While The Econ­o­mist reports on the being-negotiated CME-NYMEX deal, it also reports on the com­pet­i­tive land­scape among futures exchanges.

Namely, a field with sig­nif­i­cant bar­ri­ers to entry, suc­cess­fully pre­served, ensur­ing iner­tia in the order flows, and rec­og­nized by investors:

Some cus­tomers fear that the CME will start to raise trad­ing fees once it has swal­lowed its rivals. This worry is par­tic­u­larly acute in a busi­ness in which bar­ri­ers to entry are much higher than in cash equi­ties, where nim­ble elec­tronic trad­ing net­works have helped to ham­mer down com­mis­sions. Most attempts to poach futures busi­ness have been quickly repelled, except when an online exchange has tar­geted an inef­fi­cient “open out­cry” mar­ket, as Inter­Con­ti­nen­tal Exchange did when nab­bing oil futures from NYMEX before the lat­ter went elec­tronic. With the CME already a leader in screen trad­ing, it looks all but unassailable.[…]

Largely because they are so hard to budge, deriv­a­tives exchanges tend to trade at much higher mul­ti­ples than mar­kets that deal mostly in stocks.

Within this envi­ron­ment, one could expect an ossi­fied mar­ket­place, with play­ers com­pet­ing mainly on scale and lever­ag­ing fees within their king­dom (their cit­i­zens mostly trapped inside). Coher­ent with the CME objec­tive to con­quer and estab­lish more kingdoms:

“Their strat­egy seems fairly sim­ple: be in all prod­ucts in all mar­kets,” says Craig Abruzzo, co-head of listed deriv­a­tives at Mor­gan Stanley.

But exploit­ing the old, dying, com­pet­i­tive par­a­digm doesn’t pre­vent the CME from inno­vat­ing in the new one.

The cri­sis may help exchanges in another way, by high­light­ing the opac­ity and illiq­uid­ity of some OTC instru­ments. The CME, for instance, is push­ing new clear­ing ser­vices for swaps, cur­ren­cies and even credit derivatives—until recently the exclu­sive pre­serve of broker-dealers charg­ing fat fees for a “bespoke” ser­vice. Among the advan­tages of this hybrid model, argues Kim Tay­lor, the exchange’s head of clear­ing, are daily mark­ing to mar­ket (“so losses can’t accu­mu­late unde­tect­ed”), ease of sell­ing and less chance of not being paid, since the exchange acts as coun­ter­party to both sides of the trade.

Being able to suc­cess­fully com­pete, in par­al­lel, within the old and new par­a­digms is pretty remark­able for such a corporation.

Source: The Econ­o­mist — Jan­u­ary 31st 08