As the initial shock of the Intercontinental Exchange Inc.’s (ICE) offer for the Chicago Board of Trade (CBOT) subsides, the hard work of parsing through the proposal and comparing it to the signed merger agreement with the Chicago Mercantile Exchange (CME) has begun. CBOT Holdings Inc., parent company of the CBOT, on March 19 announced, after consultation with its legal and financial advisors, that it has authorized the company to begin discussions and exchange information with ICE. The merger agreement between the CME and CBOT allows the CBOT to engage in discussions and exchange information with another suitor if the alternate proposal can “reasonably be expected to lead to a superior proposal.”
ICE Chairman and CEO Jeffrey Sprecher responded to the announcement in a release, “We look forward to meeting with the CBOT’s management and advisors to begin the due diligence process. We are confident we can complete our review and be in a position to execute a definitive agreement within a week.”
Earlier in the day, ICE distributed a letter to CBOT members extolling its offer as superior to the CME offer and inviting members to a meeting with Sprecher on March 21 at a nearby hotel to discuss the offer. After the CBOT board had agreed to discuss ICE’s offer, ICE postponed the informational meeting with CBOT members.
In its release, the CBOT board stated it would not comment further on the ICE proposal until it had completed its review. It also stated that the merger agreement with the CME remains in effect and it has not withdrawn, modified or qualified its recommendation that stockholders of CBOT Holdings vote in favor of the agreement with the CME.
In the press conference following the announcement of ICE’s offer to the CBOT, Sprecher said the offer had several attributes beyond price, which is approximately $1 billion more than the CME offer. Those attributes include maintaining the CBOT brand, preserving the metals complex and a structure that would preserve CBOT members’ Chicago Board Options Exchange exercise rights.
Futures Magazine: With this offer, you put a price on your head, what if the CME puts a bid on you.
Jeffery Sprecher: Anything can happen in a consolidating space, so we will see how it all plays out.
FM: When the CME and CBOT combined clearing, they claimed it created $1.8 billion in savings through clearing offsets. If you buy the CBOT and move the clearing to your new clearinghouse those savings will be lost, won’t they?
Sprecher: That is what somebody will tell you, that is not our position. You have to break it down a couple of ways. One is, when we move it, it is suddenly cross-marginal against ICE’s suite of products. Second, CME sets the rules to how they run their clearing, and they do gross margining, which is a very expensive way to do clearing. And then once they set up an expensive system they say, “Well, there are discounts if you use us.” Another way to do clearing is to do net margining and never create the expensive system to begin with, which is what we use at the London Clearing House and what Liffe uses and the London Metal Exchange. There is nothing unique about the ability or inability to do net margining vs. gross margining.
FM: How does it provide savings?
Sprecher: The money that is put up for margin in the clearinghouse is the clearing firm’s money, not the individual customer’s. The clearinghouse will margin their positions and if those firms are technically flat it doesn’t matter. With gross margining, they still have to put up buy- and sell-side margin and then the clearinghouse invests the excess proceeds and shares the interest proceeds with them. If you go to net margining, those companies never put the money up to begin with, so they internalize their own customer business. One would have to do analysis of this to actually figure out what the number is. The second thing that I mentioned in the announcement was that the CBOT gave its clearing to the CME, they got no compensation for it. They get a rebate back of something like 25%. We offered $1 billion to move that clearing. Now if those positions in there are largely the members, we are going to give them their money back.
FM: The futures commission merchants (FCM) have wanted a merger of the CBOT and CME clearinghouses for 20 years. Why would they accept it being split again?
Sprecher: The members are going to get a chance to vote. You and I don’t have to debate this, the members will be able to vote and they can decide whether they have a giant Chicago Exchange that controls everything or whether they want two exchanges that compete. You suggest that $1.8 billion is a lot of money, but it is largely borrowed funds. It is invested in Treasury bonds. It is low-risk capital. It probably has a Libor based interest rate. You are probably talking under $100 million a year worth of value. What is the value of having two derivatives exchanges that compete? What is the value of just saving the gold contract and having two gold contracts? How much money can people make on commissions, on brokerage, on trading, on arbitrage, on the entire value chain around just having a gold contract? While it is easy to throw out $1.8 billion because it sounds like a big number, I think the reality is that it is a very small number in the scheme of the derivatives business and it is a very high price to pay to create a virtual monopoly in derivatives in the U.S.”
