The always-simmering competition in the Chicago futures markets boiled over 13 months ago when Frankfurt-based Eurex, the world's biggest derivatives exchange, opened its U.S. subsidiary.
The three-way fight that has ensued among Eurex US, the Chicago Board of Trade and the Chicago Mercantile Exchange is not just a contest of product specialties and liquidity pools (such as Eurex's German Bund contracts, the CBOT's Treasuries and the CME's Eurodollars). It's a global battle of business models -- the electronic European exchange versus the U.S. exchanges' floor-electronic hybrids -- and their underlying technologies.
Were it not for a January 2002 decision by the CBOT, the Chicago scene might not be quite so crowded: The 158-year-old exchange opted to replace the technology platform it had licensed from Eurex with the competing Liffe Connect system from Euronext.liffe. That freed Eurex -- majority-owned by Deutsche Börse -- to launch its own U.S. market. And it was a huge boost for the global ambitions of Paris-based exchange operator and Deutsche Börse archrival Euronext, which had acquired the London International Financial Futures and Options Exchange in October 2001.
"One of the reasons Liffe was attractive to Euronext was that we have a system that can amalgamate markets on a single platform," notes James Johanik, 33, Euronext.liffe's Chicago-based senior vice president and head of U.S. technology strategy. "Today we have the derivatives markets in Amsterdam, Brussels, Lisbon, London and Paris on Liffe Connect, as well as the CBOT, the Tokyo International Financial Futures Exchange and three markets to which the CBOT has sold our technology as a hosted service: the Kansas City Board of Trade, the Minneapolis Grain Exchange and the Winnipeg Commodity Exchange."
Johanik concedes that the CME and Eurex make strong cases for their technologies. At the CME seven out of ten trades occur over its electronic Globex system, more than double the proportion in 2002. Over the past year CME's world-leading Eurodollar futures contracts have gone from less than 10 percent to about 80 percent electronic -- spurred, Johanik maintains, by Euronext.liffe's introduction of Eurodollar futures last March.
Eurex, he acknowledges, has an unequaled record of system reliability. (The CEOs of the CME and Eurex US, Craig Donohue and Satish Nandapurkar, respectively, appear in the Institutional Investor Online Finance 40 ranking [see page 124].) Johanik asserts -- unsurprisingly -- that Liffe Connect has an overriding advantage: "We had the luxury of building our system from scratch, starting in the late '90s, which allowed us to address issues and inefficiencies that others did not resolve earlier because of the technology that was available at the time."
After graduating from Illinois's Wheaton College with a BS in mathematics in 1994, Johanik spent three years as a CME Eurodollar options floor trader and three years working for that exchange in technology marketing positions before joining Liffe in May 2001. He earned an MBA in 2003 from Northwestern University's Kellogg School of Management. He discussed the merits of Liffe Connect in a recent interview with II Assistant Managing Editor Jeffrey Kutler.
Institutional Investor: How are the U.S. operations of Euronext.liffe organized?
Johanik: There are seven people in the U.S. office, but if you count others such as technology support personnel and the contractors who support our U.S. business, it adds up to more than 20.
Are you more a technology vendor than an exchange executive?
My job is to grow the business in the U.S. by understanding the needs of the market and meeting them -- and I do that by promoting the technology. But nobody calls me and says, "I need Liffe Connect." People call me because of the contracts that trade on the system, and the contracts are only as good as the system they trade on. Technology is definitely one of the value propositions: You can functionally do more on our system than you can on others.
Why is that?
Liffe began a wave of technology investment in the late 1990s when it became an all-electronic exchange. Because Connect was built around a core of short-term interest rate products, which are highly complex, it was relatively easy to add a host of other products, including equity options, commodities, single-stock futures and government bonds. But most critically, we had to figure out a way to distribute the products globally, fairly and efficiently. One way we have addressed that distribution challenge is by running our network in-house rather than farming it out. As a result, we are now in 29 countries at over 677 sites, and growing.
How essential is it to own the network?
We realized from the experience when we didn't own our network that we could never be truly reliable unless we took control of our global distribution. A lot of our efforts have been directed toward improving performance and making sure that the level of service you get in Chicago is the same as it would be in London or, say, Gibraltar.
How do you differentiate your platform from others?
We are the most distributed of all the exchanges when it comes to technology. It's one thing to roll out globally; it's another thing to operate the market fairly and efficiently. The network is uniform: No matter where our members and directly connected customers are in the world, they have equal levels of bandwidth and service, which ensures a level playing field. The system will never distribute more information than any single user can receive; in other words, no connection will ever be disadvantaged relative to another, and no customer will be disadvantaged relative to another because of bandwidth.
Don't you need data or benchmarks to prove you're really, say, the fastest market center?
On speed of execution, some values or benchmarks are almost impossible to ascertain because there are no standard metrics. We do talk to users who say that our system is one of if not the highest performing in the industry. Also, look at the multiple markets and the volume levels going over the Liffe Connect API [applications programming interface], which speaks to our scalability. Speed and scalability are just two of the factors that we believe make Connect the world's preeminent derivatives-exchange matching engine.
What are the others?
Functionality. From day one Liffe Connect has allowed implied pricing from outright contracts into spreads and vice versa. There are no limitations as to the number of calendar spreads eligible for implied pricing -- that means more than 276 different possibilities for our flagship Euribor contract alone. And unlike on other systems, end users can custom-create strategies or spreads on Liffe Connect and put them out to the market. Also, we can distribute data more efficiently and with greater frequency than our competitors -- our API distributes both orders and market data in a single session. Others have separate infrastructures that can get out of sync. Competitors are responding to these differences by copying what Liffe Connect has been doing for more than six years.
What about pricing?
When you add everything in, including the bandwidth and the equipment needed to facilitate the markets that trade on Liffe Connect, the system distributes more volume globally than other exchanges. Our customers' costs are half what competing exchanges charge. Our competitors claim that our volume and liquidity are subsidized by incentives, but I ask, what level of payment is necessary for these supposed market makers to hold on to more than $170 billion in open interest? The reality is that market makers do not hold on to open positions -- institutional customers do, and our market is growing because of the increasing confidence of such institutions.
How do you pitch Connect to the institutional market?
An important piece of functionality to the institutional customer is anonymity. In an electronic world one would think anonymity is a given, but it is not. Other systems display counterparty information upon execution. That means a customer who wants to sell a block of Eurodollars, for example, will be visible to locals [floor brokers] who can trade intelligently against that institutional flow. Liffe Connect will never waver from offering a fully anonymous order book.