芝加哥商業交易所 (CME) 2012 Q2 法說會逐字稿

Welcome to the CME Group Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. (Operator Instructions) At this time, I will turn the call over to Mr. John Peschier. Sir, you may begin.

Thank you, and thank you all for joining us this morning. Gill and Jamie will spend a few minutes outlining the highlights of the second quarter and then we'll open up the call for your questions. Terry Duffy is also on the line, along with Kim Taylor, and Derek Sammann. Before they begin, I'll read the Safe Harbor language.

Statements made on the 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.

More detailed information about factors that may affect our performance may be found in our filings with the SEC, including our most recent Forms 10-K and 10-Q on our website. Also note the final page of our earnings release contains a reconciliation to our GAAP results this quarter. Now I'd like to turn the call over to Gill.

Thank you, John, and good morning. I will discuss our performance in the second quarter and provide updates on a few of our strategic initiatives before turning things over to Jamie to review the financials. During the second quarter, several things continued to unfold, including the European crisis, bank downgrades, the continuation of Operation Twist, and the Fed's Zero Interest Rate policy. The environment we operate in remains challenged, and global trading volumes continue to be impacted by low levels of volatility.

In light of this, the entire organization is working to be as efficient as possible. Average daily volume in the quarter was 12.4 million contracts, down 9% versus the second quarter 2011. However, we did experience [bad better] volumes in May and June, 13.2 million and 13.1 million, respectively, which helped offset the slower April of 10.7 million contracts.

Interest rate ADB in the second quarter declined 20% versus the same period last year. Volumes continued to be impacted by the Fed's Zero Interest Rate policy and quantitative easing. The expectation of continued slower growth in the US has pushed out the Fed funds rate hike expectations, which also continue to weigh on volumes. Helping to stabilize our interest rate complex is the growth [out of the curve], especially in years three to five, as well as in the so called mid-curve options.

Our interest rate team has been successful in building this new liquidity, and we expect it to thrive even when activity on the front end picks up again. This is a good example of how we leverage our people and our products for the benefit of our customers, making CME Group the most compelling place to manage interest rate risk. This is evident in the strong out-performance of our markets versus interest rate products listed by other exchanges.

Also during the quarter, FX volume was flat compared to the same period last year. Overall, June average daily volume was 1.1 million, the highest FX volume month of 2012. This was driven by a boost in our euro currency volume resulting from increased volatility going into the Greek elections. Our key growth contributors continue to be the so-called commodity currencies, the Aussie dollar, the Canadian, and the New Zealand dollar, as well as our emerging-market products, led by the Mexican peso. This is indicative of how our FX business continues to diversify as we grow our entire portfolio of currency pairs.

This was also a key driver of CME Group's Q2 out-performance versus some of the larger cash FX platforms, most notably ICAP's EBS, which reported Q2 results that were down 24% compared to the last year. We also hit multiple open-interest records in June, leading up to the June quarterly expiration, hitting an all-time high of 2.3 million open FX contracts on June 7, 2012. We finished June with open interest up 22% year-on-year.

Overall, volatility remained slightly elevated going into the post-Greek election market, so we expect that we may see continued levels of concern as focus now turns to the Greek coalition government actions, as well as the fate of Italy, Portugal, and Spain. Equities volume was up 3% versus last year. The increase was driven by strong performance in E-mini Dow futures, E-mini S&P options, E-mini S&P 500 weekly options, and E-mini S&P 500 end-of-month options. While assets under management continued to decline during the quarter, volatility picked up briefly when US markets rallied sharply at the end of the quarter after better-than-expected news from the EU summit. The [VIX] hit a high of 27 on an inter-month basis, and has trickled down to close the month out near the 17 level.

Energy ADV was down 1% versus last year. This was driven by strength in natural gas and refined products, which are offset by lower WTI trade volumes. However, we have experienced strong volumes in the month of July with ADV up 9% versus July last year. We also recently launched the CME Direct platform for energy trading in June to address customer needs for straight-through processing. This new technology offers side-by-side trading of exchange-listed and OTC markets. CME Direct will initially support trading of CME Group's benchmark energy futures markets alongside OTC energy swaps through leading inter-dealer brokers.

Although metals volume is down 8% for the quarter versus last year, metals open interest continues to grow, up 9% at the end of June versus the same period last year, driven by an 11% increase in gold. We are encouraged by the recent base metal volumes, with copper average daily volume increasing more than 57% with this Q2 last year, and now representing more than 21% of our metals volume. In agricultural commodities, volume is up 11% versus last year. Severe drought conditions in the Midwest, driving higher volatility, along with the expansion of the CBOT grade and Oilseed trading hours on Globex have both contributed to strong performance.

Our markets have been particularly active in July, with volumes up more than 50% as customers turn to us to manage their risk. Open interest has grown from 6.1 million open contracts at the beginning of January to 8.7 million open contracts as of July 25, which represents a high for the year and growth of over 20% versus the same period last year. Moving on to our growth initiatives, we continue to expand and enhance our global partnerships. During the quarter, DOJ approved our S&P Dow indexes joint venture with McGraw Hill.

We closed the transaction, combining S&P's leading position in equity, commodity, real estate, and strategy indexes with Dow Jones-recognized strength in equity, commodity, emerging-market, target date, and dividend indexes provide an opportunity to offer a complete and growing index family in more asset classes, benefiting more investors throughout the world. As a result of this venture, we have also expanded our exclusive right to list for trading and clearing futures and S&P products for as long as we own equity in the joint venture.

