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Futures Markets Update. Julie Winkler March 25, 2009. Outline . Background on CME Group and Product Development Process Current Market Landscape Developments in Commodity Markets New Developing Markets - Emissions markets Career Opportunities. CME Group Overview.

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futures markets update

Futures Markets Update

Julie Winkler

March 25, 2009

outline
Outline
  • Background on CME Group and Product Development Process
  • Current Market Landscape
  • Developments in Commodity Markets
  • New Developing Markets - Emissions markets
  • Career Opportunities
cme group overview
CME Group Overview
  • #1 derivatives exchange in the U.S. and globally by 2008 volume
  • Founded in 1898
  • 2008 Pro Forma(1) Revenue of $3.1bn
  • Strong record of growth, both organically and through acquisitions
    • CBOT Holdings (2007)
    • NYMEX Holdings (2008)
  • Deep liquidity in futures and options
    • Execution and clearing services for interest rates, equities, energy, commodities, FX, metals
  • Worldwide distribution through CME Globex
  • Proven CME Clearing
    • Listed futures and options
    • OTC products via CME ClearPort
  • In this presentation, pro forma results for CME Group assume the acquisitions of CBOT and NYMEX were completed as of the beginning of the period presented. See the CME Group Inc. Reconciliation of GAAP to Pro Forma Non-GAAP Measures available on our Web site under the Investor Relations section for detail related to the adjustments made to reach the pro forma results.

3

slide4

Diverse Product Portfolio and Customer Base

Diverse Products

Diverse Customers Managing Risk

  • Customers, utilizing a wide range of trading goals and strategies for both hedging and speculating, include:

Q4 2008 Pro Forma Revenue Mix

Foreign Exchange

4%

Commodities & Other

7%

Proprietary trading firms, primarily algorithmic

Equities

28%

34%

Proprietary trading of banks and investment banks

Energy

21%

16%

Notes and Bonds

10%

Top 25 Hedge Funds

8%

Other - includes smaller member firms and individual traders

22%

Metals

3%

Eurodollars

9%

  • Non-members, including:
  • Pension funds
  • Index funds
  • Long-only mutual funds
  • Insurance companies
  • Corporates
  • Active individual traders

Quote Fees

13%

Other Revenue

5%

20%

  • All five segments had a reduction in trading activity from Q308 to Q408, but the proportion of the segments remained relatively stable
  • Of the five segments, the non-member segment dropped the least and the hedge funds dropped the most from Q308 to Q408

Note: Customer segmentation percentages are Q408 estimates and reflect legacy CME and CBOT products only

4

overview of cme group research product development rpd
Overview of CME Group Research & Product Development (RPD)
  • Historically CME Group’s primary product development efforts were for exchange listed products on CME Globex and floor
  • Changing marketplace has sparked need for innovation in clearing only offerings for the OTC market like Cleared Interest Rate Swaps and Credit Default Swaps
  • RPD Team has responsibility for global product development for all CME Group asset classes: Commodities, Energy, Metals, Interest Rates and Credit, Equity Indexes, FX, Alternative Products, and Environmental Products for Green Exchange
  • There are 30 RPD resources currently located in Chicago, New York, London, and Singapore to facilitate new product development, maintenance of our existing product suite, and general research and educational needs for our customers and employees
overview of product development process for exchange traded offerings
Overview of Product Development Process for Exchange Traded Offerings
  • New Product Idea
    • Comes from study of security, commodity and OTC market trends
    • Input received from members, customers, independent innovators, index providers, partners, other staff, anywhere
  • Stage 1: Product Assessment completed by RPD
  • If “Go”, then RPD completes Stage 2: Feasibility Study
  • If “Go”, then proceed with internal and external approval process (CFTC or other regulator, if required)
  • RPD and Sales business owners proceed with marketing launch and internal technical setup process for New Product
  • Launch of New Product
  • Post-launch marketing and product support/modification
key questions when developing new products
Key Questions When Developing New Products
  • Product Design
    • Develop a design which addresses market characteristics, delivery and trading issues
    • Generally prefer deliverable contract to keep it “honest,” but do often resort to cash settlement
    • Identify clear industry standards already in use and mirror futures contract after these standards; this will help foster acceptance of product
  • Market Description
      • Ideally looking for a large, competitive cash market
      • Market size, in outstanding value or turnover, is obvious criteria albeit without hard standards
      • Positive trends in size and turnover of interest (growing market size with increasing turnover of interest)
      • Market structure broadly categorized as competitive, oligopolistic, monopolistic
      • Presence of many prospective natural buyers and sellers is ideal
      • Volatility produces speculative opportunity and need to hedge
      • Ideal market incorporates long-term trends and significant intra-day ranges
key questions cont
Key Questions (cont.)
  • Product Alternatives
      • Identify related products that with high correlations that can be used as a cross-hedge
      • Basis risks, liquidity of alternate hedge vehicles
  • Customer Evaluation
    • Survey and assess customer demand by conducting trade calls with different types of potential customers (ideally 5-10 calls)
    • Standardize survey questions so everyone is making the inquiries in the same way
    • Document the research efforts so you can identify what participants have the most interest and are likely to be earlier adopters
    • Identify willing market makers to provide two-sided quotes
  • Strategic Positioning
    • Consider experience of other exchanges, OTC competition, etc. and how that impacts this product introduction
    • Evaluate if this new product supports an exchange strategic initiative
uncertain macroeconomic environment in 2009
Uncertain Macroeconomic Environment in 2009

