Building on the heritage of its futures exchanges (CME, CBOT, NYMEX and COMEX), CME Group serves the risk management and investment needs of customers around the globe. CME Group, formerly known as Chicago Mercantile Exchange Holdings Inc., became publicly traded in December 2002. We completed our acquisition of CBOT in July 2007 and NYMEX in August 2008.
Our customer base includes professional traders, financial institutions, institutional and individual investors, major corporations, manufacturers, producers and governments. We break our member customers into four segments based on trading activity: proprietary trading firms (primarily algorithmic); banks and investment banks; top hedge funds; and “other,” which includes smaller member firms and individual traders. We also have a fifth segment of customers, which is comprised of our non-member customers who pay higher fees than the member category. As of December 31, 2009, we had approximately 140 clearing firms. One firm represented 11% and one firm represented 10% of our clearing and transaction fees revenue in 2009. Should a clearing firm withdraw, we believe that the customer portion of the firm’s trading activity would likely transfer to another clearing firm of the exchange. Therefore, we do not believe we are exposed to significant risk from the loss of revenue received from a particular clearing firm. Our trading volume can be seasonal, and historically, we have experienced higher sequential volume during the first and second quarters followed by decreases in the third and fourth quarters of the calendar year.
During 2009, our industry, and the financial services area in particular, faced many challenges. However, we sought opportunities amongst the challenges, and we were steadfast in pursuing and executing on these opportunities as described in this Report.
Highly Liquid Markets
CME Group is the only exchange to offer access to all major asset classes for futures products from a single electronic trading platform and on trading floors in Chicago and New York City. Specifically, we offer futures and options on futures based on interest rates, equity indexes, foreign exchange, energy, agricultural commodities, metal and alternative investment products such as weather and real estate. We provide the facilities to conduct open outcry and electronic trading and we match, clear and guarantee trades executed on our exchanges and certain bilateral trades that we clear. Our markets provide an effective and transparent forum for our customers to manage their risk and meet their investment needs relating to our markets. We believe that our customers choose to trade on our centralized markets due to their liquidity and transparency and our central counterparty clearing guarantee. More than 80% of our trading volume comes from trades made electronically on our CME Globex electronic trading platform. Our aggregate volume in 2009 was approximately 2.6 billion contracts. As of December 31, 2009, our open interest stood at 78.0 million contracts. Open interest is the number of outstanding contracts at the close of the trading day. Open interest can also be defined as the total number of futures contracts or options on futures contracts that have not yet been exercised, expired or fulfilled by delivery. Open interest serves as an indicator of market liquidity. Market liquidity, or the ability of a market to absorb the execution of large purchases or sales quickly and efficiently, is key to attracting customers and contributing to a market’s success. In spite of the difficult economic climate, we experienced an improvement in our open interest during 2009, which grew by 24% from the beginning of the year.
Most Diverse Product Line
We serve the risk-management needs of customers around the globe, offering the widest range of benchmark products available on any exchange and covering all major asset classes. Our products provide a means for hedging, speculation and asset allocation relating to the risks associated with, among other things, interest rate sensitive instruments, equity ownership, changes in the value of foreign currency and changes in the prices of commodities. These include products based on the entire U.S. interest rate yield curve, equity indexes, foreign exchange, agricultural commodities, energy, metals and alternative investment products.
Futures and options provide a way to protect against—and potentially profit from—price changes in financial instruments and physical commodities. Futures contracts are legally binding agreements to buy or sell something in the future, such as livestock or foreign currency. The buyer and seller of a futures contract agree on a price today for a product to be delivered and paid for in the future. Each contract specifies the quantity of the item and the time of delivery or payment. An option on a futures contract is a right, but not an obligation, to buy or sell a futures contract at a specified price on or before a certain expiration date.
Superior Trading Technology
We strive to provide the most flexible architecture in terms of bringing new technology, innovations and solutions to the market. Our CME Globex electronic trading platform is accessible virtually 24 hours a day throughout the trading week. Our platform offers:
• high speed trade execution;
• vast capabilities to facilitate the most complex and demanding trading;
• direct market access;
• fairness, transparency and anonymity; and
• global distribution and international telecommunications hubs in key financial centers in Europe, Asia and Latin America.
Customers benefit from direct connectivity, ongoing development efforts, a single source for customer support and highly efficient access to real-time market data. The platform is continuously enhanced to serve our customers’ needs for high-speed, high-volume capacity, improved options trading capabilities and a range of new products. In 2009, we were named the number one technology innovator by InformationWeek. It was also the sixth consecutive year we were named to this prestigious list of technology innovators. CME Globex handled an average daily volume of 8.3 million contracts in 2009. Our all-time record of 20.5 million contracts was on January 22, 2008 (representing volume of 13.2 million CME products, 6.1 million CBOT products and 1.2 million NYMEX products). To ensure that we can meet the heavy demands placed on our systems, we have rigorous requirements for the performance, scalability, reliability, ease of use and costs of our infrastructure.
We offer a number of programs and products designed specifically to appeal to a global audience. Customers from all over the world trade our products, primarily electronically. As described below under “Growth Strategy—Globalizing the Business,” we continue to expand our business globally by educating non-U.S. customers on the benefits of our product suite and by entering into strategic alliances, such as our relationships with BM&FBOVESPA S.A. and the Korea Exchange Inc. and our most recently completed partnership with Bursa Malaysia Derivatives Berhad.
