Imagine if the New York Stock Exchange and Tokyo Stock Exchange proposed to merge. That is akin to what could happen in Chicago. The two biggest futures exchanges in the world - the Chicago Board of Trade and Chicago Mercantile Exchange - are discussing the possibility of merging. The enormity of a merger gives reason for concern among pension funds and other institutional investors, the largest users of the futures exchange.
A merger could risk diminishing the unique nature of futures exchanges, which, more so than stock exchanges, makes them laboratories of financial engineering, encouraged by their intense rivalry.
Their contracts have become the most powerful instruments in the financial markets. You can trade the shares of the mighty General Electric Co. on the Big Board. But on the CME can you trade the entire stock market, i.e., the Standard & Poor's 500, for only a tiny good-faith margin.
The CBOT spawned the era of financial futures with its Treasury contracts and it begat the equity options market by creating the now-separate Chicago Board Options Exchange. Long before they became the trendy promise of a new world of technology, the futures exchanges were the places of "virtual reality" in financial management.
The decision on merging should belong to the members of the exchanges. But their customers - the investors - ought to let them know how a merger might affect the things they care about: innovation, liquidity, cost, fairness, and execution safety.
Exchanges aren't easily created; merging these two behemoths could mean intangible losses for uncertain advantages. The CBOT and CME have seats owned by anyone, from individuals to securities companies. Newer futures exchanges like the MATIF are owned by banks; and they use computerized trading, unlike the Chicago auction markets that pit people trading face to face.
The CBOT and CME might feel they need to merge in the face of competition from over-the-counter swaps and other derivatives offered by global money center and investment banks (or from futures exchanges overseas). As news stories have noted, pension funds from San Diego County to Armco Inc. often bypass the exchanges for customized OTC derivatives.
A merger of the exchanges might reduce member costs and strengthen clearing operations. But how much would these aspects of a combination benefit customers? Less competition often doesn't mean lower fees for customers. The trade-off will put innovation at risk. Competition between exchanges has speeded the proliferation of derivatives worldwide. The American Stock Exchange, for example, turned to innovative option, warrant and index instruments, such as S&P 500 Spiders, to revive a market of slumping equity listings.
Competition between the CBOT and CME has allowed investors to experiment and express preferences in trading similar instruments, such as with the CBOT's one-time 30-stock Major Market Index contact against the CME's S&P 500 contract.
Their record in collaboration hasn't been good. The CBOT- and CME-led venture on the Globex trading system ended in acrimony.
A merger would reduce the number of voices expressing opinions on public-policy issues, such as regulation and transaction taxes. At this critical time, when derivatives markets face a credibility problem with the public about their value and risks, they need all the different ideas and innovation competition fosters.