CME’s European Home: A Conversation with CME’s Phupinder Gill, Lee Betsill and William Knottenbelt

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CME’s European Home: A Conversation with CME’s Phupinder Gill, Lee Betsill and William Knottenbelt

CME Group planted its first foot in Europe with the launch of CME Clearing Europe in March and the second is about to land on September 9th with the opening of its exchange, CME Europe. With regulatory approval, CME is set to begin with a set of 30 currency futures contracts, followed by other commodities and asset classes. JLN editor-in-chief Jim Kharouf sat down with CME’s top executives at the IDX Conference in London last month to talk about where CME Group is and where it is going in Europe and Asia. Here is the conversation with Phupinder Gill, Chief Executive Officer of CME Group, Lee Betsill, chief operating officer and managing director for CME Clearing Europe and William Knottenbelt, managing director of its Europe, Middle East and Africa (EMEA) regions.

CME Group’s volumes were up in the first half of the year, and it’s posted some record volumes as well. Have we turned a corner in your view and are you seeing something different that you haven’t in the last few years?

Gill: We’ve had some pretty healthy volumes in June. We had our best one day volume with almost 27 million contracts. But the way to look at that is in the context of the asset classes that we trade. That’s why we are doing well now. Our customers and shareholders are seeing what we’ve described as a tightly coiled spring. And whenever there is market uncertainty in the marketplace, even in the past two or three years, you’ve seen a spike in volumes. Have we turned the corner on the rates side? It’s not clear. There are pockets of uncertainty. We have people coming into the FOMC, both of whom are disagreeing with the entire core. That is good for us. That debate they generate is phenomenal for us. But the more important part is the benchmark status of the products we have, allowing the volume growth to occur, allowing people to actually hedge. What we know is that whenever we return to a normal rate environment, whatever normal means, you will see volumes pick up. The FCM community has to return to another way of making money from client deposits. In the meantime, the community has revamped the business model. They have focused on, correctly so, on the fee element. It is a healthy thing that is going on in the industry. The more discerning FCMs that we have, are connected to the points where they have the pools of liquidity.

CME Clearing Europe recently received UK regulatory approval to clear interest rate swaps. How has the rollout been going for your clearing house in London?

Betsill: We launched CME Clearing Europe with the intention of being a broad asset class clearinghouse, offering products and services to European and possibly Asian-based clients. We started with commodities and energies and moved into rates. We got approval from the FSA in February and launched in March. We have 10 clearing firms, one of whom recently joined. So we’ve been setting the platform for growth in rates by working with a number of clients, and a number of firms to get ready ahead of the clearing mandate. And we’ve gotten a good reception from clients. I think there is a genuine desire to have competition in this space, just like competition among clearing partners. Right now we’re looking to expand into rates and will be adding new products shortly and continue that into things like inflation swaps, and swaptions here in Europe. We’re also looking at FX as well and rolling that out in the coming months, as well as, exchange traded derivatives.

So what is the potential for the IRS space in Europe for you?

Knottenbelt: It’s a bigger market than in the US. It’s interesting for me, coming from the FCM side where I worked at a bank. And there I spent a lot of time speaking to clients about impending regulation. And now I’ve joined a clearing house and I’m right in the middle of it. There is a lot of opportunity out there. So we need to get out into Europe and tell people what we’ve been doing. This year was the second year in which we did what we call our “European Road Show.” We went around to the main cities in Europe and saw significant numbers of people turning up. This is a process of getting people to understand who the CME is. Some know who NYMEX and CBOT is. But some actually haven’t connected the fact that all three are now part of one entity. So it’s a process of talking to people. We also have the trade repository coming out as well. So we’ve spent a lot of time talking to the asset managers, very much from the buy-side as we had to do in the US, because the dealer-to-dealer side is currently, firmly with LCH.Clearnet. So what we’re seeing is some good understanding of what we’re doing here from the buy side.

When you look at the broader OTC space, where are we at in the US and from a European perspective?

Gill: William is right that you have to approach it from a global perspective. The market in Europe is larger than the market in the US, but that is a very relevant market for us. In June, we had a record day with $108 billion in OTC, IRS swaps cleared. So the momentum is picking up because we have all the fundamental pieces. Everyone is looking for margin efficiencies. Margin efficiencies is the top thing we offer in the US. And as CME Europe launches its exchange in the fall, you’re going to see open interest build from futures over time. You will see us become very effective in terms of margin efficiency. So we have to take a global view. We’ve also had many conversations with many of the entities in Asia, finding the solution for them that allows them to use CME Clearing Europe as a starting point. And if it makes sense down the road, we could even have a physical clearing house there. But right now, as our client base sees the CME Clearing Europe as very well positioned for both Europe and Asia. Betsill: And I think that’s the key that we offer clients, choice of clearing. We see a large number of clients with an interest in clearing their OTC products within European legal and regulatory jurisdiction. Knottenbelt: This is not regulatory arbitrage. This is really about entities that are comfortable with their regulatory regime. They are in Europe and why would they want to expose themselves to the US regime when at any time that could change? Outside of hedge funds, we’re seeing that most European entities wanting to clear through a European clearing house. Then they know they have certainty of regulatory outcome, so the cash side and execution clearing side is held in one entity with one regulatory body.

