20 S. Wacker Drive
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Since 1919, when it evolved into the Chicago Mercantile Exchange, the Merc has traded futures on over 50 products, from frozen pork bellie s and live cattle to Eurodollar and index futures.
Chicago Mercantile Exchange Holdings Inc. is the parent company of Ch icago Mercantile Exchange Inc. (CME), which specializes in the tradin g of futures (contracts to buy or sell something on a specified futur e date) and options on futures. At its core, the CME, also known as " the Merc," plays an important role in global risk management. It is i nvolved in four major product areas: commodities, the CME's original focus; foreign exchange; interest rates; and stock indexes. The CME i s famous for its hectic trading floors where "price discovery" is pur sued by traders practicing the open outcry system, shouting out price s and quantities and also using hand signals to make themselves under stood over the din. The system has been abused in the past, resulting in a major Federal Bureau of Investigation (FBI) sting operation in the late 1980s, but traditionalists cling to open outcry nonetheless. In recent years, however, the method has been undercut by the rise o f electronic trading, including CME's Globex round-the-clock electron ic trading system. Many traders now trade electronically as well as i n the pits. The CME is a public company listed on the New York Stock Exchange.
The Merc: An Outgrowth of Chicago's 19th-Century Rise to Power
The opening of the Erie Canal in 1825 not only transformed New York C ity into the United States' commercial and financial capital, it gave rise to the country's "Second City." Chicago, advantageously located on the shores of Lake Michigan and, later, a major railroad hub, bec ame the bridge between the farm products of the Midwest and New York and the other major cities of the East Coast. In the mid-1800s Chicag o emerged as the country's largest market for corn, wheat, lumber, an d meat. It was through the grain market that the futures market becam e a key factor in the city's financial system. Because transporting g rain from the farm to the city was dicey, with rain in the summer and snow in the winter often making country roads impassable, Chicago so metimes found itself bereft of grain or glutted with it. The result c ould be economic chaos. If there was no grain, livestock could not be fed, resulting in meat shortages and people going hungry. If there w as an overabundance of grain on the market, prices would plummet, far mers could not buy equipment, manufacturers faced bankruptcy, and wor kers were laid off. Forward contracting was a way to instill some cer tainty into the market to level off the peaks and valleys that could have such a devastating effect on the economy. Chicago's grain trader s began using forward contracting in the early 1830s. In 1848 the Chi cago Board of Trade was formed, providing a place, an exchange, where buyers and sellers could negotiate prices on the future delivery of grain, as well as a forum where business issues could be resolved.
Far less prominent than grain, livestock, or lumber, the butter and e gg business also found its center in Chicago in the 1800s. This secto r was served by the Chicago Produce Exchange, founded in 1874, but th e butter-and-egg dealers grew dissatisfied with the exchange and the way it allowed its secretary to determine prices by querying merchant s in a haphazard way. In 1895 they formed the Produce Exchange Butter and Egg Board as part of the Chicago Produce Exchange, its only purp ose being to provide a better way to determine butter and egg prices. But in the next couple of years the exchange suffered from a civil w ar, as the butter merchants battled with their hated rivals, the marg arine men or oleo faction. The butter merchants tried to use the exch ange to influence state legislators to limit the sale of margarine in Illinois. The oleo producers thwarted them, and so in February 1898 the butter-and-egg men walked out, forming their own organization: Th e Chicago Butter and Egg Board, destined to one day become the Merc.
Launching the Merc in 1919
The board was part trade association, part marketing. Initially its m embers were not overly enamored with the concept of egg futures, inst ead preferring the cash market. In 1915 the trading of futures contra cts was banned for a brief period, then limited for the next year bef ore the progressives prevailed and time contracts were restored. Gove rnment restrictions due to the United States' entry into World War I soon resulted in the suspension of time contracts in butter and eggs, however, and normal trading was not resumed until 1919. It was also in 1919 that some egg dealers banded together to look deeper into the idea of futures trading. They then convinced the Butter and Egg Boar d to amend its rules book to include organized futures trading and pe rmit a new organization under the rubric of the board to engage in fu tures trading. Because the members expected to deal in commodities ot her than just butter and eggs, the unit took the name of the Chicago Mercantile Exchange. In October 1919 the Chicago Butter and Egg Board went out of existence, and the next day the Chicago Mercantile Excha nge (CME) was launched, although it would not be until December that it actually began trading in butter-and-egg futures, when three contr acts were traded in less than an hour. At the end of the first week, only eight contracts were negotiated.
