芝加哥商業交易所 (CME) 2008 Q3 法說會逐字稿

Good day, everyone, and welcome to the CME Group third quarter earnings call.

As a reminder, this call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the conference over to Mr. John Peschier. Please go ahead, sir.

Thank you very much, and thank you all for joining us.

Craig Donohue, our CEO and Jamie Parisi, our CFO will spend a few minutes outlining the highlights of the third quarter and then we will open up the call for your questions. Also joining us for participation in the Q&A session is Terry Duffy, our Executive Chairman; Rick Redding, our head of products and services; we have Phupinder Gill and Kim Taylor calling in from New York; and before they begin, I'll read the Safe Harbor language.

Statements made on this call and in the accompanying slides on our website that are not historical facts are forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that are difficult to predict; therefore, actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. For detailed information about factors that may affect our performance may be found in our filings with the SEC, including our most recent Form 10K and Form 10Q, which are available on the Investor Relations portion of the website.

During this call, we will refer to GAAP and non-GAAP proforma results. A reconciliation is available in our press release and there is an accompanying file on the Investor Relations portion of our site that provides detailed quarterly information on both a GAAP and proforma basis.

With that, I would like to turn the call over to Craig.

Thank you for joining us this afternoon.

The third quarter has been--has seen many key developments in our business, including the completion of the NYMEX acquisition, record volumes in our equity and FX product lines, and the announcement of our CDS initiative, which will facilitate migration of existing CDS transactions to our clearing house, allow for submission of bilaterally executed trades into clearing, and provide an optional electronic platform for execution and clearing of new CDS trades.

I will discuss each of these items in detail in a moment, but first, I would like to share a few thoughts regarding the recent and unprecedented market turmoil. Throughout September and October, tumultuous market conditions were driven in large part by concerns about counterparty credit risks. The ensuing upheaval in financial markets has affected us all and continues to prompt regulatory and legislative action from governments around the world.

CME Group's proven risk management and financial safeguard techniques have allowed our markets to continue to operate above the fray of counterparty credit concerns. During September and October, our markets remained deeply liquid. Daily pay and collects took place on schedule and without incident, and as has always been true over our 110 year history, no customers lost any money due to counterparty failure.

What we are most proud of is that this is business as usual for us. Our markets, our clearing methodology, and our technology are designed for robust, seamless functionality during the most chaotic conditions imaginable. These systems are backed by management and staff with extensive experience and a deep commitment to principled, transparent, secure, and efficient markets. While we are pleased with our track record and historical performance, by no means do we feel complacent. We continue to look for ways to build on our proven strength and create value for our customers and our shareholders.

I would like to now discuss our third quarter accomplishments and our future strategic plans. First of all, we are very proud of the successful completion of the NYMEX acquisition on August 22nd. With the addition of NYMEX, which contributed $204 million in revenue on a proforma basis in the third quarter or 26% of total revenue, our already diverse product set now includes energy, metals, and the ClearPort over the counter clearing platform.

The NYMEX CME Group combination offers many strategic benefits, and we are very focused on executing on these benefits. To that end, NYMEX integration is well underway. We have been able to apply many lessons learned from our successful CBOT integration, which was completed ahead of our original schedule, and which will achieve our $150 million annual synergy target on a run rate basis by year end.

We met an integration target last week when we communicated our staffing decisions to employees, which was an early step on our way to achieving $60 million a year in operating synergies. We are excited about the growth potential of NYMEX's energy and metals complexes, and the ClearPort OTC clearing platform when coupled with CME Group's established global capabilities and strategic momentum. We see tremendous opportunity in energy derivatives.

To highlight, for 2007, energy was 72% of the Goldman Sach's commodity index, but global energy futures were only 6% of overall futures volume compared to commodities waiting at 18% of the index and comprising 9% of derivatives volume. We believe that energy is a globally significant product and we will be actively pursuing growth strategies for this important asset class.

Another NYMEX asset that we are tremendously excited about is ClearPort, which shows considerable strategic capabilities. The platform's value is underscored by recent market events, and we believe that market dynamics have aligned to drive increased usage of ClearPort's central counterparty clearing and swaps performance guarantee services. Customer recognition of the benefits of centralized clearing to reduce counterparty risk and multilateral netting to alleviate balance street constraints has never been higher.

Besides year-over-year volume growth of 40% for the third quarter, we have seen a 25% increase in customer registrations year-to-date through September on the ClearPort platform. These statistics highlight the value of these services during market uncertainty.

In addition to ClearPort, we've been working actively on other initiatives to bring the security and soundness of CME's proven clearing services to the OTC markets. The benefits of centralized clearing have never been more apparent. As the world's largest derivatives clearing house and with a 110 -year history of no defaults and no customer loss of funds due to a default, CME is ideally positioned to provide increased security and safety to those transacting in the over-the-counter markets.

We maintain a financial safeguards package that at the end of the third quarter includes over $100 billion of posted collateral, nearly 10 billion of which is in excess of requirements, all protected by a proven 24/7 risk monitoring and financial safeguards capability. As an example of the scope of our clearing operations, our twice daily mark-to-market resulted in average daily pay and collects of nearly $5 billion in the third quarter.

As part of our over-the-counter initiatives, we are excited to be rolling out our flexible and open credit default swaps initiative, which provides the benefits of central counterparty clearing and netting, while supporting existing over-the-counter trading paradigms. The initiative will facilitate migration of existing CDS to our clearing house, allow for submission of bilaterally executed trades into our clearing house, and provide an optional electronic platform for execution and clearing of new CDS trades.

We believe we are further advanced than our competitors in our operational readiness and preparedness to launch our services; and like all of our competitors in this arena, we are subject to regulatory review and approval. As with any new product that we clear, we have devoted significant resources to determining the appropriate margining and risk management practices for credit default swaps. Since CDS margining techniques are an important consideration, I would like to make a few observations on our abilities and methodology.

In 2007, CME cleared 2.3 billion contracts with notional value exceeding $1 quadrillion. The notional value of our open interest at the end of the third quarter was $35 trillion. The notional value of outstanding CDS contracts is estimated at 55 to $64 trillion, and it's important to note that those are gross figures, which would be reduced significantly in a central counterparty clearing environment. These numbers speak to the scope and scale that CME brings as a clearing provider. As to risk management and margining methodology, we recognize that credit default swaps have some unique characteristics and we have developed a robust framework to ensure effective protection of customers.