Turning to technology, in Q3 of this year, we will launch a significant CME Globex performance release. The new platform introduces advanced order entry and market data gateways deployed on our jointly developed PUMA network to provide improved processing speeds, decreased variability, and significant hardware efficiencies. This will provide a more consistent trading experience for all of our electronic trading customers, with a significantly reduced server footprint while increasing capacity on peak. As we execute our long-term CME Globex strategy, we also maintain focus on cost and efficiency.

Through continual improvement and the elimination of legacy systems, we have been able to keep technology-related expenses essentially flat, lowering technology cost as a percentage of operating expense from approximately 35% in 2008 to approximately 27% this year. Over the last four years, the CME technology division has been executing our long-term CME Globex strategy to evolve the trading platform around the customer experience. We defined a carefully planned road map to globalize our infrastructure, provide critical market controls, and move to a more efficient and less expensive hardware platform while maintaining the highest levels of reliability, integrity, and trust.

In that time frame, we successfully completed the migration of our legacy electronic matching engine to a modern distributed computing platform for increased performance and efficiency. We also built our state-of-the-art, next-generation data center, and migrated all of our CME Globex to prepare for launch of the CME co-location services, which went live early this year. We have also expanded our global distribution to enable the business growth we have seen internationally with the launch of network hubs in key strategic countries and a global network backbone to efficiently and reliably transmit the network traffic.

Turning to the clearing area. We continue to expand our OTC product offering, and remain well-positioned to benefit from the regulatory mandate. Earlier this week, the CFTC voted to propose several classes of interest rate and credit default swaps for the clearing mandate, and also finalize the rule on the phasing of the clearing mandate. The proposal on interest rate and credit default swaps marked a significant milestone for mandated clearing. Once it is published in the Federal Register, a 90-day review period will start, with the first month including a public comment period.

This proposal also applies to interest rate and credit default swaps, and will be followed by energy swaps and other asset classes, which will generally follow the same process. Assuming the proposed and final rules are published in the coming weeks, our current working assumption is the clearing mandate for all or a subset of these interest rate and credit default swaps will be in effect for swap dealers and major buy-side participants in early 2013. The clearing mandate for additional market participants will be phased in over the course of next year.

Also earlier this month, the CFTC passed final product definitions, as well as the final rules for the end user exception to the clearing requirement for swaps. Once the long-awaited product definition rules and the rules for implementing the clearing mandate are published in the Federal Register, the clock officially starts for compliance with a host of rules already passed by the CFTC. This progress in rule-making is a key step forward for the CFTC, and clears the way for them to finalize the remaining rules.

Several new buy-side firms cleared their first OTC swaps at CME over the last two weeks. We have seen a significant increase in firms finalizing their internal OTC clearing readiness, and setting up production accounts to prepare for launch. Importantly during the second quarter, we finalized our long-term OTC clearing agreements with the major sell-side banks for clearing both interest rate swaps and credit default swaps. Of particular note is the global nature of the interest rate swap clearing arrangement, which enables expansion of our clearing services with this group and other potential partners into Europe and other regions around the world.

To date, we have cleared nearly $700 billion across OTC financial products, with $554 billion in rate swaps and another $138 billion in credit fault swaps. The open interest currently stands at $362 billion, which represents a $52 billion increase since May. We remain the leader in D2C OTC clearing for US clients. Also in the quarter, we began clearing FX OTC non-deliverable forward trades, further expanding our market-leading OTC solution across multiple asset classes. We continue to work with buy-side, sell-side, and clearing member firms to further develop our overall OTC offering, and FX has become a key priority for clients in the last few months.

As we noted on the last earnings call, we've started to provide portfolio margining of OTC interest rate swap positions and euro dollar and treasury futures for house accounts on the 7 of May. The risk reduction achieved will result in capital efficiencies of up to 85% for certain portfolios, and this is a number that remains unparalleled in the industry. We expect the same capital benefits should be available for customer accounts prior to the mandatory clearing date.

Shifting to our globalization efforts, we continued to make progress during the quarter. Our processing services revenue has more than doubled to $4.2 million compared to last year, the strongest quarter we have had, and up significantly from Q1. This strong growth was driven mainly by increases from BM&F BOVESPA, Bursa Malaysia, and the Korean Exchange. In addition, looking at the breakdown of trading in CME Group's products on a global basis, we had an 8% increase in Globex trading revenue during the quarter compared to Q1, with the strongest growth coming from Asia and South America, each up more than 20%. We also continued to see improved liquidity throughout the trading day, with Globex average daily volume during non-US trading hours up 9% sequentially, while US trading hours average daily volume grew at 3%.

In summary, this was another challenging quarter for the financial services sector. However, we do not let that distract us from positioning the Company to build on its industry-leading business by expanding our diverse product offerings while continuing to invest in our global growth strategy. We will continue to remain as efficient as we can with a strong focus on expense discipline, which you saw this quarter. We continue to generate significant cash flow and we remain committed to returning excess capital to our shareholders. We are well situated to ride out the current weakness and are focusing on positioning ourselves to fully benefit when the current headwinds turn into tailwinds. With that, I will turn the call over to Jamie to discuss the financials.

Thanks Gill, and good morning everyone. Today I'm going to review the results of what has been a very productive quarter, while we also continue our focus on efficiency. We accomplished a lot during the quarter, including the sale of the CBOT building, a smooth CEO transition, and the close of our joint venture with McGraw Hill at the end of June. I'm going to cover quite a few details, which should assist with modeling going forward. Many of the activity in the quarter drove non-recurring items which are included in our GAAP results, and were noted in the earnings release. I will touch on these during my comments. In addition, we completed a five-for-one stock split in July, which is reflected in our results today for all periods referenced.

