Streetwise Professor

July 10, 2007

The End of One Era, the Beginning of Another

Filed under: Derivatives,Energy,Exchanges — The Professor @ 7:17 pm

It’s a bummer (grew up in the 70s? who? me?) to have to read about the approval of the CBT-CME merger from distant China, where I am teaching until mid-July. But it’s good news nonetheless. Things played out pretty well as I forecast, with CME bumping its bid at the last minute, and ICE folding because it just couldn’t afford to overcome the CME’s efficiency advantages. Congratulations to the managements of both exchanges, and to their owner-members.

Although this brings down the curtain on the longest running act in the derivatives business (at least as an independent venture) it is a smart move. Due to mis-steps in the 90s (born out of a futile hope that they could stave off the electronic era by failing to create a viable electronic system and building a huge new trading floor–sorry guys, but Econ 1o1 says sunk costs are sunk), the CBT has been living on borrowed time for years. It never owned its clearing operation, and due to its failure to create and own its own technology, it was inevitable that it would be snapped up post-demutualization by somebody who owned both. And who better than the CME, with a first class clearing operation and arguably the best trading system in the business. The CBT-CME combination was clearly the most efficient way to go.

As I noted in an earlier post, things will develop quickly, and the remaining independent exchanges will soon cease to be such. NYMEX and ICE will soon be the next to go–and for quite handsome prices, thank you. The FT surmises that NYSE-EuroNext will try to snap up NYMEX to break up the CME-NYMEX strategic partnership. I doubt it. That partnership has worked very well, so why should NYMEX migrate to a new platform only months after moving to Globex? Moreover, the clearing efficiencies would be large. As I have said for well over a year, I expect NYMEX to end up in the CME Group ASAP. The natural thing is for NYSE-EuroNext to buy ICE.

That pretty much leaves CBOE, and various small fry, at least in the US. (LSE is another matter altogether). One could see a rationale for CBOE combining with CME, but I think that (a) the CME’s reluctance to suffer any more SEC oversight than it has to, and (b) the lingering rancor over the CBT-CBOE trading rights will make that a difficult deal to do. (Although a marriage might be one way of dealing with that troublesome issue.) So I see CBOE going with NYSE too, although that’s going to have to wait resolution of the trading rights issue.

But those are tomorrow’s stories. Now it is appropriate to reflect on the glorious and colorful–though often contentious–history of the Chicago Board of Trade. Truly a pioneer, the derivatives business as we know it would not exist if it hadn’t blazed the trail for almost a century and a half. In some respects, however, that very historical legacy–the traditions and habits and interests that grow like barnacles on venerable institutions–impaired its ability to lead the industry in the 21st century. Its management made the wise choice of partnering with a younger, more dynamic, and lately more innovative exchange. I fully expect that this partnership will blaze yet more trails, and thereby enhance the efficiency of the financial markets in the 21st century and beyond.

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