The Chicago Board of Trade and Chicago Mercantile Exchange have forever dominated futures trading in this country. Together they control 85 percent of the U.S. market. But they no longer rule the world. That title now belongs to Eurex, the all-electronic Swiss-German exchange that is shaking up futures trading and wants to bring its act to Chicago.
Eurex features no raucous trading floors crammed with a heaving mass of humanity in a sea of colored jackets screaming out a cacophony of orders. Eurex is totally electronic. What it does feature is low prices.
Eurex has applied with federal regulators to open a Chicago-based electronic futures market next year. That means, to name just a couple of possibilities, the CBOT would no longer have a lock on futures trading in U.S. Treasury securities and the Merc would no longer be the only game in town for eurodollar contract trading.
That competition would benefit customers who want to bet–or hedge their bets–on whether U.S. interest rates or the euro will rise or fall in value in the future. But it could further pressure two Chicago institutions that together personify LaSalle Street.
The CBOT and Merc insist they are all for competition. They know how to compete, they say. Futures trading in financial instruments was invented in Chicago in the early 1970s. Before the Merc introduced futures on foreign currencies and the CBOT futures on treasuries, futures trading was limited to agricultural products. Farmers and produce customers bought or sold contracts derived from the underlying value of corn, soybeans or whatever, hoping to lock in a good price or hedge against a sharp drop or rise.
The two exchanges have embraced electronic trading too, they insist. About half of all their trading has migrated. A much higher percentage of financial futures trading–80 percent at the CBOT and 90 percent at the Merc–is electronic. “Bring it on,” they say of the coming battle with Eurex.
That’s what they say. But here’s what they’ve done: used their significant lobbying clout in Washington to convince regulators to dump the Eurex application off the fast track it was on. Rather than a 60-day review, the Eurex U.S. application will now be subject to a thorough 180-day review before the Commodity Futures Trading Commission, which regulates futures exchanges in the U.S. A six-month review? That only serves to delay Eurex’s startup.
The CBOT and Merc aren’t against competition, they keep insisting. But they say that Eurex “seeks to introduce questionable business practices that are alien to U.S. futures markets and not in the public interest.” They say its plan to offer financial incentives to persuade traders to switch from the CBOT and Merc to Eurex is “improper and unprecedented.”
Eurex says a rebate plan hasn’t yet been finalized, but that incentive programs that reward trading volume with lower costs are common at U.S. exchanges.
The Merc and CBOT worry about the potential for insider dealing that could result from “internalization” of trading–allowing brokers to match customer trades on their own books rather than putting all orders out to the open market where better prices might be found. They’re concerned that the Eurex application is incomplete and that Eurex won’t be able to comply with U.S. regulatory rules regarding, among other things, surveillance and disciplinary procedures.
Sounds pretty serious, doesn’t it? Those are the kind of concerns that would raise red flags with the CFTC and the Federal Reserve Board. So what do they say?
Testifying before Congress earlier this month, James Newsome, chairman of the CFTC, had this to say about incentives to generate volume. “They have long been viewed as acceptable by the commission. Most U.S. exchanges offer such incentives in the normal course of business.” He also emphasized that the CFTC wouldn’t allow Eurex to “offer any incentive plan that (others) would not be permitted to offer” and that all of the activities of Eurex U.S. would “be subject to the CFTC’s direct regulatory authority.”
That hardly sounds like a red flag. “Competition has long served both our overall economy and our financial markets,” said Fed Chairman Alan Greenspan. “We are best served by permitting (foreign) firms to enter our markets but requiring that their U.S. activities be subject to the same regulations as domestic entities.”
And that sounds like the opening of a competitive race–which the Chicago exchanges would like to delay. That competition is inevitable. It is disheartening to see Chicago’s exchanges trying to throw up barriers to such competition rather than facing it head on.
Chicago’s exchanges are fierce and able competitors. After a slow start, they have embraced electronic trading at their own exchanges. Customers that want to trade electronically can do so. Those that want or need the customization that may be best served through the open-outcry pits have that option available to them too.
Even if Eurex prices are lower–not necessarily a given since the Chicago exchanges insist their prices will be competitive–customers may well decide to stick with the CBOT and Merc because of the service and because of the depth of their liquidity. The key to winning this battle is likely to be liquidity. Traders come to a market because they believe it’s fair, because they’ll get the best deal–and because it’s where everyone else goes. The “where everyone else goes” is what maintains depth of liquidity. Customers will decide this and that’s the way it ought to be.
The Merc and CBOT insist theirs are the superior systems best able to serve customers and the public interest. Eurex insists all-electronic is the future. It’s time to let the market decide. That’s the Chicago way.
