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Patricia Campbell
Peregrine Financial Group, Inc. (PFG)
(312) 775-3411
pcampbell@PFGBEST.com

CME's Mega Merger – CME Group is migrating the CBOT's elecronic trading to the Globex platform while consolidating two trading floors into one.

Ivy Schmerken
1 January 2008
Wall Street & Technology
© 2008 CMP Media LLC. All rights reserved.

Less than six months after completing the historic merger between Chicago Mercantile Exchange Holdings and its former rival CBOT Holdings in July, the new CME Group is about to move all of its asset classes onto a single electronic trading platform. While the CBOT is best known for futures and options on agricultural products, and Treasury notes and T-bills, the CME dominates futures and options on futures on currencies, Eurodollars and stock indexes.

Over the course of two weekends in January, CME will migrate the electronically traded CBOT products to the CME Globex electronic trading platform, whose capacity has been expanded to accommodate the increase in volume, according to Kevin Kometer, deputy CIO at CME Group. And in a sign that the future of open-outcry trading could be waning, CME will consolidate the two trading floors into one by moving all of the floor-traded products over to the CBOT's 60,000-square-foot trading floor on Jackson Blvd. during the second quarter of 2008.

"It's an enormous project," says Kometer, who is spearheading the technology migration for the mega derivatives exchange, which is estimated to have 85 percent of the market share in U.S. futures trading after fending off a competing takeover bid for CBOT from the InterContinental Exchange (ICE). After the CME-CBOT deal was announced on Oct. 17, 2006, the two legacy exchanges started planning for the merger as early as January 2007, so when ICE entered an unsolicited bid for CBOT in March, CME already had a head start. However, the bulk of the IT work was done in July, after the transaction closed, Kometer notes.

CME is splitting up the migration of agricultural, equities and financial products over two consecutive weekends. On the weekend of Jan. 14, plans are to go live with the equity and commodity products first, Kometer reports; the financials would go live the weekend of Jan. 27. All the CBOT electronically traded products will be moved to Globex, with the exception of CBOT metals, which will remain on the existing eCBOT system, Liffe Connect, until next year, Kometer says.

"They're doing a very good job of providing customer access," says Russ Wassendorf Jr., COO of Chicago-based PFGBEST.com, fomerly Peregrine Financial Group, an online broker that provides proprietary platforms for accessing futures, options, foreign exchange and alternative investment products. "Now that they will have the Board of Trade products out there, that gives them the full array of debt and stock instruments, bonds, notes and Eurodollars," he adds, noting that the CME group will have stock index futures on the Dow Jones Industrial Average, the S&P 500 and the Russell indexes.

The question is: What does the CME-CBOT technology migration mean for brokers that provide direct access to electronic trading for their customers, and what kind of IT changes will they need to make?

"Definitely, from the systems side, it will simplify things," asserts CME Group's Kometer. "Where customers' systems groups in the past had to deal with changes from two exchanges and different technology requirements from two exchanges, now, obviously, it will be one," the deputy CIO says. Customers that already trade at both exchanges will have small changes to make, according to Kometer. For example, they'll need to change their logic for Globex messaging. "New customers to Globex will obviously have to change their systems over to Globex," he says, but there aren't too many customers that will be new to the platform.

Saving By Consolidating Tech

The massive technology consolidation is occurring at a time when publicly traded stock exchanges are consolidating across the globe to diversify their products into multiple asset classes and drive down technology costs by processing trades on a single platform. In citing reasons for the merger, CME officials said the $11.5 billion deal would position the combined entity to compete with fast-growing global exchanges such as Eurex and NYSE Euronext, as well as the OTC derivatives markets. But successfully pulling off the technology consolidation and realizing potential cost savings certainly are part of the equation.

"One of the reasons they have to do this is they said they're going to get these efficiencies out of the merger," relates Michael Henry, the head of Accenture's financial services strategy practice in North America. "Part of that is technology consolidation."

CME initially said the CME-CBOT combination would result in pre-tax savings of $125 million from administrative and IT costs in the second year after the closing. In May, when the bidding war with ICE heated up and CME was forced to raise its bid from $7.9 billion to $9.2 billion, CME found another $25 million in incremental cost savings, bringing the total cost savings up to $150 million, plus annual savings of approximately $70 million as a result of the accelerated time line.

"There should definitely be cost savings because running one platform is less expensive than running two," says Henry. But, "It has to be flexible enough to handle the diversity of products and robust enough to handle the additional volume," he cautions.

And those volumes, as well as market data rates, will increase further as automated trading strategies grow. According to a December TABB Group report, nearly 50 percent of all futures markets trades in 2007 were transacted through automated trading strategies, including market making and black-box trading. But that figure is expected to climb to 90 percent of total activity by 2010. Today, the CME has algorithmic or automated trading systems executing through Globex, as does the CBOT. "That won't be unusual to us," says CME Group's Kometer. "We have a larger capacity, and I think our performance on Globex will help Board of Trade algorithmic traders."

The End of Pit Trading?

Cost savings also should come from running one combined trading floor instead of operating two trading floors from separate locations. But the consolidation of products onto a single trading floor has created speculation that the era of pit trading is fading.

"The reason they're moving the floor-traded products to CBOT is that CME is going to close its floor," observes William Cline, managing partner at Acai Solutions, a financial services and technology consultancy in New York. Cline believes the move is the beginning of a two-step process to eliminate the floor altogether, beginning with the CME's floor. "They'll close the [remaining] floor once electronic trading gains more of a foothold in their products," he contends. "There'll be too little order flow going to the floor to justify the expense of keeping the floor open." In November, CME Group reported that it trades approximately 13 million contracts a day, with about 2.4 million traded via open-outcry.