CME will apply our traditional time tested risk management practices to CDS, including twice daily mark-to-market and daily margining. CDS will also be subject to enhanced risk management practices, including periodic default drills, account level profit and loss reviews, and CDS specific stress testing. We'll be using a multi-factor model for margining, which addresses seven unique risk factors, including several components of macroeconomic risk and liquidity risk, among others.

Our clearing team has conducted extensive testing of sample CDS portfolios using these margining models, with recent market events providing many worst case scenarios against which to test. We are pleased that the results of these tests confirm our abilities to manage CDS risk through even the worst market conditions. Full details on margining methodology and the testing that we have conducted have been shared with the regulators. Beyond counterparty risk management, centralized clearing also provides balance sheet relief to CDS market participants from multilateral netting.

We have been in active discussions with both the sell side and buy side market participants and believe that we will need to assess the various CDS offerings with many factors, many of which include financial safeguards, credit worthiness, clearing expertise, established track record, and operational readiness. As we have described above, our initiative offers several substantial benefits in each of these areas and addresses current issues in the marketplace. We have structured the offering to allow market participants the opportunity to be founding members and share an equity stake in the platform, as well as to benefit from certain market maker privileges. We are confident that our initiative has tremendous benefits for all market participants and look forward to launching the platform.

Next, I would like to discuss our volume for the third quarter. Our diverse product set saw several key records during the third quarter, even as interest rate volumes were lower. October overall trading volumes to date are trending approximately 15% higher than October of last year. On a proforma basis, third quarter average daily volume was 13.2 million contracts per day, with multiple volume records across our diverse asset classes. Overall, volume was down 7% year-over-year, largely due to reduced activity and interest rate products, which I will address.

Our interest rate products have seen impacts due to the ongoing credit crisis and were down 25% year-over-year. There are many factors affecting interest rate volumes, including the decoupling of LIBOR from fed funds, a trend to the shorter end of the yield curve in treasury products, a slowdown incorporate debt origination, difficulties in the agency market, and a decrease in mortgage-related transactions. We continue to see these factors as essentially cyclical in nature. Offsetting the effects of the interest rate product, however, was very strong third quarter performance in other asset classes. Our E-mini equity indexes averaged a record 3.6 million contracts per day, up 19% versus the prior year.

FX products also had record quarterly volumes of 710,000 contracts per day, up 12% year-over-year. Additionally, we believe CME's FX futures are gaining strength versus the over-the-counter FX markets, and one data point we note in the third quarter is that our record average notional value of $97 billion per day was up 24%, while EBS was up only 10%. We are pleased with these records, both as an indicator of the growth potential and strength of the individual asset classes, and also as an indicator of the diversity and strength of our product base.

NYMEX and COMEX also had outstanding volumes, with NYMEX trading 1.8 million contracts per day during the third quarter, up 23%; and COMEX metals averaging 250,000 per day, up 66%. Finally, we cleared 492,000 contracts per day through the ClearPort over-the-counter clearing platform, up 40% compared with the third quarter of 2007. October to date, ClearPort clearing has also been strong, with average daily volumes up 54% versus last year. As we mentioned previously, this strong growth underscores the value of ClearPort's central counterparty clearing model, including its performance guarantee of over-the-counter swap transactions.

Given the severity of the recent financial crisis, we recognize that certain potentially negative trends, including deleveraging hedge fund redemptions and customer consolidation are occurring; but we firmly believe that the forces causing these phenomena highlight the strengths of CME's business model and the strategic opportunities on which we are well positioned to capitalize.

First, I would like to discuss customer trends that we've observed to date. While it is difficult to classify our volumes by customer type, we have insight into certain firms that participate in special programs, or which are clearing members and we can track their volumes closely. We have noted in the past that bank proprietary trading has historically been 15% to 20% of average daily volumes, and it remains within that range in the third quarter. While banks use our market for many reasons, it is important to understand that a considerable amount of their transactions is hedging related to their ongoing proprietary swap dealing activities.

We have also had insight into the volume of the 25 hedge funds that are our largest hedge fund customers, and we've seen their participation decrease only slightly from the first quarter to approximately 10% in the third quarter. This modest decline has been offset by increased participation by high velocity proprietary trading organizations. The volatility of the markets, as well as the low carrying cost of trading strategies involving rapid moves in and out of the markets, made conditions ideal for this style of trading.

We have always noted the strength of our diversified product set, as well as our diversified customer base, and we look forward to working with them to bring our products and services to market. Diverse customers and diverse asset classes are a key element of our strong business model and there are additional positive factors that we see for the business in the coming months. We continue to implement technology upgrades that provide speed and functionality enhancements for our customers.

This coming weekend, we will complete server upgrades for our interest rate match engines. These upgrades will allow for sizable speed improvements and they will allow us to launch implied intercommodity spreads for treasury futures and swap futures in mid-November. This product should provide customer benefits including increased matching opportunities, concentrated liquidity, and reduced legging risk for customers.

There are many secular factors that we believe create favorable long-term conditions for growth. Recognition of the need for risk management has never been greater. Exchange traded and cleared markets offer compelling value propositions compared to over-the-counter markets. Growth and interest from global customers continues. The next year should see an increase in treasury issuance and increase the need to hedge treasuries. These factors all contribute to growing worldwide demands for our markets.

Finally, we have long recognized the security transparency and efficiencies that our exchange model could bring to the over-the-counter markets. The success of ClearPort demonstrates the market's desire for these services and we look forward to extending our capabilities into the credit default swaps and cleared interest rate swaps market.

We are also excited about our global progress to date. The opportunities we see in the global strategies we are pursuing, which I will discuss now. Our non-U.S. hours trading volume has remained at 17% for the third quarter and we see this as a positive, reflecting the entrenched nature of the customers using Globex during non-U.S. hours. We have been working very diligently on our global marketing strategy following the NYMEX acquisition. We have been able to hire for several key global positions, and have identified others that will be critical to the strategic cross-selling plans that we have in place.

Additionally, we have been actively engaging CME management with NYMEX customers to foster those relationships. We are using customer feedback to further hone our cross-selling plans and our product innovation, and will continue to develop globally compelling products.

