This annual broker meeting is one of the most important events the CBOT attends every year. It is a tremendous opportunity for the CBOT. Not only do we get the chance to update you on all of the new developments at the Exchange, but this meeting also provides the opportunity to talk with you, some of our most valued customers, and receive your input on how well the CBOT is meeting your needs and to hear about the trends you see emerging on your side of the business.
Without question, 2005 was one of the best years in CBOT’s history. We launched one of the most successful IPOs of the year, and we also saw trading volume reach more than 674 million contracts in our fourth consecutive record-breaking year. In the third quarter of 2005, our most recently released earnings report, CBOT revenue rose 20 percent and our net income climbed 63 percent. Amid these achievements, our IPO served as a major turning point for the Chicago Board of Trade as an institution.
The Exchange’s restructuring and the subsequent IPO enhances our competitive position within the industry, making us a more flexible organization. Still the basic foundation of the Exchange--our beliefs, our values, and the very purpose for our existence--remains unchanged. The CBOT is fully committed to the basic principles of providing fair and liquid markets for price discovery and risk-management to market participants around the world.
Our success during the last 12 months was not by chance. In 2005, the CBOT refocused on growth – of our business and of opportunities for our customers. We know that in order for the CBOT to expand its leadership role within our industry, we need to consistently work to deliver the best products and services to you. We were dedicated to that goal in 2005, and it will remain a priority for the Exchange going forward.
Looking at our industry as a whole, I believe there are several major trends unfolding. Each of these is already shaping great changes within derivatives trading, as well as at the CBOT. One, we are seeing shifting trends in global agricultural production, which is acting as a catalyst for the creation of new products. Two, while globalization has already left an indelible mark on futures trading, this trend holds tremendous power to continue to mold how we – exchanges, IBs, our collective customers – all conduct business. Three, sophisticated technology remains a critical vehicle for delivering new and innovative benefits to all participants in our industry. And finally, changing demographics in the U.S. are bringing significant opportunities to IBs and the industry at-large.
With respect to the first trend, I think that shifts in global production will increasingly spur the creation of new products. The CBOT is well aware of this phenomenon – in fact, our South American Soybean futures is a perfect example. Factors in two different parts of the world served as the impetus to begin research on this new product. First, we looked at trends in South America. In 1993, Brazil and Argentina together produced 1.3 billion bushels of soybeans and exported 312 million bushels, just over one-half of U.S. exports of the product. Fast forward to 2004/2005, and the two South American countries produced more than the U.S., with 3.3 billion bushels of soybeans produced -- a 154 percent increase from nearly a decade prior. Further, exports of the product from Brazil and Argentina surpassed the U.S. for the first time in 2003 and typically have done so since that time.
Next, we looked at shifting trends in China, home to 1.3 billion people and the world’s sixth largest economy based on purchasing power. A large portion of those South American soybeans are imported by China. In 1994, China imported 155,000 metric tons of soybeans. Ten years later, imports approached 25 million metric tons, an incredible increase of 16,400 percent.
These shifts in production and consumption not only impact how the markets trade, but they also call for the development of new products that better match global risk management needs. Looking at these numbers, it wasn’t surprising that our customers were requesting a futures product that would allow them to hedge their risk exposure to soybeans produced in South America.
After determining both an economic need and consumer demand for the product, we launched South American Soybean futures last spring. While we haven’t seen expected growth in volume and open interest in the contract as of yet, we at the CBOT believe in giving new products the opportunity to grow and develop liquidity. Relatively strong correlations between South American and domestic bean prices last year encouraged hedgers to continue to use the more liquid and established U.S. Soybean futures contract. Nevertheless, we still anticipate that the South American Soybean complex will grow in importance as a risk management tool, particularly if global demand for South American soybean and soy products continues to rise. Further, if Brazil continues to improve its infrastructure, we will likely see continued expansion of soybean production there, further enhancing the country’s competitiveness as a major exporter of soybeans and soy products.
Supporting our efforts in this area is the fact that right now seven firms – many of them international commercial firms, including your parent company -- are deemed regular for delivery in CBOT South American Soybeans. We are fully committed to building upon our offerings of risk management tools based on soybeans produced in South America and currently are working on plans for a South American Soybean Meal futures contract, which we currently expect to introduce in 2006.
