Driven by its desire to fend off threats from electronic competitors, the Chicago Mercantile Exchange last week became the first U.S. exchange to approve a plan for demutualization. The proposal - which was unanimously approved by the board of directors but still must be ratified by two-thirds of the Merc's members - calls for the CME to convert its members' seats into two classes of shares, and would eventually cut the exchange's board in half. Members' existing trading rights would also be preserved under the plan, which contains some language that protects the exchange's traditional open outcry pits. The plan does not, however, stipulate that the CME will issue an initial public offering any time in the near future.
Jim Oliff, chairman of the CME's strategic planning committee, said in a conference call last week that the for-profit scheme would enable the exchange to streamline its governance structure and eliminate member politics. "Demutualization ...will permit us to use our assets to grow our business without regard to the external concerns of members, who may be, in fact, operating competing enterprises," said Oliff, who also serves as second vice chairman of the CME. "The board of directors will be able to fully concentrate on strategy and the performance of management against objective standards. And...both management and the board will be freed from an outlook of consensus building."
Under the for-profit proposal, the new entity would be led by a yet-to-be named president and chief executive officer, and - over the course of two years - the Merc's existing 39-member board would be sliced to 19. Members' seats, meanwhile, would be converted into Class A and Class B shares. Class A shares will give members pure equity in the exchange; Class B shares will represent a combination of equity and members' trading rights.
Oliff said that the Class B shares are especially significant because they preserve members' trading rights and emphasize the Merc's commitment to open outcry. "We ... recognize that open outcry will continue to play a role in our future, thanks to its liquidity and stability. Accordingly, access to the trading floor, the right to lease and the right to preferential fees for owners and lessees will be preserved," he said.
Just a couple of months ago, Leslie Rosenthal - a managing partner at CME and Chicago Board of Trade (CBOT) clearing member firm the Rosenthal-Collins Group - was extremely skeptical about the potential demutualization of the Chicago futures markets. In fact, he said he would not vote for any for-profit plan that did not include a component that would protect open outcry for "a set period of time." But Rosenthal says that the Merc's proposal has won his support. "I think they've got a chance at getting it passed because they're explained it thoroughly to the members and managed to come up with a plan that keeps everybody's trading rights the same," he says.
On top of oral promises, Rosenthal says that the Merc has sent out a for-profit brochure that outlines its commitment to open outcry. "As long as an open outcry market is liquid, CME will continue to provide a facility for conducting business and reasonable financial support," says Rosenthal, reading from the brochure. In other words, he says, the CME has promised that it won't dump its open outcry pits as long as the contracts traded there continue to thrive.
The Merc's plan - which will only be implemented if the exchange receives a favorable for-profit tax ruling from the Internal Revenue Service - is currently under review by the SEC. CME members are expected to vote on the proposal early next year.