ADV trending up so far in Q1 2009

CME Group Pro Forma ADV by Month

Opportunities

(round turns in millions)

  • Significant Treasury debt issuance
  • Stabilization in credit, mortgage and corporate debt markets
  • Redeployment of capital
  • High, but moderating volatility levels
  • Customer recognition of the value of CME Group services

10.8

To Date

  • Average daily volume across all product lines up from January 2009 to February 2009 to date

FX up 10%

Commodities/Alt. Inv. Up 21%

Energy/Metals up 10%

Interest Rates up 15%

E-mini Equities up 14%

Equity Standard up 14%

current perceptions
Current Perceptions

“ All markets need more transparency.”

“ Markets would be safer if they were all on a regulated exchange.”

“ OTC markets are opaque and risky.”

“ In 1994 we sounded a number of clear warnings …to assure this rapidly growing [OTC] market did not result in systemic problems for our economy.”

“ OTC markets have had dire consequences… in contrast our markets have been a net positive for the economy.”

“superiority”

“ OTC markets can be fixed with several key changes.”

“ We were right then and we are right now.”

“ Banks key to CDS delay”

plain vanilla credit default swap cds
Plain Vanilla Credit Default Swap (CDS)
  • Protection Buyer (PB) agrees to make quarterly payments to the Protection Seller (PS). In exchange for this quarterly “swap” payment, the PB establishes the right to sell the reference obligation (e.g., a bond or note) issued by a reference entity (e.g., a corporation or a sovereign entity) to the PS at the agreed upon notional value frequently established at par, if a credit event should occur.
  • PB is reducing or hedging the credit risk component of the reference bond by transferring the credit risk to the PS. The PB’s asset remains subject to non-credit related elements of market risk.
key constituents in the financial markets
Key Constituents in the Financial Markets

Many players which are part of the global financial eco-sphere, which are key to the trade facilitation process and functioning of our financial markets.

Prime

Brokers

Brokers/

IDBs

Bank, Dealer & Broker Execs

Trade Facilitators

Banks/

Dealers

Customers/

Hedgers

Execution

Venues

Regulators and

Central

Banks

Traders

FCMs/ Clearing Firms

Service

Bureaus

Back

Office

market demand for clearing services has changed
Market Demand for Clearing Services has Changed
  • Operational maturity and market dynamics developed considerably from 2000-2005
    • There wasn’t a core demand for central counterparty
    • CME used a platform approach to OTC (execution and clearing)
    • Central execution (CLOB) is not always the best place to quote markets
  • The nature and value of central counterparty has changed
    • Nationalization effects the risk taking and compensation for trading of the major Dealers – major deleveraging has taken place
    • Due to credit line reductions, mutualization of risk must occur in order to restore markets
    • Funds now concerned about their exposure to the banks and prime brokers
    • Opportunity to partner with sell-side to rebuild confidence in the markets, but still not easy
otc clearing is part of a 3 pronged offering
OTC Clearing is Part of a 3-Pronged Offering
  • Primary venue is either liquid Central Limit Order Book on an electronic platform or open outcry
  • Blocks and EFPs facilitate alternative/OTC executions
  • S&P 500 Options
  • Eurodollar Futures
  • Corn futures