Before detailing another product the CBOT introduced in response to shifting trends last year, I want to take a moment to discuss the CBOT’s approach to new product creation. We know how tough it is for you to keep up with the multitude of new products that are listed by all of the major exchanges each year. It is one of the reasons we are very targeted and measured in our approach to introducing new contracts. 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 market users themselves. Secondly, we work to diversify our product mix with global financial instruments designed to meet an outstanding and definitive need in the international marketplace. I think you might see others following our lead in the future, as exchanges around the world focus more intently on the best allocation of their resources for bringing maximum benefits to market users.
However, it isn’t only existing production patterns that spur innovation. Sometimes it is an anticipated shift in production that encourages new product development. Last year the CBOT also introduced Ethanol futures, an example of the Exchange working to meet market users’ current and future risk management needs. We collaborated extensively with the U.S. ethanol industry to develop the contract, which includes an innovative delivery mechanism created to help ensure the contract’s effectiveness for price discovery and managing price volatility within the ethanol market. During times of extreme price movement, such as this summer when volatility of Ethanol futures doubled in a two-month period, the contract served as a transparent hedging instrument.
We have a number of reasons to maintain our optimism about Ethanol futures’ growth potential. Open interest in the contract is steadily expanding. Volume in new products often climbs as open interest grows, a trend we hope to see in this particular product. Also, U.S. ethanol demand and production 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, we are told that there is potential for 40 to 50 new ethanol plants to be built over the next two decades. As a result, new byproducts such as dried distilled grain are in our sights as the ethanol industry develops.
This trend could increase demand for tools to manage risk associated with price movements in the ethanol cash market. It could also add new demand pressure on corn, potentially impacting corn’s volatility. Moreover, if bio-diesel fuel development continues to progress over the next several years, similar market dynamics may affect the soybean market.
Today, we at the CBOT are delighted that ethanol market participants have accepted our contract as a pricing benchmark, as the industry previously lacked a centralized market for price discovery.
These are just some of the areas in which the CBOT has focused. With the significant economic development taking place in Asia and the Middle East, as well as production shifts in the U.S. and abroad, I expect that new markets will continue to develop in commodities where either the supply is abundant, or where new, emerging risks are causing the marketplace to respond with the development of a listed futures contract. Remember, it was only 20 years ago that equity indices were being launched. Thirty years ago, the CBOT launched the very first interest rate futures contract. Contracts like South American Soybeans are only the beginning - more products will likely be designed to tap into these permanent changes in global trends.
While production trends are constantly shifting, the globalization of our industry has remained a constant. It is a trend that has been one of the most significant influences to shape our industry’s landscape in the last decade and will continue to do so. I believe that globalization has tremendous potential to further influence how we do business and the efficiencies we drive for you, our customers.
Within the arena of globalization, you will see exchanges being even more innovative than ever before in order to cultivate new customers and better serve existing ones. One method the CBOT has employed to create new opportunities to extend its own global reach is the establishment of hosting agreements. For a little more than a year, the CBOT has been hosting on its electronic trading platform the agricultural futures and options products of the Winnipeg Commodity Exchange, Kansas City Board of Trade and Minneapolis Grain Exchange. This initiative has allowed you and the international trading community the convenience of accessing key agricultural products on one platform. We expect to see this type of hosting arrangement replicated, as it reduces the fragmentation that is synonymous with regional exchanges and creates greater efficiencies for customers.
The CBOT has taken the hosting agreement concept even further with its recently announced joint venture with the Singapore Exchange to form the Joint Asian Derivatives Exchange, or JADE. Under the JV, SGX and CBOT plan to develop commodity contracts to be traded on a new electronic Exchange and hosted on the CBOT’s electronic platform. All trades are expected to be cleared by SGX’s clearing house.
Access to the new Exchange is expected to be approved by the JADE Exchange Clearing firms. Details will be forthcoming on how to trade JADE products on e-cbot. We are hopeful that ADM will consider trading on JADE or becoming a clearing participant.