During the quarter, we also made progress with our order routing agreement with BM&F. Several ISVs have established connectivity, while others continue to make progress. We have successfully routed some volume to BM&F and are working actively with them on additional components of the strategy, such as the rollout of the south to north order routing in Q4. We are pleased to announce our telecommunications hub in Brazil is now operational, bringing our total hubs to seven globally. Plans for a joint clearing structure are in place and we are pursuing required regulatory approvals to launch this.

Finally, we are working closely together on joint product development and as a first step, we have shared settlement prices for select CME FX products in order to create better trading opportunities for BM&F currency pairs. We also continue to pursue long-term opportunities through strategic partnerships with exchanges around the world, such as KRx, where we have an agreement to list KOSPI 200 futures on Globex; and OSE, where we have an MOU to jointly develop products and services. And finally, through equity stakes, such as our investment in the Dubai Mercantile Exchange.

To conclude, market events over the last year highlight the value of both our business model and our market model. Our market is well regulated and transparent with regard to participants and position reporting, and provides a deep pool of centralized liquidity. Our central counterparty clearing services reduce systemic risk and benefit all market participants. Throughout extraordinary market turbulence, CME Group has been one of the best functioning parts of the financial services markets. We believe recent events create tremendous strategic opportunities for CME Group, and we intend to leverage our core strengths to actively pursue over-the-counter opportunities, global growth opportunities, and the expansion of our core business.

With that, let me turn the call over to Jamie.

Thank you, Craig.

Despite the turmoil brought about by the credit crisis, CME Group turned in a solid financial performance. The third quarter was also a busy one from a financial perspective. We closed the NYMEX transaction, entered the debt markets, began our share buyback program in mid-September, completed the sale of the legacy of CBOT metals business, and started winding down FX market space.

Today I'll go through the details of Q3 on a proforma basis, as if we own NYMEX and CBOT for all periods considered. We have also posted a view of the quarter, including the NYMEX revenue, expense, and shares from August 25th forward on our website, as I know some of you modeled the business that way. Finally, I'll touch on a few of the non-core and merger-related items including in our GAAP statements.

Let me start with the proforma results. On a proforma basis, we generated $787 million in revenue for the quarter and $518 million of operating income. While average daily volumes were down 7% year-over-year driven solely by interest rate volumes, a strong rate per contract in Q3 and disciplined expense management more than offset the cyclical volume decline.

The rate for contract for the legacy CME business was $0.659, up 2% sequentially and up 6% versus Q3 '07. The primary mix drivers of the increase were a lower percentage of interest rate products and a slightly higher proportion of non-member activity. On the NYMEX side, the average growth rate was $1.57, up 1% both sequentially and year-over-year, driven primarily by a larger percentage of trades cleared through ClearPort, a higher percentage of COMEX metals volume, and a higher percentage of non-member volume.

Now, turning to the quotation data fees. They were $92 million for the quarter, up 24% from Q3 of 2007. This increase is explained by the year-over-year price increase that went into effect at the beginning of this year, and to a market data audit assessment in the current quarter, totaling $4 million. At the end of the quarter, we had approximately 437,000 users who subscribe for the base devices across CME, CBOT, and NYMEX products.

I'll now take a few minutes to review expenses. Total proforma operating expenses were $269 million for Q3, down 3%, both sequentially and versus Q3 last year. Our largest expense, compensation, was down about $1 million sequentially to $90 million. Our combined head count at the end of Q3 stood at 2,337 people. We announced approximately 150 head count reductions related to the NYMEX acquisition with the vast majority of reductions occurring in 2009.

Compared to Q3 '07, compensation expense is down 10%, driven by lower annual bonus estimates, lower earnings on deferred compensation, and synergies from our merger with the CBOT. Non-compensation expenses were down about $8 million sequentially due primarily to the expiration of the CBOT electronic trading contract with Life. This was an important expense synergy, which drove a reduction in the technology support, depreciation, and communication expense lines. This savings was somewhat offset by increased marketing spend, primarily driven by our efforts to highlight the benefits of our centrally cleared model during a period when users are becoming justifiably concerned about the counterparty credit risk and capital efficiency.

Looking forward, we expect proforma operating expenses for Q4 to come in at 270 to $275 million. Q3 proforma operating income was $518 million resulting in an operating margin of 66%, up from 63% in both the prior quarter and the year-ago quarter. This was the second highest margin in the history of the combined company, which illustrates the operating leverage in the model, even during periods when volume may be impacted by cyclical headwinds. Within the third quarter, non-operating expense category, we had a few positive and a few negative impacts.

On the positive side, we received a dividend of $9 million from BM&F, which increased investment income; while within the securities lending area, we accrued a $6 million loss due to an investment in a money fund that had Lehman exposure. Proforma net income was $278 million and EPS was $4.13. For Q3, our proforma effective tax rate was 43.3%. In Q4 in 2009, we would expect an effective tax rate of between 41% and 42%.

So basically if you offset the quotation data fee audit assessment and the BM&F dividend with the securities lending loss and the temporary increase in our effective tax rate, the proforma EPS would have been a few cents higher. I know some of you did not have a full proforma model. Instead, you had NYMEX business included from August 25th through September 30th. A view of the third quarter using that methodology is available on the historical Excel file on our website, but let me give you the highlights. Bringing in NYMEX volumes on August 25th resulted in average daily volume for Q3 of 12.2 million contracts. Proforma revenue totaled $673 million.

Operating expenses would have been $231 million with an operating margin of 66%, still the second highest quarterly margin ever. Net income would have been $245 million and EPS would have been $4.07 per share, with share count at just about 60 million shares. There are a few items on the GAAP income statement that we have excluded from the proforma view that I would like to mention. We are writing off our investment in FX market space, which you can see in the processing services, depreciation, and equity and losses of unconsolidated subsidiaries lines.

In addition, we are impairing our original investment in swap stream, which you see in other expense and depreciation. We have shifted our focus to more of a cleared-only solution and we are very actively meeting with dealers and buy side clients. With respect to the ERP guarantee, there was an $8 million credit due to the proposed settlement between CBOE and CBOT members, and we also had a $7 million gain in our BM&F currency hedge for the quarter. That hedge has been terminated as the counterparty was a subsidiary of Lehman Brothers, who, as you know, is in bankruptcy. Upon termination, we retained possession of the cash collateral associated with the hedge. The cost to set up a new hedge is currently uneconomical, so we continue to examine our options.

