CME Group Earnings Call Nuggets: Market Structure, Cash Levels

On Thursday, CME Group, Inc. Class A (NASDAQ:CME) reported its third quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Market Structure

Alex Kramm – UBS: Gill, I just heard your comment on this high turnover discounts that you’re talking about now on the OTC, I guess clearing side. So, maybe you can elaborate a little bit on that. I guess, the questions are that sounds to me like, okay, proprietary market maker not sure how much of that exists in the swap market today, but obviously market structure is changing. So, how do you think those guys are going to enter the market and how quickly do you think they’re going to be there most importantly, I guess for the Jamie, how does that change your $5 to $6 outlook for interest rate swap clearing on average per million?

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Phupinder Gill – President, CME Group: Alex, that’s a good question. Yes, we’re talking very specifically about a very select number of clients who would actually trade a lot but may not hold the types of open interest. So, as we focus on clearing of this OTC transactions what we are trying to do is this pricing scheme is to capture every different type of clients and so this is just simply one type of client that may not hold the open interest that you might expect, the majority of the client base to actually hold. So, it is appropriate given the role that this particular type of client plays.

James E. Parisi – CFO and Managing Director, Finance and Corporate Development: Yeah, remember this is a group of customers that we haven’t previously been targeting so it’s incremental to the model for us and remember most of the expenses associated with the OTC clearing were already in our expe4nse base. So, the more business we can drive across the platform even at an incentive rate the better off we are.

Phupinder Gill – President, CME Group: Alex I would like to just add one more thing to what Jamie just said. I mean keep in mind we’re talking about a marketplace in an environment that is evolving and you won’t see the full impact of what is going to be done by the so-called high frequency guys versus the rest of the marketplace until about the end of the year when the full impact of clearing things in the end of next year.

Alex Kramm – UBS: Then maybe just shifting gears for a second here to energy obviously it’s not a secret that Brent has been taking market share from WTI and to some degree that’s really not your fault, obviously that’s where the market is going. But I guess one of the things we’ve seen here over I don’t last year or so is that when you look at open interest trends, your competitor is actually been taking some market share when it comes to open interest in particular and talking to some energy traders people are saying that there are some folks that are moving acquisitions over away from you because they want to get the capital efficiencies with Brent which has obviously taking market share. So, obviously it’s not a great trend so I guess may question is are you seeing that our self are you engaging with clients and what kind of options do you have to kind of recapture some of that a particular capital efficiency side that you might be losing here?

Phupinder Gill – President, CME Group: I didn’t understand the capital efficiency point, because if you’re talking about capital efficient markets, you’ve got to have both sides of it, because we have, as you may know, upwards of 85% of the TI marketplace and Brent is enjoying the lead that they have largely because of the short-term nature of the issues that TI is facing, the structural issues that TI is facing.. so, I would sum up the environment as TI having some short-term challenges, which is the reversal of the pipeline, when that occurs I think some of the short-term challenges will be behind us and Brent having, what I will describe as long-term challenges that are supply based which is widely acknowledged in the industry. So, if you look forward, on a going forward basis with respect to what the environment might look like as far as the transparent marketplaces for pricing crude are going to shape themselves out, you can expect three benchmarks around the world, where you can have a North American benchmark, which TI very clearly is the North American benchmark or the benchmark in this part of the world, the European benchmark which is Brent and then the unmet need, which is on the Asian consumer base. They tend to; for the most part consume solid crude and no one’s meeting their need with the exception potentially of the DME that is beginning to get the volume that has been illusive for them over the last few years. So, the open interest shift that you have seen is largely based I think, not so much on capital efficiencies as much as it is pricing, which is one way to move open interest and those types of moves by enlarge, by our experience and not generally sustainable over the long-term.

Alex Kramm – UBS: Maybe we’ll follow-up on the capital efficiency of those lines?

Cash Levels

Richard Repetto – Sandler O’Neill: The question on the cash and the special, so it look like cash levels absent the debt raise did stayed flat, I was wondering, if you could explain some of the ins and outs of that, Jamie? Then related to the special dividend, as we approach year-end because you’re carrying this extra debt, would you go below the $700 million sort of target, no one that you could replenish it and you have that that cash — I know, its dedicated for the debt pay down. So, just about the special dividend I guess on the parameters?

James E. Parisi – CFO and Managing Director, Finance and Corporate Development: Rich, there are couple of questions there. One was on the cash side, there’s some activity on the cash side this quarter that I’d classify it on investing or financing side activity. So, every quarter we have the $150 million dividend roughly that we pay, so that certainly was an outflow. We also had outflows associated with our acquisition of Pivot and some other outflows tied to some interest rate loss that we have. So, it was all financing related and the total that was probably in the area of $270 million. In terms of using some of that $750 million at the end of the year as part of the return and then replenishing that later. We tend to take a pretty conservative approach here. We want to maintain that $750 million to fulfill the maturity that’s coming up next year. So, as I said on the last call, that’s kind of off the table in terms of the consideration for return. We will have excess cash above and beyond that that we’ll be looking at.

Richard Repetto – Sandler O’Neill: My follow-up would be on the OTC side. I guess you’re as you noted today you’re seeing the spike again in OTC Clearing bond, that doesn’t seem like there is not a lot of revenue right at this point and that’s one part of it. But I guess the broader question as we look at your OTC strategy Terry and Gill, you launched this DFS or will launch the DFS product, you got arrangement with Eris, you got arrangement now with 2X, you’re trying to be a swap or will be a swap data depository. So, I guess the question is there an overarching strategy you talked about puff will be set in as well as an overarching strategy as you attack the OTC or is it going to be we’re trying to get in every area and every opportunity?

Phupinder Gill – President, CME Group: I think you summed up the part of the strategy that we have and if I were to describe an overarching strategy for the CME here is generally going to be to serve a full comprehensive service offering to our client base that includes options that they have. They can either continue to execute the swap as they do now and clear them with us. They can for various and sundry reasons convert into the swap deliverable futures that you talked about and for both of these (camps) if they’re looking for capital efficiency, CME Group is probably the only entity that provides them with the most comprehensive capital efficiencies with our margin offsets both in the house side and in a couple of weeks, it will be introduced onto the client side wherein some of the portfolios that we have run, we have seen savings of up to 90%. So, no other offering that we know of can provide the same kind of efficiencies because no other offering that we know of has the futures offset and we’re talking here in terms of the OTC world even though we are focused in the first instance on the interest rate side, we’re talking about all asset classes here. So, CME Group across six asset classes is in a position to offer margin offsets that no other exchange can.

A Closer Look: CME Group Earnings Cheat Sheet>>