CBOT President and CEO Bernard Dan Remarks
Futures Industry Association Chicago
February 22, 2006
Thank you for that kind introduction. It is really a pleasure to speak with you today on behalf of the Chicago Board of Trade. We at the CBOT value our solid working relationship with the FIA Chicago. The truth is, without your support and cooperation, it would have been very difficult to complete many of the large-scale projects we’ve launched in the last few years. Thank you for partnering with us on initiatives that bring significant benefits to our industry at-large, and we look forward to continuing to work together in the future.
The year 2005 was pivotal for the CBOT – not only did the Exchange make the transformation to a for-profit company and shortly thereafter launch its successful IPO, but the CBOT also achieved a fourth consecutive annual trading volume record. In 2005, 674 million contracts changed hands at the Exchange, and the CBOT also achieved record financial results for the year. Revenue rose 23 percent to nearly $467 million, and net income climbed to an all-time high as well, up 82 percent to almost $77 million. This impressive financial growth provides the Exchange with increased capital, one use for which is the possible reinvestment in our business for the benefit of the entire marketplace.
The CBOT has not been alone in enjoying significant expansion. I think that you will agree with me that now is an excellent time to be involved in the futures industry. According to FIA numbers, we have seen increases in volume of derivatives traded internationally every year of the last decade, and turnover worldwide during the last five years is up a total of 230 percent.
Very few industries can claim the kind of phenomenal growth our industry has witnessed. I think I speak for all of us here when I say I’d like to see this trend continue on the same positive path. But we also all know that there are no guarantees that our rate of expansion will remain in place. That uncertainty is a call to action for the entire derivatives industry, and exchanges in particular. There are several steps we can take to collectively encourage ongoing growth of derivatives trading: first, remain committed to the highest level of innovation, second, drive efficiencies for market users, third, we need to create opportunity via technology, and finally, work to maintain the integrity of our industry. Today I will address each of these action items from an industry perspective, while also putting them into the context of how the Chicago Board of Trade’s progressive strategy is designed to accomplish these goals.
Innovation has been a hallmark of derivatives trading since its inception. The industry is constantly reinventing itself in order to remain ahead of the trends and forces of the ever-changing global marketplace. This pioneering spirit was the catalyst for introducing the multitude of successful products that are actively traded today. Innovation is our collective growth engine; without it, I am convinced that expansion will subside. A large part of the onus is clearly on exchanges to be as creative as possible in order to encourage growth within the industry. I would also argue that we cannot innovate without input from you, our customers, who ultimately determine the success of any new initiative.
New products are a key vehicle to both meeting customers’ changing needs and remaining relevant in our dynamic industry. This is an area, however, where I believe exchanges should be extremely thoughtful in their approach. At the CBOT, we are committed to allocating our resources in the most fiscally responsible manner possible. At the same time, we know how tough it is for you to keep up with the many new products that are listed by all of the major exchanges each year. We also are well aware that you incur costs associated with each new product launch. This cost to customers is another important reason we are very targeted and measured in our strategy for introducing new contracts.
Let’s consider the last two years, when eight of the world’s leading futures exchanges introduced 148 new futures and options-on-futures products. When examining the list, only 17 percent of those new products can be considered successful – the threshold we used was average daily volume of 1,000 contracts and open interest of 5,000. However, I am happy to note that among that long list of new products, two success stories are the CBOT’s mini-sized DowSMoptions contract and our 100 oz. Gold futures contract. We are especially pleased with the performance of our Gold contracts, which have garnered considerable attention from market users. In January, 15 percent of total listed gold futures traded in North America changed hands at the CBOT.
Our rigorous standards for creating new products focus on two critical areas. First, the CBOT conducts extensive economic research, including in-depth conversations and input from a broad range of market participants. Secondly, we are working to diversify our product mix with global financial instruments, which are specifically designed to meet a broad economic need in the international marketplace.
Another important aspect of product development at the CBOT is giving new products the opportunity to build liquidity and earn acceptance within the marketplace. Sometimes that process simply takes time, especially when an innovative product is created in anticipation of the future needs of current and potential customers. Our Ethanol futures contract is a prime example of this strategy.
