Eurex Blows Into Chicago

The Merc and CBOT lobbied to keep the upstart exchange out of their turf. Now, with that fight lost, a battle royal is set to begin

By Joseph Weber

In an era when computerized trading is almost always more efficient and cheaper than relying on human market-makers, the famed trading pits at Chicago's futures exchanges are about to face the fight of their lives. Eurex, the computerized Swiss-German bourse that in just a few years has soared past the Chicago markets to become the world's largest futures exchange, on Feb. 4 won the Commodity Futures Trading Commission's (CFTC) O.K. to open for business in the U.S.

It will happen on Feb. 8, when Eurex ramps up its Chicago-based computers to handle an anticipated tens of millions of dollars worth of business. Expected to provide cheap and fast trading -- without many of the costly middlemen now filling the pits at the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange -- Eurex aims to steal away plenty of contract trading from its less-automated rivals.

Odds are that Eurex will force a new style of doing business on the CBOT and the Merc. Already, the CBOT has been rushing to cut fees, trimming some last fall and still more on Feb. 3, as it tries to compete with the new challenger.


  Eurex is targeting the CBOT by first giving customers the ability to trade contracts for U.S. securities, the CBOT's bread and butter. Eventually, the European bourse -- whose U.S. arm is based in Chicago -- likely will go after the Merc's futures products as well.

Those ambitions, however, face the same obstacles that have humbled other upstart exchanges. First, it must prove that it can offer lower-cost trading for big corporate and brokerage-house futures customers. Backed by the likes of Goldman Sachs, Lehman Bros., and Citigroup (C ) and equipped with fast, state-of-the-art computer systems, it should be able to clear that hurdle. Such owner-customers, along with independent traders, will see to it that Eurex is cheaper for themselves and others alike.

Typical Eurex trades will cost just 20 cents (with some ranging up to 30 cents), while those at the CBOT, after the recent fee reductions, will be 30 cents for nonmembers. However, the CBOT says the fee reduction is only temporary and will be reviewed in six months.


  More daunting for Eurex, though, will be the challenge of wooing enough business to make it worthwhile for more customers to go to switch. Moving liquidity from established markets -- and few are more established than the century-old CBOT -- is notoriously difficult. That liquidity is crucial because it means buyers and sellers can always rely on the market to find others to trade with them. If too few traders flock to do business on the new bourse, it will never get off the ground. Upstart exchanges such as BrokerTec have failed in this critical area.

What's more, the Chicago exchanges have been moving, however belatedly, to modernize: At the CBOT, some 90% of the business in Treasury securities now is done on computers outside the pits. The Merc has moved even more quickly than the CBOT to computerize, even while also keeping its pits alive.

Eurex has some edges in the liquidity fight. For one, over 100 customers already have elected to train on Eurex's system -- including many who now trade at the CBOT. They'll know how to trade contracts on their computers from Day One. What's more, it has signed up some 36 outfits to act as market-makers, standing ready to buy and sell the products for customers.


  The trades will be cleared, moreover, by an outfit well-known to American market players: Clearing Corp., which formerly cleared business for the CBOT. Another big name associated with the venture is the National Futures Assn., Eurex' U.S. self-regulatory watchdog.

The Chicago markets fought hard but unsuccessfully to stifle Eurex' application. Both the Merc and the CBOT testified against the idea to Congress, wrote damning letters to the CFTC, and railed against it at industry meetings, where they raised concerns about Eurex' foreign ownership and criticizing its marketing style.

In the end, though, they couldn't overcome recommendations from the likes of Federal Reserve Chairman Alan Greenspan, along with such customer groups as the American Bankers Assn. and the Futures Industry Assn., which argued that unfettered competition would best serve customers.


  For decades, the Chicago markets have enjoyed monopolies in many of the products they provide. The CFTC staff took note of the Chicago markets' domination in an exceptionally detailed report for the commission, saying the CBOT has 100% of the market for Treasury contracts. Citing Eurex advocates such as the Treasury Dept. and the Fed, the report went on to argue that competition would enhance efficiency and foster innovation.

Now, the battle begins. Plenty of market players -- including even some of the more tech-savvy folks on the floors at the Merc and the CBOT -- expect Eurex will live up to its bold promises. CBOT Chief Executive Bernard Dan insists that his exchange is still "setting the standard for the industry." But if Eurex follows through, it will undoubtedly force sweeping changes in some of the time-tested techniques Chicago has long relied on.

Weber is BusinessWeek's Chicago bureau chief

Edited by Beth Belton

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