Chicago Mercantile Exchange and Board of Trade Merger Report

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Introduction

Chicago mercantile exchange (CME) is an American financial exchange situated in Chicago. It was founded in 1898 as Chicago Butter and Egg Board. It started as a not-for-profit organization, however, it went public in December 2002. It is a stock exchange that provides an option on futures contracts on its financial products. It trades on several types of financial instruments such as interest rates, equities stock indexes, foreign exchanges, and commodities. It also offers trading in other investments such as real estate and weather. It also offers an electronic trading floor and an electronic trading platform known as ‘GLOBEX’.

Chicago mercantile is the world’s biggest regulated foreign exchange trading complex and the second biggest electronic marketplace for foreign trading in the world. It provides its customers with liquid, clear markets, guaranteed implementation, and clearing risks management on 41 individual foreign exchange futures products.

In the year 2006, the Chicago Mercantile exchange purchased the Chicago Board of Trade for $ 8 billion in stock. The two financial institutions merged to form the present Chicago mercantile Exchange group.

Chicago Board of Trade (CBOT) was established in 1848. It’s the world’s oldest futures and options exchange. It started as a not-for-profit organization; in 2005 it transformed into a for-profit organization with an initial public offering on the New York stock exchange (NYSE) Listed as CBOT Holdings Inc. It has about 3,600 members who trade through open outcry and e-trade. In the year 2007, it merged with Chicago Mercantile Exchange and stopped trading as an independent entity

Discussion

On July 12, 2007, Chicago Mercantile exchange bought and merged with the Chicago board of trade to form Chicago Mercantile Exchange Group, the largest merger ever in the world. The buying and merging of the Chicago board of trade by CME Holdings was a strategic action to strengthen and increase its influence in the global market and provide the expected higher savings. It entered into this merger specifically to diversify and expand its product base and further influence its existing operating model and increase its competitiveness and foreign exchange worldwide. Chicago board of trade with its outsourced technology platforms was aimed at steering the Chicago Mercantile Exchange’s trading system. Hunger, J. David & Wheelen, Thomas L. (2003)

Chicago Mercantile Exchange Group is the largest and most varied merger in the world. Through this strategy, it serves the risk management needs of its customers throughout the world. Since it’s an international marketplace, it brings the buyers and sellers together on their electronic trading platform and their trading floor.

Chicago mercantile exchange Group is currently working on a business strategy, to be the global reader and the world’s largest and most diverse derivative exchange. It offers a combination of classes of assets that were offered by individual firms before the merger. It provides and offers a variety of customer products ranging from all major assets. They include agricultural commodities, equities indexes, foreign exchange and interest rates, and alternative investment products such as weather and real estate. The CMC Group is keenly focusing on electronic trading, risk management, and cost control which they have identified as key investment areas as they are areas with the highest growth record in the global foreign exchange market. McGahan, A. (2004)

Research has shown that electronic trading venues need to provide state-of-the-art execution and post-trade services. This has made the Chicago Mercantile Exchange further increase its share as a major player in this fast-growing electronic market as the firm’s managing director observes, that their execution platform is a leading-edge for multiple user types and their post-trade services capabilities, including clearing, directly addressing the requirements of traders, risk managers and regulators.

Chicago Mercantile Exchange has the largest number of contracts outstanding of any futures exchange in the world. Durica, Dr. Michael (2006).

As a matter of performance, the Chicago Mercantile Exchange group has a proven record of handling large volumes of days trading and as well as during peaks. It has also proved to be very reliable as it utilizes two state-of-the-art data centers to ensure the reliability of its systems. These data centers provide basic production environments for clearing and trading platforms at all times. It provides all-time support of trading in the market, application, and network services from CME Globex control centers in Chicago and London. They also provide TeleStart automated systems that give traders the ability to ask for canceled orders through the telephone. Coyne, K.P. and Sujit Balakrishnan (1996),

Chicago mercantile exchange holding can offer its customers choices of its various products through Internet applications or direct connections all over the world. Its distribution channels are well interconnected. It also operates six European telecommunications hubs in Amsterdam, Dublin, Gibraltar, London Milan, and Paris. It also operates an Asian telecommunication hub in Singapore. The hubs lower connectivity costs for customers, which in turn increase their trading volume.

