CME Group 10% Upside Potential on New Derivatives Rules
Exchanges such as CME Group Ltd. ( CME ), Nasdaq OMX ( NDAQ ), NYSE Euronext ( NYX ) are lined up to get a piece of OTC derivatives market as new regulations will require that derivatives trading should go through exchanges and be cleared through clearing houses. As this occurs, the CME Group, the world's largest futures exchange, is set to benefit and it plans to launch derivatives clearing house in Europe after it received approval from UK regulators.
We have a Trefis price estimate of $323 for CME Group Ltd. , which is about the same as the current market price.
The new regulation is a part of Dodd-Frank financial reform act, under which the Commodity Futures Trading Commission (CFTC) proposed rules for how over-the-counter (OTC) derivatives clearing houses should be regulated. While these rules pertain to the US securities laws, we believe regulation in the EU should mirror that of the US with regard to derivatives. The new rules aims to reduce risk when trades go through clearing houses by standing between and guaranteeing both sides of each trade. In the present system, the banks are still in control of the OTC derivatives trade and hold almost 97% of the $580 trillion OTC derivatives market which is not well regulated and not transparent.
The CFTC also proposed to limit the ownership of clearing houses, exchanges and trading systems by banks and major swaps dealers to 20%, which the banks are disputing as they have economic interests in the controlling the derivatives trade.
The derivatives market will continue to grow with the growth in technology and algorithmic trading techniques which will push trade volume higher and more and more of this trade will go through an exchange or at least be tracked better using clearing houses. This should bring transparency and better risk control in the market but a lot still depend on how the new regulations are adopted.
CME's Average Daily Trade Volume would increase
The two biggest driver of the CME's stock are the average daily trade volume in energy contracts and interest rate contracts. As the economy improves, we should see increased volume of traded contracts and leading exchanges like CME should benefit.
We currently estimate that average daily trade volume of energy contracts would increase from 1.7 million in 2010 to 2.4 million in 2013 and the average daily trade volume of interest rate contracts would increase from 5 million in 2010 to 7.3 million in 2013.
There could be a 10% upside to our price estimate for CME's stock if the trade volume of energy contracts and interest rate contracts increased 20% above our estimates.