We own our own clearing house—CME Clearing. Our integrated clearing function is designed to ensure the safety and soundness of our markets. CME Clearing protects the financial integrity of our markets by serving as the counterparty to every trade—becoming the buyer to each seller and the seller to each buyer—and limiting credit risk. It is responsible for settling trading accounts, clearing trades, collecting and maintaining performance bond funds, regulating delivery and reporting trading data. CME Clearing limits the accumulation of debt from trading losses with twice daily mark-to-market settlement.
In 2009, our industry was subjected to increased concerns about counterparty credit risk stemming from the financial crisis that began in 2008. During such times, our financial safeguards continued to provide our customers with transparency and liquidity in all asset classes. Importantly, none of our customers incurred a financial loss due to a counterparty failure. Following our merger with NYMEX, we extended the benefits of our clearing model to the over-the-counter market through CME ClearPort, which is a comprehensive set of flexible solutions for mitigating counterparty risk in over-the-counter trading. In December 2009, we also began providing clearing services for credit default swaps. Basically, a credit default swap contract provides the buyer with protection against specific credit risks. We believe that providing clearing services to the credit default swap market will provide greater transparency, security and stability to that marketplace.
As of December 31, 2009, we maintained approximately $83.7 billion in cash, investments and letters of credit related to performance bonds, security deposits and other collateral of which $11.4 billion was in excess of the clearing house requirements we set for our customers. Performance bonds are deposits required from our clearing firms to ensure that they can cover potential losses in connection with their trading positions. We require these deposits as part of our financial safeguards to help ensure that clearing firms can meet their obligations to their customers and to CME Clearing.
Ownership of our clearing house also enables us to more quickly and efficiently bring new products to market through coordination of our clearing functions with our product development, technology, market regulation and other risk management activities.
CME was founded in 1898 as a not-for-profit corporation. In November 2000, CME demutualized and became a shareholder-owned corporation. As a consequence, we adopted a for-profit approach to our business, including strategic initiatives aimed at optimizing trading volume, efficiency and liquidity. In December 2002, CME Holdings completed its initial public offering of its Class A common stock. In July 2007, CME Holdings completed its merger with CBOT Holdings. As a result, we acquired CBOT. CBOT is a leading marketplace for trading agricultural and U.S. Treasury futures as well as options on futures. In August 2008, we merged with NYMEX Holdings and acquired NYMEX and COMEX, its wholly-owned subsidiaries. On NYMEX, customers primarily trade energy futures and options contracts, including contracts for crude oil, natural gas, heating oil and gasoline. On COMEX, customers trade metals futures and options contracts, including contracts for gold, silver, copper and aluminum.
Our principal executive offices are located at 20 South Wacker Drive, Chicago, Illinois 60606, and our telephone number is 312-930-1000.
Increased market awareness and acceptance of derivatives, increased price volatility, technological advances and the increasing need for counterparty risk mitigation and clearing services create significant opportunities for growth. We believe that we can capitalize on these trends and build on our competitive strengths by implementing the following strategies:
• growing the core business, including expanding into complementary businesses;
• globalizing the business; and
• serving the over-the-counter markets.
Growing the Core Business. We intend to advance our position as a leader in the futures industry by growing our core business. As part of this initiative, we plan to continue to generate organic growth through the launch of new products, expanding on the strength of our existing benchmark products and by enhancing our customer relations to allow us to cross-sell our products.
We plan to continue to work with existing and potential customers to develop new futures and options products that provide an array of relevant risk management tools. We are also enhancing our marketing capabilities with a focus on customer education, advertising and public relations to cross-sell our existing products to our current customer base. We continue to communicate our unique benefits—a secure, effective and cost-efficient place for customers to come and manage their risk through our diverse products, liquidity, anonymity and central counterparty clearing. We continue to look for ways to build upon our success as we continue to grow our business in areas such as emerging markets and the over-the-counter market.
On February 10, 2010, we announced that we had entered into a definitive agreement with Dow Jones in which we would take a 90% ownership interest and Dow Jones would own the remaining 10% in a new joint venture that will own the Dow Jones Indexes, which include the Dow Jones Industrial Average and approximately 130,000 index properties. Pending regulatory approval and completion of customary closing conditions, the transaction is expected to close during the first quarter of 2010. This venture creates a new opportunity for us to grow our index business and to further diversify our revenue streams by building on our existing brands and expanding the global reach of Dow Jones’ index creation and calculation services businesses across complementary asset classes, including cash, derivatives and customized over-the-counter markets.
Globalizing the Business. Our goal is to expand and diversify our customer base worldwide and offer customers around the world the most broadly diversified portfolio of benchmark products. In 2009, we continued our initiative to enhance our global marketing efforts in order to broaden the understanding of the benefits of our products, targeting in particular Asia and Europe and implementing global sales and marketing plans to reach new customers and cross-sell our products to existing customers as well as extending our international incentive programs to apply to our energy and metal customers. During 2009, we extended our global reach with several key partnerships. We launched the first phase of our program with the Korea Exchange to provide customers with after-hours access to the KOSPI 200 futures hosted on our CME Globex platform by providing order routing services. We are awaiting approval from the Korean regulators to expand access beyond our Seoul telecommunications hub to allow us to reach a broader group of market participants. During the year, we acquired an equity stake in Bursa Malaysia Derivatives Berhad and entered into an agreement to provide Globex order routing and matching services for its derivatives segment, which will also provide us with a license to use its crude palm oil settlement prices for future product development. On February 11, 2010, we announced a non-binding letter of intent with BM&FBOVESPA to expand our existing strategic partnership to develop a new multi-asset class electronic trading platform that will be deployed by BM&FBOVESPA for use in its own cash equities and derivatives markets, and both of us will have the ability to license the platform to other exchanges internationally. These partnerships are expected to expand our transaction processing opportunities and increase our global presence.
