CME/BOT/ICE - the edge still rests with CME

CME just issued a press release saying that they will talk with CBOT management and seatholders on Thursday, March 22nd, after they update the press, CME shareholders and analysts in a series of conference calls scheduled for Thursday morning, where they will make their case for their acquisition of BOT.

My own personal opinion is that CME still retains the edge over ICE as the eventual acquirer of BOT, since in an interview with Maria Bartiromo of CNBC last week on the day that ICE announced its offer for BOT, ICE's CEO Jeff Sprecher said that the clearing operation will be split between ICE and the BOT 50% / 50%.

As I wrote in an earlier post to this blog last week, the clearing function and operation is a huge but rather silent or hidden aspect of this deal, and CME has the low-cost clearing operation, (which in fact could be a regulatory hurdle for the CME by Justice) so when Mr. Sprecher announced that the clearing would be split 50% / 50%, my first thought was "well, does BOT re-acquire the clearing function that they sold to CME in 2005, or does CME continue to clear for BOT's 50% stake ?"

Before the BOT went public in late 2005, they sold their clearing operation to CME, since CME was the low-cost clearing operation, and although this is strictly my opinion, my guess is that BOT management knew that eventually they would be acquired by the CME, since the CME tried to buy the BOT before the BOT IPO. Thus the BOT shed the clearing operation to cut overhead, and did the romantic equivalent of starting to move their furniture into their potential mate's apartment.

I can see why Justice might have an issue with the CME - BOT acquisition since the combination will control (from one graph I've seen) at least 60% - 70% of all futures volume, and in addition, with the CME's low-cost clearing operation, the combination will have Buffett would call a formidable "strategic competitive advantage" but one where - given the low-cost approach, and the depth and breadth of product offerings, the customer is certainly not disadvantaged (it would appear).

Finally, ICE is a pure-electronic exchange, and supposedly they have shut down open outcry trading at the NYBOT, which was the brick-and-mortar exchange they acquired last year. That in and of itself isn't a negative, since open outcry will and has diminished in importance since the growth in electronic trading has taken off, but open-outcry will never fully go away in my opinion, since when system interruptions occur as happened at the Chicago Board of Trade (BOT) last year, all that order flow was executed via open outcry in the pits.

The point being that open outcry traders that want a place to ply their living might be a little more inclined to prefer the CME than the ICE, given the treatment of open outcry, but this is likely the least important of all the reasons being considered.

To conclude, CME has long been a leader and innovator in the futures business, and those who have lived in Chicago and been in the financial business know the CME under Leo Melamed, took the lead from the CBOT in the 1980's and 1990's by getting into foreign currencies and euro-dollars and other innovative and risk-managing tools for the investor and trader. I don't think CME would have approached the BOT with the acquisition offer if they didn't have some reasonably good probability of clearing the regulatory hurdles.

Although the ICE offer is intriguing I still think the BOT marries CME, and perhaps gets a slightly higher offer from the CME (which the CME can afford to do, either in cash or stock) given the formidable product offerings (eurodollars, forex, S&P 500 contracts from the CME, Treasuries, grains and now metals from the BOT) and the low-cost clearing operation at the CME.

This is an educated guess, but I would still bet that CME wins BOT's hand at the end of the day.

Either way, it will be interesting.

long CME, S&P 500 index funds