Part of the impetus for launching a CBOT Ethanol futures contract was that ethanol production in the United States is expected to increase sharply, particularly as demand for alternative fuel intensifies. The energy bill passed by Congress last year requires that no less than 7.5 billion gallons of ethanol be produced annually by 2012, doubling the amount of ethanol produced in the United States today. Further, projections indicate that there is a strong possibility for 40 to 50 new ethanol plants to be built over the next two decades. All of this potential activity in the industry, as well as our discussions with participants in this growing market, pointed to a strong need for a central marketplace for price discovery and risk management.
Already, our ethanol contract is serving as a benchmark for the industry, which previously lacked pricing transparency. During times of extreme price movement, such as last summer when volatility of Ethanol futures doubled in a two-month period, the contract was a true instrument for hedging risk.
As is the case with ethanol, changing global trends, especially within the production and consumption of commodities, necessitate inventiveness. I think a growing number of exchanges will try to pinpoint where risk management needs will be in the future and offer products in line with those newly emerging trends.
In addition to innovation, another method of encouraging growth is by creating higher levels of efficiency for market users. The partnership between exchanges and their customers is critical here, as your insights have tremendous potential to drive initiatives that cut down on redundancies and create synergies that did not exist before.
Standardization of electronic trading, and more specifically, of the trading platforms powering that trading, is one such vehicle for creating efficiency for the entire marketplace. I believe hosting agreements offer an excellent opportunity to facilitate access to multiple markets via a single trading platform. They allow different marketplaces to retain their individual identities, yet offer the economy of scale of being on a common platform. At the same time, market users benefit from the convenience of trading multiple products, even asset classes, via one connection.
It was this principle that inspired the CBOT’s hosting agreement with the Kansas City Board of Trade, Minneapolis Grain Exchange and Winnipeg Commodity Exchange, whose agricultural futures and options-on-futures contracts are now available via the CBOT’s electronic trading platform. Building on the momentum of those successful agreements, we recently announced a non-binding letter of intent with the New York Board of Trade to host its financial products on the CBOT platform. This arrangement will expand our North American effort to drive industry standardization and seamless electronic trading access that leverages common access points on the same global network.
And the CBOT has pushed the hosting concept even further with our recent joint venture to form the Joint Asian Derivatives Exchange, or JADE, with the Singapore Exchange. This new, all-electronic exchange’s products are expected to trade exclusively on the CBOT’s electronic trading platform. Together with SGX, we will develop Asian-based commodities and risk management tools which are in demand by both consumers and producers of those products. This exciting initiative will create a pan-Asian exchange that addresses many of the operational and risk management problems created by the fragmented regional marketplaces across Asia. I believe that JADE will offer a high level of efficiency for market users around the world, providing easy access to much-needed risk management tools. I also expect the new Exchange to create trading opportunities between highly correlated contracts in other markets as well.
Of course, another area where the CBOT has been successful in lowering costs and delivering greater efficiency to the industry is through our approach to clearing. The Common Clearing Link with the CME was an extremely important initiative for customers of both exchanges. Not only did the agreement eliminate redundancies and lower many margin requirements, but it also brought innovation into the clearing of the majority of U.S.-based futures products. This is one of those initiatives that I mentioned at the beginning of my remarks that could not have been accomplished without you. Further, I personally am very proud of the results of this ambitious project and the ongoing value it delivers.
To foster greater efficiency, we as an industry must also continually focus on deploying the most sophisticated technology possible. I would give us high marks in this area so far. I think our industry has been very aware of the value of technology, and we have all benefited from the positive impact it has had on our businesses. Technology has introduced new customers located around the world to futures trading, and that increased activity has added to the depth of liquidity that exchanges offer market participants.
But before we congratulate ourselves too heartily on our successes in the area of technology, I think that it is important to emphasize that our efforts here are always a work in progress. Because technology is constantly evolving with potential for further improvements to existing systems, creating the best possible trading environment via technology is an ongoing endeavor at the CBOT. We are well aware that if exchanges are going to encourage growth of futures and options trading, either within existing products or new ones, we need to be able to accommodate that growth. That means reinvesting in our technology.
Last year, the Exchange upgraded its electronic trading platform, rolling out new functionality such as expanded spread trading for both futures and options, improved risk management and market making capabilities and enhancements to the operating system and architecture. While upgrading the system, we went to great lengths to make sure that we maintained the speed that our customers count on. We appreciate your efforts to insure that the process went smoothly and was such a tremendous success.