We will continue to explore opportunities to position CME Group to benefit from growth in key geographies by targeting global customers, making strategic investments and leveraging our diverse product offerings.
Serving the Over-the-Counter Markets. We continue to expand our business serving the over-the-counter markets by developing over-the-counter products and services along with new capabilities and functionalities and entering these markets through acquisitions, strategic partnerships and commercial arrangements. As a result of our merger with NYMEX Holdings in 2008, we now own ClearPort. Launched in 2002 to provide centralized clearing services and mitigate risk in the energy marketplace, CME ClearPort now clears transactions across a broad array of products around the world with tailored offerings for the needs of each market with the benefit of central counterparty clearing. During 2009, we launched more than 330 products on CME ClearPort and cleared an average of more than 494,000 contracts daily.
In 2009, we restructured our joint effort with Citadel Investment Group related to credit default swaps to target clearing-only services. Beginning in December 2009, we began providing our clearing solution for the credit default swap market which delivers:
• customer segregation and a portability framework that protects customer positions and margin in the event of a clearing member default;
• clearing of credit default swap trades at the point of execution, which provides immediate cleared trade confirmation and settlement, thereby limiting credit exposure;
• migration of legacy non-cleared positions to cleared trades;
• the ability to leverage existing relationships with our clearing firms; and
• our more than 100 years of experience in clearing, settlement and risk management.
Our cleared credit default swap products comprise the highest volume Markit CDX and Markit iTraxx indices. They are designed to mirror bilateral over-the-counter contracts. We also support trade submission through CME ClearPort, enabling connectivity from any affirmation/confirmation or trading platform.
We believe that the range and diversity of our products contribute significantly to our success. We offer markets in futures and options on futures contracts based on the U.S. interest rate yield curve, equity indexes, foreign exchange, agricultural commodities, energy, metals and alternative investment products. Our products are traded through the CME Globex electronic trading platform, our open outcry auction markets in Chicago and New York City or through privately negotiated transactions that we clear. For the year ended December 31, 2009, we derived $2.2 billion, or 83% of our total revenues, from fees associated with trading and clearing our products. These fees include per contract charges for trade execution as well as clearing and CME Globex fees. Fees are charged at various rates based on the product traded, the method of trade and the trading privileges of the customer making the trade. Generally, members are charged lower fees than non-members. Certain of our customers benefit from volume discounts and limits on fees as part of our efforts to encourage increased liquidity in our markets. Our markets also generate valuable data and information regarding pricing and trading activity in our products which provides us with the opportunity to sell our market data. We identify new products by monitoring economic trends and their impact on the risk management and speculative needs of our existing and prospective customers. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” page 55, for the average daily volume of contracts traded in our principal product lines for the last three years.
Interest Rate Products. Our interest rate products enable banks and other financial institutions worldwide to hedge interest rate risks, and in turn help to reduce the overall cost of borrowing and financing. Our interest rate products allow our customers to execute transactions across the entire U.S. dollar-denominated yield curve using some of the world’s most actively traded futures and options products. Customers may manage short-, medium- and long-term interest rate risk using our products based on Eurodollars, U.S. Treasuries, swaps and other dollar-related instruments. In 2009, we extended our relationship with the British Banker’s Association with a long-term agreement for our use of its London Interbank Offered Rate to settle various interest rate products, including our benchmark Eurodollar contract. As a result of our acquisition of CBOT, our interest rate products include CBOT’s thirty-year U.S. Treasury bond futures and options on futures; ten-year, five-year and two-year U.S. Treasury note futures and options; interest rate swap futures and options; and federal funds futures and options. In 2009, we launched three-year Treasury note futures. In January 2010, we launched our Ultra T-bond futures contract. To date, this is the most successful new interest rate product launch in our history in terms of volume and open interest growth since launch.
Forty-two percent of our overall annual trading volume in 2009 and 26% of our clearing and transaction fees was based upon our interest rate products. In 2009, we experienced an overall decline in interest rate volume due largely to the credit crisis and the Federal Reserve Bank’s zero interest rate policy for short-term interest rates. Several macroeconomic factors that drive interest rates have begun to stabilize over the course of the year, including improvements in liquidity and credit spreads, but areas of weakness remain. In 2010, we plan to continue our efforts to expand our customer base and increase international participation through additional marketing efforts and educational programs. We will also look to expand our benchmark products.
Equity Products. Our equity products permit investors to obtain exposure, for hedging or speculative purposes, to changes in the weighting of one or more equity market sectors more efficiently than by buying or selling the underlying securities. By allowing investors to effectively manage stock market risks, our equity products increase investor confidence and overall participation in these important markets.
