Good day, everyone, and welcome to the CME Group First Quarter 2010 Earnings Conference Call. As a reminder, this call is being recorded. At this time for opening remarks, and introductions I would like to turn the conference over to John Peschier. Please go ahead, sir.
Thank you all for joining us. Craig Donohue, our CEO; Terry Duffy, our Executive Chairman; and Jamie Parisi, our CFO will spend a few minutes outlining the highlights of the first quarter, and then we will open up the call for your questions. Also joining us for participation in the Q&A session are Phupinder Gill, our President; Bryan Durkin; our Chief Operating Officer; Kim Taylor, our head of Clearing; Laurent Paulhac, Managing Director, OTC Products & Services; and Rick Redding; Managing Director, Products & Services initiative.
Some of our team is working from Chicago, while others are working hard in New York, so please bear with us as we may jump around a little bit during the Q&A session. Before they begin, I’d read the safe harbor language. Statements made on this call and in the accompanying slides on our website that are not historical facts are forward-looking statements. These statements are not guarantees of future performance, and involve risks, uncertainties, and assumptions that are difficult to predict. Therefore actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. More detailed information about factors that may affect our performance may be found in our filings with the SEC, including our most recent Form 10-K and 10-Q which are available on the Investor Relations portion of our website.
Now I would like to turn the call over to Craig.
Good morning and thank you for joining us. I’m pleased to be speaking to you today from a really different place both in the macroeconomic sense, and certainly from CME’s perspective than we found ourselves during the first quarter last year.
To begin with first quarter volumes tell a positive and compelling story with 12% growth in average daily volume and a 24% increase in open interest since Q1 ’09. With the exception of equities exchange-traded volumes by asset class are up by double digit percentages from first quarter last year. April ADV of 11.6 million contracts is strong, and up from the first quarter. This notable as April has traditionally been one of the slowest months for us. Interest rates were up 33% in Q1, and this month’s volume is up 64% compared to last April.
Recognizing that Q1 ’09 was an extremely depressed volume environment for interest rates, we are very pleased with these growth percentages, but also continue to look forward for potential indicators of ongoing growth.
To that end, we continue to believe that the growing inventory of treasuries will need to be hedged in a more volatile interest rate environment. The expectation for treasury issuance this year is $2.3 trillion, up 7% from $2.1 trillion in 2009.
In addition, the Federal Reserve officially ended its $1.25 trillion program to purchase mortgage-backed securities, a plan that was one of the single largest initiatives ever undertaken by the federal government to support the US economy.
In terms of trading activity, the Fed’s participation in this market restrained hedging and futures trading as they acted to keep the mortgage market range bound. Additionally, Eurodollars have historically been used to express opinions about future Fed activity, and expectations are for a more active Fed once the zero interest rate policy draws to a close.
CME Group’s Fed funds futures are currently reflecting a 34% probability of a rate hike by September, a 52% probability of an increase in November, and a 68% increase by December. As we have mentioned before, we have seen the depth of our central limit order book significantly expand in many product areas and our average bid-ask spread has tightened, particularly in interest rates since the credit crisis.
Slide eight shows the growing liquidity available on our treasury and Eurodollar markets along with other products. The recently announced interest rate offerings from other exchanges and consortiums have captured some headlines. However, our focus has been and will continue to be fostering liquidity in our markets, which supports customer trading, helps us attract new customers and reduces overall trading costs.
Equities have been challenged in the first quarter by the weight of decreasing volatility, a slow upward rise in equity values, and difficult comparables in Q1 ’09. Low volatility has impacted the cash equities market and other futures products, such as the EURO STOXX and FTSE.
However, we have had two days over the last few weeks including this Wednesday when equity volumes exceeded 4.5 million contracts, so as equity markets become less range bound we would expect these volumes to rise as well.
In addition, we’re very pleased with the success we’ve had increasing the volume and revenue contributions from other asset classes. The FX asset class had a record revenue quarter and energy and metals were near peak from a revenue perspective. Taken together, revenue from these three asset classes was up 18% from Q1 ’09. Trends in these products during the month of April continued to show strong strength with volume up 45% compared with April last year.
I would like to now provide you with an update on our globalization strategy as this past quarter has been a very active period for us with a number of significant accomplishments. Our globalization strategy is primarily oriented to expanding our core businesses and building deep liquidity in our products 24 hours a day.
We have a multipronged effort which includes expanding our own global sales force and technology distribution, and by also partnering with leading exchanges and markets where we see high growth potential.
The partnerships allow us to accelerate our market penetration, expand our customer reach, and develop our product sales channels with local brokers. Nearly all of our products are global benchmarks that have universal appeal to customers, both domestically and internationally. We are selectively adding sales and marketing staff in the EMEA, Latin American, and Asian markets, and we now have 50 sales and marketing and business development employees outside of the US contributing to our strong progress and future growth potential in these markets.
In the first quarter, we enhanced the liquidity and volume in our core products and markets during non-US trading hours in order to better serve our European and Asian customers, which you can see on slide 10. Volumes on CME Globex during these periods grew 58% compared to Q1 ’09, with volume during European hours up 55%, and during Asian hours 75%.
Another way we measure our progress is to look at volume processed through our eight international telecommunications hubs. These low-cost, high reliability services continue to generate excellent results in our core business. Volumes through these hubs represented 12% of our overall electronic volume in Q1, up from 10% in Q1 ’09, and the hub volumes grew 35% versus the prior year, faster than our overall volume growth rate.
We are focusing on core growth in global markets, because we fundamentally believe that Asia, Latin America, and other emerging markets will experience superior economic and financial markets growth over the next decade compared with the more mature North American and European markets.
Slide 11 shows expected GDP growth rates in countries around the world between now and 2020. As I mentioned, our approach also includes launching or partnering with premier exchanges to launch more foreign products on the CME Globex platform that are attractive to our international customers. In recent months, we have been very active and successful in expanding the range of foreign products to be traded on or accessed through the CME Globex platform, including five of the world’s most actively traded equity futures contracts, the Brazilian iBovespa, the Korean KOSPI 200, the Indian Nifty 50, the Mexican IPC, and trading hours extension of our already successful Japanese Nikkei 225 contract.