The use of technology permeates every aspect of our business. Another example of technology increasing the efficiency of the CBOT’s markets has been our project Denali, which streamlined open auction trading at the CBOT. This initiative reduced the time between order acceptance and confirmation and provided near real-time trade matching and management. Denali was a tremendous success and testimony to the value this ongoing trend of combining the power of innovation and technology.
The numbers associated with Denali really speak for themselves:
- Out-trades have been reduced by one-third compared with two years ago.
- Order turnaround time has decreased by 38 percent.
- Nearly 90 percent of all customer orders filled in the Agricultural complex are entered through the order routing system.
- And on the other side of the trade, approximately 400 individual traders are using electronic hand-held devices, submitting more than 80 percent of their trades via the new hand-held technology.
Of course, the value of technology is far greater than driving efficiencies in our businesses. Technology is the channel that makes our products accessible globally. It is pretty simple. The more available exchanges and their products are, the more customers are able to manage their risk from anywhere in the world. In recognition of that dynamic, last year the CBOT expanded its electronic trading day to 22 hours. This initiative made our electronically traded products accessible an additional hour each day and was designed to meet the needs of Asian and European market participants.
Our strategy of using technology to expand access to CBOT products internationally has multiple tenets. We are actively working to facilitate connections to our customers on a global basis. To further this goal, last year, we launched a telecom hub in Singapore. This initiative provides market users in Asia with a direct and efficient method of trading our products from that part of the world.
One of the best opportunities for harnessing technology is via customer input, and we all should make every effort possible to keep our lines of communication open. A case in point is the success the CBOT is having with its market maker program for U.S. Treasury options during extended trading hours. We initiated this program after talking to customers in Asia and learning that our market users wanted to see more liquidity develop in electronically traded U.S. Treasury options during their business hours.
In 2005, the number of the CBOT’s Financial options that traded electronically surged by 180 percent, with the EMM program contributing significantly to that growth. For all of 2005, more than 7 percent of Financial options traded electronically at the CBOT. That number reached 13 percent in January 2006, with more than one million financial options contracts trading electronically last month. These results only underscore the possibilities that exist when exchanges take seriously their partnership with their customers.
I would like to note one more thing regarding technology and our open auction markets. You may be aware of a recent announcement that the CBOT Board of Directors has requested a special meeting of members. At that meeting, the Board will ask for approval to change the CBOT’s rules and eliminate the member approval requirement for electronic trading of Ag products during the day. The vote is scheduled for March 8. This is an exciting opportunity for the CBOT, and a ‘yes’ vote would signify that CBOT members recognize value in adding to the organization’s flexibility and ability to quickly respond to new market opportunities in all venues. This transformation would be one of many that the Exchange has undergone in a matter of months – from our demutualization, to our IPO launch, to getting acclimated with our status as a publicly traded company – and I believe we have emerged from these changes stronger, more competitive, and better able to respond and to act proactively in the face of change.
As a publicly traded company, the CBOT is now subject to a series of laws that impose significant obligations as well as severe penalties for violating them. But whether or not exchanges are public, integrity is a long-valued principle within our industry, and we all have the highest commitment to it. Integrity is what inspires market users to participate in our markets with confidence, and it is our responsibility to maintain this level of trust we have worked so hard to build.
No single event in recent memory underscored how critical integrity is to our industry more than the collapse of Refco. It was during a very sensitive time for the CBOT – in the middle of our road show, just prior to our IPO -- when the news broke that Refco was on the verge of collapse.
While devastating for Refco employees and some of its customers, the impact of Refco’s demise reached far beyond the firm itself. For the CBOT, the situation presented several challenges to those of us meeting with potential investors at the time. It is well known that Refco was a large CBOT customer, so the bankruptcy often became a focal point during meetings. In addition to walking potential investors through the CBOT’s story, we were also in a position where we actually had to defend futures as an asset class. What I found was that even during the five or six minutes we had between meetings, I was on the phone with potential investors and analysts that we had met earlier, explaining to them 1)that Refco’s bankruptcy would not shake the integrity of the CBOT’s business and 2)that not one CBOT customer would lose money as a result of Refco’s failure. In the end, the timing of the news was actually very beneficial for us, as we were able to tackle the issue directly and explain how the bankruptcy underscored the benefits provided by a highly regulated exchange. Because of the unique rules that govern the futures industry, such as the regulations requiring segregation of customer funds and other financial safeguards, our markets participants were protected from the fallout of Refco’s bankruptcy. This event, while terrible and previously unthinkable, did highlight the integrity that defines our business.