We are a leading equity index marketplace, offering futures and options products (including our E-mini contracts) on key benchmark equity indexes covering small-, medium- and large-cap companies in the U.S., Europe and Asia. These include the Standard & Poor’s, Dow Jones, NASDAQ, Nikkei, MSCI and FTSE/Xinhua indexes, and others. We have exclusive licensing arrangements with Standard & Poor’s Corporation (S&P), NASDAQ OMX Group, Inc. (NASDAQ OMX) and Dow Jones & Company, Inc. (Dow Jones), which allow us to offer futures and options on futures on their indexes, including our contracts based on the S&P 500 Index, the NASDAQ-100 Index and the Dow Jones Industrial Average. As previously discussed, we have also entered into a definitive agreement with Dow Jones to create a joint venture which will create new opportunities for growing our index business. For a detailed description of these licensing arrangements, see the section of this Annual Report on Form 10-K entitled “Item 1. Business—Licensing Agreements.”
Trading in our equity products represented 28% of our total trading volume and 24% of our clearing and transaction fees during 2009.
We believe our leading market position in equity products is a result of the liquidity of our markets, the status of the S&P 500, the NASDAQ-100 and the Dow Jones Industrial Average indexes as the principal U.S. financial standards for benchmarking stock market returns, and the appeal to investors and traders of our E-mini products and other equity products and our CME Globex platform. These investors include public and private pension funds, investment companies, mutual funds, insurance companies and other financial services companies that benchmark their investment performance to different segments of the equity markets.
We believe future growth in our equity products will come from continued counterparty credit concerns, continued education of our customers as to the benefits of our equity product portfolio and our trading platform to serve their risk management needs, and the benefits of futures products over cash equities. We believe that our equity volumes may continue to be impacted by and are in large part influenced by the trading volume levels of the underlying markets as well as the level of market volatility.
Foreign Exchange Products. We became the first exchange to introduce financial futures when we launched foreign exchange futures in 1972. Our foreign exchange market serves as an effective and efficient means of risk transfer for the global foreign exchange market, bringing together a broad array of client segments by offering investment as well as risk management opportunities. Our customers benefit from dealing anonymously in a fully transparent market, where large and small customers have equal access to the same prices and deep pool of liquidity. Our foreign exchange products provide the tools and resources to hedge foreign exchange risk, facilitating cross-border trade and commerce while mitigating the risks to profitability due to fluctuations in the foreign exchange market. Our foreign exchange market attracts both buy- and sell-side investors, including commercial and investment banks, hedge funds, commodity trading advisors, proprietary trading firms and individual investors. In 2009, we launched a series of innovative smaller-sized foreign exchange contracts, called Forex E-Micros, designed to enable retail traders and investors to cost-effectively access the security, transparency and liquidity of our products. We also added Turkish Lira futures to our foreign exchange product suite. Approximately 97% of our foreign exchange products are traded electronically on the CME Globex platform, ensuring that business is transacted quickly with maximum operational efficiency.
Today, we offer approximately 40 foreign exchange futures and approximately 30 foreign exchange options on futures products, covering major as well as a broad array of emerging market currency pairs in more than 20 different currencies.
In 2009, we saw an average daily volume of 624,000 foreign exchange contracts, with a notional value of $79.8 billion a day. Trading in our foreign exchange products represented 6% of our total trading volume in 2009 and 6% of our clearing and transaction fees. In 2009, while the broader over-the-counter FX market volume declined by roughly 25% based on central bank turnover statistics, CME Group’s average daily volume for foreign exchange products was flat when compared with 2008. We believe this result is largely due to the breadth of our product coverage and diversity of our customer base as the global FX market was marked by extreme market volatility, changes in global interest rates and increased risk aversion by market participants resulting from the credit crisis.
We believe future growth in our foreign exchange product line will come from expanding and diversifying our product suite and customer base. We continue to expand our foreign exchange options product suite to appeal to a broader array of customer segments. As we continue to expand our global footprint in the foreign exchange market, we expect increased trading volume from customers outside of the United States. We also expect an increased demand in the over-the-counter market for cleared products, which we have been targeting to serve.
Commodity Products. Our commodity products help establish benchmark prices and play an important role in risk management. These products provide hedging tools for our customers who deal in tangible physical commodities, including agricultural producers of commodities and food processors. Commodity products were our only products when our exchange first opened for business. We have maintained a strong franchise in our commodity products, including futures contracts based on cattle, hogs, pork bellies, lumber, dairy products, soybeans, corn, wheat, oats and rough rice. We also added 11 agricultural swaps on CME ClearPort. Commodity products accounted for 7% of our trading volume and 10% of clearing and transaction fees during 2009.
Energy Products. Following our acquisition of NYMEX and COMEX, we now offer the most extensive and liquid energy complex in the world, including Light Sweet Crude Oil (WTI), Natural Gas (Henry Hub), and electricity products. Many of our energy contracts are benchmarks that set the price for these resources worldwide. In 2009, we launched over 300 new energy products on CME ClearPort in response to customer demand stemming from counterparty credit risk concerns. Energy products accounted for 15% of our trading volume and 29% of clearing and transaction fees during 2009.
Metal Products. Our metals futures markets include full-size contracts on gold, silver, platinum, palladium, copper and steel; as well as E-mini contracts for gold, silver and copper. We also extended our CME ClearPort clearing services to London gold futures. Metal products accounted for 2% of our trading volume and 5% of clearing and transaction fees during 2009.
Market Data and Information Products. Our markets generate valuable information regarding prices and trading activity in our products that we believe enhances the appeal of our products. The dissemination of real-time data generates revenues and supports our customer base with timely market information. We sell our market data, which includes information about bids, offers, trades and trade size in our products, to banks, broker-dealers, pension funds, investment companies, mutual funds, insurance companies, individual investors and other financial services companies or organizations that use our markets or monitor general economic conditions. We distribute our market data over the CME market data platform directly to our electronic trading customers as part of their access to our markets and to quote vendors who consolidate our market data with that from other exchanges, other third-party data providers and news services, and then resell their consolidated data. Revenues from market data products totaled $331.1 million, or 13% of our total revenues, in 2009.