What is the client type you are addressing?

Knottenbelt: It’s the insurance companies, pension funds, asset managers. It’s an area, in interest rates, where they haven’t had to rely on futures up until now. And a lot of the asset managers two or three years ago didn’t have the capability to use futures because it just wasn’t in their mandate. So, over the last 10 years, we’ve seen more asset managers use futures as part of their overall portfolio and using them quite aggressively. Most have seen growth, up to 300 percent, as they looked for ways to hedge their portfolio. So from an FCM’s perspective, when it came to OTC clearing, no longer did you have to go through an FCM to reach the end client. FCMs have said, they will clear where their clients want to clear. Here all of a sudden, you have to change the way you deal with a client. You have to talk to the end client to convince them that yours is the clearing house that they want to use. So you have to be very specific about the type of clearing you offer to the client. You start off with OTC, but it’s an opportunity for us to talk to the end client. That’s not the detriment of the FCM, but it actually helps us understand what services and products we should launch. So you have a much broader perspective on what the client wants. New products, in theory, should be more successful because any new launch will be for a specific reason, which is the end client.

Do the clearing services you offer now differ from traditional clearing services CME has offered?

Betsill: On the technology side, we wanted to leverage what has already been in place. So where there are clients of CME and have a European client base, they can do that more easily because they can leverage the infrastructure they’ve already built.

The European exchange is set to launch September 9. How are you preparing for the launch?

Knottenbelt: From now until launch we are getting all the clearers signed up to CME Clearing Europe. We will have a good number of clearers when we come to launch. One of the things we are doing is starting to talk to more of the European banks about our offering and opportunities futures have over OTC FX in terms of margin requirements. When you look at CME’s current FX capability, the majority, 75 percent, is traded from the US at CME. And 65 percent of the global FX market is here in London. So the two don’t match up and that’s why we think it’s a good opportunity to launch this. We’re talking to market makers and constituents in the FX market and we have a number lined up on day one.

CME has long invested in technology. Tell us what you are doing in terms of IT development now.

Gill: Our technology investment began 20 years ago and it picked up steam in the last 13, since we demutualized. To date, we’ve spent over $1 billion and we continue to invest. All the issues we talk about today – speed, reliability – those are actually assumed functions. As technology becomes more commoditized, companies like ours that offer multi-asset classes have customers with varying needs. For many years, our client-base was doing one thing and one thing only, and that was trading futures. Their OTC trades and cash trades were being done with various other entities. Now they are all coming through execution channels and with all having to be cleared. Now with OTC clearing, margin efficiency, collateral efficiency, collateral flexibility, trading efficiencies – we provided tools to optimize the margins. So we have shifted our attention from what was commoditized technology on trading and clearing, to client-based technology that makes their life as efficient as we possibly can. We have a much broader customer base than we traditionally had. This goes to what William said about the road shows we’ve done. There are a lot of customers that have not been exposed to futures before, so cross-selling opportunities abound. And if we look at what a lot of customers are doing, they’ve never been introduced to the futures world because it’s too efficient. Now they are looking for alternatives to the five-day margin, they are looking for a more efficient solution that meets their needs. Many of the futures products that we have including deliverable swaps, actually meet those customer needs almost more precisely than what they have been using.

You also have a sizeable technology group working out of Belfast. What is happening there?

Gill: When we consolidated, it made a lot of sense that we engage in a bunch of (exchange) alliances. And we wanted to provide technology services. We have CME Europe’s exchange coming live in the fall. We have the clearing house which has been running since May 2011. The support needs they have are first being met by the folks in Belfast. We have about 80 people there now with room to grow. As we looked around and asked, how can we set up shop outside the US to more efficiently serve our global needs, multiple options came up. We chose Belfast because the quality of life and how close it was to our operations in Europe. That something that is just a start and will continue to grow over time.

Asia has been a focus or CME Group for a long time. What is your strategy there?

Gill: Asia like Europe continues to be a significant growth focus for us. Our growth rate there is up 43 percent this year so it’s going very well. There is a lot of combination of business coming from Taiwan, Hong Kong and China. So a lot of the investment we’ve put into the region is beginning to reap its rewards. A lot of it is coming into our London hub as well. So London and Asia operations continue to work well together as we continue to expand our services in London. The SDR is expected to come on board soon as well, so you can expect a lot of the OTC business going on in Asia to find a home within the CME infrastructure that is based here. On the futures front, our sales continue there. We opened an office in Korea, reopened an office in Hong Kong and reestablished an office in Tokyo.