FM: Is the value of cross margining between CME and CBOT products that will be lost be what you have to overcome for members to choose your offer?
Sprecher: Sure. But we are paying $1 billion upfront. That goes a long way in overcoming that. [The clearing link] freed up $1.8 billion. In moving it, if we just made $1.8 billion come back in, I am paying $1 billion out, so now we are net $800 million for the industry. I am keeping the gold complex. What is that worth? We are suggesting that we can come up with a new paradigm in clearing and go to net margining and have more participation by the FCM community. And I think if you talk to the FCM community and talk to people that are much more involved in clearing and have more knowledge than I do, you are going to find that there is a tremendous level of savings. I have not heard anybody suggest that is not a good idea.
FM: Where is the financing coming from?
Sprecher: We proposed a straight-up stock-for-stock merger, so no financing, but the other proposal has the ability to have up to $3 billion in cash. We suggested that if the CBOT board wants us to come up with cash, we have tremendous borrowing capabilities, so it wouldn’t be a problem raising cash. We personally don’t think any of the shareholders want cash. Anybody who wants cash can sell the shares in a very liquid market. People want to hold theses shares. It is amazing that the members still own 80% of the company. It is hard to imagine that cash is an integral component of the merger.
FM: There have been serious questions raised about your trading platform. Is your technology up to the task?
Sprecher: Right now almost all the platforms are running similarly: CME Globex, LiffeConnect and the Eurex platform; we are all in the 30-millisecond execution range. Anyone who said that has old information. You can look at us going up against CME Globex on WTI and we are growing. We have much more advanced spread functionality than any of the platforms, which is partly why you see ICE continue to grow. We are the fastest growing derivatives exchange. Anyone who has suggested that the platform is not up to snuff cannot comport that with the reality of our business. The fact that we can do energy so well, we are confident that we can do the rest of the CBOT complex.
FM: What about the hosting agreements with regional commodity exchanges — the CBOT’s joint venture with the SGX?
Sprecher: We would love to host them and we would love to have Jade.
FM: The other reservation expressed is the ability of your clearinghouse to handle the size of the CBOT.
Sprecher: Before we bought the company, they just updated the basic clearing software that they bought from the old Board of Trade Clearing Corporation and it probably has the most up-to-date clearing platform. What it needs to handle this business is to scale it and we are in the process of scaling it. We already have increased its scale by a factor of 10 just in the first month that we have owned the business. There is still a lot of work to do but the clearing agreement that the CBOT has with the CME doesn’t end until the beginning of 2009, so it is not like there isn’t a tremendous amount of time to work with the industry to get the clearinghouse up to snuff. If the CME were to terminate early or to cause an early termination, we’ve had a lot of people approach us and say they would rally the troops to help get it ready to take that option off of the table.
I haven’t had anybody that has suggested that they wouldn’t come to our aid, so I think that you would see the industry rally around this company and do what it takes to help. There is so much good will we’ve seen around this proposal and there is an understanding of the work that needs to be done at the New York Board of Trade (Nybot) clearinghouse. Look, I built a $10 billion business with the platform that I started myself with my own checkbook; these things can scale. We have suggested in our discussions that technology and clearing wouldn’t kick in for years under the proposal. For people to raise issues as if this were going to happen tomorrow is just not the case.
FM: Would you consider extending the CME clearing arrangement?
Sprecher: The [CME/CBOT clearing arrangement] goes through 2009 and has the ability to extend, but it would be our intent to be ready by 2009 to handle that business. We will be building and scaling our own systems in that period. And I think the regulator will hold the current provider of clearing accountable for continuing to do a good job — it is a fundamental part of our financial system.
