City of Chicago pols better pay attention. They have embraced the idea of a transaction tax on exchange financial transactions to fill gaping holes in the city budget. It’s always been a terrible idea but it is especially terrible because even though they think an exchange like CME has a monopoly over trading, it doesn’t.
Today Howard Lutnick’s new exchange FMX will take on CME in the US Treasury market.
I know how CME’s annual report likes to say how diversified they are with volume coming from all kinds of places but the truth is at its core, it is highly dependent on interest rate futures.
The bond market dwarfs the stock market and ag futures market. The only larger market is currency futures which left CME in bulk back in the late 90s though they still do a fair amount of forex business.
The FT has an article that is heavy with positive spin for FMX. This is not Lutnick’s first try at trying to wrestle the interest rate futures market from CME. It’s his third.
Futures tend to be an all or none business. They are hard to move. There are a lot of network effects on futures in the entire value chain from inception to clearing to reporting. If I set up an Ag only exchange today, it’s pretty impossible to move them from CME to my exchange.
The FMX exchange is why Lutnick is one of Trump’s economic advisors. He’s not doing it for any other reason than the money he might make if Trump’s administration carried out some favorable regulatory policy to help FMX. I think Lutnick is a smart guy and it’s good he is advising Trump because I think he will curb some of Trump’s worse instincts when it comes to world finance. Despite the way Lutnick is portrayed in the press post 911, which was a terrible tragedy and anyone might change after that. There are those of us in the futures industry who remember him pre-911, and it’s hard to forget.
Lutnick was a tough guy, tough negotiator, and not really amenable to any compromises as I recall. If anyone wants to weigh in down below, feel free.
There is one fly in his business plan that I see. It is clearing. CME president Terry Duffy highlights that the US might not want US debt cleared outside the US. It is a fair point.
It is my opinion that the LIFFE lost the German debt contracts not necessarily because of open outcry vs electronic trading. They lost them because the German government told German banks to trade German debt on a German exchange. National security reasons and all.
FMX will clear at the London Clearinghouse. However, if you follow futures you know what happened during the LME Nickel scandal. Search Cliff Asness tweets for some reaction. Futures expert Craig Pirrong wrote about it. Foreign regulators are not the same as the CFTC.
The other thing to remember is the big banks will tell you anything you want to hear as long as it’s on your dime. Even though they contributed some money to this effort, it’s pennies to them. Their interest is in keeping CME in check so CME cannot raise prices.
Bill Sheperd told me about a contract they spent hundreds of thousands to bring to market in the mid-nineties at CME. It was a currency contract. All the big banks said they’d trade it. When it was approved by the CFTC, an expensive process, CME got excited and let the banks know when it was going to trade.
No bank ever traded it.
There might be an initial splash at FMX. I freely admit, the market is different now with computerized trading and with no captive local population like we used to have on the floor. Trades might flow through FMX just to show they can do it, and to have the internal experience of dealing with them just in case.
But, I think it will be very difficult to grab meaningful volume long term. The way to compete with CME is not to take them head on. It’s to create contracts they are either unwilling to list, or to create contracts that they are unwilling to do because it will undermine existing contracts.
Most of this article went "whoosh" right past me, but it really struck me, not an investing novice by any means, just how little is commonly known about financial markets. The line about how "[t]he bond market dwarfs the stock market and ag futures market" was the catalyst. I mean, I knew this fact once but had forgotten it and in the context of the rest of the post, it was weird to realize just how ignorant I am.
Thanks. I learned something.
Imo, the time to compete against the CME has long passed. Lutnick (Cantor Fitz) couldn't beat out the CBOT when it was a stand alone, open outcry exchange, then, EUREX then couldn't make it happen either.
If I were Lutnick, I would've opened the first cash Treasuries on margin exchange, with retail banking operations. I'm sure there's a need for those with deposits exceeding FDIC protection who'd like to pick from the immense menu of Treasury coupons to park their money, while knowing that those holdings are backstopped by the "full credit and faith" of Uncle Sam rather than the murky FDIC.