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Patricia Campbell
Peregrine Financial Group, Inc. (PFG)
(312) 775-3411

CME out to get in on OTC trading

By Joshua Boak


February 4, 2008

Buried within the $224 million annual profit announced Friday by the New York Mercantile Exchange is a vein CME Group wants to tap: over-the-counter trading. “It’s absolutely what we think is a gold mine for the future," Nymex Chairman Richard Schaeffer said during its earnings conference call.

CME Group last week entered into an exclusive 30-day negotiation period to acquire Nymex for more than $11 billion in stock and cash. Many analysts and brokers cheered the possibility of CME adding energy and metals futures to its financial and agricultural stable, without addressing the over-the-counter opportunities.

OTC trades occur outside of exchanges, traditionally without using clearing services to guarantee the value of what was traded or that either party has sufficient funds available. In response to the Enron scandal, the Nymex introduced an OTC clearing system, ClearPort, that treats independent trades as futures contracts.

The amount of money at stake in OTC trading defies the imagination. The Bank for International Settlements, an international organization for central bankers headquartered in Switzerland, pegged the notional amount of OTC derivatives contracts worldwide at $516 trillion.

Nymex reported annual revenue of $673.6 million, primarily from clearing and transaction fees. Of the 1.48 million contracts routed daily through Nymex, more than 22 percent originate with ClearPort. The average fee charged for clearing OTC trades is 70 cents higher than the rate Nymex billed its brokers for using the electronic platform provided by CME Group.

A similar high-margin revenue stream will be missing from CME Group's fourth-quarter earnings release Tuesday. However, shortly after the Chicago Mercantile Exchange and the Chicago Board of Trade merged in July to form CME Group, the company unveiled a strategy meant to access the OTC space. It plans to launch clearing services this quarter for interest rate swaps, deals in which parties trade interest rate payments for the cash flow of an underlying asset.

"It's a lot easier to embrace over-the-counter business than wire around it," said Russell R. Wasendorf Sr., chairman and chief executive of Chicago futures merchant

"If the CME can provide a safer, more efficient way of doing that, more power to them."

CME Group CEO Craig Donohue is not publicly commenting on the Nymex merger discussions. But after a trader at the French bank Societe Generale allegedly tried to mask billions of dollars in losses with fictionalized OTC deals, Donohue said last week that the scandal "highlights" the transparency made possible by having an exchange clear trades.

It also is the next competitive frontier as exchanges consolidate.

The Intercontinental Exchange has an electronic interface and clearing for over-the-counter trades. It reported Thursday a 68 percent increase in annual net income, to $240.6 million, or $3.39 a diluted share, on $574.3 million in revenue.

The Atlanta-based electronic exchange, which specializes in energy contracts, received about 37 percent of its revenue from OTC operations.

But unlike Nymex, ICE does not figure in OTC clearances as part of its futures volume. That helps explain why Nymex has 6.5 times the futures trading volume and 15 percent more revenue than ICE, yet earned $16 million less in annual net income.

The ICE challenged the Merc last year with a counterbid for the CBOT, but it has expressed no interest in Nymex so far.

On Wednesday, ICE agreed to purchase YellowJacket Software Inc., a peer-to-peer quoting system that exchange CEO Jeffrey Sprecher said would move OTC trades to its computer screens.