UPDATE 3-CME Group Q3 profit drops, but beats expectations
* Earnings 70 cents/share, excluding one-time item
* Q3 EPS beat street view of 69 cents
* Trading volume fell 26 percent in the quarter
* Sights set on OTC, international expansion
By Ann Saphir
Oct 25 (Reuters) - CME Group Inc, the biggest operator of U.S. futures exchanges, reported a slide in third-quarter profit as investors used fewer futures and options, but it beat expectations by a penny per share due to lower expenses.
Blaming sluggish trading on macroeconomic factors like anemic growth and fears of the coming U.S. "fiscal cliff," CME executives are banking on a lift as they move to take advantage of regulatory changes in the over-the-counter swaps market and to expand internationally.
Wall Street reforms since the 2007-2009 financial crisis have tightened oversight of the vast OTC derivatives industry, forcing more swaps contracts into regulated clearinghouses. To take advantage, CME is both beefing up its swaps clearing business and rolling out new swaps-like futures for those who want to avoid the intensifying regulation of the off-exchange market.
"We've taken steps to strengthen our business in this environment, and we will not be complacent," Phupinder Gill, who took over as chief executive in May, told analysts on a conference call after results were released on Thursday.
Alex Kramm, an analyst at UBS, has said he believes the clearing of interest rate swaps alone could add $500 million in annual revenue in the medium term - almost as much revenue as CME generated last quarter.
CME officials on Thursday did not give estimates for expected revenue from OTC clearing, but said they expect regulatory change to drive up demand for rate contracts in waves as the new rules hit market participants. Hedge funds and other big swaps users will be the first to come under new requirements, in February, they said.
Gill is also expanding CME's international footprint, and next year plans to open the company's first non-U.S. exchange, in London.
The new market would cater to European-based traders who are wary of the new rules governing the U.S. futures markets and who prefer to deal in a familiar regulatory environment, Gill said.
Regulators have been churning out new rules to implement Wall Street reform legislation, and confusion over new requirements has been cited as one factor hurting futures industry volume.
A regulatory "about face" on rules for the swaps market confused markets and slammed CME's Clearport energy clearing business for a two-week period in early October, CME Executive Chairman Terrence Duffy said.
But volumes recovered once regulators exempted Clearport energy swaps until the end of the year from counting toward thresholds that trigger higher capital requirements for swaps traders, he said
Overall, Duffy said, the macroeconomic environment, and the fact that last year was a record year for volumes, has made the year a tough one so far.
"Regulatory issues have a play in it - but this year was setting up for a disaster in volumes from day one," Duffy said.
CME is also expanding its stable of exchanges at home. It agreed earlier this month to buy the much smaller Kansas City Board of Trade, cementing CME's dominance in world grain futures markets and keeping rival IntercontinentalExchange from gaining an important foothold.
The deal comes as ICE renews its efforts to build its agricultural markets business, including the launch this year of look-alike U.S. grain futures that opened a new front in the decade-long battle for commodity derivatives dominance.
CME already operates the Chicago Mercantile Exchange, the Chicago Board of Trade, and the New York Mercantile Exchange.
BY THE NUMBERS
Net income fell to $218.9 million, or 66 cents a share, in the quarter, from $315 million, or 95 cents a share, a year earlier, CME said.
Excluding a one-time tax hit, net income was 70 cents per share, better than the 69 cents expected by analysts.
Revenue dropped 22 percent to $683 million, missing the Wall Street forecast of $693 million, as trading declined 26 percent.
Expenses of $287.2 million were slightly lower than expected in the quarter; results were also helped by better-than-expected per-contract revenue, analysts said.
The one-time tax hit was largely due to a change in how CME reports its stock-index business, now a joint venture with McGraw Hill.
CME, which recorded $2.1 billion in cash at the quarter's end, will hold a board meeting before the end of the year to decide how best to distribute excess cash to shareholders.
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