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CME Group (NASDAQ:CME)

Q3 2012 Earnings Call

October 25, 2012 8:30 am ET

Executives

John C. Peschier - Managing Director of Investor Relations

Phupinder S. Gill - Chief Executive Officer, Director, Member of Executive Committee and Member of Strategic Steering Committee

James E. Parisi - Chief Financial Officer and Senior Managing Director of Finance & Corporate Development

Terrence A. Duffy - Executive Chairman, President, Chairman of Executive Committee and Member of Strategic Steering Committee

Derek Sammann - Senior Managing Director of Financial Products & Services

Kimberly S. Taylor - President of CME Clearing House Division

Analysts

Alex Kramm - UBS Investment Bank, Research Division

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Howard Chen - Crédit Suisse AG, Research Division

Jillian Miller - BMO Capital Markets U.S.

Roger A. Freeman - Barclays Capital, Research Division

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

Donald Fandetti - Citigroup Inc, Research Division

Daniel Thomas Fannon - Jefferies & Company, Inc., Research Division

Christopher J. Allen - Evercore Partners Inc., Research Division

Kenneth B. Worthington - JP Morgan Chase & Co, Research Division

Brian Bedell - ISI Group Inc., Research Division

Matthew S. Heinz - Stifel, Nicolaus & Co., Inc., Research Division

Gaston F. Ceron - Morningstar Inc., Research Division

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Akhil Bhatia

Operator

Welcome to the CME Group Third Quarter Earnings Call. [Operator Instructions] At this time, I'll turn the call over to Mr. John Peschier. You may begin, sir.

John C. Peschier

Thanks, and I thank all of you for joining us this morning. Gill and Jamie will spend a few minutes outlining the highlights for the third quarter, and then we'll open up the call for your questions. Terry Duffy, Kim Taylor and Derek Sammann are on the call as well.

Before we begin, I'll read the Safe Harbor language. Statements made on the call and in the 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. For detailed information about factors that may affect our performance may be found in our filings with the SEC, including our most recent Forms 10-K and 10-Q, which are available on our website. Also note, the final page of our earnings release contains a reconciliation to our GAAP results this quarter.

Now, I'd like to turn the call over to Gill.

Phupinder S. Gill

Thank you, John, and good morning, and thank you for joining us this morning. I will discuss our performance in the third quarter and provide updates on a few of our strategic initiatives before turning things over to Jamie to review the financials.

During the third quarter, we continued to take steps to strengthen our business in a dynamically changing environment. One of the main things we think about and have focused on during the last few years is how to position the company to address customer needs as the market rapidly shifts. I'll talk a bit about that today.

Let me start with interest rates. We have worked hard over the last few years to enhance our interest rate product offering in light of the Fed zero-interest rate policy and have had several successful product introductions since 2010. These developments have added more than 305,000 to our average daily volume and 3.8 million of open interest to our interest rate complex. More recently, we announced that we will launch deliverable interest rate swap futures contracts in a couple of weeks. This innovative new product will benefit clients by providing a unique way of -- a unique way to access interest rate swap exposures. Our customers will now have a complementary standardized product that provides the advantages offered by futures contracts, including pricing transparency, ease of legal documentation, the automatic netting of positions and margin savings. Interest rate swap futures were created to meet strong demand from financial market participants, including banks, hedge funds, asset managers and insurers. Citibank, Credit Suisse, Goldman Sachs and Morgan Stanley are among the firms who are for planning to serve as market makers [ph] for the product, enabling market participants to access deep and liquid markets.

Turning to foreign exchange. For the first time ever, CME Group's foreign exchange average daily volume surpassed the volumes of all of the OTC FX platform to become the largest FX venue globally, with CME Group's September average daily notional trade of $129 billion. This was driven by strong growth with asset managers and particularly, with banks. In addition, FX open interest reached its highest level ever in September, and the CFTC's Traders of Financial Futures Report also shows a record level of large open interest holders for CME Group FX products. This confirms that there is -- that the increasing number of market participants are holding more FX risk in the form of CME Group FX futures, which is a trend that counters much of the risk of sentiment in the OTC FX cash markets.

Moving on to energy. We are in the process of expanding our OTC energy offering. Dodd-Frank Regulation is driving changes to the OTC energy markets. CME Group has a long history of providing customer choice and flexibility within a strong regulatory framework. And with this background, we are well-positioned to help customers adapt their current practices to new regulations. Customers can now access the CME ClearPort slate via multiple execution methods, including the ClearPort EFS offered historically, our Globex central limit order book, the trading floor, cross trades and block trades. These expanded execution options provide futures regulatory treatment for those customers to whom this is a concern.

To help energy markets manage through this transition period, ClearPort EFS transactions are exempt from counting towards swap dealer thresholds through the end of this year. In this evolving regulatory climate, we continue to roll out new tools to boost the customer choice, including CME Direct, our platform for side-by-side online trading of exchange listed and OTC markets, and CME Direct Messenger, a sophisticated messaging platform integrated with CME Direct and confirm how to trade confirmation services.

CME Direct Messenger will be powered by market-leading instant messaging software developed by Pivot, which we recently acquired. Additionally, we are in the process of applying to be a swaps data repository, which will allow us to assist customers in managing their swap reporting needs. We understand our customers' concerns during this slate of regulatory flux. We continue to deal -- to lead the effort with other market participants to ensure our offering meets their needs and to advocate on behalf of our clients for clear, logical regulatory policy that protects end-user's ability to manage risk safely and effectively.

Our leadership here, the strength of our product offering and its flexibility going forward, as well as our strong focus on meeting customer needs will continue to make CME ClearPort a key risk management tool for energy markets during and after this period of regulatory change.

CME Group's agriculture commodities continue to meet the demand of our customers. Average daily volume for the third quarter was up 14% compared to the same period last year. Open interest has also grown from 6.1 million open contracts at the beginning of the year to 8.8 million contracts on October 23, which represents a growth of 44%.

