CME Group Inc. Ratings Affirmed, Removed From CreditWatch; Outlook Negative
- A new margin relief program offered through a competing exchange represents a credible threat to CME Group's dominant position in listed interest-rate futures in the U.S.
- We are affirming our ratings on CME Group.
- Potential business risks to the exchange and credit risks to the clearinghouse have recently emerged.
NEW YORK (Standard & Poor's) June 23, 2011--Standard & Poor's Ratings Services said today that it affirmed its ratings on CME Group Inc., including the 'AA/A-1+' counterparty credit rating. At the same time, we removed the ratings from CreditWatch Negative, where they were placed on March 3, 2011. We have also affirmed our ratings on $612.5 million of 4.4% notes due 2018 issued by CME Group Index Services LLC that CME Group guarantees. The outlook is negative.
"The affirmation reflects CME Group's dominant position as the marketplace for trading and clearing a diverse set of listed futures and options on futures in the U.S.," said Standard & Poor's credit analyst Charles D. Rauch. In addition, CME Group's own financial strength, including its strong cash-flow generation and ample capacity for servicing outstanding debt, support the ratings.
The negative outlook, which means there is a one-third chance we could lower the ratings during the next six to 24 months, considers two developments.
First, NYSE Liffe U.S. lists interest-rate contracts in direct competition to CME Group's flagship products. NYSE Liffe U.S. recently launched its joint venture with Depository Trust & Clearing Corp., called New York Portfolio Clearing (NYPC). NYPC, which offers one-pot margining is, in our opinion, a credible threat to CME Group's most important listed interest-rate contracts. So far, NYSE Liffe U.S. has gained only a 3% market share of trading volume in its Eurodollar contract and has practically no market share in its U.S. Treasury bond contract. During the next six to 12 months, we should have a better idea whether NYSE Liffe U.S. will continue to take market share from CME Group or will ultimately fade away like others before that tried, but failed, to break CME Group's hegemony.
If CME Group loses a substantial portion of its market share in interest-rate products, the impact on its financial performance could be material, but not serious. Under an extreme scenario, in which CME Group's
market share in interest-rate products goes to zero, we estimate its debt-to-EBITDA multiple would go to 1.2x from 0.9x. This modest increase in debt leverage reflects the diversity of CME Group's listed businesses, its low expense base, and the fact that the average rate per contract for interest-rate products is much lower than for CME Group's other listed products.
Second, we believe the clearinghouse division of the Chicago Mercantile Exchange (CME Clearing) devised the Financial Instruments Clearing Membership(FICM) in response to the competitive threat posed by NYSE Liffe U.S. FICMs can only trade listed Eurodollar or Treasury bond contracts and can obtain material margin relief if they hold offsetting eligible fixed-income securities elsewhere. We are concerned there could be incremental credit risk because CME Clearing does not have direct control of the cash securities for which it is granting margin relief. Instead, it shifts this responsibility to the facilities manager (i.e., a specially designated clearing member), which is also the guarantor of the FICM. If the FICM program is successful, the financial safeguard system at the clearinghouse would still be strong, but incrementally less so, in our opinion.
The outlook is negative. We could lower the ratings on CME Group if it loses significant market share in its flagship interest-rate products, which would hurt its business profile, in our opinion. We could also lower the ratings if new clearing initiatives dilute the financial safeguard systems at CME Clearing or if management pursues more aggressive financial policies beyond the already-announced $750 million share repurchase program.
Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.