In the beginning CME relied on a chalkboard method, with offerings on one board, bids on another, and the final transactions listed on the sales board. Traders worked off of the posted information to negotia te the deals, with the market sometimes closing in a matter of minute s after its 10 a.m. opening. The blackboard method was far from satis factory but it was the standard for an entire generation, not replace d until 1945 when the trading pit was introduced. In addition to eggs and butter, by now the CME was trading in potatoes and onions and, o ccasionally, involved in frozen eggs and cheese. It even tried a cont ract in animal hides as a trial.
The CME struggled to survive the war years 1941 to 1945, barely able to pay its mortgage, as a planned wartime economy handcuffed the coun try's futures exchanges. In eggs, for instance, there was no trading in futures in 1942 and 1943, and only minor business during 1944 and 1945 due to an imposed price ceiling. The exchange's leadership took the time to plan for the postwar period, installing new leadership th at would seek to add new commodities to the trading mix. Shortly afte r World War II ended in 1945, the CME added a turkey contract. In 194 9 it began trading in apples and dressed poultry. But just as it appe ared to be gaining momentum the CME took some backward steps in the 1 950s. Price supports ended futures trading in butter, then in 1958, a fter pressure was brought to bear on Congress by disgruntled onion gr owers, the practice of futures trading in onions was banned. Onions w ere the CME's second most heavily traded futures contract. Its loss m eant that the Merc was essentially a one-commodity exchange, trading in eggs.
As the CME entered the 1960s, its prospects appeared bleak, especiall y since the exchange's attempts over the years to trade in other prod ucts, including apples, potatoes, turkey, hides, cheese, and even scr ap iron, had never met with a great deal of success. The potato busin ess was meager and the egg business was no longer a seasonal business conducive to futures trading, the result of modern technology that o ffered a consistent supply of eggs year-round. The CME was on the ver ge of closing its doors, but discontent among the membership led to s ome changes and the exchange introducing three successful new contrac ts between 1960 and 1966. In 1961 the exchange added a frozen pork be lly (used to make bacon) futures contract, a major innovation since i t was the first futures contract related to frozen, stored meats. Few of the members knew what a pork belly was, and fewer investors, so t hat it was not until 1965 that the business took off, resulting in a significant rise in the price of a CME membership, from $3,000 in 1964 to $8,500 a year later. (In 1968 the price climbed to $ 38,000.) Another important contract also had been launched in 1964, a live cattle futures contract, notable because it was the first futur es contract related to a nonstorable commodity.
Broker's Club Taking Charge in 1968
A group of CME's younger traders, who had forced the Board of Governo rs to take action in the beginning of the 1960s, were still not satis fied with the direction the Merc was taking. The group, known as the Broker's Club, launched a revolt in 1967 to force the board to be mor e responsive to the desires of membership. A showdown between the old guard and the dissident traders resulted in the latter winning the d ay, and in January 1968 a new chairman was installed and the CME ente red a new era, governed by new bylaws. The dissidents also would spea rhead the move into the financial markets that would transform the ol d Chicago Butter and Egg Board into a global exchange.
Always on the lookout for an opportunity, the CME found one in foreig n currency in the early 1970s. It engaged the services of economist M ilton Friedman, who wrote a paper on the possibility of doing busines s on foreign currency futures. Not only was there money to be made on money, he argued, the ongoing growth of foreign trade actually requi red a futures market in which currencies could be hedged and risk man aged. Thus in 1972 the CME introduced the first financial futures mar ket, involved in futures contracts on seven foreign currencies. The e xchange's International Monetary Market would soon add gold, other pr ecious metals, and Treasury Bills to the mix of financial instruments in which it dealt.
As a result, the CME was poised for a period of explosive growth in t he 1980s. In 1981 it introduced CME Eurodollar futures, a highly succ essful market. A year later the CME S&P 500 Index futures contrac t was first offered, and it too attracted a great deal of interest. T he 1980s was a period of innovation for the exchange on other fronts as well. The CME began developing an electronic trading system to ope rate when the trading floors in Chicago were closed, mostly to benefi t the Japanese. According to Euromoney, "When originally annou nced in September 1987 this system was hard to take seriously. Even i ts name, Post-Market Trading, or PMT, was a joke: the initials PMT ar e more frequently used in the English speaking world to signify Pre-M enstrual Tension." The idea of electronic trading also met with oppos ition from old school Merc members who were worried that the venerabl e outcry system of trading would be imperiled. The new high-tech syst em would take years to develop, however. In the meantime, the CME had to contend with a scandal that not only called into question the out cry system but sullied the reputation of the institution.
