CME Cans Old Gear
Waters, September 1, 2004

The once musty and traditional Chicago Mercantile Exchange is embracing new technology and is ready for the future. When Craig Donohue, CEO of the Chicago Mercantile Exchange (CME), visited Dublin recently to attend the opening of a new facility of proprietary trading firm Geneva Trading, he asked Geneva's proprietor, Mary McDonnell, how the firm vetted its traders, most of whom are in their early twenties.

"She said, 'We give them a Game Boy and test them on that, and have them play online poker,'" Donohue says. "I was laughing. It sounded like my 10-year-old son, but that is the skillset of today's trader."

The CME, the largest futures exchange in the US, is doing everything in its power to ensure that its trading operations reflect and exploit this specialized skillset. That has meant installing a screen-trading demonstration room in the exchange building, just steps from the clamor of the trading pits, forging a number of strategic partnerships with electronic trading forces in the interdealer bond and FX markets, and establishing telecom hubs throughout Europe to attract the legions of Game Boy-trained "arcade" traders popping up on the Continent.

Despite the popular image that depicts the incumbent Chicago futures exchanges as conservative protectors of the outdated open-outcry trading method, resistant to the electronic revolution that overtook their European rivals in the 1990s, there is impressive evidence to the contrary at the CME. In its second quarter 2004 earnings report, CME officials announced that the exchange has turned a corner: Its 12-year-old electronic trading platform, Globex, now accounts for more than 50 percent of total contract volume at the exchange. Globex-traded volume in CME's signature Eurodollar futures product tripled between January and June. On top of this, the exchange recorded a 64 percent increase in net income over the second quarter of 2003. In Q2 2004, electronic revenue outpaced open outcry, at $82.9 million versus $50.5 million, respectively. In Q2 2003, electronic revenue was $49.2 million versus $56.3 million in open outcry.

It isn't just that more trading is being done electronically. The CME actually makes more money per electronic trade than for an open-outcry trade: an average of $0.79 per side versus $0.53, Donohue says. But it isn't as simple as saying that e-trading is supplanting open-outcry.

"In e-trading, we collect the same clearing fee that we do for open-outcry, but additionally, we charge a Globex fee for the trade match that achieves a reasonable rate of return on the technology," Donohue says. "I think the dirty little secret of our experience with electronic trading is that it is not what most people think. In each case, a product on Globex was made successful by the floor, because they were the initial arbitrageurs who provided the trading and liquidity and price conversions." Many floor traders are now adept at both screen- and open-outcry trading, and they arbitrage between both systems all day long, Donohue says.

The CME has attempted to make the transition as easy as possible by building the Globex Learning Center (GLC), a room full of trading screens from 15 independent software vendors (ISVs) that subsidize the screens. Here, traders can wander off the floor and get guided tours of the software, which also includes the exchange's Galax-C Hewlett Packard iPaq handheld devices, says Maz Chadid, managing director of trading operations and facilities.

"You can come here and play with live market data at no risk," Chadid says.
The CME is also engaged in making the handhelds more amenable to the brokers' workflow preferences. This summer, the CME augmented the Galax-Cs' current functionality, which only supports Globex, with floor-trade recording capabilities, so that users can easily toggle between the two, Chadid says. Such strategies appear to be working: Between January and May, there was a 600 percent increase in handheld usage, to 450, with 125 on the waiting list, Chadid says.

'Open Outcry Forever!'
Even so, there is a generational schism between traders who have grown up with electronic interactions and those who have not. Although part of his job is to introduce traders to the handhelds, Brian Linker, a technologist with CME, wears a button that declares, "Open outcry will not die!" Management disagrees, if quietly.

"At this point, some older floor traders ask, 'Do I learn Globex, or do I go to Phoenix?'" says Arman Falsafi, formerly the managing director of global electronic trading and data, who was recently promoted to the role of managing director of Europe and Asia. "This business will be electronic one day. That is not a reason not to bring the members along if they are so inclined."

To continue to thrive, the CME must not only cultivate a pro-electronic culture within the exchange, but also must reach out to new participants. That is Falsafi's job, and she is moving to London this summer to head up a staff of 12, charged with furthering the distribution of Globex outside of North America. She will be replaced by Elizabeth Gisch, who will head a new department called Globex Account Management, which will be a single point of contact for customer support and strategy on Globex. Gisch will also lead the eTrading User Group (eTUG), a customer-feedback effort.
CME has seven telecom hubs in Europe, the first being London, which went online in 2001, with Gibraltar and Milan coming online this year. Rather than force customers to run expensive lines to Chicago, the CME established local hubs to cut local connection costs.

"There is a big push to bring in a European customer base," Falsafi says. "A lot of end users who trade Eurodollars and FX, such as prop desks, use [S&P 500 e-mini contracts] to hedge, and that is normally done through brokers. But today, we go after that special segment directly. These are traders who grew up around Eurex and Liffe." These highly price-sensitive players have meant that nearly 80 percent of CME's business is now discounted, Falsafi says, and so volume must make up the difference.