Sophisticated quantitative approaches to risk management as well as customer time sensitivity have created new needs, uses and demands for trading-related data and analytics. This timely information has become even more important in light of the volatility and uncertainty in today’s markets. We continue to enhance our current market data and information product offerings by creating new value-added services to complement our market data products, including databases, analytical tools and other services to assist end-users. Our market data was significantly enhanced in 2009 with the expansion of futures market depth to include additional order information. Our real-time web-based market data application, CME E-quotes, experienced growth in subscribers in 2009 as we added NYMEX and COMEX data and as subscribers looked for a more cost-effective solution. CME DataMine, our historical market data service, continued to have strong demand from the hedge fund and algorithmic trading community to power their trading models.
As part of our market data and information products business, we also supply services to S&P and the Dubai Mercantile Exchange in connection with the usage reporting, contract administration and associated billing and revenue collection for the display and integration of their market data into our standard market data distribution. We are the exclusive distributor of Dow Jones Index data from our market data distribution platform. We also provide access to all prices for products listed on the Minneapolis Grain Exchange and the Kansas City Board of Trade, which are available for electronic trading on CME Globex. In 2009, we began offering real-time market data on our CME market data platform for BM&FBOVESPA as well. We believe that there will be further opportunities to continue leveraging our market data distribution capabilities with new or existing strategic partners.
We believe that there has been a decline in subscriptions of market data due primarily to the consolidation of many of our customers and related headcount reductions as a result of the recent financial crisis. Based upon historical trends, we believe that real-time market data subscribers will increase again as unemployment numbers begin to improve in the financial services industry.
Our primary trade execution facilities consist of our CME Globex electronic trading platform and our open outcry trading floors in Chicago and New York City. These execution facilities offer our customers immediate trade execution and price transparency and are supported by substantial infrastructure and technology for order routing, trade reporting, market data dissemination and market surveillance and regulation. In addition, trades can be executed through privately negotiated transactions that are cleared and settled through our clearing house.
Electronic Trading. Our CME Globex electronic trading platform maintains an electronic, centralized order book and trade execution algorithm for futures contracts and options on futures contracts and allows users to enter orders directly into the order book. In 2009, 81% of our average daily trading volume was executed electronically, compared with 80% in 2008. During 2009, approximately 72% of our clearing and transaction fees revenue was derived from electronic trading.
Open Outcry Trading. We also offer our members the ability to execute transactions in an open-auction format on our trading floors—a centralized meeting place for traders and floor brokers to trade our products. Orders by market participants not physically located on the trading floor are communicated to floor brokers. Current market information and news are displayed on wallboards hung above the trading pits. In the second quarter of 2008, we integrated the CME and CBOT trading floors at one location at 141 West Jackson Boulevard in Chicago. As a result of our acquisition of NYMEX, we now operate open outcry trading in New York City at One North End Avenue. We completed the integration of the NYMEX and COMEX trading floors into one floor in the second quarter of 2009. During 2009, approximately 11% of our clearing and transaction fees revenue was derived from open outcry trading.
Privately Negotiated and Over-the-Counter Transactions. In addition to offering traditional open outcry and electronic trading through the CME Globex platform, we permit qualified customers to trade our products by entering into privately negotiated transactions, which are reported and included in the market data we distribute. We also clear, settle and guarantee these transactions through our clearing house and CME ClearPort. These transactions provide our customers with the flexibility to negotiate their own prices, trade a wide array of financial and commodity products, and still take advantage of our financial safeguards. During 2009, approximately 17% of our clearing and transaction fees revenue was derived from this type of trading.
We own and operate our clearing house—CME Clearing—that clears, settles and guarantees every futures and options contract traded through our exchange, in addition to over-the-counter products cleared through CME ClearPort and credit default swap contracts. Our integrated clearing function is designed to ensure the safety and soundness of our markets. Ownership and control of our own clearing house also enables us to retain the revenue associated with both the trading and clearing of our products. By owning our clearing house, we control the cost structure and the technology development cycle for our clearing services. It helps us manage our new product initiatives without being dependent on an outside entity. It also benefits our customers by creating operational, risk management and product benefits. Additionally, owning our own clearing house allows us to generate additional revenue by providing clearing services to other exchanges.
In 2009, our clearing house cleared an average of 10.3 million contracts daily and 2.6 billion contracts overall. As of December 31, 2009, we maintained approximately $83.7 billion in cash, investments and letters of credit related to performance bonds, security deposits and other collateral deposited by our clearing firms and, during 2009, we transferred an average of approximately $3.0 billion a day in settlement funds through our clearing system. In addition, our clearing house guarantees the performance of all our contracts with a financial safeguards package of approximately $9.3 billion (as of December 31, 2009). During 2009, we submitted an application to the Financial Services Authority to become a UK Recognised Clearing House. Based on growing demand for centrally cleared solutions in global financial markets, our efforts to launch CME Clearing Europe are intended to provide greater efficiencies to our European customer base during local market hours. The EMEA region has been a significant source of growth for our business, and we have experienced volume growth during non-U.S. trading hours. As part of our global growth strategy, CME Clearing Europe will help to extend the safety and security of central counterparty clearing to our European clients, both through our initial offering of credit default swaps clearing and additional locally relevant products we plan to offer in the future.
