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12:15 PM

This Market's On The Move

Aided by technology innovation, including a systems upgrade, the Chicago Mercantile Exchange's biggest challenge is keeping up with growth

Three years ago, the Chicago Mercantile Exchange Inc. had an impressive business, handling an average daily volume of 2.2 million futures and options contracts, particularly complex financial instruments. Yet the exchange was in danger of becoming an anachronism. Customers were complaining that its technology was outdated and its service poor. In a world shifting to electronic trading, it appeared slow to adapt, too wedded to the open-outcry pits where exchange members traded face to face. And its grip on U.S. market share appeared suddenly vulnerable to overseas competition.

The picture looks a lot different as this year begins. Trading volume rose 23% last year, and electronic trading grew 71%, surpassing face-to-face trading to become the clear majority of the exchange's volume. Aided by technology innovation, including a systems upgrade that pared response times by two-thirds, the Chicago Mercantile Exchange's biggest challenge last year was keeping up with growth.

This transformation in how the exchange does business happened during a time of massive internal change, as it went from being an organization owned and run by trading members to a publicly traded company. It couldn't have worked without changing the IT performance and strategy, says CEO Craig Donohue. "What we're doing is practically impossible to do," Donohue says. "Technology has been actually the way we have kept the whole thing together in a way that has allowed us to compete and do it with the cooperation and involvement of our members."

Electronic trading was 69% of the exchange's total volume in January, up from 43% a year earlier. Several factors came together last year to cause volume on its electronic platform, known as Globex, to explode: the growing use of derivatives such as options and futures, greater acceptance of electronic trading as an adjunct or replacement to floor trading, and technology improvements that have made Globex faster and more reliable.

The technical improvements came just as automated trading systems, or ATS, have become one of the megatrends of Wall Street. In these systems, computers are programmed to execute trading strategies, often driving huge amounts of trading and data traffic. "Two years ago, ATS was just a name," chief technology officer Charlie Troxel says. "Now, it's changing the landscape."

Automated trading systems are changing the landscape, chief technology officer Troxel says.

Automated trading systems are changing the landscape, chief technology officer Troxel says.

Photo by Chris Lake
It's also forcing the IT people to change how they think about their jobs, Donohue says. In the past, innovation at the Chicago Mercantile Exchange was the domain of the financial wizards--come up with a new financial instrument to trade, and that would drive volume. In a world of electronic trading, business-technology leaders need to be the innovators as well.

Something called a "butterfly trade" offers an example of how thinking at the exchange has changed. Butterfly trades are a popular way of hedging a bet. A trader buys and sells four options contracts, but the deal only makes sense if all four trades can happen at the right price. In the past, that kind of complexity could only be handled by floor traders. Last year, the exchange bought a software company called Liquidity Direct and incorporated its technology for executing butterfly trades into Globex. In the first week after the product launch in October, an average of 19,000 butterfly contracts per day changed hands on Globex.

Although the open-outcry system is unlikely to disappear for a while, its role is clearly diminishing. Electronic trading provides speed, anonymity, and reliability of execution--and increasingly electronic platforms also can handle the kind of complicated, multipart trading strategies that in the past could only be handled by the pros in the trading pits. "These are high-performance traders; milliseconds matter," says Dieter Marlovics, CIO of Gelber Group LLC, which provides technology and services to professional traders and hedge funds.

The exchange has come a long way from its roots as a Chicago emporium for trading dairy commodities. Yet in its efforts to transform itself into a modern-day financial exchange, it has had to overcome many obstacles, not the least of which was a reputation for stodginess. "Two and a half years ago, I would have rated the Chicago Mercantile Exchange as terrible in terms of customer communication and technology," Marlovics says. The exchange at times miscalculated the amount of telecommunications bandwidth needed to connect to Globex, which sometimes caused massive bottlenecks throughout the trade-execution chain. Even worse, Marlovics says, it refused to acknowledge complaints from customers "until the system was almost unusable."

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