News Release

Craig S. Donohue Speaks at the China Derivatives Forum

Tue Sep 27 2005

CME CEO Craig S. Donohue talked about ‘CME’s Leadership in Financial Derivatives’ before the China Financial Derivatives Forum on Tuesday, September 27, 2005. Craig S. Donohue Outline “CME’s Leadership in Financial Derivatives��? China Financial Derivatives Forum Pudong Shangri-la Hotel Shanghai September 27, 2005 9:00 a.m. Final Draft Welcome Let me begin by saying how wonderful it is to be in Shanghai. On behalf of all of us at CME, I welcome the opportunity to address the topic of China’s role in the financial marketplace. We are pleased to acknowledge our honored co-sponsors, the Shanghai Futures Exchange and Shanghai Stock Exchange. Thanks to their support, we are able to offer an historic opportunity for senior government officials, regulators and industry experts to share their knowledge about the role of financial derivatives in a market economy. I will be speaking to you today from my perspective as chief executive officer of the largest and most diversified exchange in the world for trading futures and options. To give you a sense of our scale, in 2004 we handled 800 million contracts worth $460 trillion – in interest rates, equities, foreign exchange, commodities and alternative investment products. That is about ten times larger than the Gross Domestic Product of the United States. Our nearest competitor trades less than one-fifth that amount. Trading on our CME Globex electronic platform is available virtually 24 hours a day, more than any other exchange in the world. CME is the most global derivatives exchange, with customer access in 36 countries through more than 800 direct customer connections as well as multiple indirect connections. Last year, CME launched six telecommunications hubs in key European financial centers following our inaugural hub in London in 2002. And CME is the first overseas derivatives exchange to open an Asian telecommunications hub – which we launched in Singapore in June to improve access for current and potential CME market users in the Asia Pacific region. These hubs provide fast, efficient access to electronic markets while saving customers as much as 75 percent in connectivity costs. Our Singapore hub and our Asian Incentive Plan launched last year are examples of our growing commitment to Asia. Also, we announced earlier this month a new Emerging Markets Partner Program that will allow us to extend the global reach of our products to new markets through partnerships with new customers. 2 For more than 20 years, CME has been a leader in partnering with Asian exchanges, officials and market participants to foster the growth of exchange traded derivatives in this important region. In 1984, we were the first to initiate a mutual offset agreement with the Singapore Exchange – an agreement that still exists today. Most recently, we established memorandums of understanding with the Shanghai Futures Exchange, the Shanghai Stock Exchange, and the China Foreign Exchange Trade System & National Interbank Funding Center to pursue the potential development of futures products relevant to the Chinese marketplace. CME’s history of innovation Before I talk about my view of opportunities in the derivatives markets of China, I want to give you an overview of CME’s history of innovation because I think it will be helpful as you chart your course in the marketplace. We started out in 1898 as a not-for-profit agricultural exchange for trading butter and eggs. Then, more than 30 years ago, we began evolving beyond commodities. In 1972, through the leadership of our then chairman Leo Melamed, CME created the world’s first financial futures contract by introducing futures on seven foreign currencies. Today, we trade the widest array of benchmark products of any futures exchange, with presently 7 out of 10 trades conducted electronically via the CME Globex platform. Continuing our history of innovation, in 2000 we became the first U.S. exchange to demutualize, in 2002 we became the first financial exchange in the United States to go public, and in 2003 we implemented a common clearing link in partnership with the Chicago Board of Trade that has created nearly $2 billion in capital efficiencies for market participants. As a result of successfully executing these changes, CME today is the largest futures exchange in the world and the also largest derivatives clearing house. We are traded on the New York Stock Exchange – where our stock price has increased nearly ninefold, from $35 at the IPO in December 2002 to around $300 today – as well as on NASDAQ. We have a market capitalization of approximately $10 billion. CME’s success is a catalyst that is revitalizing the entire financial services sector. Following in the footsteps of CME, the New York Stock Exchange entered into a proposed merger agreement with Archipelago and hopes to become a public company through that acquisition. And many other exchanges, including the Chicago Board of Trade, the Chicago Board Options Exchange and others, are looking to emulate what we accomplished as the first publicly traded U.S. financial exchange. This is a recognition of the huge growth in business and shareholder value that we have unleashed at CME. 3 Helping improve