Turning to securities lending, NYMEX had a $25 million investment in the Sigma fund, which is currently valued at 2.5 million; $16 million of this loss in recognized in CME statements, while the remainder was recognized in NYMEX's preacquisition financials. We were well aware of the potential for this writedown when we completed the NYMEX transaction and accounted for this in our own valuation work. Lastly, we revalued our deferred tax liabilities as a result of the merger and had a non-cash adjustment of $48 million in income taxes.

Moving on to the balance sheet, as of September 30th, we had $700 million of cash and marketable securities, and total debt of $2.9 billion resulting in a net debt position of approximately $2.2 billion. With regard to our debt, we issued $1.3 billion of public debt, with maturities of one, two and five years and we have a three year $420 million term bank loan. In addition, we currently have approximately 1.6 billion in commercial paper outstanding, which is back stopped by a three year revolver and a 364 day bridge facility. We affixed the rate on our public debt as well as on our term loan and we currently expect to pay a blended rate of approximately 4% across all of our debt, including the amortization of all upfront fees.

On the bridge, we are scheduled to pay a $6.4 million cash continuation fee in mid-November based on our current structure and we are currently working on various alternatives to replace the bridge on more favorable terms. If we replace the bridge, we will avoid the $6.4 million duration fee and accelerate certain one-time upfront costs that have already been paid related to the bridge. This acceleration will result in additional interest expense of approximately $9 million in the fourth quarter. Capital expenditures net of lease hold improvement allowances totaled $40 million in the third quarter, driven by $37 million of technology investments, including $17 million of construction related to data centers. In Q4, we expect CapEx to range from 85 to $95 million primarily related to data center and staff space construction.

Now turning to other matters. At the end of June, we announced that our board had authorized a share buyback program of up to $1.1 billion over the next 18 months. Through yesterday, we have purchased approximately 284,000 shares of stock for a total of $100 million. So far in October, we are averaging 12.7 million contracts per day, up approximately 15% compared to the full month of October last year.

In summary, this was a busy quarter in which we spent many--in which we met many challenges and continued to execute on our plans while turning in a solid financial performance.

With that, we would now like to open up the call for your questions.

Thank you.

(OPERATOR INSTRUCTIONS)

And our first question comes from Roger Freeman with Barclays Capital.

Hey, good evening. It's actually Alex Cramm for Roger.

The first question, I hate to harp on the volume issue, which obviously has been around for more than a year now; but you gave a lot of color on the interest rate side, so I'm hoping that you could just give a little more in terms of what you think are the biggest factors and what you would be looking for in terms of a normalization of that market.

And then related to that, there's been a lot of focus on the hedge fund community and you also gave a little bit of color there; but with all the redemptions that they are probably facing, deleveraging and so forth, maybe you can give us a little more clarity around how your hedge fund customers break down, how much of the volume they are, and how much is really concentrated in the biggest guys, arguably the ones are better positioned, and maybe not so well positioned hedge funds out there? Thank you.

Alex, this is Rick Redding.

As far as the hedge funds are concerned, what we have seen is in the marketplace is a lot of the smaller funds having difficult times and actually a number of them shutting down their operations, but I think it's important to note that those typically are not our customer base. Most of the hedge funds that are our customer base are in these larger hedge funds that are well established and have--are mostly in the kind of global macro and the multi-strategy areas. What we said was their volume was around 10% and that was on a percentage basis, down very slightly from previous quarters. So, as much talk as there is out there in the market about the health of the hedge funds, we've seen a very little change in their volumes over this year.

I think the bigger issue with the hedge funds is actually the lack of conviction a lot of them have in investment themes. So a lot of them are sitting on tremendous amounts of cash, both anticipating redemptions at the end of the year; but also when that gets out of the way, there seems to be an awful lot of cash that something's going to have to be done with it. So that likely will be moved in one of the asset classes and this is a time where it's very fortunate that we are in every asset class. So we'll be able to take advantage of whatever asset class that they find or the asset classes they find attractive.

A little more color on just kind of the overall volumes. As we said--with as much said with the banks and with a couple of banks going out of business or being merged out in the third quarter, they were still in that 15% to 20% of volume from the proprietary side. We essentially didn't see an aggregate change in their volumes. I mean obviously one or two of them went out of business, but again, in the aggregate, there's still that same percentage. So they are still utilizing our markets because quite honestly, these are some of the most liquid places that they can transact in because of all the dislocations in the markets.

A little more color on the first part of your question, as what's going on in the interest rate space. Craig laid that out pretty clearly that the short-term part of the market, the rates have decoupled. Fed funds and LIBOR have decoupled. Over the last few days, you've seen that spread come in, but it's still at extremely high levels. What you've also seen in a treasury market is people trading on the shorter end of the curve.

I think you see this in the cash market. You also see it in Europe as well. So we are tracking with the overall market on the treasury side. The other thing that I think you have to understand what's going on in this crisis is the volatility in the short end of the market, volatility in euro dollars has just exploded; and I think that's caused a number of strategies that used to work, earlier parts of the year not to work during this crisis.

And the other thing that Craig mentioned was the treasury issuance. I mean obviously with taking--the government taking on all this debt, we see some opportunities that people will have to manage that debt going forward.

Okay, great.

And then just shifting gears a little bit to the CDS side, which obviously is a big focus right now as well. Can you talk a little bit about the reception you have gotten from both the sell side and the buy side? I mean we would argue that the market right now is dominated by 10 or 12 or so players, so their support is very important. So again in particular, can you talk about the--not only the reception, but the concerns you've heard in particular from the sell side and how you've been addressing those?

Thank you.

Sure. Let me take a stab at that.

First of all, there's been an awful lot of work done, not just by us, but by others as well in a fairly short period of time to try to bring solutions to the CDS market that include central counterparty clearing services. We've been working very extensively with the regulators on that, as well as bringing our offering to market in terms of marketing to both the sell side and the buy side; and I would say that there's an awful lot of interest in discovery that people are doing right now to try to understand how these competing offerings will work, what the risk methodologies will be, what's the structure of the entity, what's the credit worthiness of it, how can they participate, etc. And I think that process is still reasonably early. We literally have people who are working very hard to get out and talk to the sell side community, as well as the buy side to help them understand those different issues. So it's still early stages yet.

