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Chicago Futures Exchanges Uniting in $8-Billion Deal

The parent of the Merc agrees to buy the Board of Trade as a joint niche, derivatives, expands.

October 18, 2006|Walter Hamilton | Times Staff Writer

The nation's two largest futures exchanges announced plans Tuesday to join forces in an $8-billion deal that reflects the growing role of trading in complex financial instruments tied to interest rates, foreign currencies and even the weather.

Under the deal, the parent company of the Chicago Mercantile Exchange will buy the holding company that runs its longtime rival, the Chicago Board of Trade. The acquisition is part of a wave of consolidation in financial markets, as securities exchanges seek to cut costs, expand product offerings and fortify themselves against global competition.

Both of the institutions involved in Tuesday's deal specialize in derivatives, which are known by that moniker because their values are derived from the value of other securities or factors such as interest rates.

Derivatives have soared in popularity among big investors such as hedge funds because of their potential to pay bigger returns than stocks do, and without a long wait. Corporations also use derivatives to limit their risk from unforeseen changes in business conditions.

"The derivatives market is growing much faster than the equities market, and it's more profitable," said David Easthope, an analyst at Celent, a Boston-based financial research firm. "This creates the biggest derivatives powerhouse that there is."

Both exchanges lie at the heart of Chicago's close-knit financial community. Their trading floors, like the New York Stock Exchange's, are filled with traders who wear multihued jackets and scream and gesticulate at each other.

Each exchange was founded in the 1800s as an agricultural marketplace. Farmers and merchants met to swap futures contracts for livestock and grains, in which they agreed to buy or sell commodities at predetermined prices in the future.

The exchanges still trade futures on such commodities, but each began branching out in the 1970s into derivatives tied to foreign currencies and prices on U.S. Treasury bonds.

U.S. and foreign companies use derivatives to cut their risks from adverse shifts in foreign exchange rates or other market conditions. Derivatives are most commonly based on interest rates, because even minor rate swings can upset a corporate bottom line, experts said.

"Interest-rate futures are where the CME and the CBOT have always shined and will now shine brighter," said Michael Pagano, an associate finance professor at Villanova University's School of Business.

But there are growing markets in other kinds of derivatives, including instruments tied to the weather, which can affect business performance in many ways.

For example, weather-related derivatives allow energy companies to hedge against losses that they may suffer from storms in an offshore drilling area, or help retailers protect themselves against a downturn in sales caused by snowstorms in the Northeast.

The use of derivatives has soared in part because of speculative trading by hedge funds, investment pools that seek fast profits in global markets.

The complexity and rapid growth of derivatives have raised concerns about the potential destabilizing effect on security markets in the event of an exogenous financial shock.

Nevertheless, their popularity has stoked enormous gains in the share prices of the two companies. CBOT Holdings Inc., the parent company of the Board of Trade, went public a year ago at $54. It soared $17.48, or 13%, Tuesday to $151.99.

Chicago Mercantile Exchange Holdings Inc. has fared even better. Since going public in December 2002 at $35, it has surged more than fourteen-fold. It rose $13.25 on Tuesday to $516.50.

"This merger takes us to the next level in the evolution of our high-growth business," said Terry Duffy, the Chicago Merc's chairman.

Under the deal, Chicago Mercantile Exchange Holdings would acquire CBOT Holdings for $8 billion in stock, up to $3 billion of which could be paid in cash if shareholders preferred greenbacks. The resulting entity, CME Group Inc., would have a market capitalization of more than $25 billion.

Chicago Merc shareholders would own 69% of the new company, with Board of Trade shareholders controlling 31%. The transaction is expected to be completed by mid-2007.

The deal, which is subject to shareholder and regulatory approval, calls for the Chicago Merc to close its trading floor and consolidate operations at the Board of Trade.

The companies employ nearly 2,200 people. Executives declined to say whether there would be layoffs, but they predicted the deal would generate $125 million in cost savings.

Leo Melamed, chairman emeritus of the Chicago Merc who now owns a financial consulting firm, said the deal would help the city in the long run.

"It's going to bring new jobs and business here," he said.

Analysts say the combination could benefit mutual funds and other big investors if trading volumes increase and it becomes easier to complete trades at desired prices. However, these customers could suffer if the new market were to take advantage of its size by raising trading fees.

The combination also could affect some small investors. The Chicago Merc trades a futures contract known as the E-mini that lets small investors wager on the direction of the Standard & Poor's 500-stock index.



Begin text of infobox

Chicago combo

Here are the highlights of the deal announced Tuesday for Chicago Mercantile Exchange to acquire Chicago Board of Trade, above.

* The combined entity, to be called CME Group Inc. would be valued at $25 billion based on current stock prices.

* The Chicago Merc would close its trading floor and move its operations to the Board of Trade.

* The companies employ 2,200 people. Executives decline to address potential layoffs but project $125 million in cost savings.

* The deal is expected to close in mid-2007 pending shareholder and regulatory approvals.


Source: Times research

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