NYSE-ICE Deal Could Disrupt CME’s European Expansion

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IntercontinentalExchange’s (ICE) potential acquisition of NYSE Euronext (NYSE:NYX) grabbed the headlines at the end of 2012. Having discussed in detail the potential effects and the reasons for the deal in a previous article, we will now analyze the implications the acquisition might have on ICE’s main competitor, CME Group (NASDAQ:CME). CME will face increased competition in the growing futures trading business, particularly in interest rate contracts trading. To gauge the potential impact on CME’s operations, let’s explore the company’s business model.

See Full Analysis for CME Group Here

Comparing The Two Exchanges

CME Group is the second largest derivatives exchange in the world in terms of trade volume behind Korea Exchange [1] and consists of the Chicago Mercantile Exchange, the Chicago Board of Trade and the New York Mercantile Exchange. Transaction fees from energy and interest rate contracts trades are the main sources of income for the company, accounting for about one-fifth of the revenues each.

Regulatory changes and uncertainty in the market led to low trading volumes last year as the company reported a drop in revenues for most of 2012. CME is expected to recover in 2013 as new regulations requiring all over-the-counter (OTC) trades be cleared through a central exchange will be implemented both in Europe and the U.S. The regulations are expected to generate revenues of about 1.2 billion per year. [2] Analysts at UBS (NYSE:UBS) estimate a 25% increase in revenues from OTC interest rates swaps clearing and CME and ICE are scrambling to gear up for the revenue opportunity. [3]

ICE is a relatively new exchange, established in 2000 by a consortium of energy companies and banks, and it earns most of its revenues from transaction and clearing fees on energy contracts trades. About 15% of its revenues are generated from transaction fees charged on ICE Brent Crude futures and options trades. The company has had its eye on the lucrative interest rates futures business for some time and NYSE Liffe provides the perfect platform for ICE, with 70% of its revenues derived from interest rates contracts trading. ICE made a bid for NYSE’s Liffe business along with Nasdaq (NASDAQ:NDAQ) in April 2011 but the deal was blocked by the U.S. Justice Department as it would give Nasdaq a monopoly over listings in the U.S. As Nasdaq is not involved in the transaction with NYSE this time, the authorities might be more inclined to allow the deal.

Taking a look at trade volumes, CME currently clears/trades about 3.5 billion contracts per year and is the second largest exchange in the world behind Korea Exchange. It is followed by Deutsche Boerse AG’s Eurex exchange which trades around 2.8 billion contracts per year and NYSE which trades 2.3 billion. ICE is currently outside the top 10, trading close to 400 million contracts per year but is mainly focused on the energy domain.

Both ICE and CME have seen high revenue growth in the five years prior to 2012 as the futures industry has expanded following the 2008 financial crisis and both will be looking to capitalize on the regulatory reforms in 2013. We expect an increase in energy contracts trading volumes in the coming years.

The Battleground

NYSE Liffe primarily operates in Europe where it enjoys a near duopoly with Deutsche Boerse AG’s Eurex exchange. About one-fifth of the world’s options and futures trades are executed in Europe which makes it a lucrative market. NYSE Liffe trades about 1.1 billion contracts per year while ICE clears/trades around 270 million. Eurex is the market leader with 2 billion contracts traded/cleared per year.

CME has announced plans to open a derivatives exchange but will have a tough time fighting the incumbent exchanges for market share. ICE already operates a clearinghouse in Europe which will give it the upper hand once regulations requiring OTC transactions to be cleared come into play. Further, competition is expected from Nasdaq which also plans to launch a derivatives exchange in London in 2013. Given the competitive nature of the industry, CME might be interested in making a bid for Deutsche Boerse’s established business instead of entering the market as a new player.

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Notes:
  1. Annual Volume Survey, futuresindustry.org []
  2. Analysis: Commodity exchange battleground switches to “swaps”, Reuters, 11th October, 2012 []
  3. CME Group third-quarter profit drops, but beats Wall Street view, Reuters, 25th October, 2012 []
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