In an Aug. 28 update of the trading floor integration, CME said that products with more than 90 percent of liquidity traded electronically could be traded entirely electronically. For example, CME said it was moving one-month Libor futures and Euroyen futures, frozen pork bellies futures, and options and Ethanol futures exclusively to electronic trading. Trading of the major FX products, including the Australian dollar, British Pound, Canadian dollar, Euro and Japanese Yen, will be consolidated into a single trading pit.

Brokerage Customer Savings?

But will the technology consolidation strategy, as well as the downsizing of 380 employees across both exchanges, lead to cost savings for the CME's and CBOT's brokerage customers?

"There's cost savings on the exchange's side as well as on the customer's side," explains CME Group's Kometer. "Their systems will be talking to one exchange's systems versus two," he adds, allowing customers to consolidate redundant systems as well. And in addition to migrating the matching platforms, the order-entry and market data feeds also will go to Globex, Kometer notes. "We are moving matching, market data and order entry toward the Globex system, and so all the Board of Trade systems that were doing the same thing are being retired," he says. "All eCBOT data will be coming out of our Market Data Platform [MDP]."

Since futures brokers will have a single connection to both exchanges, PFGBEST.com's Wassendorf says, the merger of CME and CBOT trading platforms could cut the connectivity bill in half. "The connectivity charge - a fixed expense per month - over time will definitely become one of our big savings," he says.

"The more you can simplify these platforms," the lower the costs will be, adds Accenture's Henry. If CME can consolidate the trading platforms down to one, it will set itself apart from other exchanges, such as NYSE Euronext, which still is running four platforms: NYSE Hybrid, Archipelago, NSC and LiffeConnect, he notes.

But PFGBEST.com's Wassendorf maintains that CME cost savings and efficiencies won't materialize until the end of 2008 or early 2009. "Any changes, any development, any new and improved [feature] is not going to improve costs [right away]," he asserts, pointing out that the big expenses in IT are new integration and development, and testing and connectivity changes. But, "At some point in time, those cost savings would take affect." he says.

Meanwhile, member firms would like to see the CME lower some of its fees, notes Wassendorf. "The CME has to make a commitment not to charge for electronically traded quotes," he insists. CME differentiates between electronically traded quotes disseminated through Globex versus market data viewed on quote terminals - CME provides free access to quotes if firms are trading on Globex, but charges if the quotes are viewed on a market data terminal, explains Wassendorf.

Wassendorf notes that CME waived the fee for electronically traded quotes, which has increased the volume and transparency for those products. "It's no coincidence that increased transparency and efficient pricing are related to the huge volume that you see on electronic trading on Globex," he says. "If they hurt that by raising prices or charging for the market data, you'll see a competitor move in."

According to Wassendorf, Eurex and NYSE Euronext are among the CME competitors that would like to get into the U.S. futures market. "If the CME makes a mistake, you'll see another exchange step in," he says.

Competition is another reason CME is moving CBOT off LiffeConnect to consolidate the exchanges' platforms on Globex, Accenture's Henry suggests. CME "is not going to want to pay revenue to a competitor," he asserts. "There's no way the CME is going to pay royalties to NYSE Euronext," the owner of Euronext Liffe, which licenses LiffeConnect to CBOT.

Meanwhile, there is speculation that cash-rich CME Group will acquire other exchanges. PFGBEST.com's Wassendorf says the CME "can become a big acquisition machine and buy other exchanges" around the world as long as there aren't any antitrust issues.

Accenture's Henry says the current technology project could position CME to make future deals. "To the extent that they can do a merger like this and migrate all these products over smoothly, this would be a huge plus," says the consultant. "If they can demonstrate that they merged all of CBOT's products within three months [of closing the deal] as opposed to somebody else that hasn't done it before or has done it badly, that would be a big difference."

wallstreetandtech.com

CME managing director and cio jim Krause was instrumental in preparing the exchange for the CBOT merger:

wallstreetandtech.com/features/showArticle.jhtml?articleID=201201412

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CME Scales Globex to Boost Capacity

CME is scaling Globex, its electronic trading platform, to handle CBOT products by adding more hardware for order entry, matching engines and market data. "The Board of Trade products will be running on their own matching engines" for different products, explains Kevin Kometer, deputy CIO at CME Group. For example, CBOT agricultural products will run on one engine and the financial products will run on another engine.

To handle increasing market data volumes, CME will create separate market data channels for each product group. "We might have a channel for equity futures and equity options, and we might have a channel for Board of Trade options," says Kometer. "This allows the customer to choose what they listen to instead of taking in a whole suite of products." According to Kometer, CME might add an agricultural futures channel, a financial futures channel and a channel for options.

As an early adopter of the FAST Protocol, CME also has an initiative underway to speed up market data. CME has changed its legacy format for market data to the FIX Protocol and will use the new compression algorithm FAST (FIX Adopted for Streaming) for all market data, including for CBOT products, relates Kometer. By moving over to FIX FAST, customers' bandwidth requirements will be reduced by more than 50 percent, he contends. "We end up batching messages together with a higher level of compression," Kometer says. "Therefore, we're able to deliver a larger payload across the network at a more efficient bandwidth." he says.

While customers currently are not required to move over to FAST, Kometer notes, CME will discontinue the legacy market data format by the end of 2008. -I.S.