Also two of the world’s most actively traded interest rate products, the Brazilian overnight interest rate contract and Mexican bond futures. And finally, all of the Malaysian and Dubai derivatives products, including the benchmark crude palm oil contract and the Oman sour crude contracts.
Our efforts to globalize our business are in an early stage, but we are encouraged by our progress to-date reflected in both the current volume numbers and the quality of the firms with whom we have partnered. Based on our track record of helping our partners prosper, we believe we are well positioned to maximize the revenue generated from the trading of our entire suite of CME Group products.
In conclusion, volume and open interest in all of our business segments with the exception of equities is considerably stronger than a year ago with double-digit growth from year ago levels.
Second, we continue to focus intently on growing our core businesses through expanding our distribution, global client acquisition, new product development, and further enhancing the technology and clearing services we provide our customers.
Finally, we believe that financial services regulatory reform will likely serve as a positive catalyst for both our core business results as well as our growth initiatives in OTC clearing services.
Now, I’d like to turn it over to Terry to discuss recent developments in this area.
Thanks, Craig. I’d like to update you on the most recent developments with regulatory reform. In general, the focus continues to be consumer protection and increasing transparency and safety and soundness in the OTC derivatives market. Our transparent and regulated exchange markets continue to be the model that market users and policymakers are looking to in crafting new legislation. The following is an overview of the House and Senate derivatives provisions. Of course, the legislation process is not yet final, and these provisions as well as others could be changed as the process continues.
With respect to futures markets, the current draft bill generally provides for limited changes. First; the House bill requires the CFTC to establish position limits for physical commodities and limit exemptions to pure commercial hedgers.
It also requires that the CFTC’s position on this apply simultaneously to OTC participants and foreign boards of trade. The Senate version requires that the CFTC to establish aggregate position limits across markets for contracts based on the same underlying commodity, but preserves the authority of exchanges and swap execution facilities to establish position limits that are not higher than the maximum limits set by the CFTC. The Senate version does not limit hedge exemptions to commercial hedgers.
Apart from the draft bills, the CFTC has already proposed a position limits regime for energy markets. We continue to oppose position limits on US futures markets until such time as the Commission has imposed similar requirements on foreign boards of trade, exempt commercial markets, and OTC market participants.
Second; both the House and Senate versions propose extensive changes for the OTC markets. All swaps listed for clearing by a clearing house would be required to be cleared, as well as traded on exchanges or swap execution facilities pursuant to CFTC rules and procedures. The Senate bill would extend this requirement to foreign exchange swaps.
Both the House and Senate bills include exemptions for end users. The House bill provides an automatic exemption for legitimate hedging by parties that are not swap dealers or major swap participants. The Senate version is more limited, applying only to commercial end users hedging their own commercial risks. The Senate language provides that in the case of clear swaps between either swap dealers or major swap participants and financial entities, the financial entity has the sole right to select the clearing house at which the swap will be clear. The House bill does not include such a provision. Also, the Senate version provides that even where a swap is not required to be clearer, a financial entity or end user counterparty to such a swap can elect to have the swap cleared and has the sole right to select the clearing house at which the swap will be cleared. The House bill does not include this provision.
Both the House and the Senate language require that clearing houses must provide for open access and non-discriminatory clearing of a swap executed at an unaffiliated platform. Unlike the House bill, the Senate version stipulates that a clearing house is not required to clear any swap that adversely effects its business operations or financial position or which could pose systemic risk to the clearing house. The Senate language requires banks to spin off swap dealing activities or forego Federal protection such as deposit insurance or access to the Fed discount window. The House bill does not include such a requirement.
The Senate language prohibits Federal assistance to swap dealers. Major swap participants are exchanges and clearing houses.
This provision is counter to the Senate Banking Committee language reported in March that grants clearing houses the ability to seek loans from the Federal Reserve. The House bill does not preclude the Federal Reserve from providing assistance to clearing houses or exchanges.
Under both the House and Senate provisions, swap dealers and major swap participants will be subject to registration, recordkeeping and reporting rules, as well as capital and margin requirements.
Finally, customized non-standardized swaps would not be subject to the mandatory clearing requirement, but would be subject to higher capital requirements. While we have urged lawmakers to adopt capital and other incentives to encourage the adoption of central counterparty clearing service systems for OTC derivates versus mandatory requirements, we nevertheless believe the draft legislation will be a positive catalyst for our various OTC clearing services initiatives in interest rate swaps, OTC, FX, and credit default swaps.
We believe that our expertise in clearing, our strong financial safeguard systems, and our substantial portfolio and cross-margining capabilities, makes us well positioned to work with the swap market participants to develop clearing services that meet their needs as the OTC business evolves.
Before I turn the call over to Jamie, I would just like to note that the Senate did vote last night with the motion to proceed, so we will begin to see the debate on the Senate floor on the regulatory reform package. Jamie?
CME Group turned in a strong first quarter financial performance as average daily volume climbed to 11.5 million contracts per day, up from the 10.1 to 10.3 million ADV range we experienced in each quarter last year, and up 12% compared to the first quarter 2009. We generated $693 million in revenue and operating expenses were up 5% sequentially. This resulted in $415 million of operating income and diluted earnings per share of $3.62.
Since we completed the NYMEX integration in the fourth quarter last year, we are no longer providing pro forma comparisons. Rather this quarter we will provide our results on a GAAP basis only, and explain any unusual items which are included. First quarter 2010 results did include $6 million in non-operating income for the recovery of the bankruptcy claim, and a $6 million reduction in certain tax reserves, offset primarily by $10 million of professional fees related to establishing the Company’s joint venture with Dow Jones.
These three items increased net income by less than $2 million. Additionally, first quarter 2010 figures include the results of Dow Jones indexes beginning March 19th and there is a new line in the income statement and balance sheet related to the Dow Jones, Inc. minority interest in the CME Group Index Services business.
Turning to customer segmentation, we made some enhancements to the data we provided last year by adding in the NYMEX user data and allocating the other member total more precisely to other categories including individual members, hedge funds, et cetera. We also now show a new category, which is the volume from corporate participants for those we can track, with the remainder of these types of users falling in with the rest of the non-member customer category.
