How Much Could Declining Trading Volumes Affect CME?

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CME Group

CME Group (NASDAQ:CME) had a solid start to 2014, with its trading volumes growing across different derivative classes. Overall trading volumes rose by around 10% year-on-year (y-o-y) in the quarter ending in March, with the most volume growth coming from interest rate products (+19%), equity derivatives (+10%) and commodity derivatives (+8%). The exchange operator witnessed similar growth for interest rate derivative volumes last year as well, as trading volumes rose by 20% in 2013. In its recent monthly volumes report, CME reported a slowdown in trading activity with net volumes declining by 4% y-o-y. [1] The mild decline in volumes was offset by a corresponding increase in the revenue per contract of certain derivative classes including equities, energy, commodities and metals. Competing exchange operator NASDAQ OMX Group (NASDAQ:NDAQ) has also witnessed a decline in trading volumes of derivatives, similar to that of CME in the current quarter.

See our full analysis for CME Group

Can The Increasing Rate Per Contract Offset The Decline In Volumes?

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CME witnessed a 20% decline in average trading volumes of metal derivatives in 2014 (through May), compared to the year ago period. This decline has been slightly offset by a 3% y-o-y increase in average implied rate per contract (RPC) for metals. Similarly, the average RPC for commodities is up by 3% in the first half of the year, compared to the prior year period. Moreover, the year-to-date average trading volumes for commodities have been up by 3% compared to the same period in 2013. Going forward, CME Europe could help the exchange operator increase metals trading with recently started aluminum trading. We forecast the combined volumes of metals and agricultural commodities to increase by 7% for the full year.

Trading volumes for energy products started slowing down at the end of the last quarter, after strong volumes during the peak winter months. After February, the volatility in gas prices decreased, causing a decline in trading activity of energy derivatives. Volumes of energy products are down by over 20% y-o-y since the end of February. Similar to metals and commodities, the decline in volumes has been slightly offset by a 4% increase in average RPC of energy products.

The global foreign exchange (FX) markets have suffered of late due to the benchmarking scandal and low levels of volatility. [2] The company reported a 28% y-o-y decline in FX traded products for the first half of the year, with the average RPC also down by 4% year-to-date. However, the company has a positive outlook for the coming quarters as it launched CME Europe at the end of March, although it seems like it could take time to gain popularity. According to CME estimates, the FX market is likely to be driven by the increasing adoption of exchange-traded FX futures, which CME Europe is in a position to offer along with 30 FX pairs. [3] The company has noticed strong demand for FX trading in Asian markets and believes CME Europe can cater to its growing Asian client base.

Interest rate products make up more than half of the trading volumes on CME’s platform. However, interest rate derivatives have the lowest average RPC among all derivative classes traded on CME’s exchanges. The RPC for interest rate products of under $0.50  per contract is lower than the company-wide average of $0.78 per contract and significantly lower than energy, metals or commodities derivatives, which range from $1.30-1.70 per contract.

Assuming the current rate of decline in volumes continues for the rest of the year with a slight increase in average RPC across some derivative classes, the exchange operator would see a decline in revenues. Taking an aggressive estimate of a 10% decline in trading volumes for the full year and a 3% average y-o-y increase in RPC across all derivative classes, the clearing and transaction-based revenues could decline by 6%. There would be a downside of about 2% to our $66 price estimate for CME’s stock in this scenario. Our price estimate is slightly lower than the current market price.

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Notes:
  1. CME Monthly Volumes, CME Investor Relations, June 2014 []
  2. The FX Fixing Scandal, Reuters, March 2014 []
  3. FX A ‘go’ On Eve Of CME Europe Launch, Financial News, March 2014 []