Refco’s collapse also underscores how regulation plays a tremendous role in maintaining the integrity of the futures industry. Self-regulation has been a cornerstone of the regulatory structure for the U.S. futures markets for many years. At the CBOT, we pride ourselves on the rigorous, fair and balanced regulatory standards we have established over the years. Under the oversight of the CFTC, exchanges have long demonstrated the ability to effectively regulate their own market users through the establishment and enforcement of rules and regulations that are designed to ensure market integrity and protect customers.
As the marketplace changes and as exchanges like the CBOT restructure, exchanges should be afforded the flexibility to continue to adjust their rules and regulations to address new issues that may arise and establish thoughtful, fair and balanced standards. Today, exchanges more than ever have a strong incentive to effectively fulfill their self-regulatory responsibilities.
As competition has increased and more exchanges have entered the business, and as many of us demutualize, there is a very real competitive incentive for exchanges to distinguish themselves on the basis of their integrity, efficiency of their markets and fairness to customers. As our industry and the CBOT itself evolve, we continue to develop standards we believe uphold the integrity and soundness of our business and the marketplace.
Looking toward the rest of 2006, the CBOT is very hopeful that reauthorization of the CFTC can be completed this year. The Commission has been a productive and effective regulator, and the modernization act has served as a key catalyst for growth in our business. The CFTC is doing an excellent job in supporting and encouraging the development of our industry, and all of us – exchanges and customers alike -- are fortunate to have such a skilled regulator overseeing U.S. futures trading.
As for other potential developments in the futures industry, like many of my colleagues, I believe that you will see continued growth of futures trading in Asia. That is particularly true for products based on commodities whose supply is abundant, or where there are new, emerging risks. I think more and more, we will see customers, particularly in Asia, requesting futures products that allow them to hedge their risk exposure to a greater number of commodities produced and consumed globally.
In the near future I also expect we will witness exchanges expanding the scope of their product offerings. The trend of asset class convergence stands to create a higher level of efficiency for market users, which as I mentioned earlier, is extremely important to the CBOT. We are attentively monitoring this trend, and given the flexibility of our electronic trading platform, we believe we are well positioned to participate.
I am often asked what is in store for the CBOT, and I can tell you that we have several exciting new product introductions slated for 2006. We will be expanding our highly successful, 100 percent electronic Gold complex by rolling out a Full-sized Gold options contract on March 3. We believe that this addition has the potential to further strengthen liquidity within the entire complex. We are very pleased that we already have three market makers in the contract who are ready to provide a competitive two-sided market.
The Exchange also is scheduled to introduce a $25 Dow contract, a new product based on the Dow Jones Industrial Average to trade exclusively on the CBOT’s electronic platform. The “Big Dow” contract is designed to expand the use of CBOT Dow products and meet demand for an electronically traded Dow futures contract with a larger notional value and tick size.
Finally, the CBOT is set to list Soybean Crush Spread options this Friday. The contract will complement our existing Soybean complex, while meeting customer requests for expanded price-risk management tools available to the soybean processing industry.
I think that 2006 will continue to mirror recent history in that there will be many new developments unfolding, both at the CBOT and within our entire industry. Of course, it is only to our advantage to work together to encourage growth via the four avenues I discussed earlier: remaining committed to innovation, driving efficiencies for market users, creating opportunity via technology, and working to maintain the integrity of our industry. With more exchanges either considering making the transition to or actually transforming into a publicly traded company, our industry is focused on growth now more than ever. We at the CBOT are concentrating as intently as possible on growth, but it is not just growth for shareholders. It is also growth of innovation and opportunity for market users, as well as expanding our reputation for excellence worldwide. I am optimistic that we will have many opportunities to work together on just that: fostering the growth of both of our businesses. Thank you for your support in 2005, and we hope to continue strengthening our partnership with you in the coming year and beyond.
Now, if there are any questions, I would be happy to answer them.
