CME (CME)

Chicago, USA

KEY TAKEAWAY: CME Group of Chicago has built an $80 billion market cap company as the dominant exchange for interest rate and commodities derivatives.

Network effects make it difficult to to dislodge in these areas, where it is largest and most liquid exchange in the world, both in terms of connecting the parties to the transaction, and the interconnectedness of the products themselves.

The more products that can be traded by CME, the more traders want to trade there. The more traders CME attracts, the more products it can offer. This flywheel is very difficult for a new entrant to replicate.
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Whereas stock exchanges compete for listings, the lion's share of interest rate products - swaps, treasury futures, etc. are traded on CME.

These products are interconnected such that changes in prices of one, usually affect prices of the others.

One example is "cross margining". The same trader can buy a long position on US treasury bonds and a short position on interest swaps. The long t-bond position loses value when interest rates rise, and the short interest swap position gains value in that situation. Thus the overall risk is less than either position in isolation.

CME considers risk of the entire trader's portfolio, in setting the margin requirement for each trade. The trader can use a lower margin for this trade than for each trade separately. Traders with many, many positions totally millions of dollars can transact in much larger amounts with the same cash investment.

While CME dominates the market in interest rate products and commodities futures and options, it also offers derivatives related to stock indices, fiat currencies, cryptocurrencies, and more. The ability to cross margin across all of these different products is valuable to customers.

CME competes with the Intercontinental Exchange, CBOE, and others in various areas. It handles triple the volume of its closest competitor, Eurex.

The National Stock Exchange in India actually trades by far the most derivatives contracts, but these are usually in Indian Rupees, and not directly competitive with CME. Some 40% of trades are done by retail investors, often for less than $1.

Brasil Bolsa Balcão ("B3") is rapidly growing its business in agricultural commodities, given Brazil's global importance in traded agricultural items, e.g. soybeans, corn and live cattle. At the moment B3 primarily trades in Brazilian agricultural items.

None of these competitors offers the combination of product breadth and liquidity of CME.

CME's revenues have grown 6%-7% annually over the past decade, while net income has grown 12%-13%, as it has invested in infrastructure to improve operating efficiency.