One quick method for increasing volume by way of distribution has been through partnerships with major players in the interbank markets: Reuters and Tullett Liberty.

By the fourth quarter of 2004, interbank traders on Reuters Dealing 3000 platform will be able to transact spot-equivalent FX trades using CME's clearing facility, allowing the elimination of counterparty risk. Straight through processing (STP) for Reuters' bank customers will be accomplished through the Reuters' Ticket Output Feed (TOF) format, while CME customers get access to a $500 billion FX market involving 3,500 banks.

In July, CME expanded its partnership with interdealer broker Tullett Liberty, by offering matches on Globex for three-month Eurodollar futures on London Interbank Offered Rate (Libor)-based products. Tullett customers submit orders via Tullett's TLfast interface and algorithms, which link to Globex for weekly, multi-lateral matching that improves upon the current bilateral methodology for the over-the-counter (OTC) fixed-income market.

Globex has come a long way since its inception in 1992, when it ran on a closed terminal system and only overnight. Now, it is a 24-hour system with an open application programming interface (API) through which vendors and customers can create custom screens and strategies. Globex grows in volume by 10 percent each month, says CTO Charlie Troxel.

"People have to remember this was before the Web and the dot-com craze," Falsafi says. "I'm always annoyed when people say we came to the electronic market kicking and screaming. We were ahead of Eurex and Liffe."

Of course, all these initiatives to bring in more traffic inevitably create more strain on the technology that underlies Globex. That's why Troxel began re-engineering the system five years ago, so that changes could be made to the underlying rafts of servers without interfering with client interfaces.

Traders access the market through iLink, a connectivity layer now on version 2.0, which uses FIX 4.2 protocol over managed frame relay circuits.

"Behind the gateway is a converter between FIX and our fixed-format protocol," Troxel says. Then the order passes to CME's Tibco Rendezvous message bus, which uses multicast addressing to reach each of four product environments: equity indices, interest rates, FX, and "other," including commodities and weather derivatives. All rest on HP NonStop Himalaya servers that allow horizontal scaling.

"Each module listens for its subject adapter; its subject name is published on the bus," Troxel says. "Nothing needs to change above the bus if you add new functions. Each module has different pricing characteristics, which why I went to this architecture. You can tune each module as needed."

During Q2 and Q3 2004, Troxel was adding a separate module within the complex to support options on futures, which are currently supported on futures boxes.

Although the unique features of the ex-Tandem NonStop operating system, such as built-in failover capabilities, will probably keep CME on the Himalayas for some time, at the iLink gateway level, the exchange is repeating a refrain seen throughout the industry that has become much more cost-conscious after the Internet bubble burst: It is replacing its Sun Microsystems' Sun Solaris Fire V240 boxes with HP ProLiant DL380 blade servers running on Red Hat Linux. The exchange's goal was to have 20 percent of its servers switched to Linux by the end of the year, but Troxel estimates the number will be closer to 50 percent.

"We had 700 Sun boxes and we now have 500," Troxel says. "Our biggest challenge is capacity planning." The 12-CPU 4800 models that support some database functions won't be replaced for some time, since their functions are not reproducible in Linux yet, Troxel says, noting that the number of database entries at the CME has jumped from 2 million per week two years ago to 250 million now.

It doesn't look like the deluge of new trade types and customers on Globex is going to end anytime soon. Two major functions came online this year. In August, the CME introduced implied "butterfly" spreads in Eurodollar futures, which involves six contracts traded at once, and in September will introduce Eurodollar options trading, using technology from a company the CME acquired in January, Liquidity Direct Technology.

"It's probably some of the most sophisticated market modeling we have done," Donohue says.

In June, the implied spread functionality, internally dubbed Eagle 2.0, was in certification and quality assurance testing in the Globex Control Center, using the Fixionary library from Javelin Technologies.

The exchange is looking to further improve its capacity as well as the all-important business continuity planning (BCP) capabilities. Currently, CME's trading and processing hardware is located at its main Wacker Drive facility and at a remote data center (RDC) some 30 miles from Chicago.

"We are in the process of finding a second RDC as we grow," says chief information officer (CIO) Jim Krause. "We are expanding, and we'd like to get into the space by early 2005." The raised-floor space at Wacker Drive that now incorporates a diminishing number of blades, servers, switches, tape drives and mainframes, will probably be converted into offices, Krause says.

"This room used to hold only two machines: one IBM and one Tandem, and they filled most of it," Krause says.

By next year, there will be few vestiges of CME's back-end technology visible at the building that houses its trading floor and most of its staff. It's telling, and a bit ironic that as technology has become ever more important at the exchange, and its membership has become more integrated with it, the machines that each week turn over the equivalent of the US gross domestic product -$10 trillion-are moving farther away.

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