Moving onto our growth initiatives. We continue to expand our product offering and enhance our global partnerships. We announced the launch of U.S. dollar-denominated Ibovespa futures that have recently started to trade. This new cost listing arrangement provides our customers access to Brazil's key benchmark product, and this initiative allows our clients to improve their ability to manage market and counter-party risk exposure across various asset classes. In addition, BM&FBOVESPA has began trading in the S&P 500 futures contract, which is settled to cash to the price of the S&P 500 Index futures contract. This is the first futures contract traded on the Brazilian exchange to reference a U.S. stock index, and it has gotten off to a good start.

Turning to the clearing arena. We remain well-positioned to benefit from the regulatory mandates as we continue to focus on our capability to onboard new customers and expand our OTC product offerings. We have worked extensively with the buy side and sell side for a purpose-built solution, to meet the needs for real-time clearing unlike some of our competitors. Overall, we continue to experience a significant increase in firms finalizing their internal OTC clearing readiness and setting up production accounts to prepare for clearing.

In addition, we recently announced the approval to provide portfolio margining of OTC interest rate swap positions in Eurodollar and treasury futures for customer accounts beginning in the fourth quarter of 2012. The risk reduction achieved will result in capital efficiencies for customers of up to 90% for certain portfolios, and these are numbers that remain unparalleled in the industry. This offering complements the same portfolio margining for house accounts that went into effect in May of this year.

Also, we recently incorporated a pricing discount plan for high turnover swap participants who tend to maintain risk-neutral portfolios that do not require large amounts of initial margin. This is an important step for us to continue to on-board a more diverse portfolio of clients, which we feel will benefit our markets by providing liquidity and higher efficiencies.

Shifting onto our globalization efforts. We continue to make progress during the quarter. We applied to the FSA to create a London-based derivative exchange with an expected launch in mid-2013, pending regulatory approval. This will allow us to build on the success I mentioned earlier in FX. Similar to the demand we have experienced in the U.S. with customers migrating to the FX product suite, there has been a strong demand for market participants in Europe, who have access to the FX futures market under the umbrella of the FSA.

With that in mind, we will initially begin offering foreign-exchange futures product and then expand into other asset classes. We continue to see an increase in business coming from our diverse set of clients in Europe, with more than 16% of our total volume now originating from that area and 24% of that in foreign exchange. Having an exchange in London that can leverage to central counter-party model of CME Clearing Europe will allow us to align ourselves even more closely with our regional clients in both listed futures and OTC markets and provide additional opportunities to expand our non-U.S. customer base through regional trading and clearing solutions for Europe, as well as for Asia.

Additionally, we continue to make significant progress in our efforts in China. As we have mentioned before, our objective has been to facilitate operational readiness of the Chinese FCM. This progress was evident when 35 chairman and CEOs of Chinese FCMs visited Chicago last month and spent a week at CME Group in order to bridge their knowledge and operational gaps in market access, on-boarding, clearing and risk management, regulatory readiness and products and hedging.

We also renewed the existing MOU with the Shanghai futures exchange, which has created a forum for information sharing between the 2 organizations regarding the potential development of derivatives products in China. In addition, we expanded our overall suite of Chinese renminbi products to include deliverable renminbi futures. We also announced the launch of Chinese Steel Rebar Swap Futures which allows customers who have exposure to the Chinese construction and rebar industry to manage their price risk by using the most relevant price data.

Lastly, we also announced last week that we have entered into a definitive agreement to acquire the Kansas City Board of Trade, the world's premiere exchange for trading hard red winter wheat futures and option contracts, which serve as the international benchmark for wheat used in bread. This acquisition will expand and diversify our agricultural product offerings to include high-protein wheat, which is the largest, physically produced U.S. wheat grade and the primary export of wheat globally from North America. In addition, it will provide us the opportunity to grow the coal through spread opportunities between wheat products, as well as growth in options, including new products. It will also give an enhanced opportunity to provide capital and operational efficiencies for clients.

In summary, I want to reiterate that we have taken steps to strengthen our business in this environment, and we will not be complacent. We remain efficient and continue to generate a lot of cash while also investing in the business. We are working hand-in-hand with clients, including an expanding group of intermediaries, to help them navigate in this new world.

Now, I'd like to turn the call over to Jamie to discuss the financials.

James E. Parisi

Thanks, Gill, and good morning, everyone. Today, I'm going to review the results of the quarter. It was a tough environment with regard to trading volume, but we continue to make progress in terms of what we can control.

Excluding the nonrecurring tax entries, our earnings per share would have been $0.70 for the quarter. Let me start a detailed discussion on the quarter with revenue. As Gill mentioned, average daily volume was down compared to an exceptionally strong third quarter last year. However, we saw an uptake -- uptick in the rate per contract over the same period. The rate per contract for the third quarter was $0.822, which was up 6% from the third quarter last year and up 1% sequentially. Compared to the last quarter, the product mix was favorable and lower incentives had a positive impact on the RPC.

Turning to expenses. Total operating expense was $287 million. Although the lower expense was partially driven by the removal of costs previously associated with the Dow Jones and CMA businesses, it also reflects our continued focus on managing the organization as efficiently as possible, while still progressing with these longer-term growth initiatives. That said, we also had some positive timing-related benefits in Q3 which will result in additional expense in Q4.

Let's get into some of the details. Compensation and benefits was $118 million, which included a $12 million bonus accrual, down 38% from Q3 last year. And we also recorded $14 million in stock-based compensation. In addition, due to the 6% increase in the equity market in Q3, we booked $1.9 million in deferred compensation expense, which is offset with higher investment income, compared to a $1.7 million credit to expense in Q2 for deferred compensation losses.

With respect to staffing, our overall headcount went down during Q3 from 2,604 to 2,546, driven primarily by the S&P Dow Jones transaction, with 110 employees having moved off to CME Group payroll in July. Additionally in the quarter, we added 33 employees from the Pivot acquisition and we hired 13 folks in our new Northern Ireland office.

