving member firms their cash back. Other, less drastic, options included selling the clearing house to a firm or exchange in financial services or teaming up with Eurex.
“When you looked at all the alternatives, it appeared that the best opportunity from a shareholder’s point of view was to continue to operate as an enterprise,” says Mr Dutterer. “It became clear to us that the business opportunity that we might have with Eurex was a sound one.”
Instead of despair at the prospect of facing liquidation, Mr Dutterer says pride in the company kicked in. “It’s a 78-year-old company with tremendous ownership and tremendous tradition,” he says. “Your instinct is to say: ‘We’re going to continue as a company and we’re going to keep going.’”
Tough decisions
Perhaps the hardest part of moving forward, came in downsizing the company by one-third, from 150 employees to 100. Mr Dutterer says those cuts often came down to making some “tough decisions.”
What emerged was a two-pronged plan – a long-term deal with Eurex and a corporate restructuring. Mr Dutterer and his colleagues worked out a seven-year deal with Eurex, whereby Eurex would invest $15m for a 15% equity stake and a seat on the board of the newly named CCorp. Second, the guarantee clearing function was changed to run through a separate clearing fund. That meant CCorp customers no longer needed to hold a stake in the company in order to clear there and CCorp repurchased shares from those member firms. Board members voted 9-0 for the restructuring and a deal with Eurex.
A total of 48 out of 87 member firms held onto some or all of their original shares. Just like shareholders in a publicly held firm or a private business with shareholders, those shares can be sold to anyone inside or out of the clearing business. In other words, prior to the restructuring, clearing member firms and owners were one in the same at the BOTCC. Currently, there are 67 firms registered with CCorp as clearing participants, with several more soon to be added.
Under the CCorp model, Mr Dutterer says the company is streamlined and has flexibility to make decisions about new clearing business. He says it plans to do just that in the coming months, with a trade processing deal with chemical exchange ChemConnect and another for the Options Clearing Corporation, which is handling the clearing for the new CBOE Futures Exchange.
The next giant step for CCorp is to implement the cross-Atlantic Clearing Link with Eurex Clearing in Germany. Details and regulatory issues are still being worked out, but the plan is that CCorp and Eurex Clearing will create a mutual offset system whereby trades in Frankfurt could be settled in Chicago and vice-versa.
“Conceptually, it’s like us having an additional clearing member, which happens to be Eurex Clearing AG, and them having an additional clearing member, which happens to be The Clearing Corporation,” Mr Dutterer says. “And it will work a lot like the CME-Singapore Exchange mutual offset link, where you can trade Eurodollar futures in Singapore and clear them at the Merc, and trade Eurodollars at the Merc and clear them in Singapore.”
New world
The clearing deal with Eurex and the clearing link between the CBOT and the CME are two of the biggest shifts in the US futures industry in years, perhaps ever. Mr Dutterer and his shareholders agree that those two events have shifted the industry into a new gear regarding competition for products, services and innovation.
“I think it clearly signals that the futures industry is an extremely important part of the financial services industry,” he says. “Second, it highlights the element of increasing competition, not only in prices, but you’re going to see better service and better products.”
Those clearing deals and subsequent competition between Eurex and the Chicago exchange could also serve as the catalyst for a long-awaited merger between the CBOT and the CME.
Other market participants agree on the importance of the tectonic shifts seen in the last year. Says Alan Zavarro, head of global futures for ABN Amro: “I’d be surprised if we didn’t end up with one Chicago exchange with the CBOT and CME.”
