Commentary: Wake Up, Chicago: It's the Electronic Age

By Pallavi Gogoi

At first glance, it seems that the fat years are back at the Chicago futures exchanges. With war, recession, and Enron roiling the markets, investors are clamoring to hedge their portfolios with the options and futures that trade on the raucous Windy City bourses. Volume is soaring, and profits are back after a year of red ink. The renewal is particularly vivid at the Chicago Mercantile Exchange, which saw a $5.9 million loss in 2000 become a $69.2 million profit in 2001.

A closer look, however, shows that all is hardly well at the storied exchanges. Rival markets around the world, most of them purely electronic exchanges, have been nabbing more and more business from Chicago. Combined, the global market share of the Chicago Board of Trade and the Merc has now slipped to a troubling 21%, from 30% just four years ago and 46% back in 1989. The Chicago bourses have a long history of rivalry and cutthroat competition for market share. Still wedded to their colorful pit-trading culture, they have been slow to embrace electronic systems that have revolutionized securities trading worldwide.

All this is hurting business. Trading in Chicago is vexing for many customers: "It is very expensive to do business in the Chicago markets because of the exchange fees, the floor fees, and the brokerage fees. We go there only because of the liquidity today," says Marc Breillout, chief executive of Fimat Group, a French brokerage.

Customers are flocking to the competition, which is largely electronic. Eurex, the Swiss-German electronic exchange, overtook the Chicagoans in volume several years ago. And on Feb. 20, the electronic-trading powerhouse Island ECN launched the Island Futures Exchange, a direct attack on the Chicago markets with its offerings of futures on stocks and indexes. This comes less than three months after the launch of Jersey City's BrokerTec Futures Exchange, a venture of 14 international banks and big brokerage houses that is making inroads in bond futures.

Chicago needs a wake-up call. The message has penetrated better at the traditional underdog, the Merc, which last year pumped its share of the global market back up to its 1997 level of 13%, after slipping to 11% in 1999. Under Chairman Scott Gordon and CEO James J. McNulty, the Merc last year managed to topple the CBOT from its perch as the largest futures market in the U.S. The pair persuaded members to give up the exchange's clubby structure, and they turned the Merc into a stockholder-owned company that may even go public this year. They launched newer contracts on an electronic platform--based on the Standard & Poor's 500-stock index, the Nasdaq 100, and the Russell 2000--that have had a tremendous run, proving fans of electronic markets right. The Merc also spearheaded the effort to form an all-electronic exchange that will trade single-stock futures.

By contrast, the managers at the CBOT look like Luddites. After 150 years with the top volume of the world's futures exchanges, the CBOT slipped to No. 2 in 1999. By 2001, it was fifth. New products based on municipal and government-agency bonds flopped. Then, in October, the U.S. Treasury stopped issuing the 30-year bond, which backed the CBOT's flagship product. Chairman Nickolas J. Neubauer is still committed to the pits. "The open-auction system generally provides tighter, deeper markets for products that are more complicated," he insists.

Clinging to the past will hurt Chicago. Sure, electronic trading still accounts for only 20% of the volume at both exchanges--but that's where the growth is. At the Merc, electronic volume rose 137% in 2001, while floor volume rose 70%. "We make both available and let our customers choose," argues the Merc's McNulty. That's not good enough. The exchanges need to school their floor brokers about computers and push them out of the pits.

As nearly everyone in the business acknowledges, computers have won. Electronic exchanges are faster, more efficient, and more successful. This past January, Eurex' trading volume of 65 million contracts equaled that of the Chicago exchanges combined. Now Island and BrokerTec could rub in the salt with cheaper, more efficient products. The Chicago bourses ignore such rivals at their peril.

Chicago correspondent Gogoi covers the markets in the Windy City.

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