I would say that there's a divergence of views among the sell side and the buy side on issues like product construction, breadth of solution; for example, should the products be limited to index products or should they extend to single name, should they be Europe and U.S. based or more limited? Should there be an execution facility or only a clearing facility? So one of the things that we're doing is talking to people and trying to gain input on that.

I think also one of the key issues that we're finding as we're out talking to many people on the buy side is whether a solution that doesn't include the buy side in the central counterparty clearing service is really effective in that obviously many of the buy side participants are concerned not just about limiting systemic risks between and among the dealer community, but also between the buy side or the client segment of the market and the dealer community; and that's certainly a key advantage that we provide. So, I think the best answer is we're working hard to try to make sure people understand our offering, understand the comparative differences between what we provide and what the other competitors in the marketplace will be providing, and we're working hard to try to generate support for what we're doing.

Okay, great.

And then just lastly, one quick one before I move on, on the acquisition on the synergies, do you have--there are a lot of moving pieces obviously; so do you have a set number for the $150 million on the CBOT and $60 million of NYMEX, how much of the expenses have you actually realized to date in the run rate?

Right now on the run rate, we're at about $137 million in the third quarter and by the end of this year, we should be at the $150 million run rate for the board of trade synergies. It's still very early in the game. On the NYMEX synergies, we will realize those over the next 12 to 18 months; and as you've seen, we did announce the staff--the staff reductions of about 150.

All right. Very good. Thank you.

Thank you.

And our next question comes from Rich Repetto with Sandler O'Neill.

Good evening, guys.

Hi, Rich.

Just to follow up on the CDS, everybody's asking about it, is just trying to understand, Craig, what's the process here? We're being--it's very much in the press about the New York fed, but what would you expect to come? What would be the best case scenario, the process that could get you into business here as you work with the regulators?

Rich, it's a good question, but it's difficult to answer in part because we can't speak for the regulators. What I think is fair to say is that we have been working for quite some time with the various regulators, which include the New York fed and the SEC and the CFTC, and we're trying to work through that process with them. Ultimately they will determine the timeframe within which they will act on the various requests that we have in front of them.

But a lot of work and time has been put into this, not just by us, but by those regulators as well and I know that they have a sense of wanting to see these solutions come to market as quickly as possible, subject to making sure that they have satisfied themselves on how these things will work. So I don't have a great answer for that. I mean operationally we've already indicated that we're prepared very eminently to implement this, but it will require regulatory approval.

And eminently, about three weeks--like the month from the time that you talked about it would be about next week, am I correct?

Correct, and so it's just a question now of getting the regulatory approvals that are necessary.

Okay, and then the next question, Craig, you talked about--or investors are definitely trying to sort out what is cyclical and what is secular, and I appreciate the information on the customer sort of mix. But I'm just trying to see, do you see any secular changes here? And I'm hearing about the percentage mix is not changing between bank, proprietary, and hedge funds, but could we just have the coincidence where the secular changes are driving just everybody down sort of in the same--in the same sort of percentage?

Well, I mean there's no algorithm that we can give you on that, but I do think that many of the longer-term secular drivers of growth in the industry remain. I mean, we have increased volatility, increased uncertainty, and I think it's fair to say increased need for risk management products, hedging risk transfer products. I think we're still finding in our own marketing and sales efforts that there's increased sophistication among investors about how to use these products for a broad range of trading strategies that even go beyond hedging and management and it's clear to us anyway that the globalization trend is continuing, and that we'll see tremendous growth in these markets on a global basis, certainly including emerging markets over the course of the next decade. So I don't really see those things changing for the long run.

And, Rich, I think one thing that we did see in the third quarter, and we continue to see is the high velocity algorithmic guys actually increasing their activity, but that makes sense in kind of these high volatility markets. And also as people's kind of ability to hold positions for long periods of time has been affected by the credit crisis. So kind of all the things that you would expect to see, given the market conditions, we are seeing.

Okay, and just one last quick one on the buyback. Craig or Jamie, I do the math and it looks like the average purchase price per share was $352; and I guess the question is, were you blacked out in October from purchasing your own shares?

Rich, basically what we've done is we've put a plan in place shortly after we closed the NYMEX transaction, and so that plan is in place and operating and there's aspects of that plan that are opportunistic in nature.

Understood. Thanks, guys.

And our next question comes from Patrick O'Shaughnessy with Raymond James.

Good afternoon.

Hi, Patrick.

Curious if you can kind of tell us about, how do you think the decision-making process is going to work as far as the CDS clearing offering? So who do you think is going to be making the decision here? Is it the dealer community, is it the regulators? Are they going to make it in conjunction? How do you think that's going work out?

I think it's very difficult to speculate on that and I don't think we want to be presumptuous about what the regulatory community will ultimately decide. I think it's fair to say that their interest is in helping address some of the risk issues that exist and the way the market is currently organized and functioning. And it seems to us anyway that they are working well with everybody to try to facilitate their ability to bring these solutions to market, and we're expecting that that will be the case. There will be more than one competitor in this market, that we will be one of them, and that ultimately our success or failure will depend on whether the market participants find value in what we're offering.

Great, and then a follow-up CDS question, how would you say that your CDS clearing offering would differentiate itself from some of the other offerings that some of your competitors are throwing out there? You've mentioned that you're probably farther along in the development process, but how else would you say that what you have is differentiated from what other people are suggesting?

Right.

Well, to speak I guess to our virtues without criticizing others, we certainly feel like we have tremendous financial capacity. I think if you looked at the amount of collateral that we hold on a daily basis, which exceeds $100 billion, the fact that we have a financial safeguards package worth $7 billion, the fact that we do daily pays and collects of approximately $5 billion, and the fact that we've been in this business for more than 110 years with a tremendous base of experience in dealing with volatile products and tumultuous market conditions, and I think an extraordinary reputation for risk management capabilities, I think that's a significant distinguishing factor.

The other thing that I would say is that we've been aggressively working on this for quite a number of months and we're doing that prior to the time that we started to see the meltdown in the financial sector and the defaults in the financial services sector; and so that, I think, does provide us with some time to market advantages that are significant. We also have a very inclusive approach that we think is valuable not just to the sell side, but to the buy side as well, and where the large buy side participants in the credit defaults swaps market could participate and help reduce counterparty credit risks as between themselves and the dealer community in a way that I think our competitors have not yet facilitated.

