(Bloomberg) -- Leo Melamed helped create the first contracts almost 40 years ago in what would become the $20 trillion financial futures market. In the 1980s he pushed for electronic trading, propelling his Chicago-based CME Group Inc. to dominate U.S. futures exchanges.
“We think we’re better than everybody else,” said Melamed, CME Group’s chairman emeritus.
In the $28 trillion world of the credit-default swap market, though, the Chicago swagger is less certain. Six months after announcing its plan to back credit-default swaps with its clearinghouse, and six weeks after gaining regulatory approval, CME Group hasn’t processed a single dollar of the contracts. It’s losing to the 9-year-old Intercontinental Exchange Inc., which is about to hit the $100 billion mark.
CME Group’s stumble in this new market has forced the world’s largest futures exchange to admit mistakes and change course. Melamed, 77, and his colleagues got fresh evidence of the need to do so last week when the company reported a 30 percent drop in first-quarter profit because trading in its largest contract, interest-rate futures, fell 53 percent.
“We started a little wrong,” Melamed said in an April 22 interview in his office, where photographs of him with Federal Reserve Chairman Ben S. Bernanke and every president back to Gerald Ford hang on the wall. “We said you had to trade with us to go to our clearinghouse. That was wrong. We’ve now adjusted that, and that was a big difference.”
Lehman Fallout
CME Group is battling to penetrate the credit-default swap market where regulators are demanding more transparency after Lehman Brothers Holdings Inc., one of the largest swaps dealers, filed the biggest bankruptcy in U.S. history last September with $613 billion of debt. American International Group Inc.’s bad bets using the contracts led to four attempts by the U.S. to salvage the insurer in a rescue package valued at $182.5 billion.
A clearinghouse that backs the contracts spreads the counterparty default risk among the members that capitalize it by becoming the buyer to every seller and seller to every buyer. It also creates one location for regulators to see prices and positions in the market.
Credit-default swaps are derivatives used to hedge against losses or speculate on companies’ ability to repay their debt. The swaps pay the buyer face value if a borrower defaults in exchange for the underlying securities or the cash equivalent.
110-year History
While clearing credit-default swap trades is a goal of CME Group, the exchange has its eye on the broader over-the-counter business, which is the world’s largest derivative market with a notional value of $684 trillion.
“We think that’s the next frontier,” Melamed said, adding that the CME Group eventually would prevail in attracting customers to its clearinghouse. “If one were to choose where one wants to go with credit-default swaps, how about the place that has a 110-year history without default?”
Intercontinental Exchange, based in Atlanta, is an upstart compared with that pedigree, having begun in 2000 with a system to guarantee over-the-counter energy transactions. The company has since grown to the second-largest U.S. futures market, owning exchanges in New York, London and Winnipeg.
CME Group fell $9.02, or 3.8 percent, to $230.78 in Nasdaq Stock Market trading. Intercontinental Exchange gained $3.31, or 3.9 percent, to $87.70 in New York Stock Exchange composite trading. CME had risen 11 percent his year while ICE was up 6.4 percent.
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