ICE and CME Competition Heats Up

Posted by Jeff Carter
on May 14th, 2012

Can ICE ($ICE) beat CME($CME) in grains? Yesterday, the ICE began trading grain contracts for the first time. They are structured a little differently than CME’s.

Instead of taking delivery, they are cash settled. They have longer trading hours. But this isn’t a competition of open outcry v electronic trading since the CME already trades grains($ZC_F, $YC_F, $ZW_F, $YW_F, $ZO_F, $ZR_F) on the screen. Initially, margins are lower on the ICE, but that is risky on ICE’s part. An adverse move in the market could put some stress on the clearinghouse if traders couldn’t come up with margin money.

Plenty of exchanges have tried to steal contracts before. Usually, it’s been in treasury contracts which have never moved. The list of contenders for them is long. But, the CME hangs on to the lion’s share of volume. One reason is lower all in trading costs. But the other is structural. Networks built over time are hard to break. The grain network funneling into CME has been there since 1849. It is hard for me to believe that the ICE foray into grains will be anything more than an arbitrage opportunity for traders.

However, if an exchange screws up, and sometimes they do, ICE could benefit. The differentiation ICE has brought to the table isn’t necessarily being heralded as innovative by traders. Longer hours in agricultural contracts don’t mean better liquidity or risk management. Because contracts will be open during crucial crop reports, it could adversely affect the market. Only time will tell.

If we look at the stock prices of the two firms, Mr. Market is telling a story. ICE has outperformed CME in the past five years.

ICE data by YCharts

Past year

ICE data by YCharts

and year to date

ICE data by YCharts

I wouldn’t say ICE has out innovated CME. Neither has been particularly innovative. But they have kept their internal costs under control better and they have been the beneficiary of a switch from West Texas Intermediate Crude ($CL_F) to Brent Crude as the dominant oil trade. That sentiment may or may not continue. Markets are fickle.

Since ICE stole the Russell ($TF_F) from CME, it hasn’t been able to build volume any quicker than other equity products on the market. In fact, Russell would have been better off at CME because of the cross margining with the other equity contracts ($ES_F) traded there.

For the trader that is entering the market, they are more devoted to their front end provider than any particular exchange. CME and ICE both used to have a cadre of very loyal traders that would respond to incentives. Those former members of the CME, CBOT, NYMEX and NYBOT don’t feel the same exchange affinity or identity that they had in the past. Exchange management squandered the esprit de corps that used to exist in the industry. With the right incentives, it could be rekindled. But neither exchanges management team is interested in doing that right now.

The other drag on CME stock is it is heavily tied to interest rate volatility. With the Federal Reserve seemingly on hold until Armageddon, volatility in interest rates ($ZF_F, $ZT_F, $ZQ_F, $ZB_F, $ZN_F, $GE_F) isn’t returning any time soon. When it does CME volume ought to explode.

I’ll watch the grain competition with interest. My bet is CME keeps the grains. The only question in my mind is when does CME retaliate on the softs ($CJ_F, $CC_F, $TT_F, $CT_F, $KT_F, $KC_F, $YO_F, $SB_F, $OJ_F)-and how do they do it?

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.