Let me start with revenue. As Gill mentioned, average daily volume was down compared to the second quarter last year. However, volume trended up in the latter part of the second quarter, and in total, increased slightly from Q1. Total revenue came in at $796 million, up 3% from the first quarter. The rate per contract for the second quarter was $0.812, which was up slightly versus last year, and in line with the Q1 rate. Compared to last quarter, the product mix was favorable, offset by unfavorable venue mix and higher volume discounts. Turning to expenses, total GAAP expense was $327 million. Excluding the non-recurring items from the quarter, operating expense would have been $306 million, down $17 million from the first-quarter operating expense of $323 million. These items impacted us in the compensation, professional fees, and license fees line.

Starting with compensation and benefits, this line item was $131 million, which included $12 million of contractual payments, including costs associated with the accelerated vesting of stock-based compensation associated with Craig's retirement, and severance related to the S&P Dow Jones JV, the CBOT building sale, the Green Exchange transaction, are voluntary exit incentive program. In addition, due to the 3% decrease in the equity market in Q2, we had a credit of $1.7 million in deferred compensation, which is offset with lower investment income, compared to a $4.1 million of deferred compensation expense in the first quarter.

Our overall head count went down during Q2 from 2,702 to 2,604, driven by the S&P Dow Jones transaction and the sales of CMA and the CBOT building. Another 110 employees from the S&P Dow Jones transaction will move off the CME payroll in July, bringing the total CME Group number of employees down to approximately 2,500. Lastly, as mentioned in Q1, we opened an office in Northern Ireland, which is focused on certain technology functions we are augmenting overseas, and our plan is to initially hire between 80 and 90 employees there. This addition of head count will reduce our overall expense as these individuals will replace existing technology consultants.

Turning to non-compensation expense, there were two primary expense categories which were impacted by index JV transaction. Within professional fees, we incurred approximately $6 million of success fees related to the deal. Also, within license fees, we'll move to a profit-sharing arrangement from a per-contract fee, which we discussed when we announced the deal. Despite closing on the last day of June, we did pay a retroactive incremental amount of $3 million for the full impact of the second-quarter profit sharing. Our operating margin, excluding the $21 million of expense adjustments, was 61.6%.

Turning to non-operating income for the quarter, we had a net $65 million gain related to the S&P Dow Jones transaction, which is included in our GAAP results. Our tax expense on a GAAP basis totaled $257 million, which includes a $132 million non-cash charge to establish deferred tax liabilities associated with the closing of the S&P Dow Jones JV. Capital expenditures net of lease-hold improvement allowances totaled $34 million in the second quarter. For 2012, our CapEx expectations remain in the $140 million to $150 million range.

A couple of final comments on modeling. During the second quarter, we recorded approximately $27 million of revenue from the Dow, CMA, and real estate businesses, which will not continue going forward. We expect expenses in the second half of the year to drop to $595 million from $629 million in the first half. Several expense items are back-end loaded, such as marketing and depreciation. In addition, based on CFTC rule-making progress around the clearing mandate, our total build-out of a swap -- our potential build-out of a swap data repository and other requirements, we expect higher regulatory and legal-related costs in Q3 and Q4. For Q3 at this point, I would expect expenses to be in the $300 million range.

One final note. Going forward, we will be recognizing our share of the quarterly income from the JV in non-operating income. An early, rough estimate for this year is $15 million per quarter this year, pending largely on index trading volumes and assets under management. Lastly, we continued to make progress on the tax front, and we are adjusting our tax guidance. For the second half of the year, we expect taxes to come in around 40.5%, down from our prior 41% guidance. A preliminary estimate for 2013 would be in the 38% to 39% range, down from our prior estimate of 39.5%, and we will update this estimate as appropriate.

Turning to the balance sheet, we had $1.3 million of cash and marketable securities at the end of June, an increase of $230 million from the prior quarter. $149 million of this increase is tied to the sale of the CBOT building. Keep in mind, we made two tax payments during the second quarter versus none in the first quarter, and versus one payment in each of the remaining quarters. Total tax payments in Q2 totaled $325 million, and we paid out $150 million in regular quarterly dividends in June. As of mid-July, we had approximately $1.6 billion of cash and marketable securities on the balance sheet.

In summary, we accomplished a lot this quarter. We closed the S&P Dow Jones JV, we sold the CBOT building, we finalized our clearing agreements with the major OTC dealers, and we decreased our ongoing expenses. We are taking advantage of the current state of the markets to focus on positioning CME Group to capture future growth opportunities and to bring excess capital out of the business to return to our shareholders. With that, we'd like to open up the call for your questions -- only one question and one follow-up, please.

Rich Repetto, Sandler O'Neill.

I guess the question -- the first, I think there's a follow-up -- but Jamie can you just give us the expenses that are coming out with the JV that were attributed to the Dow CME prior. If you had $27 million in revenue, it was roughly break even?

With the Dow and with the JV and the sale of CMA as part of that JV, that's all embedded in the guidance, the expense guidance that I gave you for the second half of $595 million of the areas that those particular ones will impact the most will be on the compensation line, the amortization of intangible line; on the license fee line, you'll actually see an increase in license fees as a result of this due to that profit-sharing that I noted earlier.

Okay. The one follow-up would be, I guess, for Terry and Gill. You went through some good detail in walking through on the OTC expectations, the OTC clearing. Gill you said 1Q 2013. If you just did the three months, you'd be in November and I guess the phase-in is major swap deals in the beginning. Would you expect to see a significant up-tick at the end of the year, or the first step-up at the end of this year? Why that delay to later in the early 2013?