Slide 15 shows this new breakdown going back to the second quarter of 2009, which is as far back as the NYMEX data is available on a comparable basis. Sequentially, we saw an increase in the bank dealer and buy-side [prop] percentages, while the individual member percentage decreased.
The overall pro forma rate per contracts for all CME Group volume decreased 2% to $0.821 compared with $0.839 in the first quarter 2009, primarily due to an increase in our lower priced interest rate contracts to 44% of total volume from 37% a year ago. Sequentially, the rate per contract decreased $0.028 from $0.849 to $0.821 also due to product mix shift. We experienced higher volume from our lower priced interest rate and currency contracts, and a smaller percentage of volume originating from the ClearPort products. Additionally, the proportion of contracts traded by members increased slightly from Q4 2009 to Q1 2010.
Some of you may have noticed the decrease in our rolling three month RPC from February to March. This was driven primarily by a higher mix of member trades in the month of March versus the month of December, as member trading grew at 23%, and non-member trading grew at 9% between these two periods.
Market data revenue of $88 million for the quarter was up 7% sequentially, driven by a price increase and slightly offset by lower professional screen count. At the end of the first quarter, users subscribed to 386,000 base devices across CME, CBOT, and NYMEX, down 10% versus Q1 of last year, and down 3% sequentially.
We had a professional screen fee increase from $55 to $61 per month beginning in January of 2010. In addition, we booked $1.1 million in this category related to the Dow business during the first quarter.
I’ll now take a few minutes to review expenses. Total operating expenses were $279 million for Q1, which included $10 million in professional fees this quarter for banker and legal fees related to negotiating and closing the Dow Jones transaction. Drilling into Q1 expenses, compensation and benefits was $98.8 million, up $9.8 million from the prior quarter. This increase was due primarily to higher base comp and benefits, resulting from a $7 million sequential increase in the vacation accrual and FICA expenses and $1 million related to merit and promotion increases. Our combined headcount at the end of Q1 stood at 2,415, an increase of 25 people since the beginning of the year, plus the impact of 130 related to the Dow Jones transaction. We expect to add more resources in the coming year to support our core and non-core growth initiatives. Our first quarter bonus expense was $13 million, basically in line with target 2010 annual bonus guidance we gave of $54 million. Non-compensation expenses totaled $180 million or $170 million excluding the Dow transaction cost I mentioned earlier. Excluding the Dow, this is roughly flat versus Q4 2009.
Q1 operating income was $415 million, the high watermark since Q3 of 2008. During the first quarter, our operating margin was 60% or more than 61% excluding the Dow transaction related expenses. In the non-operating income and expense category on the investment income line, we received a $9.4 million dividend from BM&F Bovespa. Also interest expense increased due to the $612.5 million of additional debt we incurred for the Dow transaction. The normalized interest expense including the Dow-related debt is expected to trend from $38 million in Q2 to $34 million in Q4 as we plan to pay down $300 million of debt due in August. The detail related to our debt structure is available on slide 18.
In addition, as I mentioned earlier, during Q1 we had a $6 million gain from a settlement related to a currency hedge we had with Lehman. During the quarter, we repurchased 935,000 shares of CME stock, totaling $282 million at an average price of $301.25. As part of our announced transaction with BM&F Bovespa, which Craig spoke about earlier, we plan to issue them 2.2 million shares at the close of the transaction following regulatory approval, which we expect in the June-July timeframe.
For the quarter, our effective tax rate was 39.8%, which was lower than normal due to a favorable adjustment of $6 million related to the deductibility of merger cost related to the CBOT transaction. For the full year 2010, we expect an effective rate of between 41% and 42%. Capital expenditures, net of leasehold improvement allowances, totaled $26 million in the first quarter driven primarily by hardware and software attributed to migration of trading systems to our new datacenter as well as continued build out in our office facilities.
Since we provided our previous expense guidance of $1.1 billion of full-year 2010 expense, we’ve completed the Dow transaction, which added $10 million of transaction related expense plus approximately $21 million in terms of 2010 operating expenses. For modeling purposes, the ongoing quarterly net impact on expenses related to Dow is approximately $7 million with increases spread primarily across compensation, amortization, and professional fees, and a reduction in license fees.
In addition, our share of the multi-asset class trading platform we are building with BM&FBOVESPA is expected to result in $10 million of expense in 2010, which will likely be offset in revenue from our partner. So with the addition of these recently announced transactions, we now expect full year expense of $1.13 billion to $1.14 billion. In summary, we have started the year with strong improvement in our top line and bottom line results, relative to a challenging environment in 2009. So far in April, we are averaging 11.6 million contracts per day, up 24%, despite counting Good Friday with its limited trading of 3.3 million contracts. Excluding that day, our average daily volume is up more than 30% in April versus the prior year.
We will now open up the call to your questions but in order to get to everyone, we are limiting all of you to one question and one follow-up, and then please feel free to get back in the queue if time permits.
Mike Carrier - Deutsche Bank
Just on the OTC initiatives, it seems like in the market right now, there’s some competition growing based on competitive risk management and whether that’s the buffer fund or margin required, I guess, how focused are regulators on this and clients given that the whole point of using a clearing house is to make sure that you significantly reduce you counterparty risk?
I think that there has not been a substantial focus among our clients on that provision. I think, the clients feel that coming to a clearing house provides a significant degree of safety, and that our clearing house is very competitive. Our clearing house is very safe and secure compared to competing clearing houses.
Mike Carrier - Deutsche Bank
And then Jamie, just on the Dow Jones joint venture, you gave the update on the expenses, just from a revenue standpoint, any outlook there. I mean, we know when the transaction was announced, but anything relative to the level?
I’d just say on that point that generally for the first quarter, it was slightly dilutive for us and going forward in the next three quarters it will be neutral to slightly accretive.
Okay wonderful. And moving out we’ll take our next question from Dan Fannon of Jefferies.
Dan Fannon - Jefferies
Can you give us an update on your OTC initiatives and what has been somewhat of a holdout for your interest rates swap offering to be kind of officially out there for customers?