FM: Would moving open interest be a problem?
Sprecher: It has been done before, by the same people that we would be retaining.
What I think you are going to see is an overwhelming support from the FCM community, from the Futures Industry Association, from Wall Street. I haven’t found a user community yet that isn’t interested in keeping a competitive CBOT in Chicago. At the time that that clearing was moved, it was a different landscape than it is today. People have had the opportunity to see and think about one large Chicago-based derivatives exchange and I don’t think that, ultimately, the industry really wants that to exist.
FM: The CME argues that they compete globally.
Sprecher: Global competition, the way people have been talking about it in the context of that merger, is taking a U.S. company and trying to compete outside the U.S. It is not realistic that [a merged CME and CBOT] has competition from foreign companies coming into the U.S. With great respect to our friends at Eurex US, it is not putting any competitive threat to the CME or CBOT. Probably the best competitive foreign exchange is my exchange, ICE Futures, which is competing with the New York Mercantile Exchange, but is still on Capital Hill being asked whether or not it has the right to be in this country doing business. So we do not, in this country, have a landscape where we’re inviting foreign competition. This is not like the Maytag-Whirlpool merger where two large appliance companies were allowed to come together because [overseas] appliances are being made very cheaply and making their way into this country. The Department of Justice (DOJ) looked at that and said there is real foreign competition for appliances in North America. It is hard to see how anyone is going to say there is real competition for foreign derivatives exchanges in this country and at the end of the day, the DOJ is here to protect American consumers. Retail customers who buy futures probably do an insignificant amount of business with any foreign exchange in this country.
FM: Is there a possibility the DOJ would not allow a CME-CBOT merger?
Sprecher: Nobody has any visibility into the DOJ thinking. People that say, ‘it is going great,’ I don’t believe; and people that say, ‘it is not going great,’ I don’t believe because I think the DOJ is still gathering information and I don’t think they have come to a view. The only visibility that we have is that they have stepped the process for which they are gathering information by sending out subpoenas and asking for affidavits. Where they come out on it, I don’t know that anybody knows.
FM: Does the possibility the DOJ will not approve a CME-CBOT merger give your proposal an advantage?
Sprecher: We don’t think that we have any anti-trust issue. We think that we are in the exact same position that we were in when we acquired the Nybot and that review was done within 30 days. We don’t have any overlapping products with the CBOT. We have a clearinghouse and a technology and they don’t. It looks very clean to our lawyers and the advice we are getting is that we think it could be put together quickly. I am not suggesting they have problems. I am suggesting they are going through a process and there is no visibility into what is going to come out of it or when it is going to happen.
FM: Do you anticipate additional bidders?
Sprecher: It is hard to say. I only know why we decided to bid at this time and the timing worked for us. And we though it worked within the process that the CBOT set out. Whether that stimulates others is hard to know. Admittedly, this is towards the end of the approval process for the shareholders so there is not a lot of time. They have a vote scheduled for April 4, but you never know.
FM: If another offer comes in are you still in the game? Is this your best final offer?
Sprecher: We have, in my mind, the superior offer right now, so we are not bidding against ourselves. And I think it is superior for a lot of reasons, not just price. The social issues that we have proposed and the regulatory issues we’ve discussed — I think it is just really solid and anybody else entering the process would have to deal with all those issues.
FM: What about the leadership?
Sprecher: We proposed to speak to current management. Most of them have been given their walking papers, so it is hard to know where they are in their own career thinking, but we want to sit down with them and ask ‘who is willing to stay and in what role,’ and see if we can put together a combined management team. It is pretty clear that the CBOT has some very good execution capabilities. They did seamlessly move its clearing, which is something that would be important to us. And it did seamlessly move off of Eurex onto the Aems platform, which is important to us. And they launched the gold contract, which has been really successful. There clearly are some good executors in there and we want to make sure we identify them and keep those people from leaving, and if they are thinking of going, hopefully the idea that they are making something other than the CME structure will keep them around for a while until we have a chance to talk to them.