I think, Rich, what you're going to see, the mandate will kick in it seems to us in February of next year. What you're going to see, because we are talking about thousands of accounts that are going to come on board, the ramp up is definitely going to be in full gear in the fourth quarter of this year. As I said a short while ago, we are seeing many accounts that are already now preparing to launch, and in the last two weeks especially, we've seen activity coming in to us. A safe assumption would be you're going to start seeing mostly serious clearing beginning around the end of the third quarter, and the fourth quarter is going to be very busy for everybody.

I think you're adding three months on to sort of the feedback loop that the CFTC --I think that's where the three months comes from.

Yes.

Okay, thank you.

Alex Cram, UBS

Maybe we'll just stay on the OTC topic for a second here. I think you mentioned that in the quarter you finalized some of the agreements with the dealers, and you said in the past that you are going be focused more on getting some of that dealer volume to, even though at LCH they have a pretty nice sweetheart deal right now. Can you give us any more color on how those discussions are going? Could there still be some sort of restructuring of the agreements with the deal? It sounds like you've been very aggressive in talking to the dealers in terms of getting some volume over here. Any indications would be great, thanks.

Sure. This is Gill and I'll ask Kim to chime in if she has anything to add. I think with the finalization of the agreement with the dealers, it simply formalizes all the activity that has been going on up to this point in time, which both of us had taken on a good-faith basis. I think that the dealers will continue to work with the buy-sides just like we are working with them, and the buy-side.

Keep in mind for every one of these pairs that the buy-side does, there's a sell-side transaction also associated with it. The dealers are clearing here. As capital efficiencies become more of an issue, which it actually is, especially when [Bob-3] kicks in as a requirement. I think the rational thing to do is to work efficiently to lower the capital.

All right, good. I don't know if Terry is on, but clearly it was some of these customer losses of MF and PFG, there's been more discussions or more noise from you guys in terms of holding some of -- or more collateral at the clearing-house level, and not at the FCM level. So just wondering in what stage we are, if you're engaging with FCMs in terms of talking about them how this could look; what the reception is.

In particular, I think historically FCM's have made like, I don't know, 40% to 60% of their income on interest. Would this change, or do you think there could still be a way for the FCM model to be fairly similar to how it looks like now from a profitability standpoint, and how this could maybe impact friction in the system and trading volumes? Thank you.

Gill, can you hear me?

Yes I can.

Alex, what I would say to that is -- and I testified and I said this yesterday in Washington -- this is not something that CME wants to do as far as holding the customer funds. We are not trying to impact, disintermediate, or anything of that nature of their model, realizing very much so that the percentages that you outlined are correct.

At the same time, there has been two major events in our industry. Some have come to us looking for different solutions. This has been raised. What we had said in the release the other day is that we would be prepared to work with the industry. We don't have all the mechanisms how it would work, but the important thing is we do not want to disrupt the FCM model. This would not be a profit-generator for CME Group.

Again, what we are trying to do is just again build the confidence back into the market place for the clients, which they deserve. That's really what we are trying to do here. The last thing we want to do is have any notion of it look like we're trying to disintermediate the God. The FCMs are holding their customer funds.

If I could just add and stress one thing -- this is not a proposal but it is an idea floated out there a few days ago with the intended purpose exactly as Terry pointed out. It is very specifically to restore confidence in the market place and in our FCMs. We clearly recognize that the vast majority of our FCMs have done a phenomenal job handling the client funds, and this in no way, shape, or form indicts any one of them. This is simply very specifically to restore the confidence that we know has been lost as a result of the rogue actions of two firms.

All right, so way too early to think about any potential timing, I guess?

Correct.

Howard Chen, Credit Suisse

I just wanted to get your take on the ongoing LIBOR investigations. Maybe more broadly, when I think about CME, I think one of the core principles of the Company is that you have these great global benchmark products, so how you go about ensuring you've got that right suite of benchmark products for the next 10, 20 years like you have had for like the last 10, 30 years?

This is Gill. I'll start, and Derek Sammann, who is with us, might want to add. Where the LIBOR is concerned, we expect that it is going to remain the predominant short-term reference point contract. There are issues as you did note. Those issues -- we are in support of anything that would fix those issues.

There's a lot of money that's indexed to that rate now, and CME has, in the past, work with the BBA, and we will continue to work with the authorities and anybody else to make sure that it continues to be the benchmark on a going-forward basis. Just as a point of note, though, it's not the only contract that we have; we have a suite of interest-rate products. As a reference point, we have the vast majority of any potential shifts that might occur. Derek?

Yes, Howard, a good question. Let me jump in also. I think what you're speaking to is our track record of successful product developments and product extensions. When you look at when we've talked to you guys about for the last couple of years, the products we've put on our curve, whether it's the ultra bond, or the weekly treasury options, the mid-curve options, not to mention the service development that you've heard Kim and Gill refer to around the swaps clearing piece.

We think that as we continue to look at points on the curve, and look at various product areas and opportunities, we're going to continue to put products out there that speak to both client demand, whether it's across the curve, or in terms of different products open to us as a result of OTC clearings. You'll be hearing more from us. Kim did mention about the cross-margin opportunity for our rates complex as a whole. It swaps -- that was rolled out, as Gill mentioned on May 7.

We're seeing people take up opportunities on that. We hope to have that provided out to customers over the coming months, as well. We look at this as a suite of products and services, and our track record of new product development and product expansions I think puts us in a good place, listening to our clients and putting product ideas out there to serve their needs.

Gill, can I jump in for one second?

Yes.