Yeah, I would be happy to do that. This is Laurent Paulhac. We continue to make very good progress on multiple front covering multiple asset classes. Credit default swap as you know has been a core focus of ours. Interest rate swap has been an effort that has gone on for quite some time. We are currently very actively engaged with a diverse group of industry participants. We’re working with a core group of banks as well as institutional buy-side firms. Through that process, we are working through a broad set of complex and challenging situations related to operational readiness, risk management, and other workflow related matters. We’re making very good progress in all those areas, and we continue to feel that our offering is shaping up to be a strong one. At this stage, we do not give any expectation of launch date, but this year throughout the year, we’ve made very good progress, and we continue to expect that through to end of the year.
Dan Fannon - Jefferies
And is it safe to say that kind of regulatory clarity in terms of getting finalization on the bill would be helpful in terms of you guys getting your offering out there?
We’ve been engaged on that process for quite some time, and through that period of time the regulatory landscape has evolved. The driving force behind our capability is really related to counterparty risk mitigation and capital efficiency, as well as operational efficiency. Those major themes have not Laurent really changed throughout any of the financial reform discussion. So, we feel quite secure with respect to the value that we bring to the marketplace. Now, of course, with more legislation and more activity in that front, it will create more tailwind for initiative, but to-date that has not been the core driver and actually we welcome that.
Moving on Howard Chen with Credit Suisse, has our next question.
Howard Chen - Credit Suisse
Terry, I appreciate you walking through just the update from the regulatory landscape. I guess, I have a broad question. Just following all this, it certainly feels like the world is certainly coming towards you and your Company’s business model, but just how worried are you that what’s being proposed now specifically within Senate Ag is just overall harmful to longer term liquidity levels in the overall market?
I guess, it’s speculation at best right now Howard, because the language is yet to be completed and with the vote last night by the Senate, it basically opens up the Senate to a bunch of amendments from both sides of the aisle to see if you can carve out some different end user exemptions, and that will have a big determining effect on whether the business can be migrated overseas or stays more predominantly in the US, but you've got to remember two of the biggest mortgage providers Fannie and Freddie are [going probably to] require to clear here in the US, which is going to have banks wanting to be in compliance with US law in order to do that business. So there is a lot of moving parts here still, Howard, but I think we’ll get more clarity over the next several days as the senate continues its debate and see what end user provisions come forward. I don't know if you want to add to that.
The only thing I would add, Howard, is I think in the bills that are pending and, of course, again we don’t know exactly how that will come out, but there certainly is a delegation of substantial authority to the market regulators to I think make sound judgments about what types of swap contract should be traded on either an exchange or on alternative swap execution facility and what types of swap contracts perhaps should be exempt from that. And I think if I understood your question correctly, I would imagine that they will be sensitive to respecting the fact that some contracts are complex and likely would suffer in terms of liquidity provision or risk transfer, if they were forced to be traded on an exchange. So we just don’t know the answer to that is really I think the best answer.
Howard Chen - Credit Suisse
Thanks for taking a shot at it. I guess my follow-up just switching gears to the core business. I mean the data in terms of depth of liquidity is pretty interesting and telling of kind of the restoration particularly on the rate side. But I was curious if you could just update us on the competitive landscape, particularly with some of the financial products, maybe current state with and how you are thinking about like for Treasury Futures and the impending New York Portfolio Clearing launch and just some of the things that they’ve been speaking to in terms of capital efficiencies?
Well, I’ll start and then may be my colleagues will want to add. Obviously, we are continuing to focus as I said in the prepared remarks on market efficiency, depth of liquidity, and low transaction and frictional costs for market users. Obviously, the pool of liquidity that we provide our customers is very valuable to them and very substantial. As I know you’re well aware, we also provide, I think, very superior portfolio and cross-margining benefits in terms of the range of not only interest rate products but the breadth of other products that we also clear through the CME clearing house but we are also continuing to look at new and new and innovative ways in which we can further expand those efficiencies and we’ll have more to say on that in the coming months. But I think we’re confident that if we continue to focus on the efficiency of our liquidity pool and the efficiency of our clearing house as well as the other services that we provide our clients will continue to be in a very strong competitive position. This has been always I think a very intensely competitive industry. We’ve always respected the competition that we’ve faced in the past in the Treasury and [Eurodollar] market, and I think you’ve seen from us a very strong history of doing what we do extremely well in the face of tough competition.
Moving on our next question comes from Rich Repetto of Sandler O'Neill.
Rich Repetto - Sandler O’Neill
I guess the first question is towards the [topic of this] European regulation. But, Terry, you mentioned that your review and our review as well the Dodd-Linc amendment that it appears like it gives a lot more power to the buy-side to decide where OTC derivatives are cleared. And if you look at the whole environment where Goldman Sachs certainly has had its issues that this other component of the bill that large banks might, we don’t think it’s going to stick, but could have to spin off the derivative through a swap desk. But it appears like the dealers could be weakened here. And I guess the question is in regards to either your current negotiations on say interest rate swap clearing or even as you go after CDS where you have, it has the dealer volume in right now. Do you think that changes the landscape where the dealers aren’t going to be as powerful or have as much control or you don’t have to negotiate 50-50 revenue sharing to get something like CDS?
Rich, let me start. I know Terry is going to want to add. I think first of all I would say our focus as an exchange and as a central counterparty has always been to work with both the dealer community as well as the buy-side in a very balanced way. And that will continue I think to be our focus. I think obviously you’ve got competing language out there and competing concepts between the Senate and the House versions, and we don’t really know what the net effect of that will be, and we’re certainly aware of those provisions, but we don’t know what the sustainability of them will be as the legislation goes through the process of becoming completed. But our goal and our intention will be to work with the whole community of OTC market participants in a balanced and fair way. Call him Rich. That will make him happy.
I’m going to call him Howard then. Rich, I agree with what Craig said, and as far as the buy-side determining where and how these contracts will be cleared, obviously this is all in draft legislation coming out of the two bills as you pointed out at the beginning of your question. So that can obviously change. We don’t know. So we don’t want to draw any conclusions on that. And so we’ll have to see how that shapes out. And as far as the banks being weakened, I still think that the banks have a very strong position, not only in this country but globally and they are going to continue to have that for many years to come. So, I don’t see that going away. But I do believe that they also see the value in central counterparty clearing, and the ability that CME Group offers especially with our interest rate complex.
