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The TED Spread Soap Opera

The CME announces a new plan to trade cash Treasuries, linking with the CBOT’s former partners.

By Robert Hunter

Like the 100 Years War, the century-long saga of the Chicago futures exchanges has followed a general pattern: long periods of internecine battle peppered occasionally with clenched-teeth rapprochement. Lately relations had resembled the latter—until last month, when the Merc sparked another full-fledged conflagration.

On July 1, the Merc announced that it planned to launch the Traders’ Instant Treasury Access Network (TITAN) this fall, to allow exchange members to trade cash Treasury bonds on the exchange floor. The Merc struck an agreement with Liberty and Cantor Fitzgerald to provide the trading systems, the technology and, the Merc hopes, the liquidity. Merc officials expect TITAN to increase the liquidity of its strongest product, the eurodollar contract, by enabling members to play the Treasury-eurodollar (TED) spread right on the exchange floor, enjoying dealer prices. Ironically, in late 1995 the Merc changed contract rules to effectively halt Liberty’s TED spread business.

The CBOT is far from giddy about the news. Earlier this year, it announced finalized plans for the Chicago Board Brokerage, the exchange’s cash Treasury trading partnership with Prebon Yamane. The CBOT had begun planning the CBB in 1995, and originally Liberty and Cantor Fitzgerald were part of the mix. But Liberty quickly backed out, and Cantor eventually followed, leaving the CBOT partnerless until Prebon came into the fold. Meanwhile, Cantor joined with the New York Cotton Exchange to form the Cantor Fitzgerald Futures Exchange (CFFE), an all-electronic exchange that will trade Treasury futures on its proprietary cash Treasury system pending Commodity Futures Trading Commission approval. Suddenly, the CBOT and Cantor had become rivals—Cantor for the CBOT’s Treasury futures business and the CBOT for Cantor’s cash Treasury business.

“There was never a discussion of trading Treasury futures, never an intention of that, and if we were offered such a proposition, we would have no interest.”
Fred Arditti
senior executive vice president
for planning and development,
Chicago Mercantile Exchange

High costs for CBB, as well as huge expenditures on a new trading facility and the Dow Jones Industrial Average product suite, left the CBOT fiscally challenged. In late March, during a particularly fruitful period in ongoing common-clearing negotiations, CBOT chairman Pat Arbor publicly offered the Merc an equity stake in the CBB, promising to give the Merc full access to CBB products. The Merc declined, and the CBOT has since floated the idea of taking the CBB public for a quick cash infusion. Common-clearing plans, however, remained on track.

In this context, the news of the TITAN system came as a shock to the CBOT, especially given the Merc’s history with Liberty and the positive relations the two exchanges had enjoyed of late. The move underscores the desperation both exchanges are feeling. Faced with the real possibility that electronic trading will render the pits obsolete, both exchanges have been taking aggressive steps to hold onto liquidity. The CBOT, in fact, is said to be planning to begin side-by-side electronic trading of all its products by September.

The Merc’s move sent a ripple of fear throughout the CBOT, which immediately wondered how long it would be before the Merc began trading Treasury futures. Chairman Pat Arbor publicly questioned whether the exchange would follow through on common clearing, which was to be put before the CBOT board on July 8. The Merc says the CBOT is overreacting. “The CBOT should not be concerned,” says Fred Arditti, senior executive vice president for planning and development at the Merc. “We’re not trading futures on Treasuries. There was never a discussion of that, never an intention of that, and if we were offered such a proposition, we would have no interest.”

But competitiveness aside, the Merc’s decision to partner with a clear CBOT rival came as a slap in the face to the CBOT. Upping the dramatic ante of the entire spectacle, Cantor began court proceedings in Delaware to stop the CBB from using the MarketPower trading system, the backbone of the project. The technology that forms the basis of MarketPower had been developed by Cantor for proprietary use, but an ugly settlement following the death of B. Gerald Cantor, the firm’s founder, left the MarketPower project in the hands of Iris Cantor, Gerald Cantor’s widow. Embittered by the legal battle, Iris Cantor sold the MarketPower technology to the CBB. On July 12, Delaware Chancery Court rejected Cantor’s claim of irreparable injury, clearing the way for the introduction of MarketPower. Beta testing began that same day.

With such acrimony swirling, most expected the CBOT board to reject the common-clearing proposal on July 8. But in a stunning turn of events, it passed. Some Merc bashers believe the CBOT had no choice in light of the Merc’s Machiavellian tactics. It has long been speculated that, for a variety of reasons, the Merc had no real interest in common clearing. By linking with Cantor, and announcing the decision a mere week before the CBOT common-clearing vote, the Merc could, in one fell swoop, improve its competitive position with the CBOT, effectively sink the common-clearing proposal and then blame the CBOT for the initiative’s failure. And once the CBOT-Merc common-clearing proposal was dead, the Merc could strike a common-clearing proposal with the NYCE, a partner in the CFFE, thereby creating a powerful synergy in Treasury cash and futures products. For all those reasons, conspiracy theorists say, the CBOT had little choice but to go on with common clearing.

But the Merc says there was only one objective to TITAN: to bring new liquidity quickly. “This industry is in a critical phase in its lifeline,” says Arditti. “We don’t have a lot of time to develop a completely new enterprise to bring further liquidity to the pit by developing our own bond-trading vehicle. If anybody can bring us even more liquidity—trades at the best prices and the best financing rates—Liberty and Cantor can. If we had three to four years and the luxury of no competition, maybe we would have gone exclusively with the CBB.”

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