We have, I think, a very strong reputation for neutrality and independence and establishing risk management policies and in making sure that the marks, if you will, as part of the valuation of exposures are independent and objective. And we also offer, I think, the most flexible solution in that we're providing for firstly a migration facility for existing gross exposures in the CDS market; we are contemplating allowing access to clearing-only services, where market participants can continue to transact bilaterally in the over-the-counter market, but submit those exposures and trades to the clearing house for a central counter party guarantee.

And then lastly, and I think very uniquely, we're also offering an execution platform, both a central limit order book for highly standardized indexed products, as well as an RFQ transaction platform for single name products that may not normally be deeply liquid and subject to a high turnover transaction frequency that could also be centrally cleared, and that might both enhance the liquidity in the market, improve price transparency, but also improve the quality of the marks that the clearing house can use in properly determining the value of the exposures. So I think we have a very, very strong advantage in all of those respects.

Very good. I will step out and let others get on the call.

(OPERATOR INSTRUCTIONS)

We will take our next question from Niamh Alexander with KBW.

Thanks for taking my one questions.

The open interest declining, I know Rick, earlier, you guided us earlier in the year to say that historically that may have been a good precursor to volume, but we're kind of--it looks back now, it does look like it kind of open interest peaking last year was a bit of a precursor to kind of volumes slowing, shall we say. Is there anything you can point to or anything that you see in kind of the detail of the open interest that kind of points to maybe it's flattening out or it's a specific type of customer that's just pulled back without the volatility or anything like that?

I think one of the big areas of the decline have been in a couple of the options products. Obviously the euro dollar options being the biggest one, but you have seen some decline and open interest in other interest rate products; but yet in other products, you've seen actually increases in open interests. So it's a very mixed bag of what's going on out there right now and a lot of it has to do I think with how the underlying markets are trading and whether they are functioning properly more so than what the future's open interest is.

So I do think you have to look at it on a product by product basis. I think you have to put it in context of what's going on in the market. So it is--it's difficult to use those numbers because if you look at that as the sole factor just because there's so much else going on and if you look at them over a short period of time, they actually--actually become negatively correlated. So we're refining kind of our forecasting on this as well, but there's lots going on.

Okay. Thanks so much. I'll get back in the queue.

And our next question comes from Mike Carrier with UBS.

Thanks, guys.

Obviously the volume outlook is pretty challenging. It just feels like there's more headwinds versus tail winds, and it's not just for you, just for the overall industry. So I guess when you look at like budgeting for next year versus like the past seven years, how do you look at the expense base, particularly given all the ongoing investments, with the possibility of having significant volume declines? I guess what I'm just getting at is when you look at the expense base, ex the synergies, where could you pull back if we are in an environment where volumes over across asset classes are just going to be flat to down 10% or 20%?

Yes, hi, this is Jamie.

That's a good question. It's certainly an area that we'll be very focused on as we go through the budget process. We have been disciplined throughout our history on the expense side and we'll continue to engender that. One of the things we'll have to do is we'll have to look to see what the cost benefit is of reducing certain expenses. You don't want to cut expenses that lead to growth down the line, so it's somewhat of a balancing act there.

So it's something we will look at through the budget process. Some of the areas which naturally move with volumes, because volumes are tied to cash earnings, would be the bonus line would move along with volumes and license fees are a variable expense, so those move with volumes as well. We also have discretionary expenses that we would take a harder look at, probably in the marketing area perhaps or in some of the expenses we use in prospecting; and then we would also look on the major capital spends, but I think right now all is very well and we'll just be very careful in our budgeting.

Okay. Thanks, guys.

And next is Rob Rutschow from Deutsche Bank.

Hi.

Following up on that question, can you tell us what your expectations are for next year in terms of volumes and what you're budgeting there?

No.

Rob, we don't give out the volume guidance.

Okay. I guess I'll get back in queue.

And our next question is Chris Allen with Banc of America Securities.

Hey, guys. How are you doing?

Good, Chris. How are you?

Good.

Just a quick question on CDS. Some of your customers have raised concerns that putting CDS positions on the clearing house would pose a risk to their capital. How do you answer that and also would it be necessary to raise additional capital to clear CDS contracts?

Yes, couple of comments on that.

I mean I think first of all, people are--there have only been a couple of people that have commented on that and they have done so in, I think, kind of a preliminary fashion, reacting just to people talking about what we're proposing to do. But I want to be careful to say that we have a risk committee, which we will have a discussion with them about the risk modalities that we'll use here for the credit default swaps market.

We also--we'll certainly have more substantive and detailed conversation with our clearing member firms about the risk management protocols that will be used here, but suffice it to say that we've done a tremendous amount of work here. We have very specific protocols that we're going to be putting in place that are unique to CDS; and so I think we'll be able to satisfy and address those legitimate questions that people have once we have the opportunity to get into the specifics and the particulars of that. I think we have both Phupinder Gill and Kim Taylor on the phone in New York, both of whom run the clearing house and they may want to amplify on that.

Hi, Craig, this is Kim Taylor.

I wanted to just add to what you said about the risk management protocols that are being applied to the credit product. One of the things that we looked at in considering whether it was appropriate to include these products in the existing financial safeguards package or whether it was more appropriate to establish a separate financial safeguards package was whether or not the--ultimately the risk profile that the financial safeguards package is exposed to would change significantly from the addition of the product.

And what we found was that we were very well able to control for differences in the risk profiles that these products present with the specialized margining protocols that Craig mentioned, and also some specialized suitability requirements for who would be allowed to participate in clearing these products. So we think that we have adapted for the differences in the risk profile accordingly, and that the pool of the financial safeguards does not face a significantly different risk profile than it faced before. That's the important thing.

Thanks, Kim.

And next is Mike Vinciquerra from BMO Capital Markets.

Craig, you talked about--you were pretty enthusiastic about what's going on with ClearPort right now. I noticed in the last couple of days you guys have introduced a number of new products as well on the platform. Can you talk about the outlook there and it seems like it's one that you think is going to be one of the growth engines over the next couple of years?

Yes, sure, I'm happy to do that.