Rich Repetto - Sandler O’Neill
A follow-up for Chris and Larry here then is that, the question earlier was about could you be hurt by those financial reforms, and maybe I’m looking at this the wrong way, but all this to me, certainly you could get zero incremental business or you could get a lot, but still it appears like it’s all incremental, I guess. Do I have that correct? And I’ll leave it at that. That’s the follow-up.
I think, the best answer to that is really what Terry said in his remarks, which is that the focus of the legislation, the vast majority of the focus is really on consumer protection and the market structure in OTC derivatives. I don’t think the focus of any of the legislation that we’ve seen is really primarily oriented toward the listed futures and options markets. Terry did mention the position limits language in both the House and the Senate bills and that is something that certainly has concerned us. But I think, we’ve made some success I think and progress in ensuring hopefully a more uniform application of Federal position limits not just on regulated US markets but on the other markets that Terry referred to. So I think that’s the best answer to that question.
Moving on we’ll go next to Alex Kramm of UBS.
Alex Kramm - UBS
Craig and Terry, I guess last year when you started your CDS initiative, originally you proposed a trading and clearing solution, and I think in the process, we’ve seen that that didn’t really get a lot of support and then you kind of went back and said, okay, we’re just going to focus entirely on clearing. Now when we look at what Terry just went through on the regulatory side, one of the things that has surprised us that still sticks around is that the clearing and trading kind of seems to be going hand-in-hand. So when you look at the future, what’s going to come out, obviously the devil will be in the detail, and it’s all going to come down to what’s the swap execution facility, what does it really mean? But how are you going to be navigating the relationship with the buy-side and sell-side in terms of the trading opportunity that might be there for you, and how could you be positioned there against maybe some offerings that other dealers will have?
I think one of the things we learned early on in our experience in the CDS initiative is that we need to be really responsive to the broad interest of the customer base. And so one of the early learning at least at that time was that the broader cross-section of participants in the CDS market really did want us to focus on post-trade, central counterparty clearing services, and so we certainly shifted our offering to correspond to what the feedback was from market users. And I think really that’s what we have to continue to do while the legislation may be a driver for increased focus by the market participants on alternative swap execution facilities or exchange trading of at least standardized swaps. We’re going to continue to want to be very customer focused, and structuring the offerings that we have. For the moment, we’re continuing to really focus on the post-trade clearing processing side, because that’s what the community of users has been asking us to do. So that’s what we’re going to continue to do is just respond to the needs of our customers.
Alex Kramm - UBS
And then just going back to the interest rates swap opportunity a little bit, I think you or Terry mentioned the GSEs, and the kind of commitments they have made, given that they are $3 trillion player in the market and probably put some weight behind this, can you talk a little bit about what your discussions has been with them, and if they are one of the few ones that you’ve been testing with, it sounded like, they’ve been looking at some of the competitive offerings as well?
Yeah, I think, there is not really anything to say on that, I think you’ve heard, I’m sure, certain commentary by folks within the FHFA in terms of at least their views. But beyond that I don’t think we have any specific comments where, as Laurent mentioned working with good cross-section of sell-side institution as well as institutional buy-side firms and we’re going to continue to do that.
Moving on Ken Worthington of JPMorgan has our next question.
Ken Worthington - JPMorgan
A couple questions on the global partners, how many contracts did you route to the global partners this quarter? And maybe can you tell us the timing of the remaining relationships, when they will actually launch?
I don’t have, I don’t know if Jamie, you, or John Peschier might have that. I don’t think I have that specific data. But I mean, we’re continuing to see very robust activity in our CME Group, BM&FBOVESPA relationship in terms of continued growth on the order routing from north to south and south to north. And we’re at different stages of implementation across all of the different international partnerships that we have. I think, it’s not possible to go through sort of execution milestones on that, but we’d be happy to provide more background outside of the call.
Well, I think, we’re farthest along on Brazil clearly, and we’re doing about 150,000 a day north to south, and roughly 15,000 or so from south to north.
And just to update you on the business in Korea, we basically had a record day earlier this week, basically still small about 5,000 contracts, but that’s basically double than what we’ve done over the last two month, so like what we saw with BM&F. We have definitely seen these things start small and grow.
Ken Worthington - JPMorgan
Great. And then as a follow up on the same topic. Can you take a guess and may be just guess it how big you can be as part of the contracts you’re participating in? Like does it make sense you could be like 10% or 20% of the volume given the size of your customer relationships globally?
We are already I think 10% of the average daily volume in the iBovespa contract just over the last eight or nine months. So, I think those numbers could potentially be fairly significant as we continue to expand those access arrangements with other exchanges and into other products.
And we’ll now move on to Roger Freeman of Barclays Capital.
Roger Freeman - Barclays Capital
Just wanted to come back to the trading opportunity and to say, so the legislation if it goes through basically as proposed the Senate bill sort of becomes standard. Trading and clearing are the two mandates here, and we’re talking about a 180-day implementation period, so we could be looking at this by yearend. So, I mean are you just not really wanting to talk about the opportunity yet because it’s just too new or are there concerns about the ability to trade a lot of these products. For example, in CDS, you’ve been looking at it closely and you look at the number of trades a day, may be measured in the hundreds in the average size anywhere from $10 million to $115 million of trade. In European, is that a tradable market?
I’ll answer the first one. I don’t know that I have an answer for the second one. But on the first one, look the legislation or let’s call it the shift in the emphasis of the legislation or what some people regard as [tackling] far left in terms of the provisions of the Dodd-Lincoln amendment is really only a week and a half or two weeks old. So I think it’s fair to say that all market participants are going to be vitally interested in ultimately where the legislation comes out on the exchange trading or alternative swap execution facility trading of standardized swaps. And so it’s just I think reasonable to expect that people are going to wait to see what happens and then they are going to try to make their plans accordingly. And we’ll certainly try to work with them on that if they want to work with us, but our focus continues to be on clearing.