Standard Product

    • Products in cash terms, with futures market protections
    • Clearing of custom versions of core products
  • Longer and flexible dates
  • Flexible delivery points
  • User-Defined Swaps
    • EFP/EFS/EFR and SUB trade types
    • Flexible execution platform
    • Build on deep liquidity of base markets

Hybrid OTC / Futures

  • Swap Futures with “adjustable” coupon
  • Flexible Treasury Options
  • Energy on ClearPort
  • Products in quoted & captured in cash terms
  • Clearing of bespoke products, broadly flexible
  • Flexible execution platform
  • Unique delivery/settlement mechanisms

Pure OTC

  • Credit Default Swaps
  • Gold Forwards
creating otc customer value
Creating OTC Customer Value
  • CME Group’s open clearing service provides the operational and risk management efficiencies of a central counterparty, offering a market driven solution for OTC customers which:
  • Virtually eliminate counterparty risk
    • CME Group acts as the central counterparty to all transactions
    • Market Expansion – Expands access to more OTC market participants, opening credit lines and creating potential trading opportunities
  • Decrease cost and increase operational efficiencies
    • Balance Sheet Efficiencies – Exchange-style daily marking of positions dramatically reduces the need to allocate balance sheet to cover bi-lateral counterparty limits
    • Cross Margin Efficiencies – Offset cleared OTC positions with Futures and Options positions
    • Reduction of Documentation – Eliminates costly and cumbersome ISDA documentation 
  • Access a full range of cleared OTC products
regulatory and central banks efforts
Regulatory and Central Banks Efforts
  • Many products require similar application with CFTC or other governing bodies
fundamental changes in commodity markets
Fundamental Changes in Commodity Markets
  • Basic supply and demand principles in commodity markets are resulting in higher prices and greater price volatility:
    • Weather and disease limiting supply
    • Growing demand from developing countries
    • Falling U.S. dollar
    • Higher input costs related to increasing energy prices
  • Agricultural markets are undergoing tremendous change, development, and adjustment. Traditional risk management tools have been forward-looking 1-3 crop years.
  • Higher risk resulted in market participants looking toward additional price risk management tools and longer-term protection.
  • Hedging needs have also become more individualistic and are not as easily satisfied by standardized futures contracts where contract terms are standardized and liquidity is concentrated within the first couple of crop years.
  • Instead, some market participants have looked to specialized swap dealers in the over-the-counter (OTC) market.
  • Biofuel production increases
  • Limited additional farmland in the short run
  • Restrictive export policies from some major exporters
agricultural commodity stocks are extremely low

Current ratio versus the 10-year average ratio:

Corn at 13% vs. 21%

Wheat at 19% vs. 27%

Soybean at 21% vs. 21%

Agricultural Commodity Stocks Are Extremely Low

World

Stocks-to-Use Ratio

Soybean

Wheat

Corn

21%

19%

13%

Source: www.usda.gov

slide24

Events Impacting Corn Prices Since June 2006

Global supply concerns increase, as consumption rises faster than production. World stocks-to-use ratio at historical low in 2007 at 14.2% and projected to decline further to 12.6% in 2008.

Prices stabilize due to largest planted crop since 1946. Over 93 million acres planted.

Battle for acreage due to increase in renewable fuels mandates.

Overall macro economic weakness has adversely affected commodity prices during the last half of 2008

slide25
Over Regulating US Commodity Markets Will Encourage Flow to the Already Active OTC Markets and Overseas Exchanges
  • 112% growth in OTC commodities in two years while overseas exchange traded commodity market is now 57% of global annual volume
  • OTC commodity market is estimated at 5 times the size of the exchange traded commodity market

Amounts Outstanding of OTC “Other” Commodity Forwards, Swaps, and Options (including energy)