JADE is one tenet of the CBOT’s aggressive business plan to tap into the ongoing trend of globalization and expand access to the Exchange’s current and new products across Asia. We see tremendous opportunity for growth on the continent, because we believe that demand for risk management tools in the Asia-Pacific region is rising along with expanding Asian economies and consumption of commodities such as soybeans, industrial metals and energy products. In order to provide more customers in Asia with the ability to connect directly to the CBOT, we established a telecom hub in Singapore last year. This key initiative not only further expanded the global network for direct access to the CBOT across the Asia-Pacific, but it also laid the ground work for facilitating access to JADE products from Asia.
We believe strongly that developing relationships with our counterparts in Asia is another critical step to making inroads into that marketplace and facilitating the internationalization of our markets. In addition to our relationship with SGX, the CBOT has Memoranda of Understanding with eight different exchanges located in the Pacific Rim. Each of these agreements is unique while sharing the common theme of facilitating information sharing and cooperating on joint business projects. These agreements with other leading exchanges give the CBOT the opportunity to learn about Asian markets and explore additional business possibilities in the region. Simultaneously, these relationships offer our Asian counterparts the chance to gain further knowledge of the CBOT’s market and products. It is our goal to maximize the value of each one of the MOUs we have signed and to work to realize their full potential.
As you can probably guess from the targeted initiatives I just mentioned, it is my belief that globalization of our industry is likely to create the biggest changes in Asia in coming years. As more countries on the continent lift barriers to entry into their markets, foreign participation in those markets will likely rise. Further, I believe that many of the fragmented markets with a regional or domestic focus will take steps to broaden their attractiveness to global investors. What will facilitate these developments is standardization of electronic trading platforms and of clearing practices. Common clearing arrangements, such as the one established by the CBOT and Chicago Mercantile Exchange, are likely to proliferate due to the ongoing benefits and savings they deliver to customers. Further, some exchanges will likely tap into established technology networks, such as the CBOT’s, and use the hosting model to increase the distribution of their products.
As globalization continues to unfold, so, too, does the trend behind it – that of implementing sophisticated technology. Of course, like so many businesses all over the world, we have seen the multitude of benefits that technology brings to our industry. We as an industry are avoiding the trap of complacency and working tirelessly to implement new technology solutions whenever possible. Of course, I can really only speak firsthand about the experiences of the CBOT, where we have devoted a great deal of time and resources to technology initiatives in 2005, largely because technology serves as a foundation of our business. Technology makes risk management products accessible from anywhere in the world, and in the case of the CBOT, nearly 24 hours per day. Technology also creates efficiencies for customers and provides flexible capabilities that fit the unique trading styles of our market users.
The upgrade of the CBOT’s electronic trading platform was one of our largest-scale initiatives of 2005. Rolling out new functionality, the upgrade included expanded spread trading, stop order and order book management 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 tremendous speed for which the CBOT’s electronic trading system is known. In addition to its high level of performance and reliability, the CBOT’s system is scalable. Scalability is a valued attribute for an exchange’s technology because it means that expanding volume can be handled with little additional investment. This flexibility is a benefit for any Exchange as well as its customers.
As part of the CBOT’s overall technology strategy, we also moved the trading host, the epicenter of our electronic trading platform, to Chicago. This move was made to enhance the speed and efficiency of our overall system.
When thoughtfully implemented, technology provides many benefits to the Exchange and our customers. In 2005, performance of our electronically traded products was particularly impressive. Overall electronic volume at the Exchange was up 24 percent over the prior year, and in 2005, 65 percent of total volume at the CBOT was executed electronically.
Time and time again, we have seen technology open up access to new market segments. A case in point is the CBOT’s 100 percent electronically-traded Precious Metals complex, which performed exceedingly well in 2005, setting one record after another. This success is a testament to the impact retail traders can have on a new contract -- average daily volume for the complex rose almost 74 percent during the year, and our Gold contracts had a 15 percent market share of gold futures traded in North America in December, thanks to strong participation from retail traders. Capturing such an impressive percentage of market share in just a little over one year is virtually unprecedented. We also attribute the success of these products, in part, to market users embracing the benefits of our electronic trading environment, such as immediate trade certainty and straight-through processing.
