By Jonathan Keehner - Analysis
NEW YORK (Reuters) - IntercontinentalExchange Inc.’s (ICE.N) bid for the Chicago Board of Trade may have been fomented by a broker backlash against the potential power of a combined CBOT Holdings Inc. BOT.N and original suitor Chicago Mercantile Exchange Holdings Inc. CME.N.
Atlanta-based ICE, virtually unknown in the futures business just a few years ago, stunned the industry in March with an unsolicited bid that would give CBOT shareholders a majority stake in the combined company.
Banks that are among the largest futures players have signed on to advise ICE, whose innovative proposal for CBOT has at the least created a roadblock to the consummation of a marriage between the two largest U.S. futures markets, each of which has called Chicago home for decades.
“ICE may be getting support from some some of the brokers who were critical of the CME-CBOT deal,” said Keefe, Bruyette & Woods analyst Richard Herr. “The development of ICE’s bid for CBOT speaks to a further intensification of the brokers versus exchanges.”
Last week ICE said that UBS AG UBSN.VX and Societe Generale (SOGN.PA), parent of brokerage Fimat Group, had joined Morgan Stanley (MS.N) as co-advisers in its offer for CBOT, which is the parent of the No. 2 U.S. futures exchange.
With over $5 billion in combined adjusted net capital committed to the futures business, according to the U.S. Commodity Futures Trading Commission, the three advisers are among the largest futures brokers.
Each of the three advisory firms is also represented on the board of the Futures Industry Association, a Washington-based lobbying group that has come out in opposition to a CME-CBOT merger because of the concentration of futures volume.
A combined CME-CBOT would control more than 85 percent of U.S. futures and options-on-futures volume, and near 100 percent in interest rate, equity index and foreign currency contracts.
“The CME-CBOT merger would concentrate significant market power in the new CME Group, substantially lessen competition among U.S. futures exchanges, and raise even higher the barriers to entry for new competitors,” the FIA said in a February statement.
ICE’s rival bid provides an actionable path to channel challenges to the merger.
“Separately, both the CBOT and CME already have virtual monopolies for most derivatives contracts they offer to the public,” wrote Fimat general counsel Gary DeWaal in a November editorial in the Financial Times.
“Naturally the new entity would have significant pricing power and ... unparalleled power effectively to inhibit real competition.”
ICE’s offer, which tops CME’s by about 8.4 percent per share, has jeopardized a deal that many expected to win the approval of the U.S. Department of Justice and the two exchanges’ shareholders.
CBOT’s vote, originally slated for this week, has been postponed as the company’s board considers ICE’s proposal.
“It’s another facet of the same play we’ve seen over the last year, with broker-dealers becoming a lot more aggressive in making sure they have a substantial stake in how different market structures evolve,” said Sang Lee of Boston consultant Aite Group.
The once cozy relationship between large brokers and exchanges has cooled as now-public exchanges, with shareholders to please, find themselves increasingly at odds with the firms who once helped control them.
In equity trading, broker-dealers have actively countered dominant exchanges by investing in smaller regionals and alternative trading systems.
Morgan Stanley and UBS are among a group backing Block Interest Discovery Service (BIDS), one of several recently formed alternative systems due to launch this year.
And the two banks have been busy overseas, with a plan announced in November to create a new pan-European trading platform to compete directly with European exchanges like the London Stock Exchange (LSE.L).
But with equity trading commissions under pressure from growing competition, client scrutiny and increasing costs, brokers may increasingly be looking to assert themselves in futures markets.
“Broker-dealers need to move from trading equities into other asset classes that will enable them to garner higher profit margins,” said Lee.
Additional reporting by Ros Krasny