I mean we're really excited about ClearPort, certainly the more recent performance has been outstanding. We've also been, and I'll ask Rick to comment, because he's been particularly active in getting out and talking to the customer base that is using ClearPort as well as the interdealer broker community; and I think there's a lot of enthusiasm for ClearPort and how it works. There's a lot of interest in expanding ClearPort beyond the current product set of primarily oil and gas swaps, a much broader range of product that people are interested in.

We're seeing a significant increase in customer connectivity and registrations as well and one of the things that we're trying to do on an operational level as a consequence of integrating the two companies is try to reduce bottlenecks and constraints on bringing new product to market in a very timely fashion. So all of that, I think, is very positive for us from a growth perspective.

Mike, one of the things we wanted to demonstrate to the market is we could get a number of those natural gas basis swaps out there, which we launched on Monday and we look to other products as well. I think NYMEX and COMEX had a number of products kind of in the pipeline that we are moving forward to getting those into the market and all these are what customers are asking us for.

And then the other area that Craig mentioned was expanding the product categories and the asset classes we put onto ClearPort because I think ClearPort has been a hugely successful product, but in this environment, we're getting lots of clients talking about putting more assets on there because of the credit crisis. I mean people are really attuned to credit risk right now, and I think there's products such as agricultural products and metals that we continue to roll out and those are very important for what people are looking for. And I think you saw just the other day that we've now done as much volume on ClearPort in the energies on one day as we did on Globex, which is something we've never seen before.

So this is heightened in customers' minds. I think one of the things that Craig mentioned is the number of new people registering, but it's also the type of entities that are coming on to ClearPort too. Ones that a year ago, you never thought would had need for a central counterparty clearing mechanism, and now they are there and very thankful that this is being offered.

Great, thank you.

And next we have Howard Chen from Credit Suisse.

Hi, good evening, everyone.

Hi, Howard.

A follow-up on the customer breakdown. Of those 25 major hedge funds that comprise 10% of the volume, could you provide a general sense of order breadth; i.e. opening versus closing a positions, and if that breadth is disproportionately skewed in one direction or another. And I guess more broadly, Craig, with all the increased worries of counterparty risk, is there any particular reason we haven't seen a major end user become an active clearing member of the CME and execute and clear their own volumes; is this of any interest to you? Thanks.

Okay. Just to clarify your question, Howard, are you asking whether there's a difference in the open interest trend versus the volume trend for hedge funds?

Right.

Of that major--of the 25 major hedge funds that you broke out 10% of volume, I guess I'm just trying to get a sense--?

Terminology around order--

I guess I was just trying to get a sense of is there any evidence that that's a net closing out of position?

Howard, I am interpreting your question as can we tell if people are liquidating to get out of the market. I think that's very difficult for us to see because a lot of these positions are offsetting other exposures that they have so you don't know if they are mitigating the risk they have on or if they are exiting positions. That's very difficult for us to see.

Yes, I would say you have to remember, too, Howard, that a number of these larger hedge funds are more sort of algorithmic proprietary trading operations and it doesn't appear to us that there's any sort of trend like that, at least in terms of the significant volume contributors.

Sorry, if I could add one thing. Take the comment earlier that in this environment what you tend to see is people doing these shorter term strategies, where a lot of them are literally getting closed out before the end of the day. So, again, it's very difficult for us to kind of aggregate that up and give you a general trend.

And on the second point, I do think there's a number of entities that are inactive clearing member firms currently that are examining the opportunities for them to become full self-clearing active clearing members of the exchange.

Okay. Thanks so much.

And next we have Mark Lane with William Blair and Company.

Good afternoon.

I understand that you have limited visibility into the types of customers that are trading, but beyond the bank proprietary trading group and the 25 large hedge funds; can you give any further insight or detail on the contribution from some other users?

Well, I mean I think one thing to pay attention to in this quarter to give you some general feeling is non-member volume as a percentage went up. So whether that's an asset manager or a pension plan, you're seeing a bigger percentage of that customer base coming on to exchange. That helped drive the RBC.

Mark, it's very--I think I understand your question to be can we give sort of a quantitative range or breakdown in a percentage contribution from other customer segments. That's extremely difficult for us to do.

We have special membership categories and fee programs that pertain to hedge funds, electronic proprietary trading groups and banks; and when you start to get into the areas of asset management firms or insurance companies or mutual funds or pension and retirement systems, we just don't have membership categories or fee programs that allow us to really see that. And unfortunately there--we don't have a lot of visibility because they are generally trading through the clearing member firm.

So it's just those two categories where you have insight into?

I would say the--the bank proprietary trading, the hedge fund clearing or corporate member and the inactive electronic proprietary trading group areas are the ones that we have the most visibility in. We've, I think, shared with you today as much insight as we can on that.

Okay. And another quick one.

On the CDS, are you dedicated--is your solution dedicated to a buy side model with the central order book and electronic front end, or--I mean if the market doesn't want that or you can't get enough dealer support, would you--could you potentially go in a different direction?

I think that that's a key area that we want people to understand is the flexibility of our offering, which is that it does not require that you trade on the platform in order to clear through the CME clearing house. You can continue to transact bilaterally in the over-the-counter market and submit that transaction to the central counterparty clearing system.

So I think that's the most flexible of all worlds. If the demand is simply for clearing, then we, I think, are the best positioned clearing provider. If there is interest or over time if the market evolves to one that involves more centralized execution with some degree of price transparency, either in indices or single names, then I think we're in a strong position to provide that equally, but it's not necessary. It's not required.

Okay, thanks.

And our next question comes from Don Fandetti with CitiGroup.

Hi, Rick or Craig, question about the ALGO. It's my understanding that they could contribute up to maybe around 40% of volumes. How should we think about the risk of those entities? All of your customers have some types of risk. Can you talk a little bit about that and the concentration there?

Don, it's Rick.

The ALGO guys can be the proprietary groups. They can be part of a bank proprietary--they could be some of the hedge funds. We kind of lump all those together. A lot of that, they do have very tight risk exposures, and unlike some of the longer term strategies that losses can accumulate, a lot of these things are very short-term oriented and lot of them--lot of them turn these things over many, many, many times a day.

So most of the exposure they have is literally in milliseconds, sometimes in seconds. So it's usually a function of where the next tick is. I mean if markets completely come unwound and there's no bid or offer out there, that's a problem. But you also have to understand the markets they trade in tend to be the more liquid markets because their type of trading high velocity strategies do not work in markets where you have disjointed (inaudible) spreads. So that's why they tend to gravitate in some of the larger asset classes in the most liquid products.

