It's now or never. Tomorrow will be too late.
-- Elvis Presley
The CME Group (NASDAQ:CME) has been by far the most significant innovator among the exchange management firms over the past 50 years. But since the CME acquired the Chicago Board of Trade, beginning consolidation of US futures exchanges in 2007, change came to a screeching halt.
In this "What have you done for me lately?" world, that halt surprised and disappointed me ("CME Group: Where Is The Creativity? Dump The Stock.") On the other hand, CME Group leaders deserve their proper re's. " Why CME Group Hit The Wall," suggests that CME's DNA is incompatible with SEC regulation. That SEC aversion seemed, until now, to close most spot markets to CME invasion - thus explaining the slowed innovative pace.
But if regulatory issues can be overcome, there remain many markets that may be attacked by CME - the over-the-counter (OTC) market for gold, for example.
That's why I was pleased to see CME hit its stride once more, with an announcement of a gold market venture, together with the British Royal Mint.
The CME gold trading platform uses blockchain technology, says CME, here - so trendy. But silly. There is absolutely no imaginable reason that a single storage facility, the Royal Mint, needs a blockchain. (If you wonder who needs a blockchain, here is a good explanation.)
The CME Coup.
But the basic trading objectives of the platform are CME fingerprints, all over this project. The things that futures tech brings to a market:
- Reduced trading costs,
- Same day settlement,
- Increased market access.
- Optional delivery of the metal, reducing costs of clearing.
This makes the CME the creator of the first cash market based on futures technology. Nowhere in press descriptions of the market does the word "futures" appear.
This new enterprise is also a fascinating step in the history of market regulation. Two historic departures are in evidence:
- CME succeeded in invading a cash market with no risk whatsoever of SEC regulation. Indeed, no regulator in the world can involve itself, since Brexit. No government regulates its own treasury.
- The government of the UK has outed itself as a market player, not simply a market regulator. (This leaves us to worry about unintended consequences of this decision, the subject of a following article.)
Gold is an excellent strategic entry point, if one's objective is to invade the lush plains of spot market trading, where other exchanges and OTC clearing venues are accustomed to a cushy, regulator-protected, existence. Easy picking for invaders from the rugged, competitive domain of Chicago commodities trading.
The obstacle to spot market trading, I had thought, is that every cash market is regulator-protected. But no. CME Group has adopted a well-considered, interesting posture, from a regulatory point of view. Not an exchange. An exchange clothed as information technology provider.
A lingering question, one that will raise regulatory issues, will be the cash margining side of the venture. I can imagine labeling a futures-style transaction system as a service provided to a governmental entity. But the cash balances will be a source of credit risk. Is this margin collateral in government custody, or private custody?
The British coup.
This joint venture between a government agency and an exchange management has implications beyond the Byzantine gold market. Indeed, it touches squarely on an important issue generated by Brexit.
To those of us who think of rule of law and competition as the primary legacy of Great Britain, much of the press analysis of Brexit costs and benefits misses the point. From that point of view, the gain from Brexit was freedom from the Continental ideology: land and blood; not law and competition, the legacy of Britain.
An important aspect of Brexit - one that cannot be simply measured in terms of lost jobs - is the effect of Brexit on the UK's markets franchise - an important aspect of the state as a home for competition. At the time of Brexit, The London Stock Exchange had announced a merger with Deutsche Bourse. Brexit puts this merger in a different light. Does Continental Europe, home of land and blood, consider it appropriate to move "its share" of the clearing of transactions from of the UK to the Continent?
The Continental philosophy of wealth distribution, applied to markets, answers "Yes." Trade in Euro-denominated assets belongs to the Eurozone, in the Continental notion of entitlement.
Markets: Utilities or Commodities?
As recently as 100 years ago, there would have been nothing to move to the Continent.
The marketplace - the cauldron in which value is identified - once a place to get coffee, has itself become a source of value. In less than twenty years, our idea of the purpose of an exchange has changed. Historically, an exchange was a place where individuals and firms paid for the right to use the exchange facility to place orders for themselves and their customers. Exchanges accepted payment for these membership rights, until they covered their costs - usually about mid-summer at the old Chicago Mercantile Exchange. Today exchanges are listed firms in their own right, and very high alpha investments, at that - or so they seem.
The notion of competition among exchanges is relatively new as well. The Chicago Mercantile Exchange was a Chicago Board of Trade spinoff; as was the American Stock Exchange, of the New York Stock Exchange. At the beginning, the exchanges studiously avoided listing identical products.
There is no way to pinpoint the onset of competition, but early competition occurred in 1974, when gold futures were simultaneously offered at the Chicago Board of Trade, the Chicago Mercantile Exchange, and COMEX, in New York. COMEX won that competition, which established a practical factoid: in futures trading technology, it is not likely that more than one futures market in any given underlying cash instrument will succeed simultaneously. Apparently by gaining the support of the New York gold dealing community, COMEX got an edge in liquidity, which is, ultimately, self-reinforcing.
In futures markets, competition appears to be ephemeral. The reasons are two:
- Futures clearing technology.
- Futures regulation.
Futures clearing technology. The strength of futures clearing technology is "offset," the ability to hold a market-valued purchased position until sale without taking delivery. No need to execute each trade through delivery. That is crucial, in the trading a boxcar of live cattle, for example. But clearing through acquisition is costly in any market, due to the need to finance ownership.
The effect of being able to maintain a long position without ownership or costs of delivery is dramatic. A simple sale results in no obligation to make or take delivery. Acquisition of the security or commodity being traded, with all its attendant expenses is unnecessary.
If this UK government-protected gold market is migrating futures tech to cash markets, the genie is out of the bottle. The only remaining question is where these more efficient spot markets will be located: unregulated London, lightly regulated Chicago, or over-regulated New York.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.