Turning to non-compensation expense. The main items that dropped sequentially were amortization and professional fees, both as a result of the S&P Dow transaction. In addition, other expense dropped sequentially due to timing-related items in marketing and the reduction tied to currency fluctuations.

Looking ahead to Q4, we expect expenses to come in between $300 million and $305 million, which includes a full quarter of expense from the Pivot transaction. The 2 line items which will likely rise are other expense, due primarily to higher marketing costs driven by several events in the fourth quarter, and professional fees, mainly due to regulatory-related expenditures.

During our last earnings call, I said I expected our second half expense to be $595 million. With today's results, combined with the Q4 guidance, that drops to between $587 million and $592 million.

Turning to nonoperating income. We received $9.7 million from dividends from our investments in BM&FBOVESPA and IMAREX, up from $6 million last quarter. Also in the third quarter, we issued $750 million of 10-year debt at an all-in cost of 3.4% per year. We will be using these bonds to retire our outstanding 5.4% notes due next August. In terms of modeling this, interest expense this quarter was partially impacted and increased to $30.2 million. The run rate for interest rate expense over the next few quarters will approximate $35.5 million, and then once the old debt matures, we will save approximately $15 million annually due to the lower rate over the next 9 years.

Lastly, equity and gains of unconsolidated subsidiaries was $16.5 million with our share of the S&P Dow Jones business coming in at $17 million, a bit stronger than we originally projected. Capital expenditures net of leasehold improvement allowances totaled $35 million in the third quarter. For 2012, our CapEx expectations are now in the $140 million to $145 million range. The pro forma tax rate was 40.7% in the quarter, and we expect the Q4 tax rate to be slightly below this.

Turning to the balance sheet. We had $2.1 billion of cash and marketable securities at the end of September, which included a $750 million of debt that we took on. As Gill mentioned, we announced the potential acquisition of the Kansas City Board of Trade last week. We think the combination of these complementary wheat products will lead to capital and operational efficiencies for our customers while we work to expand the business. We will be investing $126 million of cash in this transaction, and we expect the deal to generate returns in excess of our cost of capital while also being slightly accretive.

Even with this transaction, we will have excess cash at year end. As I mentioned last quarter, we remained focused on returning this excess to our shareholders, and our board will meet prior to the end of the year to discuss our plans. In summary, we continue to focus on investing for the future, being ever more efficient in generating and returning excess capital to our shareholders. With that, we'd like to open up the call for your questions.

[Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Alex Kramm with UBS.

Alex Kramm - UBS Investment Bank, Research Division

Gill, I just heard your comments on this high turnover discount that you're talking about now on the OTC, I guess, clearing side. So maybe you can elaborate a little bit on that. I guess the questions are, that sounds to me like, okay, proprietary market maker, not sure how much of that exist in the swap market today. But obviously, market structure is changing. So how do you think those guys are going to enter the market? How quickly do you think they're going to be there? And most importantly, I guess, for Jamie, how does that change your $5 to $6 outlook for interest rate swap clearing on average per million?

Phupinder S. Gill

That's a good question. Yes, we're talking very specifically about a very select number of clients who would actually trade a lot but may not hold the type of open interest. So as we focus on clearing of this OTC transactions, what we're trying to do with this pricing scheme is to capture every different type of client. And so this is just simply 1 type of client that may not hold the open interest that you might expect the majority of the client base to actually hold. So it is a prograde, given the role that this particular type of client plays.

James E. Parisi

And remember, this is a group of customers that we haven't previously been targeting, so it's incremental to the model for us. And remember, most of the expenses associated with the OTC clearing were already in our expense base. So the more business we can drive across the platform even an incentive rate, the better off we are.

Phupinder S. Gill

Alex, if I could just add 1 more thing to what Jamie just said. I mean, keep in mind, we're talking about a marketplace and an environment that is evolving, and you won't see the full impact of what is going to be done by the so-called high-frequency guys versus the rest of the marketplace until about the end of the year when the full impact of clearing sinks in the end of next year.

Alex Kramm - UBS Investment Bank, Research Division

All right, great. And then maybe just shifting gears for a second here to energy. Obviously, it's not a secret that Brent has been taking market share from WTI. And to some degree, that's really not your fault. Obviously, that's where the market is going. But I guess, one of the things we've seen here over the, I don't know, last year or so is that when you look at open interest trends, your competitor is actually been taking some market share when it comes to open interest in particular. And talking to some energy traders, people are saying that there is some folks that are moving positions over away from you because they want to get the capital efficiencies with Brent which has obviously taken market share. So obviously, that's not a great trend. So I guess my question is, are you seeing that yourself? Are you engaging with clients? And what kind of options do you have to kind of recapture some of that, in particular capital efficiency on the energy side that you might be losing here?

Phupinder S. Gill

Thanks, Alex, that's another good question. I didn't understand the capital efficiency point because if you're talking about capital-efficient markets, you've got to have both sides of it because we have, as you may know, up with a 85% of the TI marketplace, and Brent is enjoying the lead that they have largely because of the short-term nature of the issues that TI is facing, the structural issues that TI is facing. So I would sum up the environment as TI having some short-term challenges, which is the reversal of the pipeline. And when that occurs, I think some of those short-term challenges will be behind us, and Brent having what I would describe as long-term challenges that are supply base, which is why they acknowledge in the industry. So if you look forward on a going forward basis with respect to what the environment might look like as far as these transparent marketplaces for pricing crude, I will shape themselves out, you can expect 3 benchmarks around the world where you can have a North American benchmark, which TI very clearly is the North American benchmark or the benchmark on this part of the world. The European benchmark, which is Brent. And then the unmet need which is on the Asian consumer base, they tend to, for the most part, consume solid crude and no one is meeting their need with the exception potentially of the DME that is beginning to get the volume that has been elusive for them over the last few years. So the open interest shift that you have seen is largely based, I think, not so much on capital efficiencies, as much as it is pricing, which is 1 way to move open interest. And those types of moves by and large, by our experience, are not generally sustainable over the long term.

