05 July 2004

FT: Head of CME backs vertical integration

Craig Donohue, chief executive of the Chicago Mercantile Exchange, has firmly backed vertically integrated financial exchanges, which remain a controversial issue in Europe. 'We think it's quite valuable for competing in the marketplace,' Mr Donohue said during a visit to London. 'It allows us to control new business opportunities more effectively.'

Leo Melamed, chairman emeritus of the CME, added that the vertical approach was backed by the Competitive Market Advisory Council, a think tank that includes Nobel laureates Myron Scholes, Merton Miller and Gary Becker. Mr Melamed said: 'We asked them whether we should stay vertical. Their answer was 'yes'.'

In Europe the issue continues to pit the London Stock Exchange against its rivals, particularly the Deutsche Börse. The LSE opposes vertically-integrated exchanges, which control all the stages of a transaction from the trade to the clearing and settlement. It maintains that separate providers result in cheaper costs for users. It argues that separate charging of clearing and settlement tariffs makes them more transparent, leaving exchanges free to 'maximise the opportunities for competition'. The Deutsche Börse maintains that the synergies from its vertical structure improve efficiency.

The cost-effectiveness of competing exchange models in Europe has promoted more bitter arguments as demutualisation and public listing has forced them to compete more fiercely. Falling trading costs have focused attention more on the back-office costs of clearing and settlement.

In 2002 the Deutsche Börse took over Clearstream, the Luxembourg-based securities depository for international bonds. All trades in German-listed equities have to be settled through Clearstream. The Deutsche Börse also controls clearing through its offshoot Eurex Clearing.

Italy and Spain have copied Germany in consolidating all the processes under one exchange, although neither is publicly listed. The LSE tried to set up its own settlement engine in the early 1990s. The project's failure prompted the Bank of England to create Crest, the separate settlement agency.

Huw van Steenis, analyst at Morgan Stanley, believes the debate will steadily fade as more inter-operability and certain pragmatic acquisitions make the European market more horizontal. 'Clients and regulators are looking for greater inter-operability between different infrastructures,' he said. The CME owns its own clearing house.

By Alex Skorecki in London

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