Roger Freeman - Barclays Capital
Okay. Yeah, it’s obviously early days. It’s amazing that there is no common period even worked into any of this. And I guess just sort of on a related topic on the clearing, do you have concerns about the amount of collateral that is going to have to potentially be put up to retroactively clear the OTC swaps market? And I’m just thinking about the kind of collateral that could get put up here in the form of treasuries. Is that something that we end up lining up with a lot of treasury bonds in your clearing house, which could be absolutely enormous but not traded and then have any sort of negative impact on Treasury Futures volumes?
This is Kim. I’ll make just a couple of comments about collaterals generally. We already hold a significant amount of collaterals between $80 billion and $100 billion worth of collateral, so we are very conscious of having programs that offer diversity. So there’s some variety of options for people to post collateral with us. The other thing I would want to point out is that you mentioned the rate swaps and if the rate swaps came into the CME clearing house, you have to remember that the primary hedge for people who are using interest rate swaps is actually our Eurodollar futures. And so it’s very likely that combining those two pools of activity in the same clearing house would actually result overall in a substantial decrease in the amount of collateral that is required. So, I think there’s couple of elements there to factor into your thoughts.
Moving on our next question will come from Daniel Harris of Goldman Sachs.
Daniel Harris - Goldman Sachs
If you think about the opportunity in the OTC interest rate swap platform, [clearing], I am sorry, does it makes sense to think about what is larger, whether it’s swaps or whether or not dealers and end users would prefer instead to trade at the Eurodollar curve and populate that instead given the change in requirements for initial margin requirements and also the cost to enact those swaps?
Well, I’ll start and maybe Rick Redding will want to comment as well. I do think that there will continue to be a lot of complementarities between interest rate swaps and Eurodollar futures, and I’m not at all convinced that we would see any kind of wide-scale migration away from the utilization of swap contracts toward strictly Eurodollar futures and options contracts. But I think it’d be a very speculative answer to suggest that that would be likely.
Daniel, there’s a number of reasons why swaps or back-month Eurodollars might be attractive to the customers, and I don’t think it necessarily has to do with kind of the change in the legislation. I mean, each customer has its benefit to do it, but let’s assume that, as Kim said, you do get the offset between the Eurodollars and the swap positions, it should free up more capital to be used in making those kind of markets. So, there could be some spillover effect on both markets.
Just in addition to what Rick said about the efficiencies of reducing the collateral, I should probably point out that it’s wrong to look at collateral that’s posted with the clearing house as being effectively locked up and un-tradable because there is a very active amount of substitution every day. We need to have the right amount of collateral on deposit, but it doesn’t mean the collateral that’s up with us cannot be traded and freely substituted throughout the day, and we process hundreds of substitution transactions every day.
Daniel Harris - Goldman Sachs
And then moving onto another product in FX, obviously there is still really strong growth there, so I was wondering two things, first of all, can you help us understand or give a little more color on what’s been driving that recently. I know, we’ve talked about it in the past with new users, and also I guess taking share from the OTC market. And then secondarily, we see the RPC on that associated contract falling, where do you think that can ultimately go to as that product continues to grow? Thanks a lot.
Daniel, I think, there’s a couple things going on in the FX market that are worth noting. From kind of that longer-term trend that we talked about starting last summer is you’re starting to see the interest rate differential between some of the high yielding currencies and some of the G-7 currencies are so wide, you’ve seen on a percentage basis things like the Canadian dollar, the Australian dollar, British pound, on a percentage basis really increase over the last year. So the other thing obviously that’s happening, and why the euro currency is trading so much is obviously to sovereign debt crisis, and in Europe, in the southern part of Europe. So, those are the kind of the macro drivers. We are actually seeing more participants in the markets. We’ve seen some of the people that had probably diminished their activity during the crisis, come back to the market in a bigger way. So we have been able to pick up some share there. And so it continues to be a good growth area for us. As far as RPC, I mean, I think if you look at this over the longer term, if you look at it over the last 10 years, you’ll get 2001 EFPs are about 31% of our volume. And if you look where we are now, it’s about 2% of our volume, and obviously the RPC on those EFPs were extremely high. That’s something we’ve been talking about for a number of years. As liquidity increases on the platform, there is less need to do those EFPs. So we’ve successfully taken that market from kind of what transparent market to a perfectly transparent market. And that’s where you are seeing some of the decline in the RPC over time.
I think some of that decline you are seeing over time as well is that in some of the smaller markets you may see a higher percentage of non-member trading. But then as those markets begin to get more traction and more volume coming through them, then the percentage of member trading in them tends to grow. And you’ve seen some of that over the years in the FX contract as well.
Moving on we’ll go next to Chris Allen, Ticonderoga.
Christopher Allen - Ticonderoga Securities
I was wondering if we could get an update on the over-the-counter FX clearing service that you guys have rolled out.
Yes. Foreign exchange OTC clearing continues to be an important project for us. We did announce that a while back. Where we’re spending most of our time today is actually working again with industry participants and working through the workflow. So that offering is predominantly ready with respect to a lot of the work that needs to be done within CME, but a lot that needs to be done at this stage actually in partnership with third parties and market participants. So once we’ve made more progress, we will make definitive statement on that, but at this stage its work in progress.
Christopher Allen - Ticonderoga Securities
Got it. And then just one other question, just I mean obviously a lot of details need to be worked out on financial services reform and regulation, but when we kind of think about it globally, what does seem clear is capital requirements is going to be going up for market participants, whether it’s the banks or the buy-side. Have you guys done any analysis or given any thought to potential negative impact to overall trading volumes, whether it's on the futures markets or on the over-the-counter markets?
I’ll speak to part of that the assumption that capital requirements are going to be going up. I think that there are obviously provisions that would increase the capital that firms need to put aside for certain types of business. However, there are some offsetting provisions that we need to consider as well, because the capital requirements associated with centrally cleared over-the-counter derivatives are Basel proposals that are out there now are proposing a zero-risk weighting factor for the counterparty risk associated with using a central counterparty. So as more and more of that business moves to a central counterparty, the capital charges associated with that will actually be significantly reduced. So there are some offsetting elements.
And we’ll move on to the next caller in queue. Mike Vinciquerra of BMO Capital Markets.