Howard, what I think is very fascinating too, is I know LIBOR's come under a lot of scrutiny, and I agree with everything Gill and Derek has said. I do believe it will remain the preeminent benchmark. Just to add a little bit of credibility to this, some of the people that are crying the loudest are still using it, and that would be the United States federal government. The Fed still uses LIBOR as it makes its loans today. They use that as a reference point when they make their loans. I do believe that this will still continue to be the benchmark going forward.

Great. Thanks everyone for all the thoughts. My follow-up -- Jamie, as you and the team begin the 2012 budgeting process, you evaluate working capital needs, you look over the M&A landscape, I was just hoping for your latest thoughts on how much of that cash on the balance sheet -- over $700 million -- you'll sweep and return to shareholders at the end of year? Thanks.

Sure, Howard. It's hard, I can't give you an exact answer. There's certainly -- we've been fairly active in doing smaller bolt-on acquisitions that we'll use some of that cash for that and continue to do so. With that said, there is a significant amount that we've already generated through the first half of the year and will continue to generate through the second half, and we will look to -- as we always say -- look to return a significant portion of that excess to the shareholders. One thing that we are considering and thinking about is keeping our eye on the tax law as it relates to that fifth dividend, and seeing whether it would make sense to pull it forward into this year, if the tax laws progress the way that they are currently written.

Very interesting. Thanks so much.

Michael Carrier, Deutsche Bank.

Thanks, guys. Maybe just a follow-up on the customer funds. If we think about the different options that the industry has, whether the clearing houses, you manage that, or if it's out-sourced to a custodian or one of the trust banks. More important, because those are two different options, but just from the FCMs standpoint -- like it's a tough business already -- if they lose that, or the customers have to pay for that, do you sense that given the changes that are taking place, there's going to be more pressure on industry trends, volume trends, or pricing trends, or is there an outcome that can make customers more secure, yet there won't be additional pressure on either volumes or pricing?

I think there are a couple of assumptions that you have to make, and I think these assumptions are good assumptions. The vast majority of the FCMs that we have are handling the customer funds in the right way. As you rightly point out, the interest rate component is a very large part of the business model of the FCMs. It is something that we are extremely sensitive to, and have begun conversations with them with respect to how to best handle this confidence issue.

It may be the highly restrictive investment policies that are in place now would be a very good gating factor for these guys. There are several banks, as you might know, that are part the infrastructure of our system, and those banks may get involved. If those banks do get involved, they can be considered as an independent third-party. They, instead of us, might be an alternative choice. The important thing, as Terry pointed out a short while ago, is to not change or harm the FCM business model as it exists now.

There are -- to your point a short while ago there are going to be continued pressures on the FCMs, but the three big things that we are focused on with respect to this issue is -- number one, to restore the confidence; number two, to make sure that the FCMs continue to be able to operate their businesses as they do now; and the third piece, which we have heard from our firms, has been too lower the back-office costs for our firms.

If I could just add to what Gill said Michael, I think we have said this historically because it's true, the cheapest part of transactions in the futures industry are the cost of execution. What derives the real benefit is a tight-bit offer. Even though the cost of trading is down significantly, even if there was an up-tick in cost by the FCMs, you would still be a -- users would still be a main benefit, because that is still the lowest cost of the trade. The slippage is where the real big cost comes in. I don't see that as a real big impediment, even if their model was to be impacted and competitively raised up to offset some other revenue losses.

Okay, that's helpful. Maybe just a quick follow-up, just on the tax rate. Guidance a little bit lower now. When you look at your options or maybe what you're looking at in terms of how you can lower that over time. Is there a lot more to be done? Obviously there was the Illinois stuff, but then it just seems like for all companies you can look around and try to figure out if there is more ways to become more efficient. I'm just trying to gauge what inning are you in, in that process; albeit, it's an ongoing process.

That's right. It's a good question. It is an ongoing process. We're looking for continuous improvement in the rate. The fact is that the vast majority of our assets and intellectual property and all else has been developed here in the United States, so that really does limit our ability to have any tax plays outside the US. A lot of the companies that you do reference that have strategies where they have acquired businesses outside the US, property outside the US to drive income that's allocated outside the US, build cash balances outside the US that they're not able to repatriate and therefore return to shareholders.

There's a lot of moving parts and a lot of things to consider as we continue analyzing our tax situation. I'd say the biggest potential opportunity for us, I'd say we are the poster child here in the US for a reduction in corporate taxes. Corporate tax reform in the US would be a, I'd say, the best potential for us.

Just to add to that Jamie, I think Michael when you hear about the fiscal cliff coming at the end of the year and how we're going to deal with that, one of the trading blocs, for lack of a better term, has been the corporate tax rate. I think the Democratic side of the aisle is that's one of the ones that they'd like to use to modify to get other revenues up on the other side. To Jaime's point, that could be our biggest benefit, because that could be the one they could use to trade.

Okay. Thanks a lot.

Dan Fannon, Jefferies and Company.

Good morning. This is (inaudible) calling in for Dan Fannon. I just wanted to talk a little bit about the voluntary exit program. You mentioned it went by really quickly, there was about 100 or so individuals in terms of head count reductions. Was that part of the exit program, and is that program come to an end at this point, or what is the status of that?

Yes, the program, we implemented it last quarter, and it's done in terms of people subscribing to it. Most folks are still on the payroll and it's prescribed they're going to transition off over the coming months. I'd say the decrease you saw on head count this quarter was really driven by the CMA and other -- the sale of the CMA business, some of the Dow Jones head count came off this quarter, more to come next quarter. We also, obviously, have been trying to keep as efficient as we can across our core. Really, we haven't seen a decrease from the voluntary incentive program yet in terms of head count. It is a -- I'd say the number in that is a more modest number.

