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When I first accepted your invitation, I thought I would talk about all the frantic and challenging issues we faced in implementing the link. I thought I would share some stories about what a hair-raising experience it was. It would have made for an exciting speech, but it never happened.
The night of January 1 was absolutely the most boring event I ever have experienced in my 15 years in the futures industry. That is a tribute to so many in this room, and especially the Chicago and New York FIA divisions, for all of the support and cooperation you gave the Chicago Mercantile Exchange and the Chicago Board of Trade to make the link work so flawlessly. Delivering this initiative on time and without disruptions illustrates our deep commitment to our customers.
In my conversations with some of you in this room, you described the link as truly historic and momentous. We succeeded in doing what most thought was impossible: getting the Chicago futures exchanges to work together for the benefit of our clearing firms and customers.
For me, there are two really interesting things here. First, we've all seen the media wring its hands over the loss of Chicago's largest bank. Yet, very little attention has been paid to the fact that Chicago is home to the CME Clearing House - which is now far and away the largest derivatives clearing facility in the world.
By largest, I mean that we hold over $38 billion in collateral and move between $1.5 and $6.0 billion a day in settlements. We also provide investment facilities with $13 billion under active management. And, unlike the European futures markets, every major benchmark financial futures instrument is now cleared in a single facility. That means real capital and performance bond reductions of $1.6 billion to market users. As a result of the link, we expect to clear over one billion contracts in 2004. Any time you do one billion of anything; you must be doing something right.
That is a great story!
I'd like to talk for a few minutes about industry growth.
There are a number of important secular shifts taking place in our markets today. Our markets are increasingly attractive to users of the cash and over-the-counter markets because of the transparency and efficiency of our products and our central counterparty clearing mechanism. Additionally, demand for exchange-traded derivative products is being driven by significant changes in banking rules, accounting standards and tax policy.
For example, under the Basel II capital accord, banks will continue to receive favorable capital treatment for exchange-traded derivatives, while continuing to reserve balance sheet capital for OTC transactions. Similarly, the financial accounting standards board has adopted FASB 133 which requires corporations to demonstrate that derivative positions held by them meet the "hedge effectiveness test." The vagaries of valuing complex OTC instruments are again driving demand for more standardized exchange-traded instruments with objectively determined daily settlement prices. Finally, the long-standing "60/40" tax treatment for futures and options transactions is increasingly attractive for market users.
Additionally, it is clear that increased focus on bilateral credit risks and counterparty credit limits are not only driving demand for exchange-traded derivatives, they are creating demand for central counter party clearing solutions.
In today's financial sector, there is a strong awareness of the substantial balance sheet benefits that a daily mark-to-market, fully collateralized central counter-party clearing mechanism can provide. All of this promises to have a considerable positive impact on the growth of exchange traded derivative markets and clearing facilities. And I believe CME is uniquely positioned to benefit from these important trends.
CME's Place in This Evolving Market
Today, CME is:
- The largest U.S. futures exchange;
- The world's largest futures clearing organization; and
- The futures industry's largest processor of electronic transactions.
The liquidity we provide to the marketplace is evidenced by the strong growth of our volumes, up from 900,000 contracts per day only three years ago to 2.5 million contracts per day in 2003. And today, nearly 50 percent of our volume is transacted electronically on our GLOBEX® system.
CME is also by far the number one exchange in terms of notional value and open interest. In 2003, $334 trillion was traded at CME, compared to $86 trillion for our nearest competitor. And, CME's open interest was nearly 30 million contracts, compared to 4.8 million for our nearest competitor.
We have all witnessed dramatic change in our industry during the last five years. CME has responded to these opportunities by successfully executing a growth strategy based on:
- Technology innovation;
- Expanding global distribution;
- Continued product innovation; and
- Leveraging the convergence of the cash, derivatives and otc markets.
I want to share with you my insights into how we are achieving this.
First, let me emphasize my belief that CME is truly uniquely positioned to seize on the opportunities presented by such rapid change. CME's vertically integrated business model provides us with the flexibility, efficiency and scale advantages necessary to compete successfully.
Technology Innovation
In terms of technology innovation, we have redesigned our business model to leverage our electronic trading capability. A sign of our successful transformation is that five years ago, CME had 125 people focused on technology. Today, we have over 400 talented technologists, reflecting our view of the future. GLOBEX today significantly outperforms its competitors by facilitating trade around the world more than 23 hours a day, five days a week and with a 150 to 200 millisecond average turnaround time.
Technology innovation at CME has become equal in importance to product innovation. And our ability to innovate is multi-dimensional. It involves expanded user functionality and faster response times. It also involves increased reliability and the implementation of system features designed to enhance market integrity and protect customers from anomalous market conditions. Last January, we launched the Eagle Project - which offers market users the most sophisticated implied spreading functionality in the industry. As a result, electronic trading volumes in this product have increased 120 percent during the last 12 months.
Just two weeks ago, we acquired the innovative patent-pending technology of Liquidity Direct. With the Liquidity Direct platform, we will offer market users a sophisticated electronic solution for complex options combination trading. Most importantly, this new platform will preserve and enhance transparency and competition among market makers in electronic options markets. Transparency and price competition are the hallmarks of CME's successful market model. In contrast to the European "call-around" markets, which tend to be fragmented and opaque, this innovative new platform and market model will create efficiencies and lower transaction costs for market users.