The clearing function provides three primary benefits to our markets: a reliable credit guarantee; efficient, high-volume transaction processing; and cost and capital efficiencies. The services we provide can be broadly categorized as follows:
• market protection and risk management;
• transaction processing and position management;
• settlement, collateral and delivery services;
• cross-margining and mutual offset services; and
• investment services.
Market Protection and Risk Management. Our clearing house guarantee of performance is a significant attraction, and an important part of the functioning of our exchange.
Central counterparty guarantee. Because of this guarantee, our customers do not need to evaluate the credit of each potential counterparty or limit themselves to a selected set of counterparties. The benefits of centralized clearing have been made even more apparent during the recent period of financial uncertainty. Although not a guarantee of future performance, in our more than 100 year history of trading, we have never had a default or a loss of customer funds resulting from the failure of a clearing firm.
Performance bond requirements. Performance bonds are deposits that must be made by our clearing firms to ensure that they can cover potential losses in connection with their trading positions. Performance bonds are calculated by our Standard Portfolio Analysis of Risk (SPAN) system that is used by approximately 50 exchanges and clearing organizations around the world. SPAN evaluates overall portfolio risk by calculating the worst possible loss that a portfolio of derivative and physical instruments might reasonably incur over a specified time period (typically one trading day). This is done by computing the gains and losses that the portfolio would incur under different market conditions. Additionally, the substitution of our clearing house as the counterparty to every transaction allows our customers to establish a position with one party and then offset the position with another party. This contract offsetting process provides our customers with flexibility in establishing and adjusting positions and provides for performance bond efficiencies.
Twice daily mark-to-market process. At each settlement cycle, our clearing house values, at the market price prevailing at that time, or marks-to-market, all open positions and requires payments from clearing firms whose positions have lost value and makes payments to clearing firms whose positions have gained value. Our clearing house marks-to-market all open positions at least twice a day, and more often if market volatility warrants. In select circumstances where CME has introduced clearing services to newer markets, positions are market-to-market daily, with the capability to mark-to-market more frequently as market conditions warrant. Marking-to-market provides both participants in a transaction with an accounting of their financial obligations under the contract. Having a mark-to-market cycle of a minimum of two times a day helps protect the financial integrity of our clearing house, our clearing firms and market participants. This allows our clearing house to identify quickly any clearing firms that may not be able to satisfy the financial obligations resulting from changes in the prices of their open contracts before those financial obligations become exceptionally large and jeopardize the ability of our clearing house to ensure performance of their open positions. This transparency makes it difficult for traders to hide losses or disguise unusual profits.
Segregation of customer funds. Regulations require our clearing firms to separately account for and segregate customers’ positions and monies from their own (requirements that also extend to CME Clearing). If a clearing firm becomes financially unstable or insolvent due to a financial issue, a customer’s funds held in such a segregated account (provided the customer is not involved in the financial issue itself) will not be subject to the clearing firm’s creditor claims. In situations where a clearing firm were to become insolvent, the customer accounts could be transferred to another clearing firm.
Twenty-four hour monitoring by risk management team. In order to ensure performance, we establish and monitor financial requirements of our clearing firms. We employ more than 100 employees who use a variety of sophisticated tools to observe risk in our markets 24 hours a day, six days a week. These employees work closely with other teams across the organization in products and services, legal and market regulation as well as with our clearing firms to help our customers manage risk during periods of economic uncertainty.
Multi-billion dollar safeguards package. CME Clearing’s approximately $9.3 billion financial safeguard system (as of December 31, 2009) is designed for the benefit and protection of both clearing members and their customers and is described in more detail on page 84 of “Item 7A. Quantitative and Qualitative Disclosures about Market Risk.”
Credit default swaps margining. In connection with our provision of clearing services for the credit default swap market, we modified our framework to address the unique characteristics of these products. In addition to our traditional risk management procedures described above, we use a multi-factor model for margining designed to address the risk factors relating to these products.
Transaction Processing and Position Management. Our CLEARING 21 system processes reported trades and positions on a real-time basis, providing users with instantaneous information on trades, positions and risk exposure. CLEARING 21 is able to process trades in futures and options products, securities and cash instruments. CLEARING 21 can also support complex new product types. Through CLEARING 21 user interfaces, our clearing firms can electronically manage their positions, exercise options, enter transactions related to foreign exchange deliveries, manage collateral posted to meet performance bond requirements and access all of our other online applications. Together with our order routing and trade matching services, we offer straight-through electronic processing of transactions in which an order is electronically routed, matched, cleared and made available to the clearing firm’s back-office systems for further processing.
Settlement, Collateral and Delivery Services. We manage final settlement in all of our contracts, including cash settlement, physical delivery of selected commodities, and option exercises and assignments. Because some initial and maintenance performance bonds from clearing firms, as well as mark-to-market obligations on some of our contracts, are denominated in various foreign currencies, we offer multi-currency performance bond and settlement services.
Generally, although most of our futures contracts are liquidated before the expiration of the contract, the underlying financial instruments or commodities for the remainder of the contracts must be delivered or cash settled. We act as the delivery agent for all contracts, ensuring timely delivery by the seller of the exact quality and quantity specified in a contract and full and timely payment by the buyer.