the way markets work Through our history of innovation, CME has become a vital force in the global financial marketplace. Rapid growth of our electronic trading, plus our continued overseas expansion through successful strategic initiatives in both Asia and Europe, are making our markets more effective and accessible to a wider range of market users. The success of our business model is helping improve the way markets work for the benefit of customers everywhere. For example, our interest rate products help reduce the cost of borrowing and financing by enabling banks and other lenders worldwide to hedge interest rate risks. Without these tools, potential lenders would be less willing to lend, or would only be willing to lend at higher rates to offset the possibility of adverse shifts in interest rates. CME interest rate products enable lenders to manage that risk, which in turn allows them to increase their lending and pass some of the efficiencies to clients via lower costs. The CME Eurodollar futures contract, which is a short-term interest rate benchmark contract for managing interest rate risks, is the most actively traded futures contract in the world. More than 70 percent of CME Eurodollar futures are traded electronically, where we have a 98 percent market share. We do 26 times the electronic Eurodollar volume of our nearest market competitor. Our equity products enable investors to manage stock market risks, thereby increasing their confidence and overall participation in these important markets. By serving as flexible, efficient risk management tools for managing equity exposure, CME equity futures have been instrumental in driving further growth and liquidity in the underlying stock market. In fact, many investors would be unwilling or unable to invest in stocks to the degree they do without the benefit of these products. Our CME E-mini S&P 500 and CME E-mini NASDAQ-100 futures contracts are among the fastest-growing electronically traded contracts in the history of the industry, and our equity derivatives and stock index futures contracts enjoy a 93 percent share. CME also is the largest regulated electronic marketplace for foreign exchange products, which help facilitate cross-border trade and commerce without undue risks to profitability by providing large and small companies with a tool to hedge foreign currency risk. In addition to impacting the results of companies, swings in currency exchange rates affect portfolios with investments in international stocks or hard assets. CME FX futures enable users to gain a means of protection from currency risks in multinational transactions of all types. We trade contracts based on all of the world’s major currencies, including the euro, Japanese yen, British pound, Swiss franc and Canadian dollar. Today, even with a daily notional trading value of approximately $45 billion, CME FX trading accounts for just 7 percent of the overall $680 billion spot market. More than 51 million FX contracts, representing $6.2 trillion in notional value, traded at CME in 2004. 4 We remain famous for trading things like pork bellies and cattle and hogs, and we still trade those contracts quite actively on the floor. Our agricultural products help farmers and agribusinesses manage the constant price risks they face, affected by such forces as weather, disease, governmental policies, political decisions, natural disasters and wars. CME commodity products offer a way to manage these risks by making it possible for users to lock in profits, enhance business planning and more effectively serve their markets. Last year was the strongest volume in a decade for CME agricultural products. Our alternative investment products offer diversification through non-traditional investment opportunities in new markets. With innovative products such as weather derivatives, we have traded more than 500,000 weather futures contracts so far this year, which is a five-fold increase over full-year 2004. We also are partnering with Goldman Sachs to enhance the auctions for economic derivatives, based on key U.S. and European economic indicators, which allow market participants to hedge their exposure to economic releases more directly. And just last week, we launched a European inflation futures contract (based on the Eurozone Harmonized Index of Consumer Prices ex Tobacco, or HICP) that complements our existing U.S. inflation futures contract and will enable banks, hedge funds and other institutional investors to hedge their inflation exposure in the 12 European Union member states that have adopted the Euro. Secular trends benefit derivatives There are a number of important secular trends that will continue to drive growth and innovation in derivatives rather than securities markets: • Growing investor sophistication concerning derivatives and risk transfer markets, • A significant shift in asset management strategy away from passive equity market exposures to active investment strategies involving alternative investments and asset classes. • Continued strong growth in assets invested in non-equity concentrated alternative investment vehicles such as hedge funds and managed futures. Investors today understand derivatives, futures and options, and hedging and risk management. Market participants are increasingly moving away from traditional forms of investing – long-term passive buy-and-hold equity investment strategies – toward more active management strategies. For example, the managed futures industry grew to $132 billion managed in 2004, a two-year compound annual growth rate of 61 percent and 4-year compound annual growth rate of 37 percent. CME’s average daily volume was up 34 percent through the first half of 2005 in comparison with all of 2004, while NYSE and NASDAQ average daily volume increased only slightly. Regarding the shift to exchange-traded products, the four-year compound annual growth rate of notional value outstanding on exchanges was 35 percent in comparison with 27 percent for the over-the-counter market. 