The Merc and the CBOT: Together at Last

After several attempts, the two exchanges have finally ironed out a merger agreement. Will shareholders and regulators sign off?

It has taken 30 years and at least three failed attempts, but the Chicago Mercantile Exchange (CME) has finally brought the Chicago Board of Trade (BOT) to the altar. The Merc, the financially stronger and more fleet-footed of the two old bourses, plans to buy the older CBOT in an $8 billion cash and stock deal, leaders of the two exchanges announced after marathon overnight negotiations on Oct. 17. "It makes good sense," Terrence Duffy, the Merc's plainspoken chairman, said at a press conference.

The deal, expected to close in mid-2007, will bring under one roof trading in futures on U.S. Treasury securities, currencies, Eurodollars, and even the agricultural products that the exchanges were founded on but that now account for only a small and shrinking share of their business. A dizzying 9 million contracts, worth some $4.2 trillion in all, change hands through the computers at the two exchanges every day, and putting them all into one place will bring traders and customers closer together. "It's logical and compelling," says Leo Melamed, chairman emeritus and éminence grise at the Merc.

But the two crosstown exchanges—traditional rivals so feisty that they even pit champions against each other in an annual boxing match for charity—had to swallow a lot of concessions to get what Melamed calls their "Don Quixote" deal together. Hammering out an agreement to meld the boards of directors and managements, along with the financial terms, took marathon bargaining sessions that stretched until 6 a.m. on Oct. 17, just an hour and a half before they made a conference call to tell Wall Street about the deal. At first, the merged firm will be overseen by an unwieldy 29-member board of directors, with just nine hailing from the CBOT, and much of the management will stay on.


Executives of the two bourses talked about merging first in 1976 and 1977, again in 1982, and yet again in about 1987, one participant in the many talks says. What made the difference this time, says Merc Chairman emeritus Jack Sandner, was the fact that both their stocks were trading publicly. It's clear to all what the two exchanges are worth—with the Merc weighing in at $18 billion and the CBOT trailing behind at about $7 billion (both values before the merger announcement). "We can now value it," Sandner says.

Despite the last-minute horsetrading, the exchange executives expect they'll have no trouble ultimately teaming up. They spelled out rich terms designed to ease a vote by the members of the CBOT. For each of their CBOT shares, worth about $134 before the deal was announced, they'll get either cash worth about $151 or just under 1/3 share in Merc stock.

For members who hold thousands of shares, the lush terms mean a hefty payoff, even though the cash prices will vary, depending on the timing of the merger. Shareholders warmed to the deal: The stocks of both exchanges soared in response, with the CBOT closing up 13%, at a penny under $152 a share, and the Merc closing up 2.36%, at $516.50.

The deal, of course, will be subject to approval by shareholders of both companies, members of the CBOT, and regulators. Executives of the companies expect to handily persuade members, shareholders, and their joint regulator, the Commodity Futures Trading Commission, that the alliance is vital to their global competitiveness. Their argument in Washington will be that consolidation among exchanges around the world makes increased heft crucial.


Indeed, the deal will cement the Merc's global No. 1 position, in both the average daily value and the number of contracts traded, giving it a commanding lead over Europe's Euronext and Eurex exchanges. The CBOT now lags behind the European exchanges.

They may have a little more trouble persuading customers that the greater market power they have together—and their greater ability to extract higher fees for trading—will be all that welcome. Both outfits have been raising fees recently, especially since Europe's Eurex bourse backed off a couple years ago from attempting to steal away the CBOT's business in Treasury futures. When it faced competition, the CBOT responded with deep price cuts.

Even though she's pleased at the synergies the deal will bring, Cynthia Zeltwanger, chief executive officer of the U.S. arm of the giant French futures dealer, Fimat, frets about the potential costs. She says, "We will be concerned if we see the fees going up."

Indeed, regulators and customers alike will want to go over the fine print. John Damgard, president of the customer-oriented Futures Industry Assn., admits that consolidation usually leads to great efficiencies. But he also is taking a cautious tone, saying his members would be weighing the deal's implications in coming days. "Are there questions about the concentration of such a large share of futures trading on a single exchange?" Damgard asked rhetorically in a statement. "Yes, of course there are, and our members will be looking at that, as will the regulators."


The deal represents a triumph for the Merc, which long labored in the shadow of the CBOT, even though it has lately proven to be the more innovative and financially dynamic of the two exchanges. Founded in 1898, 50 years after the CBOT, the Merc went public five years ago, and its stock quickly raced from just $35 a share to above $500. The CBOT waited, while it sorted out its membership's resistance to change, and went public just under a year ago at $54 a share. Its stock hasn't rocketed quite as fast, making it susceptible to a buyout.

More tradition-bound, the CBOT only this year began to offer electronic trading in its agricultural futures. It has long offered electronic trading in the far more important U.S. Treasury futures, and lately its sprawling financial trading pits—once packed with sweaty, shouting traders—have gone largely quiet, as trading has migrated to computers. Once the deal is wrapped up, the Merc will move into the CBOT's towering high-rise on Chicago's LaSalle Street, a 45-story art deco palace built in 1930 and topped by an oversize statue of Ceres, the Roman goddess of grain.

At a press conference hearty with mutual congratulations among the bleary-eyed executives of both exchanges, CBOT officials admitted that the deal is necessary because global consolidation among exchanges is making it tougher for smaller entities to compete. "A combination makes us both able to compete as global players," said CBOT Chairman Charles Carey, whose grandfather and uncle preceded him as chairman of the hoary old exchange and whose father traded at the place. "We are facing unprecedented global competition."


All across the world, exchanges are busy in a global game of matchmaking to increase their holds on their markets. The New York Stock Exchange (NYX), which recently absorbed the Chicago-based Archipelago exchange, has agreed to combine with Europe's Euronext marketplace, which will make it a global player in at least European futures, along with stocks and options. The NYSE is vying with Europe's Deutsche Börse exchange over Euronext, which is figuring that an all-European exchange would trump the U.S. markets. That contest will likely be decided with a shareholder vote in December. Meanwhile, Nasdaq (NDAQ) is trying to take over the London Stock Exchange and has bought about 25% of it, though executives of the LSE are declining Nasdaq's advances.

Indeed, analysts say the Merc's takeover of the CBOT makes more sense than the transatlantic deals. For one thing, the Merc would shut down its trading floor, now in leased space in Chicago, and combine with the CBOT's operations, saving some overhead instead of running parallel trading venues as the NYSE and Nasdaq plan to do. "The natural progression has been toward shrinking floors," says Richard Herr, an analyst with the brokerage firm Keefe, Bruyette & Woods.


As the Merc's market value has soared with its stock price, Wall Street has been wondering why it hasn't moved faster on potential takeovers. The exchange "has been criticized for not pulling the trigger and not being vocal enough about doing deals," says Herr. He praises management there for waiting for the best deal possible, noting that the exchanges promise the deal will pay off in earnings gains in 12 to 18 months after closing. The exchanges are anticipating that workforce reductions and cost cuts will save some $125 million for them both.

For now, the deal is drawing mostly praise. "It's a very clever move," says William Cline, a managing director at the consulting firm Accenture (ACN), saying the deal locks in Chicago as the global center for futures trading.

But plenty of market players are going to press for lower costs, not higher ones, as a result of the deal. "We hope the savings will be passed on to the customer," says Randy Frederick, director of derivatives for Charles Schwab & Co. (SCHW). If they're not, the greater monopoly power the single futures exchange will have will be sure to cause problems with regulators and traders alike.

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