Rough Justice for the Chicago Merc

In the face of recent regulatory criticism, the futures-exchange firm's stock has been slammed by investors fretting over the fate of its merger with Nymex

by Joseph Weber

Having watched their stock lose almost $134 a share, nearly 22%, in two days of withering criticism from the Justice Dept., leaders of the Chicago Mercantile Exchange are firing back. They sought on Feb. 6 to reassure investors that any dramatic industry changes would require prolonged hearings and an act of Congress, and are extremely unlikely.

"It's just one opinion, and they are not the primary regulator on this industry," Chief Executive Craig Donohue of the exchange's parent, CME Group (CME), said in a hastily convened analyst conference call. "We will continue to be vigilant in defending our interests."

Falling Stock

But Justice, which called for a fundamental shakeup in how the futures industry is organized in a commentary sought by Treasury officials, could wield some heavy clubs if it battles the Chicago Exchange on the issue. It could, for instance, withhold approval for the CME's planned acquisition of the New York Mercantile Exchange (NMX) in an $11 billion deal now under discussion by the two bourses. Or it could make a spin-off of the CME clearinghouse, its lucrative trade-clearing operation, a condition of such a deal.

Taking a longer view, some outsiders suggest that Justice staffers who have long fretted over the CME's hefty market power in futures could even be laying the groundwork for an overhaul of the industry if trust-busting Democrats win the White House this fall.

Certainly, the CME is reeling from the blast by Justice, which suggested on Feb. 5 that "greater head-to-head competition" would lead to more innovation, lower trading costs, and increased trading volume. Over Feb. 5-6, the CME's stock shed about $133.75 a share, to close on Feb. 6 at 485.25, and the shares had already slid dramatically in recent months with the overall market fall; the stock fetched more than $714 a share in December. Nymex's stock has gotten caught in the downdraft, too, falling nearly $26 a share in the last two days, to 87.88.

The Future of Futures Trading

The Justice Dept. contrasted the futures industry, where the CME handles more than 85% of all the contracts traded in the U.S., with the more fragmented world of stocks. The New York Stock Exchange (NYX), Nasdaq (NDAQ), and several other exchanges or trading facilities, including low-cost upstarts such as Kansas City (Mo.)-based BATS Trading, compete for volume in stocks, and business is spread out widely. Investors can buy a stock at a New York exchange and sell it on a Chicago bourse, for instance, using a central clearinghouse owned by all the exchanges.

But the futures market is quite different. Customers who buy Eurodollar contracts at the CME can sell them only there and only by using the CME's clearinghouse. Amid bare-knuckle competition, the cost of trading stocks has fallen sharply, while futures-trading costs have seldom budged.

Justice suggested that clearinghouses should be separate from the exchanges. It argued that the current market structure in futures "has made it difficult for exchanges to enter and compete in the trading of financial futures contracts." Justice added that current rules and policies "may be unnecessarily inhibiting competition among futures exchanges in the development and trading of financial futures contracts, to the detriment of the economy and consumers."

"Not at All Impressed"

CME executives counter that competition in the futures world is global and that only a powerful U.S. exchange can go head to head with foreign rivals. Further, they say there's been no shortage of innovation in new products and that trading costs have dropped as volumes have grown sharply.