(CME) CME Group to Strengthen Footprint in UK

Beginning this week, CME Group Inc. (CME) unveiled its point of action that it is in advanced level of applications with UK’s Financial Services Authority (FSA) to build a derivative exchange in London – CME Europe Ltd. However, the implementation of the plan is subject to regulatory approval.

After receiving approval as a recognized reinvestment exchange, CME Group expects to initiate the trading of foreign exchange futures products by the first half of 2013. The company already trades foreign exchange futures in the US. Further, the new exchange will be operated on the CME Group’s Globex platform, while the clearing of products will be done by CME Clearing Europe, which was launched in May last year.

CME Group’s latest plan to launch derivatives platform in the UK also elucidates its strategic move to attain a competitive edge in Europe, where derivative giants including NYSE Euronext Inc. (NYX), IntercontinentalExchange Inc. (ICE) and Deutsche Boerse AG share the majority of the market share. The move toward Europe also aligns with the company’s long-term growth strategy to expand organically, rather than through acquisitions, in order to tap the global market demand.

Over the past several quarters, CME Group is also witnessing augmented growth in Europe, currently generating more than 20% of its volumes from the continent. Meanwhile, the ongoing global regulations to make the derivative trading more secure and transparent following the financial downturn of 2008, have increased the company’s scope for further expansion.

However, this is not the first attempt by CME Group to expand in UK. In May this year, the company lost a year-long battle to acquire London Metals Exchange. CME Group has been mulling over the launch of CME Europe for about two years now, but the then proposed NYSE-Deutsche merger, which was terminated in February this year, raised concerns for the regulators. The company also strengthened positions in Dubai and Brazil in the past couple of years.

Given the regulatory challenges posed in the US that recommends a horizontal business model, more exchange giants are expanding their derivative index in the Europe. In June of this year, NASDAQ OMX Group Inc. (NDAQ) announced its plan to build a new interest rate derivative trading platform – NASDAQ NLX – in London. The trading platform is scheduled to debut by the first quarter of 2013 although the launch is subject to regulatory approval from the FSA.

Overall, we believe that the establishment of a new derivative exchange in London will help CME Group expand its client base and volumes, which would further enhance the company’s operating efficiencies and margins. This is also crucial for the exchange giant, since volumes have deteriorated over the past few quarters given the low rate environment, adverse exchange rate fluctuations, regulatory challenges and market volatility.

Nevertheless, expenses related to the cost of launching the exchange in London is expected to weigh on the financials of the company. Additionally, competitive pressure from already well-positioned NYSE and Deutsche Boerse will be an upcoming challenge that the company has to deal with. Hence, we maintain an unbiased outlook on the proposition, and await further developments to gain more clarity on the outcome.

CME Group carries a Zacks Rank #3 that implies a short-term Hold rating, while the long-term recommendation stands at Neutral.

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