{"id":1462,"date":"2015-10-05T12:09:25","date_gmt":"2015-10-05T16:09:25","guid":{"rendered":"https:\/\/digital.hbs.edu\/platform-digit\/submission\/chicago-mercantile-exchange-the-benefits-of-a-closed-platform\/"},"modified":"2015-10-05T12:09:25","modified_gmt":"2015-10-05T16:09:25","slug":"chicago-mercantile-exchange-the-benefits-of-a-closed-platform","status":"publish","type":"hck-submission","link":"https:\/\/d3.harvard.edu\/platform-digit\/submission\/chicago-mercantile-exchange-the-benefits-of-a-closed-platform\/","title":{"rendered":"Chicago Mercantile Exchange: The Benefits of a Closed Platform"},"content":{"rendered":"

The Chicago Mercantile Exchange, or “CME”, is a U.S. financial exchange. It was founded in\u00a01898 and\u00a0for generations was the home for aggressive floor traders dealing with commodities futures (as made famous in the movie\u00a0Trading Places:<\/em>\u00a0https:\/\/www.youtube.com\/watch?v=RLySXTIBS3c).<\/p>\n

Today,\u00a0the open outcry\u00a0trading floors at the CME account for a trivial\u00a0proportion of traded volume. Humans and trading pits\u00a0have given way to electronic trading in which\u00a0software programs can be used to place orders for financial products through a financial intermediary’s network.<\/p>\n

Financial exchanges are a prototypical example\u00a0of utilizing network effects to create a sustainable advantage: more buyers and sellers (i.e. more users trying to transact at the exchange) means more liquidity. More liquidity means lower spreads and a higher likelihood of transacting (i.e. lower cost to users). The feedback loop is incredibly strong as user’s choice of exchange is largely determined by pricing and volume. CME has benefited tremendously from operating in a winner take all market. Once the company achieves slightly higher volume\u00a0than its peers, the benefits to buyers and sellers becomes apparent and network effects kick in.<\/p>\n

\"\"<\/p>\n

But not all financial exchanges are created equal. The famed New York Stock Exchange has seen substantial\u00a0deterioration in its equity trading margins and market share over the last couple of decades. This is\u00a0largely because equities are fungible across platforms. If you bought\u00a0a share of company X on\u00a0the NYSE, you could\u00a0sell the same security on Archipelago. This allows users to multihome.\u00a0The rise of electronic trading, high frequency trading, and large pools of available capital have allowed for competing platforms\u00a0to gain share.<\/p>\n

CME has largely avoided this problem because it operates a closed network. Because futures exchanges provide users with clearing services (thereby reducing\u00a0counterparty risk), contracts that are opened on one exchange\u00a0are also settled on the same\u00a0exchange. This\u00a0eliminates the opportunity for market participants to multihome for a specific type of futures contract. The result is that CME’s\u00a0margins for futures trading are materially higher than margins for equities trading and\u00a0largely benefits from a winner take all market structure.<\/p>\n

Not\u00a0all is lost for\u00a0new entrants, though. Potential strategies for CME competitors could include:<\/p>\n

    \n
  1. innovating with new\u00a0products.\u00a0<\/strong>The futures market is highly fragmented at the\u00a0product level. Creating liquid markets for new\u00a0types of contracts can lead to a first mover advantage.<\/li>\n
  2. competitively price products to attract more volume.\u00a0<\/strong>Exchanges can provide pricing incentives to customers who\u00a0prioritize or trade across many products on their platforms. This means that they can subsidize one liquidity pool (in the form of lower spreads) to attract volume for other products on their platform<\/li>\n
  3. compete on quality.\u00a0<\/b>Exchanges spend significant capital on improving their infrastructure and ease of trading for users.\u00a0CME was early to capitalize\u00a0on the transition to\u00a0electronic trading and was able to benefit\u00a0tremendously.\u00a0Further step change innovations will open the door for new entrants<\/li>\n
  4. push the industry to transition to an open network.<\/strong>\u00a0Many market participants and regulators believe that spreads would decrease and users would benefit from a move to more open fungible futures market.\u00a0creating innovative platforms that create synthetic \u00a0fungibility across exchanges or pushing regulators to adopt openness standards could\u00a0weaken the network effects that CME enjoys<\/li>\n<\/ol>\n","protected":false},"excerpt":{"rendered":"

    CME: a centuries old business that continues to benefit from compounding network effects by operating a closed platform.<\/p>\n","protected":false},"author":46,"featured_media":1463,"comment_status":"open","ping_status":"closed","template":"","categories":[632,634,631,633],"class_list":["post-1462","hck-submission","type-hck-submission","status-publish","has-post-thumbnail","hentry","category-chicago-mercantile-exchange","category-closed-platform","category-cme","category-financial-exchange"],"connected_submission_link":"https:\/\/d3.harvard.edu\/platform-digit\/assignment\/competing-with-network-effects\/","yoast_head":"\nChicago Mercantile Exchange: The Benefits of a Closed Platform - Digital Innovation and Transformation<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/d3.harvard.edu\/platform-digit\/submission\/chicago-mercantile-exchange-the-benefits-of-a-closed-platform\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Chicago Mercantile Exchange: The Benefits of a Closed Platform - 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