CME holding’s electronic trading platform is a world-class electronic trading system with a strong track record that provides the functionality needed to support the diverse range of customer needs within and between classes. A talented team of over 600 information technology specialists who provide a variety of critical enterprise technology supports it. It has developed clearing information technology, distributed computing, and enterprise wide-technology. This has enabled customers to use a wide range of trading strategies in the electronic environment that was previously only available on trading floors. Durica, Dr. Michael (2006).

CME holdings have accorded itself recognition as the pioneer of electronic trading in the late 1980s and having launched Globex in 1992. It is recognized as the leading electronic technology employer by the ‘Information week 500 as one of the most innovative users of technology between the years 2004-2006.

The CME Group is the leading firm in risk management. It offers a financial safeguards package of almost $4 billion and a specialized real-time risk monitoring trading system. It has the best financial safeguard worldwide.

It offers clearing services for a range of financial products with the lowest costs. This is made possible by its high volumes of output hence its ever-increasing economies of scale. This is geared towards broadening its customers base.

However, CME Holdings has to face some constraints on its merger strategic plan. If due consideration is not taken into account, failure to integrate the businesses and the operations of the two companies successfully may negatively influence CME Holding’s performance. The functions of CME holdings and CBOT holdings and their subsidiaries should be consolidated in a manner that does not affect their daily functioning and to the benefit of the customers. Conflict may also occur in the manner the organization is run. The directors may have interest that differs with those of the shareholders. The members may exert substantial influence over the operation of the business resulting in managerial problems. Brandenburger, A.M. and Nalebuff, B.J. (1995),

Due to its wide trading base and its dealings with a wide variety of products, CME Holdings has made a good breakthrough in the global market. However, all businesses must have competitors who produce substitutes for their products. Close substitute products increase competition and hence the likelihood of customers to switch to alternatives especially where the price of the latter is high. Through the merger, CME Holdings has been able to reduce competition from substitutes by developing high-quality and low-priced products.

Due to its product differences, its capital background, and its well-developed electronic distribution network, the group is in no threat of new competitors into the market. The cost structure of the Chicago Mercantile Exchange Group is largely fixed. This means that if their revenues decreased and they are unable to reduce their costs, their profitability would decline. The group is working on modalities to make their cost structure flexible such that it can change with change in either revenue or costs Porter, M.E. (1980).

Before their merger, the CME holdings and the CBOT Holdings were the greatest players and competitors in Chicago financial markets and consequently globally. Their merging gave the CME Group an upper hand in the financial markets. With combined resources, the resulting firm was able to outsmart all the rivalry competing firms using its up-to-date technologies and use of e-trade. The firm through its highly developed communication systems can detect any threat from competing rivals and with its vast resources and highly qualified staff, it can make accurate decisions to counteract the effort of the competing firm. The CME Group through its well-established communication centers can gather customers’ information regarding their products and their specifications. They can give special attention to their loyal customers. Porter, M.E. (1985).

No firm can succeed without a cordial relationship with its suppliers of raw materials, components, and services. A firm with a good financial base can attract the services of large-scale suppliers and hence they enjoy a constant supply of raw materials.

The financial base of CME Holding’s, and its level of savings were not growing at the projected rate, neither were the returns to shareholder’s investment before the merger. This is depicted by the consolidated statements of income below. Financial Analysis Of CME Holdings (Consolidated Statement Of Income), Before And After Merger For The Years 2005, 2006 And 2007.

Cme Group INC. And Subsidiaries

Consolidated Statements of Income. (In thousands, except per share data).