Operator

Our next question comes from Rich Repetto with Sandler O'Neill.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

The question is on cash and the special dividend. So it looks like cash levels, absent the debt raise you did, stayed flat. I was wondering if you could explain some of the ins and outs of that, Jamie. And then related to the special dividend, as we approach year end, because you carry-on this extra debt, would you go below the $700 million sort of target knowing that you could replenish it and you have that cash there, but I know it's dedicated for the debt paid down. So just about the special dividend, I guess, and the parameters.

James E. Parisi

Okay, Rich. So a couple of questions there. One was on the cash side, there is some activity on the cash side this quarter that I'd classify as investing or financing-type activities. So every quarter, we have $150 million dividend roughly that we pay. So that's certainly was an outflow. We also had outflows associated with our acquisition of Pivot, and some other outflows types of some interest losses that we have. So it's all financing-related, and the total of that was probably in the area of $270 million. On the -- in terms of using some of that $750 million at the end of the year as part of the return and then replenishing that later, we tend to take out a pretty conservative approach here. We want to maintain that $750 million to fulfill the maturity that's coming up next year. So as I said on the last call, that's kind of off-the-table in terms of the consideration for return. We will have excess cash above and beyond of that, that we'll be looking at.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Okay, that's helpful. And I guess my follow-up would be on the OTC side. I guess, you are -- as you noted today, you're seeing a spike again in OTC clearing barn. It doesn't seem like there's a lot of revenue right at this point, that's one part of it. But I guess the broader question, as we look at your OTC strategy, Terry and Gill, you launched this DFS -- or will launch the DFS product. You got an arrangement with Eris, you got an arrangement now with 2X [ph], you're trying to be a swap, or will be a swap depository, data depository. So I guess the question is, is there an overarching strategy? You talked about possibly being a set as well as an overarching strategy as you attack the OTC? Or is it going to be, we're trying to get in every area and every opportunity?

Phupinder S. Gill

Yes. Thanks, Richard. I think you summed up a part of the strategy that we have. And if I were to describe, an overarching strategy for the CME here is generally, it's going to be a full comprehensive service offering to our client base that includes options that they have. They can either continue to execute the swap as they do now and clear them with that, and they can for various and sundry reasons convert into the swaps deliverable futures that you talked about. And for both of these camps, if they're looking for capital efficiencies, CME Group is probably the only entity that provides them with the most comprehensive capital efficiencies with our margin offsets, both in the house side and in a couple of these, it will be introduced onto the client-side, where in some of the portfolios that we have run, we've seen savings of up to 90%. So no other offering that we know of can provide the same kind of efficiencies because no other offering that we know of has a futures offset. And we're talking here in terms of the OTC role. Even though we are focused in the first instance on the interest rate side, we're talking about all asset classes here, Rich. So CME Group across 6 asset classes is in a position to offer margin offsets that no other exchange can.

Operator

The next question comes from Howard Chen with Credit Suisse.

Howard Chen - Crédit Suisse AG, Research Division

Gill, you provided some helpful color on what's going on with the regulatory landscape. I think how you all see it. You mentioned the concerns your customers are having, and we can see the comments you and Terry and team have made to the market. But I'm just curious, how much do you think that confusion is impacting current activity levels? And how is it impacting current activity levels? Are you seeing any change, a mix of business being done out there?

Phupinder S. Gill

Thanks, Howard. I'll start, then Terry may want to add. In the context of the FSA regulated exchange that I talked about, they're talking about a client base that currently does not trade in this part of the world. They're extremely concerned about what the Dodd-Frank reach might actually do to them. And I think they have decided to very squarely not participate in the U.S. side. So we're not talking about a client base that is currently participating here and is choosing not to, but the uncertainty that Dodd-Frank is bringing on board has made them -- or have created a mindset for these guys to stay on that side of the pond. And so that's the reference that I made. The overall concern that market participants have is also, I think, a fact that they even saw what transpired a few weeks ago with respect to ClearPort and the transactions on ClearPort. It has created a bunch of confusion among our client base. We are trying to navigate through that confusion by trying to work in a collaborative way with the CFTC, so that we might provide guidance to our client base to help them through this difficult transition.

Terrence A. Duffy

And, Howard, it's Terry. I agree with everything that Gill said. I think that what he's referencing in the ClearPort issue of 2 weeks ago, we were clearly told by the chairman and the staff that Core Principle 9 and the rules associated with it would not be addressed until the SEF rules were written. And then they did an about-face on us, and they addressed Core Principle 9, and it put a lot of uncertainty into the marketplace and our clients. So we saw a huge drop off in the ClearPort trading, in a 2-week period, going from roughly 400,000 to 250,000 a day. And then when we're able to get the commission to allow the existing ESFs, or exchange swap futures, to push to the end of the year, give our clients a reasonable amount of time to transition to smaller block transactions versus what they were doing on ClearPort, we started to see an uptick back in that business. So people are accepting that, but there was a disruption. I actually look at the entire year, Howard, more of a macro event on volumes than I do just the regulatory issues. I think the regulatory issues have a play in it, but I do believe and I've said this here for years, so this isn't the first time I've said it, that this year was setting up for a disaster for volumes from day 1. If we had so many different macro events going on, it's going to be very difficult for volumes to grow. The market started and ended up in the same place in 2011 and people spun themselves around. And now we came out from a record year, so it's going to be very difficult to match that, and people now have had no certainty as far as government policy issues or anything of that nature. So -- and hence what we've seen is corporations hoard cash and individuals hoard cash at the same time. And that's not just me saying, that's a fact. We've got over $2 trillion sitting on the books of corporations today and the amount of money that's sitting in people's personal bank accounts or in the mattresses is got to be staggering. There's so much uncertainty, where to keep it, where it's safe, where it's not. So I think there's many macro events. And then, with this fiscal cliff coming down the road, we have a big issue here. This government of ours could be shut down if, in fact, certain things play out. And that -- people don't know what that means for the marketplace. So again, it's hard to do risk management transactions when you're figuring on decisions that we only -- we haven't seen since Newt Gingrich in '94 is the last time something like this happen. So this is not the average course of business, and I think people need to realize that. But we will get clearer skies and smoother waters as time goes on here, and I think we'll get back to more of a normalcy.