We are constantly striving to further enhance our already strong repertoire of products that appeal to the retail and regional commercial audiences: electronically traded mini-Dow futures (which trade 80,000-100,000 contracts/day); electronically traded precious metals; grains and soybeans; and ethanol.
Electronic trading of Financial options at the Exchange also saw significant growth in 2005. A total of 7 percent of all CBOT Financial options on futures volume took place on the screens – that number reached 10 percent last month. This is a huge increase from just under 3 percent of Financial options trading electronically in 2004. Driving this success was our electronic market maker program for U.S. Treasury options during extended trading hours. Originally designed to provide a transparent trading environment for these contracts nearly around-the-clock, particularly during Asian and European hours, the program has been a resounding success. In 2005, electronic trading of Financial options increased by 180 percent.
As we move forward, exchanges are likely to introduce an increasing number of innovative applications of cutting-edge technology, such as the enhancements the CBOT designed to increase efficiency of our open auction environment. Called “Project Denali,” 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 delivers to customers:
- First and foremost, Denali improved customer service and customer satisfaction. This is based on our market users’ overwhelmingly encouraging response to the new technology.
- Denali implemented straight-through processing, streamlining the entire execution process of a trade, from start to finish.
- Market users benefited from improved risk management, a feature that allows you to manage daily trading activity and to view matched versus unmatched trades on a near real-time basis. Confirmation messages are now sent to firms right away, making trades available for risk analysis more quickly.
- The ability to access the real-time status of customer orders online is something that our customers at ADM have noted as particularly helpful, and we appreciate that feedback.
- Denali also improved communication between brokers, floor traders, and firms.
When it comes to Denali, the numbers really speak for themselves:
- Out-trades have been reduced by one-third compared with two years ago.
- Order turnaround time – the amount of time it takes for an order to be sent electronically, executed, and reported back out – 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 held technology.
- Finally, in 2005, volume in our Agricultural contracts increased almost 8 percent to a record of nearly 92 million contracts. Contributing to this success was the increased capacity and efficiency created by Denali.
The fourth and final trend that I want to mention is the shifting demographics of the U.S. population and the potential impact it could have on commodities trading. Until the year 2030, the ranks of retirees in the U.S. is expected to grow steadily, and at that time, it is estimated that one U.S. resident in five will be more than 65 years old, compared with one in eight today. Some have speculated that boomers will inherit anywhere from $10 trillion to $40 trillion in wealth, which would be the equivalent to $132,000 to $560,000 per boomer.
You might be wondering how this all will affect our business. With commodities now being promoted as an asset class that offers a negative correlation to stocks, more commodity-based investment products are being introduced to add diversification to the traditional portfolio of stocks and bonds. By some estimates, it is expected that nearly $91 billion will be held in retail retirement accounts by the year 2011. If only five percent were invested in commodities, that would equate to $4.5 billion coming into those markets.
Greater numbers of people using technology tools for trading, combined with the aging “baby boomer” population looking for alternative investment opportunities will make customer service and education key to developing this growing market segment. Because we rely on IBs to develop new customers, you can count on the CBOT to continue working on new educational and sales tools, as well as products, to help you do your jobs more effectively.
When I first began my remarks, I noted that 2005 was a remarkable year for the CBOT. I believe that this momentum will continue, propelling the CBOT to extend its track record of achievement. We are poised to meet the needs of the global marketplace, particularly as global trends for consumption continue to shift. We are now working on exciting new products that we believe you will find useful. As I mentioned, we expect to launch a South American Meal contract, something that European market users have expressed an interest in. We also plan to roll out Soybean crush options, a product that ADM has strongly supported in the past. We are in the process of securing a market maker and hope to launch the contract this year. At the same time, we are working on several other exciting products, the details of which we look forward to sharing with you as soon as possible.
As these potential production, globalization, technology and demographic trends continue to emerge, and with signs of other changes occurring within the agricultural, financial and futures industries, we at the CBOT are committed to remaining your partner in creating new and innovative initiatives. I can’t urge you enough to continue our constant dialogue. It is our conversations with you that encourage the CBOT to create new products, introduce new technology, and forge beneficial partnerships that have the potential to build liquidity and ultimately meet your needs. Thank you again for inviting me to address you. I am happy to answer a few questions.