Jamie, isn't it fair to say that the first available date for these folks to do it is August 15?

Yes, right.

Okay, so we should start seeing some modest additional head count come down. As a follow up, I just wanted to talk a little bit about the open interest. We've seen the open interest come down a fairly significant amount from earlier in the year, and it seems most of that's from within the interest rate complex? It seems there's been a lot of volatility. Can you talk a little bit about some of the factors that have been driving the open interest? Is that something that's just, given the current conditions, it's just going to remain volatile, and we have to wait for interest rates to start moving up, or maybe some thoughts around that?

Sure. This is Derek, thanks for you question. I think you're seeing a lot of this driven by the rates environment right now. You've heard us talk to you over last couple quarters about what's going on in the front two contracts, or the first two years of euro dollars versus the back eight. We're continuing to see in what we call the whites and the reds, or year one and year two, both volumes and OI continue to contract, excuse me.

Certainly when you saw on June 20 when the fed announced the additional $400 billion in Twist and most likely pushing out rate rises out into late 2014, early 2015, that's continuing to be a drag on the very front of the euro-dollar curve. What we are seeing, and we've seen this trend for the last 18 months, and Gill referred to this, is we are still seeing good growth in years three, four, and five. Now that being said, that's not fully offsetting the drop-offs in both volumes and open interest in years one and two.

Where we are seeing strong growth in open interest is both foreign exchange and agricultural products. This is really driven by -- you saw a lot of risk-on appetite going into the Greek elections over the course of the first couple weeks in June. We hit multiple open interest records at about 2.3 million contracts on June 7. We're also seen significant growth in ag complex. Volumes are up and open interest is up, and that's clearly indicating to us that the market's continuing to come to CME and risk manage on the basis of what's going on here.

Rate's up. If you look at the 2012, the full year, June is up 7%, rates are up 6%, equities are up 21% -- we haven't spoken much about equities so far -- energy up 3%, and as we mentioned, ags and metals up 17% and 18%. I think we are seeing the bulk of the drop-off in the front end of the euro-dollar curve. We are making part of that up in the middle part of the curve, but it's not fully offsetting.

Okay. Thank you very much.

Niamh Alexander, KBW.

Thanks for taking my questions. If I could go back to the regulatory reform. We're so much further along now than we were two years ago. As well as that, we saw the recent report -- reports out of [IOSCO] and what-not about collaterals for these non-tier derivatives. I'm asking because -- where you feeling now about the risk that the OTC markets just shrink too much, in that it doesn't get diverted into futures, but the overall pie just shrinks? How do you think that risk has changed? Are you seeing any change in activity from your customers? Alongside that regulation, are you starting to see maybe some of the activity in the people yet pop up at non-bank shops?

In terms -- let me take the first bit and Kim might want to add -- we have not seen a -- we have not had any positive indication as to the market shrinking at this time. What we are preparing for, I would say, and this would be consistent with respect to how other exchanges would think about the world. You're going to end up in one of three places where OTC trades may become more efficient to be done because of clear nature of these trades. You may see actually more of these swap trades, which is very correspondingly very positive for the future.

You may also see a futuristic environment where futures become more efficient; or you may see the market place as it exists now, which is positive again for both sides as capital efficiencies with the cross margin offset that we provide become then will become the norm. Essentially, these three ways in which we believe the market is going to evolve. With respect to the second part of your question, you're talking about the prop traders from the banks that may be coming out?

Yes.

Yes. They have re-emerged in shops. Either they have joined some shops, or they have formed their own funds, and they have started to actually clear.

That's helpful, thanks. Kim, if I could on my follow-on. The cash, you said you're at $1.6 billion in July so far. Thanks for the information about watching the tax rate changes, that you could bring that annual variable forward to this year if the tax rates are likely to change. Can you update me on how much cash you need to keep on the balance sheet now you've got this six-move designation? Is it still around $750 million that you feel you need to operate, and everything over that is excess?

Yes, Niamh this is Jamie. We're still at the $700 million range. We're keeping an eye to see how some of the capillary requirements develop, but right now we're comfortable at that $700 million.

Okay, thanks.

Patrick O'Shaughnessy, Raymond James.

Hi, good morning. I was wondering if you could update me on your outlook for M&A, I guess how CME is viewing M&A right now, and particularly in light of the London Metals Exchange bidding process. It was rumored that you guys were a participant in that process. Any color you can add there would be useful?

Sure, this is Jamie. Our view hasn't changed all that much. I'd say we still don't see much in the way of major significant M&A around the globe for all the reasons that we've gone through before. There will be opportunities for smaller size, I'd say, or medium size like you saw with LME to take a look and review the opportunity. We'll continue to be opportunistic, but our view really hasn't changed, and we'll continue to be very disciplined in our approach.

Okay. That's helpful. My follow-up question -- the farmers and ranchers fund that you guys said you were going to make available in wake of the Peregrine issue, do you have an early read on how much that might actually be utilized?

This is Jamie again. It's obviously a very important constituency, and we did open up the fund, as you pointed out, for those impacted at Peregrine. Our early read on it is that the impact on CME is not a material impact to our financials.

Okay. Thank you.

Ken Worthington, JP Morgan

Good morning. First on the Bush-era tax cuts, they are set to expire at the end of the year. You mentioned that you might move the dividend forward. You're a big dividend payer. In a world with upwards of 40% tax rate on dividends, does that change your view on your capital return policy, or do think it still a good idea to do dividends over buy-backs?