Mike Vinciquerra - BMO Capital Markets
Just on the ClearPort side, it was a growth driver for a while. It seemingly has stalled out while your primary competitor I guess in energy OTC continues to show some growth. Can you talk about what’s being going on with ClearPort in terms of new product introductions? And I know you’re going to start pulling through some different asset classes through ClearPort in the future, but just give us an update on energy please?
Sure. This is Bryan Durkin. We’re continuing to roll out in response to our user base very customized and specific instruments both in the energy and in power sectors. The usage of the platform overall and the confidence in the platform remains very strong. We had excellent performance this past quarter, and we’re very excited about the new offerings that we’re going to be introducing on the ClearPort, which branches beyond our general energy and power sectors to also include the agricultural OTC offerings that we have pending as well as our efforts associated on the rate side. The other aspect that you have to take into consideration is the general economic effects of natural gas, which has been across the marketplace less volatile. The Brent has been more active than the WTI. However, that activity over the course of the past month and half or so has substantially reversed.
Mike, if I could add one thing to that. Also when you look at the data, as Bryan mentioned, the big decrease in ClearPort has actually been in the natural gas area, and some of that has moved to the exchange traded side. So it's being substituted under the Globex platform rather than ClearPort.
Mike Vinciquerra - BMO Capital Markets
And then just one follow-up on the slide you had, I guess, was slide 11 you talked about your global penetration, the one country without any [excess index] that stood out, of course, was China. And I think you are serving that market through your hubs either in Singapore. So are you considering putting a hub in Hong Kong or are there opportunities to kind of crack into that market? I know it’s a tough one to get into.
This is Gill. If you look at the regulatory landscape in China, what you will see is that it is changing and its changing fast. Currently, the Chinese government is allowing up to 60. I believe that’s the right amount, 60 FCMs to offer trading to their clients in China, and they are allowing them to trade foreign markets. I think if that activity picks up, CME would certainly look to put a hub in China.
Our next question will come from Niamh Alexander of KBW.
Niamh Alexander - KBW
Can I just touch back on to the electronic, because I understand that your Treasury options volume has picked up electronically, and if I look at the mix of business that has certainly kind of year-on-year you’re starting to see a higher proportion of electronics. How is that progressing? Can we expect maybe some movement towards the Eurodollar options picking up?
We’ve invested quite a bit of time and energy in terms of the functionality and the capabilities of our electronic trading platform, particularly as it deals with the ability to execute the more complex type of spreads associated with options trading. We are very pleased with the progress that we’ve made over the course of the last I’d say nine months in terms of the trends continuing to tick upward on the electronic side in the usage and the adaptation of using the electronic platform to be able to conduct the more complex type of transactions. I think you can expect to see us use that same type of emphasis and training on the euro side.
Niamh, thanks for noticing. Most people haven’t. But if you look at the Treasury Complex, overall, about 38% electronic on the option side and things on the longer end like the 30 are almost 60% electronic. So there has been quite a bit of effort made in the last year to make that happen, as Bryan mentioned, on the technical side. But we’re also getting to the point in the Treasury Complex where it’s becoming the place where people go to look first. So like other markets, that’s been very important.
Niamh Alexander - KBW
Usually, we kind of hit a critical mass (Inaudible). It helps bring in additional volume too on the electronic venues. But I suppose I should ask a regulatory question too. But I did want to understand if you could, maybe Terry or Craig, what do you think maybe would be the biggest risk to your business that may emerge just from where we stand now with the bill heading the floor for debate? What’s the biggest risk to your business? And then I think you’ve made it clear that the clearing, I think, is potentially the bigger opportunity.
It’s Terry. I think what I said earlier and I believe I don’t think there is much in the pending legislation that affects our core business. What the biggest risk could be on our growth opportunities in clearing could be some of this business migrating overseas if the laws are too onerous. So I think that would be the largest risk. But again from a core standpoint, we feel pretty comfortable that the legislation does not impact our business.
We’ll take our next question from Chris Brendler of Stifel Nicolaus.
Chris Brendler - Stifel Nicolaus
A little bit on slide 10, the discussion of non-US trading. Can you talk at all about what products are driving the significant increase that we’re seeing there? Is it some of the metals or the volume strength you saw during the quarter, is that being driven by non-US? And also if you could talk about, I’m not sure I understand the change in methodology (Inaudible) from 20% down to 15%. And do you have a goal in mind for two-three years out, and how high do you think the non-US trading revenue could be?
Well, we’ve definitely seen substantial traction in the area of metals, energy as well as our equity products. I think, the growth that you’re seeing here can be underscored by the significant investments that we have placed in our regional offices in our locales in which we have a very intensive and focused sales program reaching out to both the Asian as well as the European local users of these markets. The other thing that I think has definitely added to the benefits of our offering is, the platform that we offer and the partnerships that we’ve actually levered with a number of the leading exchanges throughout the world that has introduced interest both in our products as well as exposure to their products. And it’s definitely reaped benefits in us in terms of bringing in new clients.
Sure. On the methodology perspective under the old way we were looking at it which was we looked at the non-US dollars a little bit differently, and that the percentage would have gone from 19% to 20% in the more current quarter.
Chris Brendler - Stifel Nicolaus
And any thoughts on how that can go over the next couple of years. I mean, it seems to me that with the global opportunity here, it should be pretty compelling given your platform?
Yes. I think that’s what we were trying to show by the projected GDP growth in the slide by 2020. We do all agree that international can be a much bigger piece of our business, and you’ve seen that grow over the last few years as we’ve provided guidance on what percentage of the market it's been.
Yes. I think also we didn't I think want to burden the presentation with too much granular data. But I think certainly if you looked at the average daily volume growth among the exchange markets in Asia and Latin America, they were considerably in excess of those in North America and Europe. And I think that’s going to continue to be the case just given not just the global economy but the fact that many of these financial markets are beginning to expand and open for direct access. And I mean, there’s just a wide range of reasons, but the data when you look at it certainly suggests that we’re going to continue to experience very strong global growth in the industry.
And Don Fandetti of Citigroup is our next question.
Don Fandetti - Citigroup
Based on your history and sort of what you're seeing develop in the depth of book. Are you getting greater confidence that you could hit sort of peak levels you’ve seen in the rates complex historically? I mean I know you’ve done at that level probably a day or two ago, so I just want to get your perspective on?
