Like the hard-edged bruisers who work the trading pits, the leaders of the Chicago Board of Trade and the Chicago Mercantile Exchange are usually passionate advocates of raw, unfettered capitalism. In September, incoming Merc Chief Executive Craig S. Donohue invoked the Chicago school of economics -- the free-market philosophy that is fostered by academics such as Milton Friedman -- at a financial exhibition in Singapore. Extolling competition and innovation, Donohue argued that "as people who work in and around free-market mechanisms, we must be vigilant to adhere to these principles."
So what did the two exchanges do when Eurex, the giant Swiss-German bourse, unveiled its plan to come to the Windy City and set up a no-pits, all-electronic market to trade U.S. Treasury futures? Forget all that highfalutin talk about competition and laissez-faire.
Like any favor-seeking sugar grower or steelmaker, the Chicago boys rushed to Washington to sling as much mud as possible at Eurex. Buttonholing such powerful home state pols as House Speaker J. Dennis Hastert, they got a hearing on Nov. 6 before the influential House Agriculture Committee, where they warned that Eurex could threaten everything from open markets to U.S. national interests. All but wrapping himself in the American flag, Merc Chairman Terrence A. Duffy thundered about "abusive trading practices, allegedly permitted in Germany," that must not be allowed to "impair the fair operation of our regulated U.S. market." The Chicagoans' hope: Get the industry's regulator, the Commodity Futures Trading Commission, to deny, delay, or defang Eurex before its planned Feb. 1 opening.
THESE APOSTLES of competition -- who don't actually face much of it outside their own raucous halls -- didn't stop with lobbying. Back in Chicago, the CBOT tried to thwart Eurex' plan to get Clearing Corp. to clear its trades in the U.S. by offering more than $100 million to shareholders of Clearing Corp., according to Clearing Corp. and Eurex. The CBOT declines to comment. The Clearing Corp., owned largely by CBOT members and customers, opted to restructure anyway and cut a deal to cross over and work with Eurex. So now the Chicago exchanges have joined forces, with the Merc contracting to clear trades for the CBOT. What's more, the Chicagoans would like to scuttle a deal under which the National Futures Assn. would regulate Eurex, arguing that the NFA bylaws don't permit it.
Whatever happened to the idea of letting the market decide? The Chicagoans, particularly the CBOT folks, argue that their two-track business model -- which offers both pits-based, open-outcry trading for complex deals and electronic trading for routine transactions -- is superior to Eurex' all-electronic trading system. Since they have used the Eurex system under a soon-to-be-liquidated partnership, the CBOT execs certainly should know whether that's true. Meanwhile, the CBOT is buffing up a new electronic platform -- in partnership with the Continent's Euronext.liffe exchange -- which is set to debut on Nov. 24. Given all those advantages, surely customers will insist on sticking by the CBOT, no?
IN REALITY, the Chicago exchanges do have much to fear about Eurex. In the past few years, it has eclipsed both of them to become the world's largest futures exchange. Without pits -- which drive up costs as floor traders take a cut out of every deal -- or a fee structure that discriminates against nonmembers, the European exchange has innovated and slashed fees to win business. And the Swiss and Germans at Eurex know all too well how to compete with the pits: Their computers helped lure away German bond-futures trading from the London International Financial Futures & Options Exchange, which led to the shutdown of LIFFE's pits and its sale to Euronext.
Already, long before a single trade is posted on Eurex U.S., the exchange is changing the way the Chicago markets do business. The CBOT is crowing that it will save customers $1.6 billion in reduced margin requirements and other costs, once its alliance with the Merc on clearing kicks in fully. What's more, the CBOT will cut fees by between 18% and 54% for most customers on Jan. 1, though it will still charge nonmembers at least three times as much as members. That will give Eurex CEO Rudolf Ferscha a big opening to argue that Eurex will be far more democratic by treating everyone the same.
The Chicago exchanges must hold on to their customers to avoid a vicious cycle: If they don't keep most of the trading -- essentially hang on to the liquidity -- then even more customers will switch. "Liquidity is the key for any trader," says CBOT Chairman Charles P. Carey. But the Chicagoans have a big advantage: Stealing liquidity from a market is extraordinarily tough, since customers tend to flock to where they can always find ready buyers or sellers. On Nov. 13, the Jersey City (N.J.)-based BrokerTec Futures Exchange said it will halt trading after failing for two years to win enough business. To build its own liquidity, Eurex will offer rebates to big-volume customers. That has the Chicagoans complaining that the rebates are an improper incentive to persuade brokers to switch their business at the customers' expense.
So far, the market may be moving in Eurex' direction. A half-dozen customer groups backed Eurex' bid in a Nov. 5 letter to Congress. And Federal Reserve Chairman Alan Greenspan also sided with the European bourse, saying in a letter to Congress the same day that the arrival of foreign companies is good for competition. He promised that regulators will make sure that foreign companies abide by the same rules as American outfits, especially when U.S. government securities are involved.
THE STAKES in this battle go beyond the fortunes of the exchanges. At issue are the principles of global markets and equal access to them. The Merc, for instance, has terminals all over the world for customers to log on to its system -- even if it had to overcome bureaucratic delays to enter Germany that it blamed on Eurex.
Tempting as it is to try to protect the hometown markets, the last thing Washington -- either Congress or the CFTC -- should do is to keep the Europeans out of Chicago. Leave it to the markets to decide.
By Joseph Weber