I think it's something that we're certainly going to evaluate. We'll analyze it. We'll talk with our Board about it. As that develops, certainly we would inform the markets.

Fair enough. On the crude oil options side, ICE seems to be taking business away from CME. How are you responding to this? Is there a way to stop or slow the pace of attrition?

Hi, this is Gill. I think in all our markets, as we face competition we have to respond and we are doing exactly that.

Can you let us know, like are there tactics that you're using? I think their market share has gone like from 15% to 30%. Do your tactics -- are you adapting them, or can you share with us what you're doing?

I think if you look at some of the things I said earlier on, we're introducing CME Direct, and that just got launched a short while ago. There are certain incentives that we have put in place and those have taken hold. If you look at the performance of our options market, particularly in the last few months. A lot of that volume has started to come back to us.

In terms of the fundamentals, there are certain fundamentals that are driving the oil markets back toward the TI, and I think if you look at where the options market is going, the incentives that are put in place, the systems solutions that we put in place will all contribute to growing the market for CME, including bringing some of the volume, if not all of it, back. I think some of us compete on the basis of price, and some of us compete on the basis of the value that we add on a portfolio basis.

Great. Thank you very much.

Chris Allen, Evercore.

I was wondering if you could just talk about the sequential decline in market data and information services. You obviously had the price increase in the first quarter. Wondering if there's any pull-back on users, or there was something else driving that?

Yes, this is Jamie. Good question. We do continue to see some diminishment in the number of terminals out there, and I think it's really driven by cost-cutting on the street. As people are looking to become more efficient, they're always looking to reduce their terminals. That's one of the areas they can do it. You're seeing this across all the exchanges, actually. That said, the price increases that we've been able to put through over the last several years have been out-pacing the decrease in the terminals, and we would expect that when markets start to repair and there's more hiring going on, that we'll start to see those terminals come back out.

Got it, thanks. I just want to make sure I have the math correct in terms of the impact of the index business. Roughly $27 million is coming out of revenues. I mean, some expenses have already come out, and then another $6 million basically sequentially next quarter, offset by a $15-million increase. What kind of thinking about it from where we are from 2Q? It's about a $6 million hit, sequentially. Is that correct?

Yes. I'm sorry, you're tying it to -- you confused me a bit there. Can you go through it again with your tying it to the index business, or were you being more general?

Yes, I guess it's a little bit more general just in terms of the guidance, $27 million coming out of revenues we saw this quarter, which includes the index business and CME. Expense guidance of $6 million down sequentially, offset by $15 million in other non-operating income from the JV. Netting it all together, like $6 million sequentially -- is that kind of correct?

Yes, you got it.

Great. Thanks guys.

Matthew Heinz, Stifel Nicolaus

If we could just go back to the interest rate business for a moment. Trading activity has fallen off pretty sharply here in July following the brief recovery you saw in the back half of 2Q. I'm just wondering if this is at all LIBOR-related on the euro-dollar side? That seems to be where most of the weakness is coming from. Also, just kind of what you're seeing out there in terms of customer engagement in the overall rate complex, in light of all the moves being made by the Fed, and then whether you still anticipate influx of new business from swaps users?

Yes, this is Derek, I'll pick that one up. We haven't seen any direct correlation of the conversations around LIBOR directly impacting euro-dollar. What we're seeing is a continuation of the trend we've seen for 18 months, which is the front-two quarter, the front two annuals -- the whites and the reds, or year one, year two -- dropping off, both in volume and ADV terms, being partially offset by year's three, four, and five.

There is a couple data points I'll throw at you. When you look at the growth of the three, four, and five year -- for example, we're actually now seeing significant growth in what we call the golds, which is the fifth year. In fact, on July 6 we just hit a record of 340,000 contracts in the gold mid-curve options. This is a story that we told you a year ago in terms of what we're seeing from the blues, and that was following from the greens. While we're seeing really interest and volatility further pushing out the curve, following Twist, following the expectations that weaker global economy has most likely pushed this farther out, we're seeing that impact on our front end of the euro-dollar curve.

In terms of the clients' acquisition opportunities, you've heard each one of us talk about the clearing opportunities in the cross-margin offsets. We're also looking at the impact of the one-day versus five-day margining that's set up by CFTC. What we're looking at is as we are seeing rules clarifications, and as we're seeing definitions locked down, and now kind of the starting of the clock for a Q1 kick off, what we're actually seeing is using opportunities to talk to customers -- not just about clearing, but the potential to migrate customers directly into futures. Many of our conversations are walking into firms to talk about how we can provide OTC clearing for you as a direct result of the mandate, but we're using that opportunity to introduce futures into the equation, as well. It's one of the scenarios that Gill talked about as an opportunity set for us.

We see this in conjunction with the growth of our global sales force, and what we've created and talked to you guys about for the last18 months as client-acquisition opportunities, while leveraging a broader suite of services beyond just exchange rated derivatives, and then the benefits of cross-margining that accrue right now to house accounts, and we hope to have those accrue to clients over the course of the coming months.

This is Gill. I just want to emphasize something that Derek mentioned, which is that the cross-margin feature that we are offering here is unique in the sense that it is not replicated, not able to be replicated by anybody, so you can't offer lower price here to get cross-margin offsets. For example, you need the open interest, and that's what we have here. As more of these swap trade come on board, it becomes more capital-efficient for our client base to actually put their trades here.

Okay. That's helpful. Just a quick follow-up. It looks like you expect about $60 million of annual pretax income from the new index JV. I'm just wondering if you could remind us what your total capital outlay was for your share of the business, and what kind of ROIC you're targeting on that investment?

