Potential CME-NEX Deal Is Full of History, Dilemma, Risk and Reward

John Lothian

John Lothian

Executive Chairman

For many years, the Chicago Board of Trade had cash treasuries envy, wanting to add the trading of cash treasury bonds and notes to its offerings. For many years, the CME has had cash currency trading envy.

Both exchanges, now part of the CME Group, have tried to compete in cash Treasury and FX through various collaborations and initiatives. None of them succeeded.

Chicago Board Brokerage and FXMarketSpace are long gone, but the desire to add treasuries and cash FX trading has never disappeared.

Now, if CME Group’s confirmed interest in NEX Group becomes a deal, it can add both in a single deal that will give them a major FX platform in EBS and a dominant U.S. Treasury market in Brokertec.

Ten years ago, adding both would have been a huge strategic win. It would be the kind of move that would get validation from management gurus and investment bankers everywhere.

Today though, this great synergistic move misses the biggest risks facing the CME Group. Many consider the CME Group to be a monopoly and the forces at work today are targeting that dominant position with new technologies for trading and clearing of products.

The CME Group should perhaps be looking more to the future rather than finally getting a long desired deal done from their past.

This is a classic case of the innovator’s dilemma (See Clayton Christensen’s book, “The Innovator’s Dilemma”). The CME is doing everything right, but a disruptive technology is approaching, although it is not quite developed enough to pose a threat today. However, distributed ledger technology and machine intelligence are attracting so much investment worldwide and so many use cases are being studied or increasingly tried, that they will pose a threat to the CME’s business soon enough.

Currently, distributed ledger technology is not good enough today to replace the CME Group’s clearing business. It is not fast enough, for one, just as personal computers were not powerful enough to replace mainframe computing – that is, until they were.

A CME Group/NEX deal makes a lot of sense for today’s environment. Back in November 2016, word broke that the CME was working on a merger with Intercontinental Exchange. At the time, antitrust concerns derailed the deal. But that decision was made when Hillary Clinton was expected to become the next U.S. president.

Instead, Donald Trump became president and the dynamics impacting antitrust in the U.S. Department of Justice brightened prospects of getting the deal done. And then with former Goldman Sachs executive Gary Cohn in the White House the outlook improved further.

It appeared to me the CME Group still had ambitions for the ICE deal, as many of the moves they made after November 2016 – now with CEO Terry Duffy solely in charge – seemed to make an ICE deal more likely to pass antitrust concerns.

Close down the clearinghouse in London, check. Get out of the CDS business in the U.S., check.

This theory even made sense when ICE did not jump into the bitcoin futures competition in December against the CME and Cboe.

Conversely, there are good reasons for the CME’s moves under the leadership of Duffy.

However, with the chaos in D.C. and Cohn gone from the White House, it makes sense for the CME Group to pivot to another deal with a higher probability of success.

From NEX founder and CEO Michael Spencer’s standpoint, it could be argued his deal to sell the voice brokering business to Tullett Prebon helped him shape NEX into a configuration that would fit better with one of the leading exchanges focused on electronic trading. Selling the pieces the futures giants did not want before a deal should have Spencer getting better prices for both deals.

Now all the plans are coming together. CME Group is getting what it always wanted, and Spencer gets to cash out with a sale of NEX before new technologies change the current trading and clearing paradigm. Spencer is then well positioned as a venture capitalist in the new environment.

Dominant market positions, or even monopolies, are good and very profitable for those that have them, but they don’t last forever. The question with this deal is how long does the CME Group have before distributed ledger technology changes its world.

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