Okay, and just to confirm, your hedge fund percentage, 10% for Q3, is it fair to say that's carried through into October?

We don't have that information yet.

Okay. Thank you.

And next we have Jonathan Casteleyn with Wachovia Securities.

Yes, thanks for the question.

There's been an acceleration in the [photor] around a potential CFTC and FCC merger. Just wondering, is there risk to the existing setup of the exchange or would it just be on future products and ventures in your estimation?

Jonathan, it's Craig.

I think it's very difficult to speculate on those kinds of things. We're in an environment right now where many, many, many things will be talked about in terms of financial services markets and regulatory proposals and regulatory reforms; and I just think it's incredibly difficult to speculate on that. I mean at an appropriate time when people are not dealing with the exigencies of the current situation, I'm sure there will be a very thoughtful discussion in Washington and in Congress about how all of this should work. And I think we have a really strong and principled position on those issues that we've articulated for many, many years; and I think it's very clear that the CFTC's done a very good job.

This has been, I think, objectively speaking the best functioning part of the overall financial markets. We've had tremendous continued functioning of the market, deep liquidity, price transparency, no disruption, and safety and soundness, and the guarantee of the clearing house on every trade. So we're standing in a good spot from that perspective.

Okay, and just so I understand, when you mention balance sheet relief in your CDS, a product, does that mean there's no new capitalization required in your clearing house if you were to bolt-on CDS? Is that basically the interpretation?

Kim, do you want to take that?

Sure.

It doesn't mean there's no need for additional funds because our pool always scales automatically with increased exposure to the clearing house, so as the margin on deposit grows with our regular products or with the credit products, the pool size of the guaranteed fund would automatically grow. In addition with respect to the credit product, Craig talked quite a bit about the different margining protocols associated with those products and to a large extent what that results in is kind of a higher--think of it as a higher per unit margin deposit or margin requirement for a unit of credit, notional as opposed to a unit of other products. That will actually weight the pool over time more heavily toward contributions from those people holding credit related exposures.

What it does mean, though, is that you don't need to start from scratch and you don't need to re-seed the pool. So if, let's say, the pool needed to be $2 billion, for example, to cover the risk exposure of a book of business that included the credit product, our pool is already at $1.7 billion, so there's a significant efficiency in adding--diversifying the default risk basically that's covered under that pool. We would only need to increase the contribution by $300 million, whereas providers starting from scratch in a start-up clearing house would need to start from zero and raise the $2 billion.

So there's a significant advantage--there's a significant advantage in a couple of ways. One is actually that the default profile of the clearing house is diversified and that is a better position for systemic risk protection than a default profile that's facing the clearing house that is kind of one product, single-product oriented. It also, though, is a capital efficiency to the market participants who are participating in the clearing process because they get an efficiency from the capital that they have already put out to support the business. Does that answer your question?

I think that makes some sense, yes. Thank you.

And our next question comes from Daniel Harris with Goldman Sachs.

Hi, good afternoon.

I was hoping you guys could spend a minute here going through somewhat of a post-mortem on FX market space and thinking back to when you launched it and what either--what you've learned from the--from the experience of having--trying to enter this OTC market, having it not work, what you could have done different and how that sort of shapes what you're thinking about with regards to your CDS opportunity? And that's I guess more specifically focused on the trading side rather than the clearing side.

Daniel, I'll start.

I think one of the things that became apparent early with FX market space is that many of the market participants were actually looking for a solution that would provide efficiencies in terms of net settlement through the CLS system and ultimately the FX market space management took, I think, a conservative view on that and we continue to facilitate transactions on the platform that were centrally cleared, but that were settled through CLS on a gross versus a net basis. And that would have been, I think, an innovation that had we been able to get to some kind of a net settlement, that might have made a difference.

Apart from that, I think the other lesson is one that was obvious from the beginning, but always difficult to overcome and that's creating an entirely new kind of business and market model and processing model where you have businesses being done in a particular way and when you begin to centrally clear a spot for an exchange transaction, that has significant implications for the bank community in terms of their own systems capabilities; and that proved to be difficult in an environment where the banks are challenged in terms of their legacy systems and their development resources, and while we would like to try to hang in there forever and ever and ever, we just weren't able to get where we wanted to go in the time that we wanted to get there in terms of operational preparedness.

Great. Thanks, Craig.

And we have time for one more question.

That question comes from Edward Ditmire with Fox-Pitt Kelton.

Just wanted to ask, given what you've studied in the existing over-the-counter marketing credit default swaps, do you think users would have to post more margin or collateral under the CME solution or less than what the status quo is?

Kim, do you want to take that? Kim, do you want to take that?

I'm sorry. Could you repeat the question? I'm not sure I quite got it.

Yes, I'm assuming you guys have done extensive studies on the status quo over-the-counter market and credit default swaps. Can you tell us whether your system would require users to post more--more on margin than they were posting in collateral under the--under the status quo system, or would it be lower amounts that they would have to post?

No, I think that on a participant by participant basis, one of the problems I think that is facing the over-the-counter credit default swap market now is that collateral arrangements are kind of bespoke. So there are different arrangements that apply to different counterparties, different arrangements that apply to different customers, and so there's not, there's not kind of a disciplined standardized approach to collateral requirements; and I think there's also a lack of transparency on the part of the customers. The dealers have the ability to basically change the margin requirements or the collateral requirements kind of at will.

So our--our approach to risk margining for these products is the same kind of conceptual approach that we have in all of our products, which is we're looking to do a risk-based, portfolio-based approach to margining where we are looking to ensure that our margin covers what we consider to be the worst case loss the portfolio would suffer over the relevant time period that we would need to liquidate the position. So some of those elements are very different for credit products than they are for futures.

I would say--I can answer your question kind of generally in that we've looked at our margin requirements with different market participants versus what they pay now and we have found in some cases they are slightly higher. In some cases they are slightly lower. They are in the range of kind of reasonability and I think that each participant's experience might be slightly different, depending on the bespoke nature of the deal that they had.

Thank you.

And for closing remarks, I will turn the call over to Craig Donohue.

Thank you very much for joining us today. We look forward to being with you next quarter.

And that does conclude today's conference. Thank you for joining us, and have a wonderful day.