Annual Volume Turnover for Exchange Traded Commodity Derivatives

*Through September 2008

Source: BIS

benefits of ag otc products
Benefits of Ag OTC Products
  • Commodity forwards, swaps, and options are being transacted in the OTC space on a variety of enumerated commodities including corn, soybeans, wheat, dairy, and meat.
  • Since OTC swaps are not guaranteed by centralized clearing, these market participants can be at risk for default. One potential solution to this problem is to have centralized clearing for these OTC swaps.
  • Market participants are turning to CME Group and asking for central counterparty clearing for these types of OTC instruments in the agricultural sector.
  • Currently CFTC Rules prohibit exchanges from clearing agricultural OTC swaps. If the CFTC grants exemptions to exchanges to clear agricultural OTC swaps, these tools can be available to more market participants without the risk of counterparty default.
  • Introduction of cleared ag OTC products will provide market participants with new products to help them manage increasingly volatile basis risk, price exposure, and counterparty risk.
definition of a swap
Definition of a Swap
  • A swap is an agreement between counterparties to exchange cash flows over some period of time. The oldest and most popular swaps are exchanges of interest rates.
  • A commodity swap is similar to an interest rate swap, but the parties are exchanging a fixed price for a commodity with a floating or variable price for the commodity.
    • Ethanol producer agrees to pay the farmer a fixed price of $5 per bushel for corn. In return, farmer agrees to pay ethanol producer a variable price for corn. For example, the price of CBOT Corn futures on the day the swap expires.
    • Assuming the swap expires on April 30, on that day the ethanol producer will pay the farmer $5 per bushel for corn and the farmer will pay the ethanol producer the settlement price on May CBOT Corn futures on April 30.
    • Commodity swaps are usually settled financially and there is no physical delivery.
current state of the emissions market
Current State of the Emissions Market
  • Largest multi-national, carbon trading program is the European Union Emission Trading Scheme (ETS), which began in 1995 under Kyoto. The second trading period began in Jan 2008 and will last until Dec 2012.
      • The ETS covers over 10,000 EU energy and industrial installations. These covered facilities account for an estimated 50% of CO2 and greenhouse gas EU emissions.
      • Covered emitters are allocated allowances by EU member states without charge. The total allowances provided to the states equal the allocated member state cap for the emitter. In addition, the emitter may purchase ETS allowances from others. Excess allowances can be sold to physical or financial market participants without restriction.
  • In the first nine months of 2008, over 2 billion ETS allowances transacted with a notional value of $69 billion.
  • Carbon-based futures/options, as well as OTC products, allow project developers to finance their efforts and hedge against price declines of the credits that will flow over multiple years. These products also aid emitters under compliance programs to manage their exposure to rising allowance and credit prices.
global emissions market performance
Global Emissions Market Performance
  • Currently, the global emissions trading is focused on carbon allowances, EUAs, with 72% of the market. Certified Emission Reductions (CER’s) make up the remaining 19%.
  • In 2009 as compared to 2008, there have been nearly 60% increases in Futures OTC (OTC cleared by Exchange) and in Futures Screen transactions (electronically traded & cleared by Exchange). Options activity has decreased over 40% YOY.

2008 Global Emissions Market Cleared Futures Volumes by Product

Source: CME Group. Note this data aggregates ECX, CCFE, BlueNext, Nord Pool and Green Exchange.

competitive landscape
Competitive Landscape

* Note: All EUA and CER contracts are 1,000 metric tons of CO2, except for the CCX CFI contract is 100 metric tons of CO2.

green exchange value proposition and objectives
Green Exchange Value Proposition and Objectives

Informed industry observers believe the US carbon market could grow to 2-3 times the European market.

green exchange overview cont
Green Exchange Overview (cont.)
  • Current Activity for 17 Products Listed
  • 42,600 in total volume (3/17/08 – 3/3/09)
  • 2,233 YTD volume for 2009
    • ADV for 2008 = 189; ADV for 2009 = 77
  • Green Exchange Key Offerings
    • Committed liquidity and order flow from corepartners
    • Superior product design driven by industry feedback
    • Cross-margining with other CMEG energy products
    • Superior technology, distribution and clearing
  • Next Steps
    • Finalize documentation with 13 GX partners
    • Close partnership agreement with TBD European commercial participant
    • Executive Committee to work with management to finalize definitive agreements
    • Green Exchange will be a separate entity with a CFTC regulatory designation (DCM)
u s legislative strategy overview
U.S. Legislative Strategy Overview

We must operate as if a federal cap and trade bill

will be enacted in 2009

various opportunities in financial services based on current trends
Various Opportunities in Financial Services based on Current Trends
  • Trading and Technology
      • Industry continues to be driven by technology
      • Chicago is a key to these developments given its rich history of risk takers resulting in a vibrant algorithmic trading community
      • Technology is over 50% of the Exchange staff at CME Group
  • Clearing, Risk Management, Audits, Investigations
      • Increased focused on regulation, market oversight, and integrity so many opportunities for positions which support these risk management functions within the financial services industry
      • Good background to learn about the industry without direct industry experience
  • Regulators – CFTC, SEC, NFA, FNRA
      • More funding expected for these regulatory agencies will lead to openings