UPDATE 2-CME Group profit falls, in line with Wall Street view

Tue Feb 5, 2013 11:55pm GMT

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* 4Q EPS was 63 cents, excluding one-time items; Street view also 63 cents

* Revenue falls to $660.9 mln from $736.5 mln as trading drops

* CEO Gill sees opportunity in OTC clearing, better economic outlook

By Ann Saphir

Feb 5 (Reuters) - CME Group Inc fourth-quarter profit fell sharply from a year ago as trading sagged, a decline Wall Street had anticipated given muted market volatility and the U.S. Federal Reserve's renewed commitment to low U.S. interest rates.

The Chicago-based exchange operator said on Tuesday its net income tumbled to $167 million, or 50 cents a share, from $745.9 million a year earlier, or $2.25 a share. Revenue fell to $660.9 million from $736.5 million.

Stripping out a one-time tax expense of $43.5 million and increases in deferred tax liabilities, earnings in the fourth quarter were 63 cents a share, in line with analyst expectations as tracked by Thomson Reuters I/B/E/S.

CME CEO Phupinder Gill, who took the reins as chief executive in May, sought to reassure investors in a conference call following the release of the results, saying better economic prospects this year should help boost trading.

"We remain cautiously optimistic about the trading environment," he said. He and other CME officials declined to forecast future trading activity. CFO James Parisi predicted a rise in expenses tied in part to an uptick in trading volumes.

Gill also said CME could benefit from new mandates forcing the giant swaps industry to funnel most contracts to clearinghouses such as those run by CME. Customers already are testing and using CME's rate-swap and credit-default swap clearing services, he said, with volumes doubling January since December.

In addition to swap clearing, he said, CME stands to win business from an expected shift from swaps to futures and new regulations making over-the-counter contracts more expensive to use. The company, which runs the Chicago Board of Trade, the Chicago Mercantile Exchange and the New York Mercantile Exchange, also expects interest in new CME contracts launched specifically to bridge the gap between swaps and futures, Gill said.

One such contract, interest-rate futures that convert to swaps when they mature, have gotten "off to a great start," Gill said, with 65,000 contracts traded since the December launch. Brand-new futures contracts generally are slow to gain traction.

Trading in the fourth quarter fell 13 percent to an average of 10.2 million contracts per day. The view that short-term borrowing costs will stay near zero until mid-2015 muted interest in contracts tied to lending rates, like futures on Treasuries and fed funds. Trading in contracts tied to stock indexes also fell.

But as economic prospects strengthen, fueled by the very low-rate environment that has hurt CME's rate-linked trading, CME officials expect traders to return to the futures market.

Trading in January was down 2 percent from a year earlier, but activity in rate futures and contracts tied to energy rose.

SWAPS

U.S. regulators will start requiring dealers to clear most swaps starting next month, and apply similar mandates to hedge funds starting in June.

The new clearing requirements stem from the Dodd-Frank Wall Street reform act, and are designed to make the opaque OTC derivatives market more transparent and less vulnerable to defaults.

As one of the biggest global clearinghouses, CME stands to benefit, both by clearing swaps directly and by handling an increase in futures trading if current swaps users hit by clearing mandates decide to switch to futures, as many analysts predict.

CME officials declined to predict profit from swaps clearing, but said that customers have an extra incentive to use CME compared with rivals IntercontinentalExchange Inc or LCH.Clearnet because of "capital efficiencies."

Clients using CME rate swaps clearing have saved more than $1 billion, Gill said, by offsetting the margins they put up to back their swaps against other margins they have up at the CME clearinghouse to back related contracts, like Eurodollar futures.

"It's the most capital-efficient solution out there," Gill said.

He also defended the requirement that swaps traders put up higher margins than futures traders, saying that the clearinghouse needs a bigger cushion for swaps because they can take longer to unwind in the event of a default.

Wall Street banks that have long profited from the swaps trade have sought changes from regulators, complaining that the difference creates an uneven "playing field."

WEAK SPOTS

Traders have trimmed their "footprint" for CME colocation services, CME officials said, suggesting high-frequency traders see less opportunity at CME's exchanges than they did a year ago.

CME also tacitly acknowledged the pressure the industry has been under since the high profile collapse of two brokers in 2011 and 2012 left customers short hundreds of millions of dollars, saying it plans a $10 million marketing campaign this year to restore confidence in the futures industry.

MF Global failed in 2011, but it was only a few days ago that the parent firm's liquidating trustee assured customers they can expect to receive back all $1.6 billion lost in the collapse.

Last week Peregrine Financial CEO Russell Wasendorf was sentenced to 50 years in prison for stealing more than $200 million from his customers, who likely never will see most of that again.

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