Howard Chen - Crédit Suisse AG, Research Division

Okay. That's makes a lot of sense to me. And that's a decent segue into my follow-up, which is on near- and long-term expenses. Jamie, on the near term, can you just break out how much Pivot brings in terms of revenues, expenses? And how much did that removal of the JV-related expenses account for this quarter? And then just more broadly, kind of following up on what you just said, Terry, so volumes down 16% from an elevated level last year. Core expenses will be flat to down a little bit. I mean, I realized it's hard to bet against you guys in terms of volume growth over the whole entire exchange's life. But if some of these macro issues persist and volumes don't reaccelerate, what are some of the other options on the table?

James E. Parisi

Sure. In terms of Pivot, it's being integrated into the business. I'm not going to give you detailed financials on it. It's rather small. But I will say, for the increase that you're seeing from Q3 to Q4 in terms of the guidance that I gave you, maybe 1/2, upwards of 1/2 of that increase is tied to Pivot -- I'm sorry, a little bit less than that, maybe 1/4 of it is tied to Pivot. So that will give you some sense there. In terms of the -- taking the expenses out of the JV, from the JV and the sale of CMA, et cetera, we said that last quarter, it was probably around, on a net basis, somewhere around $11 million a quarter. So that aspect of it. In terms of expenses going forward, we are in the middle of our budgeting process for the coming years, so I don't want to give any details out there yet. We will give more details on that in the call next time around.

Phupinder S. Gill

Howard, I think there's an element of the question that you have to with respect to where growth is going to come from given the environment that we're in, that Terry so accurately summed up a short while ago. I think along the lines of what Jamie was saying, I think the expense discipline that he talked about is a cultural part of what we are on a going forward basis. So I have every confidence that, that will continue. But in terms of the new client base, in spite of the tough environment in Europe, in spite of what folks are saying there's going to be a slowdown in growth in Asia, what we are seeing is close to $800 million of our top line is coming from outside of the U.S. The new exchange in London will continue to tap a new client base. The time that we spent with those 35 CEOs from China is I think going to be extremely beneficial for us in the coming year. I think I've spoken in the past about a pipeline of Asian clearing firms coming into us from Singapore, Hong Kong, as well as Taiwan. And I think those things are going to take place over the course of the next year. And what that represents to us is a brand-new client base. So even -- as the environment continues in its current form, I think you can expect where growth will come from is going to be from a brand-new client base as well as the new product opportunities that we see as a result of Dodd-Frank.

Operator

The next question comes from Jillian Miller with BMO Capital Markets.

Jillian Miller - BMO Capital Markets U.S.

So with respect to the ClearPort transition to futures, I'm just wondering, longer term, does this transition provide potentially a boost to ClearPort activity in the sense that if this change promotes more transparent futures like trading, it could spur more activity in the products and greater trade velocity? Or do you think that the mode of execution for the product is going to remain similar, and would you see block futures trades use rather than bilateral swaps?

Phupinder S. Gill

This is Gill. I'll start, and you guys might want to add. I think from where we sit, it I think it may represent 1 of 2 outcomes, if not a combination of the 2. As you point out, there will be some set of our clients that are going to transition to futures that are -- yet, another set of our clients who are very comfortable trading what they consider to be swaps, and they would continue in that way and they will continue doing blocks and they will do blocks of some size.

Derek Sammann

Yes. It's Derek. I would add to that, across -- if you look across the breadth of products, that what we are seeing, there's greater acceptance of standardization. So it certainly creates an opportunity for futures product that align and have the same economic equivalent of the swaps market. And those products that are most standardized blend themselves to be in central limit order book key product, which is one of the core principles behind Core Principle 9. So we're seeing that. We're actually, relative to the deliverable swap future, very pleased with the progress we've made, particularly at the dealer community on the basis of accepting what might be a shift towards futures and to really execute the same level of risk. Certainly, providing client choice on the execution, whether it comes from the format of an expert transaction or a central limit order book or a swap that we clear, it's about client choice. So we've been doing a good job to listen to our customers and provide those options.

Jillian Miller - BMO Capital Markets U.S.

Okay. And then on a market data, can you tell us how much of the sequential decrease this quarter was related to stripping out Dow Jones and the CMA? And then how much might have been related to like a lower screen counterdemand for the core data products?

James E. Parisi

Sure, Jillian. This is Jamie. The Dow Jones CMA revenue in Q2 that flowed through that line was in the neighborhood of $25 million, so -- that's what came out, related to that. And the remainder of the decrease would have been tied generally to some continued decrease in terminals as you continue to see layoffs on the Street.

Operator

Our next question comes from Roger Freeman with Barclays Capital.

Roger A. Freeman - Barclays Capital, Research Division

The -- in the deliverable interest rate swap futures, that in context with other -- some of efforts on swaps and futures, is this happening to some extent do you think because of the slow progress in sort of formulating the swaps, clear swaps and trading market that the market is just kind of moving more towards a futurized product? And then on that, is this -- was this something that's -- was developed with the dealer partners? Are the economics to you any different than sort of anything else that you've developed?

Derek Sammann

This is a futures product, clear and outright, to the extent we just talked about client choice and the capital efficiency of trading this particular underlying risk and equivalency of the interest rates swap and the future creates capital efficiencies, attended to a financial future, which is a 1-day margin versus a 5-day margin treatment under Dodd-Frank for financial swaps. So to the extent that the -- the interest that we've gotten for this product is, I think it's not underestimating the support for the product, when we can claim that we've got market makers in the form of Goldman, Morgan Stanley, Citi and Credit Suisse. There's a lot of support for this product in both the buy side and the sell side. Compare that to the traction we got with our original swap future 5 years ago, it was a different time and a different opportunity. So I think the trends that you're talking about regarding the pace of change, regarding the focus on capital efficiency, has created a new climate for support for futurized products that will guard [ph] swaps.

