"People don't start wars, governments do."
-- Ronald Wilson Reagan (b. 1911), 40th US President, Republican
Writing an analysis of the most heated direct competition in exchange history is unlikely to ever be an easy task. Analysing it within weeks of the first direct trading salvos taking place may seem to some ludicrous, yet the basic precepts of the ?Battle of Chicago? had been clearly evident long before the actual first trade of the EUREX US system took place on February 8th, 2004. The autumn and winter of 2003 was marked by a rather remarkably bad tempered and petulant campaign by the Chicago exchanges which effectively lost them most support beyond the frontiers of Illinois. Battles lines were drawn and trenches dug. The US business media smelt an old fashioned closed cartel and launched some crushing attacks on the Chicago exchanges. Many of their criticisms were unjustified (borne largely one would expect of ignorance) regarding trading practices but the image of the Chicago exchange management was damaged in terms of being viewed as rather parochial protectionists driven by a desire to protect their members. Members themselves appeared above all else eager to protect their floor trading franchises.
The entire spectacle was somewhat unedifying, although EUREX itself was perhaps not subject to the best of advice in various stages of its regulatory bid, giving its detractors the opportunity to raise that old favourite complaint, EUREX?s tendency towards arrogance and inflexibility.
"History is littered with the wars which everybody knew would never
happen."
-- Enoch Powell
Even at the eleventh hour in late January, it still looked to many exchange insiders as if the Chicago establishment had managed to pull in sufficient political favours to ensure that their monopoly would; remain unchallenged for some months to come.
Chicago?s exchanges have long realized the importance of close links to Washington ? they escalated their political relations from the 1960s when a scandal in Egg trading led to government prohibition. Chicago?s exchanges remain a formidable lobbying and funding force in Washington and for several weeks over the Christmas period it looked as if they had done enough to at least secure a lengthy delay in the regulation of EUREX US.
Nevertheless, the spectre of some rather hysterical outbursts from certain Chicago exchange management figures which evidently had been intended for home troop consumption had somewhat soured the Chicago exchange?s claims that they had legitimate market concerns about the entry of EUREX into the USA.
However, with support for protectionism beyond Chicago crumbling, the way was clear for the CFTC under Chairman James Newsome to finally brave the political storm and make a decision on February 4th. Newsome, accompanied his decision with a charismatic statement, noting that his philosophy since arriving at the CFTC in July 1998 had included the notion that ?in tough situations, you must be willing to listen to all sides, consider all arguments, but in the end, you must make decisions and stand behind them.?
"An army of sheep led by a lion would defeat an army of lions led
by a sheep."
-- Arabian Proverb
The overall CEO of EUREX, Rudolf Ferscha was not to be delayed any further. Within less than 96 hours of the announcement, on February 8th, 2004, EUREX US was open for trading. That many companies had been wrong-footed by the ultimate speed of the CFTC?s decision mattered little to the Austrian former Goldman Sachs partner, he wanted the world to know that EUREX had been ready since their original proposed launch date of January 31st and trade could continue ? even if many major market players had not yet managed to attach their networks to the EUREX US systems.
Nevertheless, those expecting an instant victory were to be denied any excitement. Having said that, as it took DTB several years to overcome LIFFE?s stranglehold on German Bund futures, it seems strange that anybody believed the EUREX US war could be won in a matter of days. Besides, ahead of the launch of EUREX US, the CBOT had dropped their fees to comparable levels with their new competitor. The question remained at the time of writing could CBOT?s cut be sustainable? EUREX had long managed to profit ? and profit significantly - from remarkably modest commoditised trading fees.
Discussing the day to day trading battle for volume - while significant - would be to ignore the most significant structural issues behind the first major foreign entrant into the US exchange markets. In my book New Capital Market Revolution (Texere 2002), I outlined the phases of the revolution, noting that the first four (?Retreat,? ?Phony War,? ?The Ecstasy of Value? and ?Merger Blitzkrieg?), would be following by a fifth ?The Reign of Terror.? ?The Reign of Terror? - where everything is up for grabs - will be a central focus to all exchange behaviour during the next 3 years. Direct competition in the USA is bound to increase and in the derivatives markets, on March 18th mere weeks after the launch of EUREX US, Euronext.LIFFE launched a full frontal attack on America?s leading short term interest contract, the 3 month Eurodollar. A market long domiciled on the floor of the Chicago Mercantile Exchange (CME). The CME Eagle spread matching engine having failed to shift volume from the CME floor, Euronext.LIFFE believed it had a wonderful opportunity to add to its dominance in Euribor futures markets and provide abundant offsets in these and other short term interest rates such as the Yen.
"The only winner in the War of 1812 was Tchaikovsky."