Another measure of our ability to innovate with technology is something most people never see. Over the last five years, and due to the unique processing demands of our enormously successful E-miniä contracts, CME has built an extensive and highly scalable set of platforms and infrastructure. We now process over 590,000 match transactions daily, more than any other exchange in our industry. Therefore, part of our growth strategy, is to offer processing services - and other collateral and risk management services - to other exchanges and trading platforms around the world.
Products
Let me talk about products. Throughout the last 30 years, CME has been the leading product innovator in our industry, from financial futures in 1972, to cash settlement in 1981, stock index futures in 1982, GLOBEX in 1987 and E-mini contracts in 1997. And in every case the world followed and copied our lead.
That leadership role has positioned CME with the most diverse and successful product line in our industry. Like technology, product innovation today at CME is becoming increasingly sophisticated. We work closely with market users to continually reassess product design, delivery system, trading conventions, pricing structure and other features that drive demand for our products.
This has fueled growth in each of our major product lines. For example, electronic trading of Eurodollar futures increased by 45 percent during the last 12 months and the percentage of electronic trading in this product doubled during the same period. Our success is attributable to enhanced functionality, significant reductions in Eurodollar trading fees on GLOBEX, and the implementation of our new Eurodollar market maker program - all of which has substantially enhanced liquidity on GLOBEX.
Our popular E-mini stock index futures products also set a new record in 2003 with almost 235 million contracts traded, up 37 percent compared to 2002. Today, 90 percent of trading activity in our equity products is electronic.
And these products have significantly outperformed other competing products, such as ETFs and equity index options.
You might ask yourself, "Why is that?" Well, let me tell you why. Our E-mini contracts are far cheaper, more liquid and efficient, and more accessible than any competing products. According to published investment bank research reports, SPDR ETFs are 60 percent more expensive - and baskets of stocks are 100 percent more expensive - than our S&P 500 futures contracts. In addition, the notional value of trading activity in our E-mini NASDAQ-100 futures contracts is three times that of the QQQ, while the notional value of trading activity of our E-mini S&P 500 futures is eight times that of the SPDR ETFs. That means more trading interest and a deeper pool of liquidity.
Our foreign exchange product line has experienced nothing short of a renaissance in the last two years. Our e-FX products have achieved a compound annual growth rate of 103 percent during the last two years. Volume growth in this product line is attributable to the speed of our GLOBEX system, our increasing distribution and our clearing house guarantee, as well as the declining value of the dollar.
Today, more than 50 percent of trading in our FX products occurs electronically. And, our FX product line has tremendous growth potential when one considers the $1 trillion dollar a day turnover in global FX trading.
In addition to enhancing our existing core product lines, we will continue to innovate new products.
Many of these new products will be more complex and highly structured products that meet the needs of more narrowly defined customer segments. While such products could not be easily or economically launched in the past, electronic trading enhances our opportunity for success.
Expanding Global Distribution
CME has been working diligently over the last three years to dramatically expand global distribution and access to our GLOBEX system. We have done this by streamlining our application programming interfaces. And, we have introduced more flexible connectivity options, including user defined solutions which significantly reduce costs.
Two years ago, we installed a local telecommunications hub in London. This initiative has been successful, allowing European customers to dramatically reduce their trans-Atlantic telecommunications costs. In tandem with these technical improvements and cost efficiencies, we have put in place an aggressive 18-month European incentive plan to promote CME products and GLOBEX to new European customers. In particular, we are offering a carefully targeted customer segment - electronic proprietary trading groups and trading arcades - an all-in-flat fee of 44 cents per side for any GLOBEX traded product.
As we further expand our global reach, we will install similar hubs in Frankfurt, Dublin, Gibraltar, Amsterdam, Paris and Milan.
The strong response to this program suggests that we will succeed in our strategy to bring new customers to CME who will find our products to be an attractive alternative to comparable euro-denominated products. < P> Another avenue of attack for us in expanding our reach is to attract new distribution channel partners with the capacity to reach large numbers of nontraditional futures customers. For example, we have recently increased access to our products through an agreement with Bloomberg which allows all 180,000 screens worldwide to access CME products on GLOBEX. Additionally, as we continue to expand trading activity in our popular E-mini contracts, we are implementing connectivity agreements with E*TRADE and Schwab's CyberTrader. These new distribution channels allow us to reach the emerging professional equity retail sector who increasingly find E-mini contracts more attractive than cash equities, equity options and ETFs.
Conclusion
Everyone in this room understands full well the value of competition to the marketplace and to the end user. CME welcomes fair competition, for it challenges us to innovate and provide efficiencies that benefit our customers and shareholders.
I am extremely bullish on the future of our industry and on CME in particular. There is not a single competitor in the marketplace that we are not ready to deal with. And we have what I call the innovator's advantage.
Where will CME be five years from now? We have the growth strategy in place to evolve from a futures and options exchange into a broadly diversified financial services company.
The CME of tomorrow will likely offer trading and clearing solutions across a broader range of products and asset classes. Additionally, we will enhance our position as a leading transaction processor, providing market solutions for other exchanges and trading platforms.
Going forward, CME will continue to capitalize on our strengths and maintain our important leadership role in the global derivatives markets for many years to come.
In summary, this is a great time to be a CME customer, shareholder and employee.