James E. Parisi

And on the economic side, do remember that this product is licensed. So the license fees are similar to what we would pay on other licensed products. And then the fees are around the treasury, around the treasury rates.

Roger A. Freeman - Barclays Capital, Research Division

Okay, that's helpful. And then just a follow-up, just on the professional fees, there has been some back and forth over the quarters in terms of the sort of the regulatory component as you work through all the Dodd-Frank issues. Jamie, is there any kind of sort of run rate overhead that you could call out around all things Dodd-Frank related that we could kind of think about eventually working its way the way out?

James E. Parisi

It's really hard to pinpoint that because there's just so many different aspects of it and I don't have the number here for you. Professional fees, in general, are going to be fluctuating up and down from quarter-to-quarter, whether it's because of regulatory issues or growth opportunities that we're looking at or other issues where we've got a pulling consultants. So it's really hard to give you a run rate.

Operator

Our next question comes from Niamh Alexander with KBW.

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

One on the position limits. We saw the [indiscernible] case and they got a win there. Can you help me understand your position? I mean, am I thinking about this right? I'm not concerned about position limits with futures on futures. It's when they kind of start building the swaps with the futures that things could get a little bit more restrictive. So what is the status now, has it gone back to kind of there are no limits in place because of the court ruling? Or is the regulators still imposing limits across all the commodities in the energy?

Phupinder S. Gill

I think officially, the position is there are no position limits in place. The position limits that CME Group has, we continue to enforce them, and we expect there's going to be a response from the CFTC. You've read about all the potential responses that there might actually be. But officially, we will continue the way we have always conducted ourselves by pulling in the position limits that make sense for us.

Terrence A. Duffy

I think what's also important, to add to what Gill said. We do have hard position limits in the last 3 days of trading. And then prior to that, we have accountability levels which are basically in line with our competition that has the same kind of type of structure but may call it something different. So even though that some of our competition has come out and said that they will not adhere, obviously imposing a position limit since the rulings come out, it doesn't impact the way businesses were done prior to the ruling.

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. I appreciate it. And then, if I could come back to the soft futures, that is pretty impressive names you have supporting you on this product, and that is very different than what we had several years ago. On the economics, Jamie, I just want to probe a little farther, because at some of your competitors like Eris and whatnot, it seems like the charging there on those futures products will be more on dollar value where you'd kind of said, a, you'll be paying a license fee. I think it was Goldman that you were collaborating on developing this. And then b, you're going to price it like you're treasury futures, which is one of your lowest fee products, is that correct? I mean, it's kind of lower than the average $0.48 in the rates complex, is it?

James E. Parisi

Actually, treasuries are a little bit higher than the average in the rates complex.

Derek Sammann

Yes. And it's priced in the line. This is both the opportunity and the challenge for it. The market says, we see the conversions between OTC and futures. When you look at economic equivalent products, obviously, there's going to be a function of aligning the fees and all of them cost the transact of these products as well. So when we're looking at customer choice and trying to provide maximum customer choice, we'll try to make sure that we've got consistency in terms of what the customer chooses to transact and where they transact.

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

So yours should be less expensive than the others all are equal [ph] if you're going to be pricing on notional value, is that fair?

Derek Sammann

Well, I think when you look at the contract size, then you'll get how we've actually looked at the equivalent notional per transaction, we tried to align those. So we are consistent with equivalent risk that a customer might put in relative to a treasury future, for example. And there's no comp out there, outside CME because no one else has this particular product. But we think about the notionalized and the cost for notion a million-dollar transaction.

Operator

The next question comes from Don Fandetti with Citigroup.

Donald Fandetti - Citigroup Inc, Research Division

Gill, can you remind us where high-frequency trading is as a percentage of your total mix and kind of how that's trended, and whether or not you're seeing any movement between products? And then just lastly, around some of the drag on high-frequency. I mean it seems pretty contained. I was just curious to hear your views on that.

Phupinder S. Gill

In terms of what they represent at CME, they're less than 1/3 of the overall revenue of the firm. Our position on high-frequency traders is the same. They continue, we believe, that they provide a significant value to us. We also believe that they actually reduce frictional cost rather than add to it, and they're simply repeating what a lot of the economic analysis that has been done, that is actually seeing. And we are also seeing it ourselves. I don't know if you saw last week or the week before last, the CIO of Vanguard, who is a user of our market, he mentioned the value of these traders and these types of trades. And what we are doing actively is working with the CFTC through their so-called Technical Advisory Group. Our COO, Bryan Durkin, serves on that group. And that group is taking a very systematic approach to who are these traders, what do they do, how do you define what a high-frequency trader is and the value that they add. And so there's no change from that front. Even though the full focus of the investigation currently seems to be on the cash side, we expect that there will be some legal work to our side, too.

Donald Fandetti - Citigroup Inc, Research Division

So in terms of volumes, it's probably somewhere in that 40% range still?

Phupinder S. Gill

I think it would be between 30% and 40%.

Operator

The next question comes from Dan Fannon with Jefferies.

Daniel Thomas Fannon - Jefferies & Company, Inc., Research Division

I guess, Jamie, if we could kind of do, you did a nice walk through of kind of the puts and takes around cash flow in this past quarter. If we think about the fourth quarter, is there anything that we should think about outside of normal course of business with regards to your dividend taxes and other things that might be inhibiting to you being potentially returned to shareholders?

James E. Parisi

I guess the 1 big thing to keep in mind is that, we've got the case CBOT transaction out there. So that $126 million of cash that I mentioned earlier would be something that could come out of that cash in the fourth quarter.

Daniel Thomas Fannon - Jefferies & Company, Inc., Research Division

Okay. And then in terms of regulatory capital on the balance sheet, $700 million has been the number you guys have framed. In the context of what happens with LSE and LCH this past quarter and frankly, just the ebb and flow of the regulatory environment, does that number, do you think, go up over time? Or how much cushion is there do you think versus what's required, and what do you guys actually are holding?