To administer its system of financial safeguards efficiently, our clearing house has developed banking relationships with a network of major U.S. banks and banking industry infrastructure providers, such as the Society for Worldwide Interbank Financial Telecommunications. Among the key services provided to our clearing house by these banks and service providers are a variety of custody, credit and payment services that support the substantial financial commitments and processes backing the guarantee of our clearing house to market participants.
Cross-Margining and Mutual Offset Services. Cross-margining arrangements reduce capital costs for clearing firms and customers. These agreements permit an individual clearing house to recognize a clearing firm’s open positions at other participating clearing houses, and clearing firms are able to offset risks of positions held at one clearing house against those held at other participating clearing houses. This arrangement reduces collateral deposits by the clearing firm. For example, our cross-margining program with the Options Clearing Corporation, which celebrated its 20th anniversary in 2009, reduced performance bond requirements for our clearing members by an average of approximately $2.2 billion per day utilized in 2009. We have implemented cross-margining arrangements with the Fixed Income Clearing Corporation. We also previously had an arrangement with LCH.Clearnet Group for positions at the London International Financial Futures and Options Exchange Limited that were cleared through LCH.Clearnet Group. This arrangement was terminated in February 2010. In addition, our mutual offset agreement with the Singapore Exchange Limited allows a clearing firm of either exchange initiating trades in certain products on either exchange to execute after-hours trades at the other exchange in those products and then transfer them back to the originating exchange. This mutual offset arrangement enables firms to execute trades at either exchange virtually 24 hours per day.
Investment Services. In order to achieve collateral efficiencies for our clearing firms, we have established a number of collateral programs under the designation Interest Earning Facility. Under this program, our clearing firms may select from different programs to meet their individual needs. The programs are designed to enable our clearing firms to make optimal use of the demand deposit cash accounts and security accounts they have established to satisfy their performance bond requirements. We earn fee income in return for providing these value-added services to our clearing firms.
Our clearing house launched a securities lending program in 2001 using a portion of certain securities deposited to meet the proprietary performance bond requirements of our clearing firms. Under the securities lending program, we would lend a security to a third party and receive collateral in the form of cash. The majority of the cash was then invested to generate interest income. The related interest expense represented payment to the borrower of the security for the cash collateral retained during the duration of the lending transaction. Securities on loan were marked-to-market daily and compared to collateral received. In 2008, we suspended the program due to high volatility in the credit markets. We continue to monitor the credit markets on a regular basis and may restart the program when conditions are appropriate.
Our operation of both electronic and open outcry trading facilities and a clearing house has influenced the design and implementation of the technologies that support our operations.
Trading Technology. We have a proven track record of operating successful electronic and open outcry markets by developing and integrating multiple, evolving technologies that support a growing and substantial trading volume. The integrated suite of technologies we employ to accomplish this has been designed to support a significant expansion of our current business and provides us with an opportunity to leverage our technology base into new markets, products and services.
As electronic trading activity expands, we continue to provide greater match engine functionality unique to various markets, market models and product types. We have adopted a modular approach to technology development and engineered an integrated set of solutions that support multiple specialized markets. We continually monitor and upgrade our capacity requirements. Our goal is to design our systems to handle at least one-and-a-half times our historical peak transactions in our highest volume products. Significant investments in production planning, quality assurance and certification processes have enhanced our ability to expedite the delivery of the system enhancements that we develop for our customers. We continue to implement technology upgrades that provide speed and functionality enhancements. Also, our proposed transaction with BM&FBOVESPA will further expand the breadth of our technology and distribution capabilities into the global cash equities and options markets. The new platform will offer customers an integrated technology solution and we along with BM&FBOVESPA will have the ability to license the platform to other exchanges internationally.
Speed, reliability, scalability, capacity and functionality are critical performance criteria for electronic trading platforms. A substantial portion of our operating budget is dedicated to system design, development and operations in order to achieve high levels of overall system performance. In 2009, we continued our efforts to grow and enhance our electronic trading capabilities. For example, we successfully deployed additional functionality which provides an easy and intuitive interface that allows our customers to quickly enter and execute complex options strategies. Additionally, in 2009, we completed the construction of our new Globex Control Center and Technology Operations Command Center. The state-of-the-art facility brings the Globex Control Center, technology operations and all our other critical support teams together in one space at 20 South Wacker Drive. Bringing these teams and functions together will ensure efficient and coordinated communications, proactive monitoring of markets and systems, and timely incident crisis management. Among its critical capabilities, the facility provides 24-hour monitoring of our global technology infrastructure and market operations; global news and market information; and geographic mapping of incoming customer calls. We also maintain remote data facilities to provide additional system capacity and redundancy for our trading and clearing technology. Our data centers support our customer interfaces, trading and execution systems, as well as clearing and settlement operations. In 2010, our production electronic trading environment will be operational in our third data center.
Following our mergers with CBOT Holdings and NYMEX Holdings, we now own and manage real estate, with approximately 1.5 million square feet of commercial space in the central business district of Chicago and approximately 500,000 square feet in downtown New York City. As of December 31, 2009, our real estate was approximately 94% occupied, with nearly 38% of the total space used by us. In the second quarter of 2009, we completed consolidation of the NYMEX and COMEX trading floors located at One North End Avenue in New York City.