-- Solomon Short
In the Battle of Chicago, the key instant victor has been the end user customer. In agricultural futures for instance, fees at Chicago exchanges can be over 2 dollars per traded contract. With the arrival of EUREX US, pricing around 25 cents was the benchmark for America?s Bond market futures. Nevertheless, sustainability of cuts was a key issue. After all, if the CBOT could manage to cut rates suddenly on the arrival of a competitor, were fees not artificially high ahead of the arrival of competition? Whatever the case, customers benefited immediately from much reduced trading fees and found themselves the victors while the fog of war continued to cloud the real resources being expended by the protagonists. Chicago?s exchanges were conspicuously trying to fight EUREX US across as many fronts as possible. Politically, their long history of donations at least gave them strong access to the right legislators. Within Chicago they had vastly more resources to deploy collectively for PR and marketing than the overseas arm of the EUREX marketplace ? a relatively tiny group of staff compared to the thousands on the payroll of ?the Chicagos? as the (US-owned) Chicago exchanges have become collectively known.
The core battlegrounds of the Batlle of Chicago, centre on 2 key issues: technology and market structure. In some ways they are related. Technology has been long seen by most Chicago traders as ?the enemy.? One member one vote democracy in the Chicago pits has created a system where evolution is often painfully slow as members seek to protect their seat holder franchises. Nevertheless, the Chicago exchanges are still gradually experiencing a move to electronic trading despite member reluctance to embrace new technology on many fronts. In Europe, the more corporate oriented membership structures permitted much more rapid reform as locals found themselves being outvoted by large institutions who in Europe have embraced electronic trading while remaining somewhat mute over their preferences in the US marketplace. The less dynastic nature of European futures/options exchanges also diluted the effect of anti-reform movements, as did the fact that the fear experienced first hand of seeing the LIFFE exchange almost obliterated by the electronic DTB (now EUREX) bandwagon in the Bund market concentrated the minds in a way which has not been seen in the USA.
Nevertheless, the key issue of market reform and embracing a more open playing field to encourage more end user activity in markets has been a vast boon to EUREX and other electronic exchanges. Indeed, in the only clear example of unfettered electronic versus open outcry trading yet seen in the US derivatives marketplace, the International Securities Exchange (ISE) went from nothing to a market leading share in the US equity options market in less than 3 years. However, here the ?electronic growth dividend? now commonly seen when markets go electronic (enabling end users freer access to trading once the floor monopolists stranglehold on order flow is broken) has in fact also added to volume in the overall equity options marketplace. Thus, CBOE the former market leader was actually trading more options in early 2004 than it had before ISE existed, despite having a lower overall market share. Quite why this dividend has also flowed into open outcry markets from the electronic platforms is not clear but it has been a saviour for the existing 4 open outcry markets as they have attempted to cajole their members into abandoning floor trading for an electronic trading approach.
"There is only one principle of war and that's this. Hit the other
fellow, as quickly as you can, as hard as you can, where it hurts him most,
when he ain't lookin'."
-- Sir William Joseph Slim, British Army, Field Marshal
The business of structural reform at US markets remains a precarious one so long as the floor traders have a strong disincentive to endorse change when upside on an equity holding may represent only a modest profit compared to the gains available from open outcry. Nevertheless, signs of resignation towards the possibilities of trading electronically remain and indeed the US Treasury Bond complex at the CBOT floor was a shadow of its former self even months before EUREX US launched as members increasingly endorsed the LIFFE Connect based system CBOT had deployed during 2003.
"This is an age in which one cannot find common sense without a
search warrant."
-- George F. Will, journalist, political commentator
While EUREX US struggled to gain volume in its initial months of operation, the key word on many observers lips was ?sustainability.? In this respect it was not an environmental concern (this being presumably more the preserve of the fledgling Chicago Climate Exchange established by modern derivatives founding Father Doctor Richard Sandor) but rather the issue of pricing stability. Frequent complaints from end users that CBOT pricing was somewhat complex to follow were matched by several simplifications and tariff reductions until a few weeks ahead of EUREX US?s launch, the CBOT suddenly managed to cut fees sufficiently to essentially match the levels of EUREX?s US initiative. EUREX had long proven a highly profitable commoditised return was possible from its low cost pricing model ? could the CBOT manage to retain a similar model given that previously it had not seemed possible?
“Victory or Death.”
-Rudi Ferscha, ceo
EUREX
A key issue for any foreign entrant to the US marketplace will remain political. The Chicago exchanges well-oiled political lobbying machine was in overdrive in an election year with the apparent aim of delaying EUREX?s clearing linkage between Europe and the US, a key aspect to the EUREX US initiative. However, the risk is more significant than simply relating to mere politics and indeed it is difficult to see that in many European nations the entry of direct competitors for exchange or clearing business would be offered red carpet treatment en route to regulation. Ironically, EUREX US itself found it difficult in its initial phases to sign up existing European EUREX customers as EU regulators took a little while to endorse the new US exchange?s credentials. (In the heat of battle some conspiracy theorists noted ? undoubtedly unfairly - that it was the ?Euronext nations? whose regulators seemed to take longest to permit direct access to the EUREX US marketplace from their nations).
