Chicago exchange pins hopes on new products

With acquisition targets dwindling, competition increasing and regulatory threats looming, CME Group Inc. is hoping it can spark growth through new products and foreign partnerships.

Since the first of the year, the exchange has acquired a controlling interest in Dow Jones indexes, including the ubiquitous Dow Jones industrial average, which will form the basis for new futures on stocks. Last week, CME introduced a new palm-oil futures contract. It also struck a deal with the Chicago Board Options Exchange to form futures contracts tied to volatility indexes and initiated or extended partnerships with exchanges in India, Brazil and Mexico.

“We view the emerging markets as substantial areas of opportunities,” CME CEO Craig Donohue said. “Another exciting area of growth for us is the index services area.”

Now that the biggest U.S. derivatives exchange has swallowed the natural acquisitions, including the Chicago Board of Trade in 2007 and New York Mercantile Exchange in 2008, it's settling back into a more workaday growth strategy: boosting revenue through product innovation. But Mr. Donohue and his boss, Executive Chairman Terrence Duffy, will be hard-pressed to get the kind of growth out of new contracts that CME posted in the past decade, as the credit bubble and acquisitions fueled a spectacular run of double-digit profit growth. From 2005 to 2009, CME's earnings more than doubled. During that time, the stock rose steadily as well, to a high of $710 in December 2007.

And while CME shares are up 60% in the last year, at $313 they remain well below the pinnacle.

As deal-making dries up, the exchange is facing intensifying competition. The upstart NYSE Liffe US futures exchange is laying plans to compete with CME on the Chicago exchange's biggest franchise, interest rate derivatives. And Wall Street-backed ELX Futures LP is pushing the Commodity Futures Trading Commission to break CME's hold on the right to clear all futures-trading positions opened at the exchange.

Most of CME's innovation in recent years was tied to acquisitions, including the launch last year of its “ultra” long-term treasury futures on the CBOT.

The company could get a similar burst of new products if it acquires CBOE Holdings Inc., which CME has said it might consider.

But such a bid may be delayed by the CBOE's move toward a public offering. The options exchange filed last week for a $300 million IPO.

So while average daily trading volume is up 18% for the first quarter so far, mainly on surges in foreign exchange and metals futures, CME is moving to pack its product pipeline.

The new index products and international partnerships have a multiplier effect on revenue because the new products become available not only to existing customers on CME's Globex trading platform but to customers of the new exchanges with which CME links, the company says.

“The new international partners are all about growing users,” said Celeste Mellet Brown, an analyst at New York-based Morgan Stanley. “They're looking to get another wave of growth from the international side.”

At the same time, legislative proposals under review in Congress, where the House has passed a reform bill and the Senate is working on one, are mainly in limbo and not focused on the exchanges but still could have a negative impact.

The biggest regulatory threat to the industry is tighter regulations on other financial institutions, which could reduce liquidity and trading volumes at the exchanges, Ms. Brown said.

Lynne Marek is a reporter at Crain's Chicago Business, a sister publication of Pensions & Investments.