In January 1989 federal agents surprised 40 CME and Chicago Board of Trade traders with subpoenas, the culmination of an undercover sting operation conducted by the FBI to determine if traders had defrauded customers. Four agents, wired with tape recorders, had infiltrated th e Merc's trading pit, befriended traders, and recorded them both ther e and at places where they socialized. As Time explained, "Fed eral law requires that traders and brokers must try to get the best p ossible price for their customers when executing trades. But because the deals are conducted orally, illegal trades are difficult to catch ." A "typical shady deal," according to Time, was the "'bucket trade,' in which a broker slices an extra profit margin by buying a contract from a confederate at a bit more than the going price in the pit, or selling one for a bit less. For example, if a customer asks the broker to sell a soybean contract of 5,000 bushels and the market price is $7.50 per bushel, the crooked broker may sell the contr act to a colleague for $7.40. That gives the colleague a discount of 10 cents per bushel, or $500, some of which he kicks back to his partner. The customer probably cannot challenge the price because there is no record of precisely when the deal occurred." Scores of t raders and brokers would be indicted, and over the next two years the vast majority would plead guilty and the rest go to jury trial.
The CME spent much of the 1990s trying to rectify the damage caused b y the FBI sting. Reforms were introduced, as was Globex, the CME's re named electronic after-hours trading system, which made its debut in 1992. A virtually round-the-clock electronic trading system, Globex2, was introduced in 1998. Another innovation from this period was the CME E-mini S&P 500 contracts, electronically traded products that were much smaller than the standard S&P 500 Index futures, the f irst product of its kind to trade during regular trading hours on a U .S. exchange. It also opened the way for other E-Mini products, such as the E-mini S&P 500 futures and the E-mini NASDAQ-100 futures c ontracts.
As the 1990s came to a close, the CME unveiled a new strategic plan. It introduced more electronic order routing to the trading floor and approved side-by-side electronic and open outcry trading of Eurodolla r contracts, a bid in large part to fend off the challenge of foreign exchanges that were dropping actual trading floors for cheap, electr onic ones. The Merc also decided to become the first U.S. financial e xchange to demutualize in order to become a public company, raise mon ey, and invest in the kind of electronic infrastructure that would be a key to the exchange's future growth.
In 2000 membership shares in the CME were converted into shares of st ock, which could be bought and sold apart from trading privileges. A year later a parent company was formed, Chicago Mercantile Exchange H oldings Inc. The stock of this holding company was then offered in an initial public offering in December 2002, raising $191 million f or the CME and other selling stockholders. The stock then gained a li sting on the New York Stock Exchange, as the CME became the first pub licly traded exchange in the United States.
The Merc was on the verge of a new era in the early 2000s. Although m any of its members were loath to give up the open outcry system, it w as clear that the exchange was moving toward a totally electronic sys tem over the next few years. Such a move, according to Institution al Investor, "likely would make for cheaper, more efficient tradi ng for the exchange's 6,000 customers, speed new product development and allow the CME to market more aggressively across borders for new customers, leading to volume gains and bigger profits." When, if ever , open outcry would be eliminated was far from certain, because in th e end customer preference ruled the day, and many of the customers st ill found a great deal of value in the old system, especially when it came to complex deals. The Merc was also in the market to grow in ot her ways. In the words of Crain's Chicago Business in 2004, "F lush with cash, Chicago Mercantile Exchange Holdings Inc. will consid er acquisitions, joint ventures and other partnerships in a consolida ting futures industry." Given its history of a willingness to adopt t o changing times and an eagerness to seize opportunities when they pr esented themselves, there was every reason to expect the Merc to find a way to prosper for many years to come.
Principal Subsidiaries: Chicago Mercantile Exchange Inc.; GFX Corporation.
Principal Competitors: CBOT Holding, Inc.; Deutsche Börse AG; LIFFE (Holdings) PLC.
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