Streetwise Professor

December 23, 2007

Good Luck With That

Filed under: Economics,Exchanges — The Professor @ 9:35 am

Aaron Lucchetti reports that J. P. Morgan Chase, Deutsche Bank, Citadel and others are planning to launch a futures exchange in competition with the CME. The article is sketchy on details. For instance, it makes no mention of the clearing arrangements for the proposed exchange. (My guess–The Clearinghouse Formerly Known As BOTCC, the Board of Trade Clearing Corporation. There is a large overlap between the identity of the firms that just acquired all the shares of The Clearing Corporation and the firms mentioned in the Lucchetti article.)

Aaron argues that this initiative arises from bank dissatisfaction with high CME fees. That’s possibly part of it, but there is another angle as well. The big Wall Street dealers also want to protect their position in the OTC swaps market. The CME is aiming to offer clearing services in that market, which represents a direct competitive threat to the swap dealers.

The prospects for the upstart exchange’s success are bleak. It is always difficult for an entrant exchange to challenge an incumbent. (Just ask Eurex or Euronext.LIFFE.) As I’ve written before (both on this blog and in some working papers) due to its liquidity advantage, the incumbent is likely to prevail unless it makes an egregious error (as LIFFE did in 1997-1998.) My prediction: a short-lived price war between the upstart and the CME (and perhaps preemptive CME price cutting) followed shortly thereafter by the upstart’s demise, followed shortly thereafter by an increase in CME fees.

One last observation. The Wall Street firms lobbied the DOJ rather intensively to oppose the CME-CBT merger, arguing (among other things) that entry was not feasible. This announcement kinda refutes that argument, eh?

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