James E. Parisi

Yes. I think that for now, the $700 million is still the minimum cash that we want to get -- that we want to target as a whole, as you pointed out, includes all of our contributions to the financial safeguard packages both here and in our European clearing house. It also can cover some of our liquidity requirements that are imposed on us by our regulators. But right now, we're comfortable that we're meeting and exceeding the regulatory requirements in terms of capital from the regulators. But all of those, as you readily pointed out, have not yet been finalized. So there's still a little bit of a question mark over that. So one of the key things that's going to drive the capital requirements for the clearing house in particular is going to be the strength of the financial safeguard package. Our financial safeguard package is in a very good, very strong position and that's one of the key drivers of what FTCP [ph] Capital requirements is going to be.

Operator

[Operator Instructions] Our next question comes from Chris Allen with Evercore.

Christopher J. Allen - Evercore Partners Inc., Research Division

I just wanted to ask on the special dividend, you guys have talked before about accelerating into 2012. How dependent is that on the outcome of the election and the potential dividend tax law change?

James E. Parisi

I would say it's not dependent on the outcome of the election. I think even -- no matter what the outcome of the election is going to be, the tax laws are going to take time for people to address. So just to be on the safe side, I think it's something that we should consider at year end, and we'll be talking to our board about that.

Operator

Our next question comes from Ken Worthington with JPMorgan.

Kenneth B. Worthington - JP Morgan Chase & Co, Research Division

You just answer the last of my questions.

Operator

Our next question comes from Brian Bedell with ISI Group.

Brian Bedell - ISI Group Inc., Research Division

A question for Derek on the over-the-counter interest rate swap market and the conversion to futures. You just talked a lot about this on the call. But maybe if you can sort of help us think about sort of the timing of your expectation of getting OTC users trued up futures contracts over the next, say, couple of quarters. Given the launch of the deliverable products and the clearing mandate in the first quarter, if you can sort of give us a sense of -- it was hard to predict volumes, of course, but a sense of your expectations at sort of take up with the futures contracts maybe later this quarter, and to the first quarter and to the second quarter.

Derek Sammann

Sure. I think it probably is easiest to talk in terms of what we think the expectations or the timeline for impacting the market is. So we're really working on the assumption that the first impact from Dodd-Frank is going to hit roughly in about February, where the first phase hitting at the hedge funds, the major swap participants and the swap dealers. That's going to include most of these vanilla products on the major currencies which is the bulk of the IRS market. The second wave hits in about May, gets down on the non-dealer bank, the insurance companies and active hedge funds, and then scales out through August through the tail end of the year. So we've had, as you've heard us talk about in the past, the number of firms, both alive with us now but also number of firms testing in preparation for the actual impact of the mandate. In the launching of the deliverable swap future, you've seen us with a pretty strong track record of product launches. I think Gill had mentioned in some of his prepared comments around the ability to scale and grow our business. And you think about the impacts for open interest, over 10% of our current open interest are from products we've developed over the last 2 years. Very strong statement on track record of the other [ph] growth products to adapt to client demand. So in terms of, if I had a crystal ball, I'll tell you what those numbers are going to be. But we certainly think that given the uptick we're getting from both the buy and the sell side as the impacts start to hit the bottom line of the firms, that we're looking for a decent trajectory of our futures' launch or the deliverable swap future. It's a note '13 launch, but we're expecting that to scale for the first and second quarters of next year. Again, harping on the same issue of customer choice, if customers want to clear, they can choose the OTC clearing services. If they want to really shift their business or a part of their business directly into futures, we have that. And the smaller players that might get maybe squeezed out of the ability to clear having the opportunity to leverage the deliverable swap future as an alternative to stay in that market and stay active and also benefit directly from the capital efficiencies.

Operator

Our next question comes from Matthew Heinz with Stifel, Nicolaus.

Matthew S. Heinz - Stifel, Nicolaus & Co., Inc., Research Division

You spoke a bit earlier about the role of proprietary trading firms as OTC market makers. I'm just wondering, to what extent do you expect these firms to be involved in the swap futures product, penetrating those alongside swaps for other opportunities? And then further on that topic, how are you helping customers kind of perform all in transaction cost analysis for these products relative to swaps, aside from just the clear advantage on capital efficiencies?

Terrence A. Duffy

Yes, I can pick up. And I think Kim could probably talk to some of the current efficiencies as well. But from the perspective of the -- what we talked about on the deliverable swap futures like capital efficiency, not just the 1-day versus 5-day margin treatment, and also the fact that these positions net down because they were futures as opposed to sitting as open line items on an interest rate swap, these net down at a daily basis in some highly efficient from a trading in and out perspective. I mean to the extent of the cross margining is available day 1 from the deliverable swap futures relative to our treasuries newer dollar [ph] complex. They'll also be available as cross margin. I believe 19 November is the date that we're rolling out clients portfolio margining as well. There are some tools that we've been putting out there. We've got an optimizer tool that allows customers really for the first time to load a portfolio and actually have that help them determine what amounts and what type of their futures portfolio to allocate to their swap portfolio to optimize their margin offsets. So they have said that firms are trying to participate in CCA [ph] and understand the impact of their business with optimizer tool, we think is the best tool we can provide right now to help them optimize what they put in the clearing house for clearing.

Phupinder S. Gill

And I think that the first part of the question that you had was with respect to what extent we expected the so-called proprietary traders to participate. I think you have to make the decision between high-frequency guys and proprietary guys, some of the proprietary guys are high-frequency guys, not all of them. But I would expect some of these high-frequency traders to be very involved as the liquidity develops in the swap products themselves. And to the extent that they do participate and trade flat at the end of the day, the pricing scheme that we talked about at the start of this would actually help them and encourage them to add the liquidity to the swaps marketplace.

