CME Sparks Exchange Fever

The Chicago Merc's deal with the CBOT rallies the sector.
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The merger of two big Chicago futures exchanges sent ripples through the exchange sector on Tuesday, as investors applauded the deal and wondered about further consolidation.


Chicago Mercantile Exchange

(CME) - Get Report

plans to purchase

CBOT Holdings


, parent company of the Chicago Board of Trade, for $8 billion.

The deal will create CME Group, a trading powerhouse for derivatives and future contracts, valued at $25 billion, with an average daily trading volume of about 9 million contracts a day. But the deal also places increasing pressure on other exchanges to evaluate their competitive positions once the CME and CBOT combine. That fueled a rally in most exchange stocks today.

One market participant, who didn't want to be identified, noted that: "Violent reaction higher can't help but reinforce the idea among management teams at other exchanges that consolidation is good."

Not surprisingly, the big gainer on the day was CBOT, which rose $16.75, or 12.5%, to $151.26. Shares of the CME also surged, rising $8.30, or 8%, to $511.55. Investors clearly are betting the combination will further solidify the CME's destination as the premier exchange for derivatives and futures trading.

A derivative is a sophisticated financial instrument that derives its value from an underlying stock, bond or other security. Some of the innovative derivatives traded on the CME and the CBOT include futures contracts based on the interest rate yield curve, equity indices, foreign exchanges, agricultural and industrial commodities, energy and weather predictions.

Meanwhile, shares of the

Nasdaq Stock Market


rose 47 cents, or 1.4%, to $35.03, while the

Intercontinental Exchange

(ICE) - Get Report

rose $3.55, or 4.6%, to $80.85. However, shares of the

NYSE Group


fell $1.55, or 2.1%, to $72.35.

Consolidation has been the theme across the exchange industry recently.

The NYSE Group, the parent of the New York Stock Exchange, is trying to complete a deal with Euronext, a European exchange.

The Nasdaq, the Big Board's rival in stock trading, is continuing to make overtures for the London Stock Exchange. In March, the Nasdaq acquired a 25.1% equity stake in the LSE after the London market rebuffed an unsolicited takeover offer by the Nasdaq. Many on Wall Street are expecting the Nasdaq to resume its efforts to acquire the rest of the LSE.

Last month, the ICE, an electronic commodities trading platform, announced plans to purchase the New York Board of Trade for $1 billion.

While a merger between the CME and Chicago Board was long expected by many, the deal likely will force the hand of managers of other exchanges. Most notably, the Frankfurt-based exchange, Deutsche Boerse, could try to create a competing fixed-income derivatives market in Europe with Euronext, says Jamie Selway, a managing director at White Cap Trading LLC and a former Archipelago executive.

Recent reports say that Deutsche Boerse is interested in purchasing Euronext, something that could complicate the NYSE's plans.

The CME deal also might force the New York Mercantile Exchange, a smaller competing exchange that specializes in energy futures trading, to reconsider its outsourced clearing relationship with the CME, Selway says.

The Nymex is about to complete its own initial public offering in a matter of weeks.

Some on Wall Street are even speculating that the CME may not be done making deals.

Executives on the conference call discussing the deal laughed off an analyst's question about whether the CME would be pursuing more deals in the near future, specifically mentioning one with the Chicago Board Options Exchange. CME executives, however, say that other deals will take a back seat as the exchange focuses on integrating the Chicago board into its system.

CBOT stockholders will have the right to receive 0.3006 shares of CME stock, or an equivalent amount in cash. But the cash component of the deal will be capped at $3 billion.

The deal values CBOT, which went public just a year ago, at about $151 a share, or a 12% premium to its Monday closing price of $134.51.

"We are all aware that the global derivatives industry has growing, increasing competition," said Terry Duffy, the chairman of the CME, on a conference call. "Exchange intermediaries and even users are consolidating, and the over-the-counter and unregulated entities are constantly evolving. With a merger of the CME and CBOT, we will be better positioned to compete in this space on a global basis."

The combined company "will likely have a somewhat slower growth rate than a standalone CME," given the slower growth rate at the Chicago Board," writes Robert Rutschow, an analyst at Prudential Equity Group. "On the other hand, CME knows CBOT's business given existing agreements, which should help smooth the integration, and the combined company is a derivatives powerhouse with a superior position in interest rate futures contracts."