"How is it possible to expect mankind to take advice when they will
not so much as take warning?"
-- Jonathan Swift (1667-1745),
Irish-born English writer, "Gulliver's Travels"
In many ways, however, to discuss the minutiae of clearing links, technological connections, regulatory issues in Europe and the like is to miss the big issue. The arrival of EUREX in the US through an American-domiciled vehicle regardless of its ultimate fate, signals the fact that the largest capital marketplace in the world is now openly seen as fair game for competing foreign markets. Having entered their reformist phase with a revolutionary fervor (usually driven from sheer terror at the near death experience of LIFFE in the late 1990s), the European exchanges have the potential to provide structural advantages against even the most organized of the US hybrid floor/screen exchanges ? such as the CME. Euronext.LIFFE?s initiative trading Eurodollars exclusively electronically beginning on March 18th was a second clear sign that the European barbarians had moved beyond the gates and were already attempting to buttress the main fortifications of the castle itself. Much less trumpeted than the launch of EUREX US, the Canadian/ US joint venture Boston Options Exchange (BOX) began trading while EUREX stole the headlines in early February marking a sixth competitor in the already intense battle for US equity options business (EUREX had originally proposed a US equity options exchange as a possibility for its new venture but eventually opted to go after the CBOT?s Treasury complex instead).
The foreign attack on US derivatives markets may amount to a siege which takes years to reach a conclusion but little by little foreign competitors are going to seek to chip away at the domination of the Chicago exchanges ? unless of course the Chicago exchanges can demonstrate a genuine sustainability with a lean, commoditised business model. While CME is closer than most to achieving such an aim, the activities of certain vested interests within its walls led some critics to believe that despite an IPO little had changed in the somewhat Machiavellian world of its board elections and directorial politics. Chicago finds itself under siege at precisely the moment when while it is en route to reform, much needs to be achieved.
"The two most powerful warriors are patience and time."
-- Leo Tolstoy (1828-1910), Russian writer, philosopher,
"War and
Peace," "Anna Karenina"
And where derivatives markets go, cash markets will surely follow? The NYSE suffered an ?annus horribilis? in 2003 despite stock markets rebounding and the calls for the removal of its floor-based apartheid system which favoured specialists at the expense of end users was drawing increased concern even without the efforts of Eliott Spitzer to investigate with a ruthlessness which shook many in the securities industry. If EUREX ? or any other foreign exchange - establishes a bridgehead in the US derivatives marketplace, competition for cash equity markets will surely follow.
Nevertheless, the battle for exchange dominance is likely to be more than merely a two-sided affair between simple domestic markets and / or regional cross border entities such as Euronext. The possibility remains that new players will seek to enter the marketplace, utilizing new business models or seeking to exploit faster, cheaper network technologies, perhaps with consumer brands more common to the public. The war is on, and Chicago will only be the first of many battles in the quest for exchange dominance. The possibility of a concerted US attack on existing European franchises cannot be ruled out in the medium term and indeed the intensity of competition is unlikely to ebb substantially in the next few years ? or until a clear winner emerges.
"All diplomacy is a continuation of war by other means.
(1954)"
-- Enlai Zhou, Chinese Premier
However, just what constitutes a clear winner is another issue entirely. Large institutions want cost efficiencies from exchanges and while EUREX is highly profitable it has been consistently the best marketplace at providing very low cost electronic dealing in the world. Nevertheless, it has found the marketplace keen to have a check on its dominance with European short term interest rates still traded on Euronext.LIFFE. Therefore while rationalization of the many US, European and Asian exchanges (cash and derivatives) will accelerate in the near future, it is unlikely that a single global exchange will emerge. However, with 3 major exchanges in Chicago being joined by EUREX US, it seems unlikely that more than 2 will survive in the longer term. Then again, the US marketplace with more than a dozen futures and options exchanges is unlikely to enjoy anything but shrinkage at the top level. The last person left with an open outcry facility is the most likely to be caught in the cash flow trap of hybrid operations. The new exchange orthodoxy remains clouded by the fog of war at the time of writing but it is entirely clear that nothing will be the same again, regardless of the resolution of the first battle of Chicago. EUREX US may be a victor or face defeat but that will not stop new competition entering the market. In that respect there can be no looking back for the old established legacy exchanges in the USA, regardless of product sector. Whether this battle of Chicago proves to be a light skirmish or a massive battle which sees the overthrow of the establishment, the war is on. Nothing will be the same again?
