Later this year, OneChicago - an all-electronic, single-stock-futures exchange - will make its debut. The joint venture, backed by the CME, CBOE and CBOT, is expected to compete head-on for SSF order flow with NQLX, Amex and Island. Recently, WS&T Senior Editor Robert Sales sat down with OneChicago Chairman and Chief Executive Officer William Rainer to discuss the exchange's technology, strategy and target audience. Rainer, the former chairman of the Commodity Futures Trading Commission, also divulged his thoughts on the competitive SSF landscape.
WS&T: Trading of futures based on individual stocks has been prohibited in the United States for more than 20 years. What factors have convinced you that investors will have a sufficient appetite for these hybrid products upon OneChicago's launch?
RAINER: I think the marketplace can use a risk-transference product. This is a futures contract that's also a security - that's the hybrid nature of this product. Within the context of risk transference, we think there is a place for a futures contract on common stocks. The structure of the product itself makes the product a more efficient use of capital ... . If you're long, for example, and buy IBM in the cash market, and you are a leveraged participant, you will have to put up 50 percent (of the costs of that stock) and have to borrow 50 percent. In the futures market, you will have to deposit 20 percent, but because the transaction has not settled, and won't settle until sometime in the future, there is no borrowing.
Consequently, there is an argument to be made that these (SSF products) will be a more efficient use of capital for some participants. Not all participants, but for some participants.
WS&T:What is your projected launch date, and will you be rolling out groups of SSF products in stages?
RAINER: The launch date we haven't (finalized) yet. As you know, the (regulatory) agencies (recently) agreed to the final margin rules - in the case of the CFTC on July 2 and in the case of the SEC a couple of weeks later ... . We are (currently) working with broker/dealers and Futures Commission Merchants to determine a launch date. We're also in the process of completing a number of technology projects that are involved with our launch. And while I don't have a firm date (for our launch), I'm anticipating something like a range between the end of September and the middle of October.
Our rollout will be phased. We will (eventually roll out) 100 instruments, (including) about 80 (SSF) and 20 narrow-based indices. And what we anticipate is to start with 15 to 20 (products) on day one, and let them trade for a day or two to make sure that all of (our) systems are go. If the technology is humming, a couple of days later we will add another 20. If that works, we'll add another 20, so that over a two or three week period, we will introduce our (full complement) of 100 instruments.
WS&T: Can you please describe OneChicago's target audience?
RAINER: This is a hybrid product, which means that you can fit this product in either a futures account or a securities account. That means the futures industry could have an interest and the securities industry could have an interest. It is my belief that, on day one, there will be substantially more interest in the product on the part of the futures industry, overall, than the securities industry. This is a product that was pushed for by the futures industry. The reason that the product came about was a direct result of the futures industry working with the regulators and the Congress to figure out a way to make these things legal ... . So it's logical that the aftermath of that is that the futures industry is very interested in the product, both (from) the institutional side - including commodity-trading advisers and hedge funds that have used futures products in their portfolio management - (and) from firms that have worked with individuals to trade the e-mini contracts.
Interest (from) the securities side, in my observation, looks spottier. Some securities firms are very interested in the product, (but) some are taking a wait-and-see attitude. Within the securities industry, I would say the proprietary trading desks of these firms are very interested in the product. But the distribution side of these firms would be the side taking a wait-and-see attitude.
WS&T: When you look at the SSF landscape, there certainly is a lot of competition today. NQLX, the joint venture between Nasdaq and Liffe, seems to have the potential to be OneChicago's greatest rival. How do you size up the competitive landscape?
RAINER: I think, as you just expressed, Nasdaq/Liffe will be a fierce competitor. We're (also) certainly mindful of the successes that Instinet/Island have had, and we respect their management and their abilities and their technology. Amex is also an interesting (competitor), because they will be floor based. They have very successful options market makers, and we respect that.
I have been asked this question in a slightly different form, but implicit in the question is how many exchanges can this marketplace support. It's speculative, but my view is that if the product's not successful, it won't support any of them. If it's quite successful, I doubt that it will support, in any material way, four or five. But I would be surprised if it (couldn't support) more than one.
WS&T: Did OneChicago ever consider trading SSF contracts in a floor-based environment?
WS&T: Why not?
RAINER: When I say no, I'm speaking on behalf of the joint venture, and the joint venture (made its all-electronic) decision before I joined the joint venture. So I was not a part of that decision, although I would not have joined the enterprise on any other basis than a fully electronic exchange.
WS&T: What are the potential deficiencies of trading these hybrid products on a floor?
RAINER: Well, the obvious answers ... (are) speed, anonymity, audit-trail accuracy and, probably, costs.
WS&T: How does OneChicago plan to differentiate itself from its competitors, from both a technology perspective and a business perspective?
RAINER: We had the option of (using) two different matching engines, which had different architectures. One architecture supports the futures system of market structure, with the so-called flat and open structure. The other approach is to have a specialist system, where you assign an instrument to an entity and that entity obligates itself to make a continuous, two-sided market in every instrument that it's allocated, in all kinds of markets, at all times, with appropriate depth and appropriate spread.
The Globex technology, which has done a terrific job in the last couple of years of accommodating huge growth in the (CME's) business, supports the futures-market structure. CBOEdirect has a different architecture. It is, of course, the specialist system. The futures model is an order-driven model, where, in effect, everything is a limit order. The specialist-driven architecture is a quote-driven architecture, where people are constantly quoting the market. So for every order, you're liable to have eight, nine or 10 quotes ... . Since we were convinced that best way to launch this (SSF) product was with a specialist system, we chose the CBOEdirect architecture ... . We will have, at launch, 16 specialists, whom we call Lead Market Makers. They will be allocated products and they will be obligated, from day one, to make competitive, continuous two-sided markets in all of our products ... . I think market participants will like that because it assures two-sided markets on day one. How the world looks in two years is a different question. But on day one, we did not want to take the risk of (having any) blank screens.
WS&T: Can you tell me a little bit about the different order-routing mechanisms OneChicago participants can use to send orders electronically to the CBOEdirect?
RAINER: We have CBOE direct as our matching engine, and we are connecting the Globex distribution to CBOEdirect, so that if you are a Globex user, you will have access to our (SSF) products without doing anything technologically. That will immediately make us have very widespread distribution on day one, from current Globex users. In addition, entities that have (previously) connected directly to CBOEdirect, which will include our Lead Market Makers plus many others - right now, we're up to 45 firms that have committed to connect to CBOEdirect - (will connect) to OneChicago.