The total capital outlay when we originally bought the Dow was in the $600-million range. We typically look to get a return on our capital in the -- call it 10% to 12% range, usually a little in excess of the 10% to 12% is our kind of a hurdle.

Okay. Thank you.

Ed Ditmire, Macquarie

Yes. It does seem that the -- let me just put this question on the LIBOR issue. I understand crystal-clear that CME is committed to helping the LIBOR standard improve and continue as a global benchmark, but if due to situations out of your control the market moved away from LIBOR, could you confirm that you guys would be able to adjust the contract specifications of the euro-dollar future, and leverage the income and liquidity of your very deep franchise with whatever short-term interest rate standard the market wanted to use?

Hi, this is Gill. I'll start and I'll ask Derek to add some detail. This contract is too important for us not to continually adjust it or pay attention to it. It's one of the flagship contracts that CME has.

I think that's a great point. I would say we're continually looking at ways that we can adjust, affirm, and certainly streamline any and all of the major products that we trade, particularly our benchmark products. We would probably point to the CFTC's order and statements made a number of weeks ago as to the impact and the import that the global regulators are placing on making sure that this remains a robust market mechanism for the long time to come.

I would also just note that not only as Gill mentioned do we have our euro-dollar complex, but our treasuries complex, and our fed funds futures, which are trading about 30,000 contracts a day. That's a product that already has significant open interest, and about 500,000 contracts in the futures, and about another 300,000 contracts in the options outstanding as well. Not only do we have an existing suite of products beyond just euro-dollars, in the [stir] complex we also think that the level of import placed on this by the regulators, I think, just only enhances the long-term viability of this product over time.

Okay. On the JV, when you guys announced the deal last year, I think you guys said that you expected the deal to be break-even. It seems to me that the numbers say that it's not quite break-even on a run-rate basis right now in 2012. Is that accurate? If that's true, is it because the Dow Jones portion of the business have been doing better than S&P portion of the business going into the deal?

I think you're right. It's not quite accretive in the way we've laid it out here for you. Something to consider is that over time the equity markets have been under some pressure, assets under management have fallen, that sort of thing. The other thing to consider is that this deal is both an investment in the JV, but also extending our license fee agreement with them.

Any time you go to negotiate and extend the license fee agreement by -- almost by definition, that negotiation will end up in a dilutive transaction, if you already have that book of business, right, as they look to raise rates and that sort of thing. In some sense, there's dilution tied to the licensing side of it, but I think long-term benefits in locking down that license for as long as we own the JV. The dilution here is really not at all material to the overall CME Group.

Thank you.

Thank you. We have time for one final question. Brian Bedell, ISI Group.

Good morning folks. One more follow-up question on the rates for Derek. As we move into 2013, can you comment on what your expectation is for being able to convert users of the OTC swaps into exchange rate? Obviously, you've been having those conversations for some time, and probably not seeing any volumes yes, and I guess let me know if you think we are seeing it in the current volumes, but what's your conviction that you will be able to convince those users as we move into 2013, and about when do you think we'll start to see the impact of that on the rates complex?

I think what we're really going to focus on is what we're doing and how we're positioning ourselves on the OTC clearing side. This is as a new opportunity to be able to access and expand our customer base with a broader suite of services. This is about customer choice. This is about providing the customer with the option in terms of the product of choice, the risk tool of choice, and the source of the choice of the risk mitigant.

We've talked about the ability to walk in and talk to a customer about the suite of services and the cross-margining capabilities available to that customer. That's highly attractive to customers that are already trading our futures and trade swaps, already. This is an opportunity to be able to really put the focus on the clearing side of the business, and represent ourselves to provide the best of those clearing services into that customer base.

With the clarity of the definitions coming through over the last couple weeks and starting the clock for what we believe to be a mid-Q1 implementation and take-up. As you've heard Gill talk about before early in the conversation, there are -- beyond the few clients that are clearing in a pre-mandate world with us right now, there's a significant number of clients that are already through and have completed the testing phase and are simply waiting for the day of to kick off.

We see that beginning to ramp up over the course of Q4, and we see at a pre-mandate point, I think you'll see a more significant jump in terms of those that have simply said I'll do everything I have to, to be prepared, but will most likely do very little until the day that I have to clear. We're spending our time with the customers, making sure that they're ready and able at the point where it flips over.

Great. That's very helpful. My follow-up would be just on expense flexibility -- a question for Jamie. If we are in a tougher volume environment near term, how do you think about near-term expense control versus some of the expenditures for some of the longer-term growth initiatives? Do we have material flexibility to reduce the current guidance from $5.95 in the second half?

I'd say we have -- there's obviously a lot of operating leverage in our business model that cuts both ways, right? It's very difficult to naturally decrease expenses as volumes are not as strong as they've been in the past. You have seen us taking a lot of -- making a very strong effort to be very disciplined. We'll continue to do that.

There is a point -- there are a couple of items that are volume-related in our expenses -- license fee and incentive program expense obviously falls under that category, as does our bonus. There is a point at which the bonus hits a cliff, where if we perform below a certain level -- 20% below our target for the year, there will be no bonus payment. That's a natural mitigant. Other than that, I'll say that we're going to continue to be as disciplined as possible while also keeping our eye on the future. This is for us, we view this as a cyclical down-turn, and we're operating in that mindset.

Great. That's very helpful, thanks so much.

Thank you, and at this time I'm going to turn the call back over to the speakers.

Thank you everybody for joining us this morning, appreciate your interest in CME, and have a great day.

Thank you, this does conclude today's conference. We thank you for your participation. At this time, you may disconnect your lines.