Assessing CME’s NEX Acquisition

On March 29, CME Group (“CME”) announced a deal to acquire NEX Group for $5.5 billion. The merger combines the largest U.S. Treasury interdealer broker (BrokerTec) and futures exchange (CME). Yesterday, I spoke with twelve market participants about their thoughts on the merger at the Fixed Income Leaders Summit in Boston. Most asked to talk on background because they were not able to speak on behalf of their company.

As I discussed previously in The Great Fixed Income Acquisition Spree, CME could own the entire secondary market lifecycle with the BrokerTec acquisition: from funding to execution to clearing to settlement. That concentration of power was worrying to a number of people with whom I spoke. One executive at a competitor to BrokerTec actually thought the acquisition was “good for all firms who are not BrokerTec” because it would cause dealers and proprietary trading firms to look for an execution alternative to avoid concentrating too much power in U.S. rates in a single venue.

BrokerTec’s competitors are hoping for a situation similar to 2013 when eSpeed’s market share fell from 45% at the time Nasdaq announced the acquisition to 35% when Nasdaq completed its purchase. As discussed in The Final Nail in the Coffin, BrokerTec has not seen a fall in market share since the merger was announced. An executive who works at another interdealer broker competitor agreed, “Dealers do not seem to be changing their behavior.” At 80%+ market share, it is likely that BrokerTec’s liquidity is too critical to a dealer’s business to “turn off.”

An industry analyst speculated that the deal would also not run into anti-trust problems. The primary dealers and the DTCC might attempt to make the case to Washington, but they would not be successful. “Regulators would prefer to concentrate more risk at central clearing counterparties.” Brad Bailey, an analyst at Celent, commented, “In many times over the last administration they have tried to make the clearing of rates products more efficient to [reduce systemic risk]. A centralized clearing solution that combines cash and futures makes sense.”

An e–commerce trader at a sell-side firm was concerned that CME would attempt to disintermediate the firm from its clients by pushing an all-to-all model like in the futures market. Buy-side traders I spoke with were more cautious, stating, “We get all the liquidity we need from our dealers.” Another said, “We do a lot of business with CME,” leaving the door open.

There was universal approval among algorithm and connectivity providers, as the market would be opened up to new participants and remove counterparty risk if CME were to clear the trades. Ralf Roth, CEO of Quantitative Brokers, said “Anything that improves customer access to liquidity in the cash Treasuries market is welcome. We generally believe that BrokerTec under the CME umbrella will be more open.”

CME expanding its clearing operation to include Treasuries would make trading more efficient for market makers. All liquidity providers in rates make markets on cash and futures exchanges simultaneously. Market makers run a book that is typically flat risk, but might have large intra-day imbalances (e.g., being short futures contracts on CME and long cash on BrokerTec). An executive at a high-frequency trading firm agreed that the “margin efficiencies would make trading more efficient,” but worried that CME will “increase fees to compensate.”

Bailey summed up my thoughts on the merger perfectly, “This deal is one of the few acquisitions  that makes sense. … It makes sense for foreign exchange. It makes sense for Treasuries.”

(Jim Greco is a Special Correspondent for Markets Media Group for the WBR Fixed Income Leaders Summit, which takes place June 6-8 in Boston. Opinions expressed are the author’s and do not necessarily represent those of Markets Media Group.)