I don’t think we can forecast with a crystal ball what might happen, but obviously the increase in depth of liquidity and lower effective spreads is always very positive. So I think, the best that we can say is that that’s a very healthy indicator of the functioning of the market.
And we’ll move next to Jonathan Casteleyn of Susquehanna.
Jonathan Casteleyn - Susquehanna
With the continued regulatory scrutiny on the OTC markets, has there been any migration from former OTC-only participants into new futures participants, is there any way to measure that?
Jonathan, I think that’s very difficult to measure because we see participants getting bigger obviously from the growth numbers that we saw, but it’s also difficult for us to know what’s on the other side of their trade. But I mean in some of our sales calls anecdotally we do hear that more people are looking at putting things on exchange.
Jonathan Casteleyn - Susquehanna
I think, Craig, when you think about earnings growth for the rest of this year and into next year, what’s the best opportunity for the exchange, is it the continuation of better futures trading trends or is it OTC clearing, is it international expansion, any sort of rank and file there will be helpful?
Well, I mean, obviously, the core business, and I think, what is emerging as I think stronger growth characteristics certainly in terms of what you're seeing quarter-over-quarter for the last four to five quarters, and then very much so for the first quarter of 2010, obviously just given the size and scale of that, and the maturity of that, I think that’s going to continue to be the most important contributor. But we have the intermediate growth opportunity farther out over the next couple of years to continue to focus on the globalization and international flows into our core business and core products. And then obviously OTC is something that we’re still working hard on that as everyone is but I don’t think we could say that that's going to be the major driver or higher growth from a revenue perspective. I think you are looking at the very, very early stages of what I would expect to be a great revenue opportunity for us over the next decade.
Moving on we’ll take our next question from Rob Rutschow of CLSA.
Rob Rutschow - CLSA
First question in terms of the clearing house currently, can you tell us what the duration of the positions in the clearing house are now and how that compares to the duration of the OTC market and how clearing OTC contracts might change that duration profile?
This is Kim. I don’t think I’m going to be able to give you a definitive answer on that. I can give you a kind of a characterization of the way the open interest lays out and the Eurodollars is obviously where we have most of our open interest. The timeframes on the Eurodollars goes out for 10 years. As we enter the interest rate swap market, we will be entering that market going out as far as 30 years. But most of the activity is probably actually in the kind of seven to 10-year range. And so I can’t say that it will materially change the duration of our book of open interest. We do have Treasury securities obviously going out further out over the curve. The duration of the open interest there is also kind of primarily in the kind of 10-year range. I don’t know Rick if you have anything you want to add to that.
No, I mean, I think the issue really is what the positions are that Kim’s taken as performance bonds and a lot of that's in Treasury securities and those are, as Kim said, all throughout the maturity.
Rob Rutschow - CLSA
One of the concerns about the pending regulations that I’ve heard is that some of the smaller energy producers like to pledge proven reserves to their bankers to be able to hedge. Is there any thought for moves that you can take to accommodate them if the rules change such that they need to post collateral with you?
It's Craig. I think I’ll answer that by saying I think that most of the legislators and I think it’s embodied in the draft bills on both the House and the Senate side have been very sensitive to the sort of capital and financial aspects of posting margin collateral for end users in the swaps market. And so I think as you see it presently, there are exemptions that are available for that type of swap customer. And so, we’re still kind of looking to see how that’s going to resolve itself finally in the legislation. But I’m not expecting that to be a substantial issue given the high degree of sensitivity that most legislators have shown for those particular issues. I think they’re much less sensitive to those issues that relates to swap dealers, major swap participants or more kind of financial institution participants in the swap market.
And just to add to what Craig said, no one on either side of the aisle is opposing the end user exemption for these small producers of whatever product there maybe. So as long as you are bona fide hedger or end user in that product line, nobody is opposing that.
The final question that we have time for today from Justin Schack of Rosenblatt Securities.
Justin Schack - Rosenblatt Securities
On the regulatory stuff, one thing you guys didn’t mention that I saw in some of the press coverage of the bill was I guess there’s an interpretation that some of the language in the Senate bill would cover equity index options that are now traded on exchanges on the securities side and move that jurisdiction to the CFTC. Is that accurate, and if so, and if that survives how would that affect that business? There would be an opportunity for you to take some share.
It’s Craig. I think as in many respects with the draft legislations there are number of ambiguities and shifts that have happened and I’m sure in the ensuing weeks there will continue to be refinements done and manager’s amendments if not also floor amendments that will help to clarify that. But in general I would expect the outcome to be a continuation of the existing agreement between the CFTC and the SEC, which has been in place for 20 something years. The Shad-Johnson accord, which essentially treats cash index options as subject to the jurisdiction of the SEC and stock index futures based upon the same indexes as subject to the jurisdiction of the CFTC. And so like everyone else, we’ll be waiting to see how that resolves itself. But I’m expecting the status quo will be maintained there.
Justin Schack - Rosenblatt Securities
One last thing on the customer segmentation stuff, I noticed the buy-side (prop) number. That number has gone up quite a bit and then the characterization of it in the slide is slightly different. The word buy-side is no longer there. I know that you’ve got some NYMEX stuff in there. Jamie you mentioned that some of the miscellaneous stuff had been reallocated. Can you give us a sense of what the impact was on that buy-side prop number? Was it that the NYMEX levels and that type of activity are a lot higher or with some of the debt reallocation occurred. Any idea of the split?
No, the NYMEX numbers didn’t change the overall results that much. I mean if you look at the trend over this data over time is the proprietary algorithmic guys have gotten bigger almost every year that we can recall. So I don’t think there is anything I think by showing it in all products pretty much validates what the customer base looks like across all products, because I mean just mathematically you can’t get the numbers to change that much by moving it in.
Yes. I think there might have been a couple percent change, if you look at Q4 ’09 versus where we had been previously on that number. So, yes, the NYMEX shifted it around a little, but not in a significant fashion. With the Rick's point, I think NYMEX didn’t change the numbers generally across the board.
All right. Thank you all for participating, and we look forward to talking to you next quarter.
Operator: Ladies and gentlemen, thank you again for your participation. That does conclude today’s conference call.
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