5 Derivatives exchanges are leading growth and innovation in today’s global financial markets. Derivatives exchanges like CME, or the derivatives business segments owned by Euronext.liffe and Deutsche Borse, are outperforming the cash equities markets in terms of notional trading interest, growth in daily turnover, new product development, and, for public company exchanges, financial performance. Simply put, derivatives are inherently more innovative and flexible. They offer market participants greater risk-adjusted returns with lower frictional costs, and are increasingly accessible on a global basis. Since the derivative exchanges do not trade products created by others, they are compelled to innovate to maintain their market position. The global trade winds of deregulation, globalization and rapid advances in trading technology have swept through the derivatives markets, while trading in equities remains much the same as it has been for years. There has been a marked shift in asset management strategy to alternative investment vehicles. Witness the movement from cash baskets of securities and ETFs to stock index futures and, more recently, from mutual funds to hedge funds. Derivatives are low-cost, highly-leveraged trading instruments. They allow investors to transfer risks, optimize portfolio performance and adjust underlying exposures with low frictional costs. For example, increased transparency and sophistication today allow market users to measure liquidity costs. Everyone here is familiar with the explosive growth of hedge funds as alternative investment vehicles that are designed to generate more trading-based returns than investing on the basis of credit and other dynamics in the market. Global hedge fund assets have grown from $50 billion in 1988 to approximately $1 trillion today, and managed futures have grown from $6 billion to $132 billion in the same period. These types of alternative investment vehicles significantly utilize exchange-traded derivatives contracts and therefore have helped bring the futures markets into the mainstream. As a result, derivatives continue to show rapid growth, both in the over-the-counter and exchange-traded markets. Growth in exchange-traded derivative products also is being driven by favorable changes in banking rules, accounting standards and tax policy. For example, under the Basel II Capital Accord, banks will continue as under Basel I to receive favorable capital treatment for exchange-traded derivatives, while continuing the requirement that banks reserve balance sheet capital to secure over-the-counter derivatives exposures. The rationale underlying this capital efficiency for exchange-traded products is the central counterparty clearing system used in exchange-traded derivatives markets. Opportunities for derivatives markets in China Derivatives markets are essential adjuncts to fuel China’s further economic growth. They will provide access to global interest rate, stock index and foreign exchange futures and options, and Chinese banks, corporations and financial institutions will gain valuable hedging and risk-management tools. 6 The Chinese manufacturing and services sectors are already tightly integrated with global markets, and the benefits of this close relationship are evident. Goods made in China are available worldwide. Chinese businesses employ millions of workers whose rising incomes have allowed them to improve their standards of living. Though current policies restrict flow of capital in and out of China, continuation of the ongoing liberalization process will ensure the eventual integration of Chinese domestic markets with global financial markets. Once integrated with global financial markets, the weight of China in investment portfolios of foreign investors and institutions will rise sharply. Likewise, Chinese investors will invest in foreign capital markets so as to diversify their portfolios. Letting foreigners invest freely in Chinese capital markets will result in a lower cost of capital for Chinese businesses. Access by overseas financial markets will improve the performance of Chinese investment portfolios, thus adding to the wealth and sense of financial security of Chinese citizens. Challenges to be overcome Having said that, there are challenges to achieving successful derivatives markets in China. For example, China faces fundamental challenges relating to credit and monetary policies, property rights, resolution of financial failures and defaults, the free flow of accurate market and financial