Terrence A. Duffy

That's a great point. And just picking up 1 more theme there from a participation point of view. A lot of the kind prop firms that we're talking about are firms that have not traditionally have been able to access the OTC by data role in interest rate swaps. So by providing a liquidity pool and a customer base that's actually interacting in equivalent product, they have an opportunity as a new client to participate in the market that wasn't available to them before.

James E. Parisi

And a lot of those high turnover targeted firms in the swaps arena are members of CME already. So on the swaps future side, they would come in at their normal rates for a member.

Kimberly S. Taylor

One additional thing that I'll just mention is the theme of our over-the-counter clearing service has been to try to the greatest extent possible to capture for the end client, the efficiencies in OTC swaps that they get in futures, while letting them preserve their execution and their economic profile of the OTC product that's slightly different. And we haven't mentioned yet the real time clearing as a big factor in people's ability to -- actually, helps facilitate the entry of new participants into the market, and it also helps facilitate kind of broader choice of access method or execution method for the existing participants in the market.

Matthew S. Heinz - Stifel, Nicolaus & Co., Inc., Research Division

Okay, that's all very helpful. And then if I could just have one quick follow-up for Jamie on the debt refi. On the interest expense, you said you expect to save $15 million annually after the refi next August. And so is that kind of from your current run rate of about $29 million per quarter or $115 million per year?

James E. Parisi

Yes, because were 2%, it's a 2% savings on the all-in cost on the debt that we're replacing.

Matthew S. Heinz - Stifel, Nicolaus & Co., Inc., Research Division

And you expect that to be the case -- so that should begin to accrue in 4Q next year, correct?

James E. Parisi

Correct.

Operator

Our next question comes from Gaston Ceron with Morningstar Equity Research.

Gaston F. Ceron - Morningstar Inc., Research Division

Just real quick, I wanted to follow up on the Kansas City deal. Just wondering if you could -- we haven't -- to my recollection, we haven't seen a deal in a little bit while. So I'm wondering if you could give us a quick update on kind of your M&A philosophy coming out of this deal, if you see any more future opportunities kind of are on the same lines or not? If you think that, that is more of an isolated situation.

Phupinder S. Gill

Gaston, this is Gill. I think we had mentioned on several calls that we were going to be opportunistic. And if you look at the weak marketplace and the benchmarks that we have with our Chicago board of trade wheat, I think the Kansas City Board of trade re-contract it as a significant enhancement to the quality of the product. For us it made enormous sense for our client base. It provides an off and on opportunity to enhance the value of the weak offering that we have with this complementary add-on. So I think it's very much in line with what we have which is a set of global benchmarks across all of the asset classes, and we simply added yet another one of those benchmarks to what is a very viable offering to begin with.

Gaston F. Ceron - Morningstar Inc., Research Division

But do you see -- I mean, how do you assess some of the M&A landscape as it stands right now? I mean do you think that this was kind of a great opportunity but an isolated one? Or do you think that there could be other kind of interesting things like that down the road, or tough to say?

Phupinder S. Gill

I don't know that the Chicago Board -- or that the Kansas City Board of Trade acquisition represents the beginning of a trend, but I do know it is an opportunistic buy for us. They are -- there may be some other things out there, we have nothing to announce at this time. But as Jamie had emphasized in the past, we will continue to remain opportunistic with respect to opportunities that emerge not just here, but around the world.

Operator

Our next question comes from Patrick O'Shaughnessy with Raymond James.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

So a few weeks ago, ISA announced that they're going to start offering CDS index futures. Is this a product that you guys would be interested in? And what do you see is the success potential of that type of product?

Phupinder S. Gill

Patrick, this is Gill. I think with respect to the CDS phase, we have said that our focus is going to be in clearing the marketplace. And our philosophy there as swaps is concerned, is to be a clearing service provider, not just in credit default swaps, energy and rates, but across all the successive classes that we have. So we are focused on clearing the index futures once they get done all, I mean, of the byproducts that come about from that industry.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Okay, that's helpful. And a follow-up for Jamie. You guys have some 5-year notes that are expiring in February 2014 as well. Are you probably going through the same process of refinancing those earlier, or is it too early to tell?

James E. Parisi

It's a little early now, but I would anticipate that we will do a refinancing. We've said all along that we want to maintain a reasonable level of debt on the balance sheet. As you know, we're targeting no more than 1x debt-to-EBITDA ratio, so refinancing those would keep us right in that ballpark.

Operator

Our final question comes from Akhil Bhatia with Rosenblatt Securities.

Akhil Bhatia

I just wanted to ask about portfolio margining. What percent of customers would actually be eligible to realize the savings of up to 90% you mentioned?

Kimberly S. Taylor

Actually, the program is available to all customers who trade in both of the products. So there aren't any restrictions on who would be eligible. At the -- it's hard to estimate what the -- who would get what percentage savings because it's dependent on the product that they trade and the structure of their portfolio, so the results vary.

Phupinder S. Gill

It makes sense though to assume that because the Eurodollars and the treasuries that we trade are a natural complement to the swap that are being traded out there to the extent that you have a client base that trades swaps, they would have some portion of the asset in our futures market.

Akhil Bhatia

Okay. I guess -- so is there -- have you done any studies on what percent of customers trade in both markets and could realize some offsets versus those who only have sort of one-sided portfolios?

Phupinder S. Gill

We don't. The transparency that you have on outside of the world is not replicated on the OTC side. So the only information that we have is in talking directly to our buy side clients. And I would say a very large chunk, in fact, the majority of the buy side clients, are very enthusiastic and interested in the margin offset that we have. For that specific reason, we have put up the optimizer tool out there. We're the only ones that have the optimizer tools because we're the only ones that have the offsets. And the take-up among the client base for the optimizer tool has been very encouraging to us.

Operator

And at this time, I'll turn the call back over to the speakers.

Phupinder S. Gill

All right. Thanks, everybody, for your interest in CME Group. And we look forward to talking to you in the next quarter. Thank you.

Operator

Thank you. This does conclude today's conference. We thank you for your participation. At this time, you may disconnect your lines.

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