Year Ended December 31,
200720062005
Revenues
Clearing and transaction fees$1,427,320$866,089$696,201
Quotation data fees145,05480,83671,741
Processing services106,40490,14868,730
Access and communication fees35,80428,74227,830
Other41,51924,13225,264
Total Revenues1,756,1011,089,947889,766
Expenses
Compensation and benefits263,347202,966179,594
Communications43,47131,58031,098
Technology support services50,48031,22626,837
Professional fees and outside services53,14233,18426,118
Amortization of purchased intangibles33,8781,267732
Depreciation and amortization105,65372,78364,917
Occupancy and building operations48,20229,61428,529
Licensing and other fee agreements35,65125,72817,982
Restructuring8,892
Other62,89240,52136,013
Total Expenses705,608468,869411,820
Operating Income1,050,493621,078477,946
Non-Operating Income and Expense
Investment income73,05955,79231,441
Securities lending interest income121,49494,02858,725
Securities lending interest expense(114,453)(92,103)(56,778)
Interest expense(3,629)(223)(319)
Guarantee of exercise right privileges(17,167)
Equity in losses of unconsolidated subsidiaries(13,995)(6,915)(2,636)
Total Non-Operating45,30950,57930,433
Income before Income Taxes1,095,802671,657508,379
Income tax provision437,269264,309201,522
Net Income$658,533$407,348$306,857
Earnings per Common Share:
Basic$15.05$11.74$8.94
Diluted14.9311.608.81
Weighted Average Number of Common Shares:
Basic43,75434,69634,315
Diluted44,10735,12434,839

From the consolidated statements of income above, it can generally be noted that the total revenues of CME Holdings increased from $1,089,947 in 2006 to $1,756,101 after the merger. The operating income after the merger in 2007almost doubled. Income before income tax rose after merger from $671,657 to $1,095,802 in2007 after the merger. An increase in incomes shows that the strategic plan of merging the two firms was necessary to increase its financial base. Grant, R.M. (2005).

The Chicago Mercantile Exchange Group however has its strength and weaknesses. These strengths or weaknesses are depicted in its performance in the market and level of customer satisfaction. They include:

  • Chicago Mercantile Exchange Group currency has been stable with very few fluctuations in the last one and half years.
  • The merging of the Chicago Mercantile Exchange and Chicago Board of Trade creates a broader platform to grow business through new products and opportunities to trade across assets classes.
  • The firm has integrated clearing and technology, supported by a proven track record of large-scale system integration. This lowers costs for customers by consolidating floor operations.
  • CME has steadily reduced its rate per contract in recent years. It’s expected that with a merger, customers will enjoy higher annual savings due to electronic trading integration.
  • CME has demonstrated operational excellence through successful, timely integration of common clearing link with the Chicago Board Of trade.
  • The firm offers up-to-date electronic trade around the world making trading easy and efficient. Coyne, K.P. and Sujit Balakrishnan (1996).

References

Durica, Dr. Michael (2006). Product Development for Electronic Derivative Exchanges Pro Business. Berlin. ISBN 10: 3-939533-05-X.

Grant, R.M. (2005), “Contemporary Strategy Analysis”, Blackwell Publishing Ltd., Oxford (U.K.).

McGahan, A. (2004) “How Industries Evolve – Principles for Achieving and Sustaining Superior Performance”. Harvard Business School Press, Boston.

Hunger, J. David & Wheelen, Thomas L. (2003) “Essentials of Strategic Management”. New Jersey: Pearson Education Inc.

Coyne, K.P. and Sujit Balakrishnan (1996), “Bringing discipline to strategy”, The McKinsey Quarterly, No.4.

Brandenburger, A.M. and Nalebuff, B.J. (1995), “The Right Game: Use Game Theory to Shape Strategy”, Harvard Business Review, pp. 57-71.

Porter, M.E. (1980) “Competitive Strategy”, The Free Press, New York.

Porter, M.E. (1985) “Competitive Advantage”, The Free Press, New York.

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