BOCA RATON, Fla. — The war of the futures exchanges might yield substantial savings for money managers that invest or hedge in a broad range of derivatives contracts.
That boon to money managers is likely to be one result if the IntercontinentalExchange Inc. is successful in its bid for CBOT Holdings Inc.
ICE, the Atlanta-based over-the-counter energy market and parent of London’s ICE Futures oil exchange, announced on March 15 a $9.9 billion all-stock offer for CBOT Holdings, parent of the Chicago Board of Trade. The offer tops the $9 billion stock and cash bid from the Chicago Mercantile Exchange, made in October.
In a letter to Charles Carey, chairman of the CBOT board, ICE Chief Executive Officer Jeffrey Sprecher promised to give customers the ability “to cross-margin positions in the combined product suite and in cleared over-the-counter products.”
Mr. Sprecher did not elaborate on the details of his cross-margining plan when he spoke to reporters last week at the Futures Industry Association’s annual conference in Boca Raton, where the letter was made available. But he emphasized that the CME’s more traditional clearing model, with limited cross-margining opportunities, represents “an inefficient use of capital.”
“Price is not the only metric here. There is a lot more to this deal,” Mr. Sprecher said.
Correlation issue
One issue at the heart of the clearing debate is correlation between asset classes, many of which tend to move in tandem. Geopolitical tension, for instance, tends to push up the price of both oil and gold. As a result, an investor with long positions in both commodities might be considered as taking a similar view of the market in both instances and be required to provide less than 100% margin for each position. This is cross-margining.
Former Federal Reserve Chairman Alan Greenspan, a guest speaker at the FIA conference, commented on correlation, saying: “I think that when we have severe pressures about stability in the world, gold prices will rise. It correlates very roughly with crude oil.”
David Resler, chief economist at Nomura Securities International Inc, New York, said: “Cross-margining provides flexibility for investors. Competition, such as we currently see in the exchange sector, ultimately always benefits customers.”
The potential for cross-margining between correlated asset classes is huge for the alliance that the CBOT could forge with either the ICE or the CME.
CBOT is the home of U.S. Treasury futures, as well as some equity indexes, benchmark grain contracts and precious metals, while ICE would bring trading in energy and soft commodities, since it bought the New York Board of Trade in January.
“Cross-margining is an important issue. As far as posting margin or collateral, gaining an incremental rate of return is always a benefit when chasing a little bit of alpha and a few basis points. It should be met positively,” said Larry Peruzzi, head of international equity at Boston Co. Asset Management LLC, Boston.
The firm has $68 billion under management, which includes some equity index futures, Mr. Peruzzi said.
Big for small portfolios
At the other end of the investment spectrum, savings on cross-margining can make a huge difference for a small portfolio.
Steven Schnur, CIO at Xenon Capital Management LLC, Chicago, said in some of the low-volatility futures contracts, even tiny savings can make a difference.
“If you can get lower capital requirement on the fixed-income side, that’s what it’s all about, because the volatility is so low and everyone is very leveraged,” said Mr. Schnur, who manages a $70 million fixed-income futures portfolio.
One important feature differentiates the two offers: With the ICE, the CBOT would control the majority (51.5%) of the new entity resulting from the merger. With the CME, that control would be reduced to 39%.
This would have a bearing on the contentious issue of exercise rights on the Chicago Board Options Exchange held by a number of CBOT members, who founded the CBOE in 1973. The CBOE has made the point that such exercise rights should disappear if CBOT membership would disappear in the merger leading to a new CME Group Inc.
“The CBOT membership becomes almost unrecognizable” under the proposed merger with the Merc, Mr. Sprecher said.
Analyst Christopher Allen at Bank of America Corp., New York, questioned “the strategic value of the ICE venture given the strategic value of the current CME-CBOT deal on the table.” But he acknowledged “flexibility in the potential legal structure of the transaction exists to provide CBOT members who hold CBOE exercise rights a preferred structure to preserve these rights.”
The CME proposal is pending review by the Department of Justice for antitrust considerations and approval by the CME and CBOT shareholders and members in a vote set for April 4. An ICE-CBOT deal would likely invite similar regulatory scrutiny.
Following the ICE news, CME officials said in a statement they will keep on “working toward the successful completion of our transaction,” while the CBOT issued a release acknowledging the “unsolicited offer,” which it will review.