Tenants pay market rates for rent. The majority of tenant leases have terms of one to five years, with large tenants generally having leases for up to fifteen years. As of December 31, 2009, the largest tenant in Chicago, other than us, leased approximately 9% of the total area and the next five largest tenants leased about 14% of the total area. In New York City, the largest tenant leased approximately 12% of the total area. We manage both the real estate and the general services relating to our real estate such as cleaning, power and telephone services. Building services generated about 1% of our total revenues in 2009.
Business Continuity Planning
We continue to strengthen and upgrade our disaster recovery facilities and capabilities. We have dedicated significant resources to improve our continuity planning. For example, our disaster recovery infrastructure and activities include:
• Formal disaster recovery testing conducted twice a year at each of our data centers.
• Network disaster recovery testing conducted monthly.
• Participation in an annual industry-wide disaster recovery test sponsored by the Futures Industry Association.
• Bi-annual functional exercises utilizing remote access to our systems with employees responsible for our critical business unit procedures.
Additionally, in order to ensure proper coordination during a potential crisis, we have established relationships with the local business community, law enforcement, and local and regional governmental emergency agencies as well as our regulators.
In 2010, our production electronic trading environment will be operational in our third data center, further enhancing our disaster recovery facilities.
We continually review our growth strategy and whether it is in the interests of our shareholders to engage in discussions with other parties regarding various strategic acquisitions, partnerships, divestitures and other arrangements and alliances. The following is a summary of our key strategic relationships:
BM&FBOVESPA. To increase liquidity and expand the international market for our customers, we have established a partnership with BM&FBOVESPA, the leading exchange in Latin America. Pursuant to an order routing agreement, its products can be traded by participants connected to our CME Globex platform, and our products can be traded by participants connected to BM&FBOVESPA’s Global Trading System platform. We currently own an equity stake of approximately 5% in BM&FBOVESPA and it owns an equity stake of approximately 1.8% in us. On February 11, 2010, we announced a non-binding letter of intent with BM&FBOVESPA to expand our existing strategic partnership to develop a new multi-asset class electronic trading platform that will be deployed by BM&FBOVESPA for use in its own cash equities and derivatives markets, and both of us will have the ability to license the platform to other exchanges internationally. The new platform will offer customers an integrated technology solution for global derivatives and non-U.S. equities trading. We have agreed to an exclusive negotiation period to enter into definitive agreements. Development of the new system will begin immediately and is expected to launch in early 2011. As part of the expanded partnership, BM&FBOVESPA will increase its ownership interest in us to 5%, the same approximate stake we currently have in BM&FBOVESPA. Consummation of the transaction is subject to the negotiation of definitive agreements, approval by the regulators, completion of customary closing conditions and BM&FBOVESPA shareholder approval. In connection with the proposed transaction, our board authorized a plan to repurchase up to 2.35 million shares of our Class A common stock. We also agreed to nominate a senior representative of BM&FBOVESPA to our board in connection with the closing of the transaction.
Bursa Malaysia Derivatives. In 2009, we acquired a 25% equity stake in Bursa Malaysia Derivatives and also entered into a trade matching services agreement and a product licensing agreement. Pursuant to these agreements, we will provide CME Globex services to Bursa Malaysia for all of its derivatives products. We also will have the right to use its crude palm oil futures settlement prices to develop our own U.S. dollar denominated contract. An additional telecommunications hub is planned for Kuala Lumpur in the first half of 2010. The partnership will also further enhance our globalization efforts by facilitating our customers’ access to its important markets and will increase our presence in Asia.
Dubai Mercantile Exchange. We own an approximate 28% interest in the Dubai Mercantile Exchange. In February 2009, DME futures contracts became exclusively traded electronically on our CME Globex platform. The listing of the DME Oman crude oil futures contract on CME Globex further enhances the value proposition of DME as they seek to establish Oman crude oil—which is currently used to establish the pricing of oil shipped from Oman and Dubai—as the leading world benchmark for pricing East of Suez crude oil shipments.
Green Exchange Venture. Green Exchange Holdings LLC is a joint venture among CME and a consortium of banks and brokers. The Green Exchange venture plans to take over a number of products currently listed on NYMEX once it receives regulatory approval to operate as a designated contract market. Current products listed on NYMEX include futures and options on European Union Allowances, carbon allowances tied to the Regional Greenhouse Gas Initiative, and other greenhouse gas markets.
Korea Exchange. In 2008, we finalized our five-year agreement with the Korea Exchange to list the KOSPI 200 futures contract on CME Globex during after-hours trading in Korea. Trading began in November 2009. As part of the agreement, we created a telecommunications hub in Seoul. We are also committed to pursue with the Korea Exchange a potential bi-directional order routing initiative that would be modeled after our arrangement with BM&FBOVESPA.
Singapore Exchange Limited. In October 2006, we renewed our mutual offset agreement with the Singapore Exchange for an additional three-year term with automatic renewals for one year each unless terminated by either party. The current term is through October 2010. This relationship, which has been in effect since 1984, allows a clearing firm of either exchange initiating trades in certain products on either exchange to execute after-hours trades at the other exchange in those products, then transfer them back to the originating exchange.
As a result of our merger with CBOT Holdings, we also list the products of the Minneapolis Grain Exchange and the Kansas City Board of Trade on the CME Globex platform and act as their sole distributor of market data.
As of December 31, 2009, we had approximately 2,260 employees.
We consider relations with our employees to be good. We have never experienced a work stoppage. As of December 31, 2009, 14 of our employees were represented by one of the following unions:
• Chicago Regional Council of Carpenters; and
• International Union of Operating Engineers Local 399, AFL-CIO.