information, and the adequacy of corporate disclosure and accounting standards. But these issues are well understood within China and are being addressed. Other challenges remain, however, and Chinese exchanges must: • Ensure that all participants have equal and immediate access to accurate and fully transparent market information. • Ensure standardized practices and rules for market participants, and be able to detect, deter and punish individuals or entities that engage in practices that can lead to market manipulation or unsound business practices. • Guarantee the financial performance of all transactions in their markets, as well as the safety and soundness of the related banking, settlement and custodial functions necessary to support market transactions. These requirements need close cooperation between government and private sector. Government should strive to create environment that requires exchange directors and managers to take full responsibility for all business decisions. China also must establish strong incentives to operate efficiently and honestly. Another challenge is how best to gain entrée to the global capital and financial markets. The best way is for China’s exchanges to open up to investment, joint venture and commercial business arrangements with other global exchanges and intermediaries. This will prove most advantageous as global derivatives markets standardize and consolidate to meet user demands for lower operational costs and greater capital efficiencies. 7 In the past few years, the Chinese government has been raising the amount foreign institutions can invest in Chinese equities and bonds. Participation by overseas investors will be crucial if the government wants to succeed in reducing state holdings in Chinese businesses. If overseas investors interested in Chinese capital markets are allowed to hedge their risk exposures – interest rate, equity, commodity, and currency – they would be willing to increase their investments in Chinese bonds, stocks, and other instruments, thus letting Chinese entities – government bodies, businesses and households – raise funds at lower costs. For example, foreign investment in U.S. Treasury bonds and mortgage securities are reported to have helped maintain low interest rates in the United States for the past four to five years. This helped the U.S. economy recover from the economic downturn of 2000-2001. Developing a successful derivatives market infrastructure How can China develop its derivatives market infrastructure successfully? By concentrating on product development, economic analysis and the development of sound market regulation standards. And by engaging in education and training efforts to ensure the prudent use of Chinese financial and agricultural derivative contracts. These efforts can and should be undertaken from within. China’s exchanges can accelerate their growth by collaborating with global exchanges. They can utilize global exchanges’ extensive infrastructures, trading and clearing platforms and industry-standardized business practices. Mutually beneficial partnerships will broaden the distribution and reach of China’s derivatives markets. Similarly, the advantages of leveraging established non-Chinese equity capital markets with global reach are complementary to China’s sovereign interests in further developing its own global equity capital markets. China’s markets may face periods of uncertainty in global investment and expansion. This uncertainty should be embraced as an unavoidable and even positive feature of dynamic market economies. Changes in Chinese derivatives markets will create new opportunities to extend the rapid pace of economic growth unleashed by the country’s move toward a market economy. They also create opportunities for traders, whether speculating or hedging risks, to trade Chinese markets as readily as those in U.S., Europe, Japan and elsewhere. Conclusion In conclusion, let me share two observations. The first is the importance of innovation and execution. CME has a history that allowed it to grow rapidly even in the face of those who may have been doubtful. Only by remaining true to its innovative spirit was CME able to become a leader in the global capital markets. It is a position we intend to keep and build upon in the years to come. 8 The second is the importance of increased market access and the creation of a truly global marketplace. As it continues to grow, CME has expanded global access to its product base through enhanced technology and new distribution channels, and we have strengthened relationships with exchanges around the world. This growth strategy will allow CME to continue to evolve from a futures and options exchange into a more broadly diversified financial services company that offers trading and clearing solutions across a broader range of products and asset classes. Going forward, there are enormous opportunities for business growth as the pace of economic expansion accelerates in many parts of the world. These markets will continue to receive considerable attention from CME. Our company looks forward to developing stronger business and cultural ties with the leaders and institutions represented at this conference.

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