Eurex is rumored to be considering a cash trading facility—and that's just part of what could be in store.

By Robert Hunter

Last year, Eurex raced past the Chicago Board of Trade to become the biggest derivatives exchange in the world, a crown the CBOT had worn proudly—and perhaps a bit complacently—for decades.

Now, the aggressive German exchange is rumored to be planning an initiative that failed spectacularly at the CBOT: cash bond trading. Whether motivated by hubris (possible), business savvy (likely) or the desire to kick some sand in the CBOT's face (doubtful, since the two struck a very public alliance last year), the move could propel Eurex into the stratosphere of the exchange world.

The problem is, no one is sure if the rumors are true. Early last month, a cryptic, thinly sourced article on the Dow Jones wire service broke the story, but weeks later Eurex still had not commented. The exchange's lips have been clenched tighter than a vice grip since the rumors first surfaced among traders a few months ago.

According to the Dow Jones piece, which quoted several unnamed sources, Eurex parent company Deutsche Börse is considering launching cash bonds on the Eurex trading platform to tap into Eurex's incredibly liquid Bund futures market. The article cites the Deutsche Börse's inability to build cash bond liquidity on its Xetra system as a chief motivation.

But Deutsche Börse's ambitions are far grander than simply spiffing up a lackluster business. A cash-futures nexus on Eurex would offer customers simplified netting and clearing and thus lower back-office costs, as well as drastically lower margin costs—creating a veritable one-stop shop for bonds.

The CBOT's foray into cash bond trading, The Chicago Board Brokerage, stumbled out of the gate and was quickly abandoned, because users couldn't—or wouldn't—get the hang of a new electronic trading system. Eurex's approach would be more like that of Cantor Fitzgerald, the biggest market-maker in U.S. Treasuries in the world, which has been offering Treasury futures for more than a year via the Cantor Exchange. In Cantor's case, while the company accounted for a sizable share of the cash business, the CBOT had a bona fide franchise in Treasury futures, and dealers who were comfortable trading cash bonds via Cantor's electronic system were reluctant to transact futures until Cantor built liquidity—a process that has proved discouragingly slow.

Eurex, however, seems to have the best of both worlds. Like Cantor, it already has an established, proven electronic trading system, and like the CBOT it has virtually all of the liquidity in its main bond product, the German Bund. Euro-zone analysts note that the liquid Bund market has caused cash Bunds to trade at a premium relative to other euro-zone sovereigns over the last year. Add instant hedging on a single screen, and the resulting cash-futures synergy could be earth-shattering.

Yet the massive liquidity that the Eurex cash bond facility could attract is only a small part of Deutsche Börse's designs for the future.

Big plans

The day after the Dow Jones story broke, Deutsche Börse chief executive Werner Seifert, in an interview with the German newspaper Handelsblatt, hinted at the direction the Deutsche Börse is going. Seifert said it plans to transform itself into a completely new entity called Euroboard, which would allow pan-European trading on a single platform. Euroboard would be a holding company for a variety of electronic communication networks trading stocks, bonds, futures and options—including such entities as the European Energy Exchange, which is expected to be launched next month.

Securities firms have been clamoring loudly of late for a single, pan-European exchange with massive liquidity and low transaction costs, and the Deutsche Börse appears to be answering the call. Tradepoint Financial Networks, based in London, and Nasdaq have already announced plans to create such an entity. But the Deutsche Börse clearly has an advantage, offering a far broader array of products than either of the rivals. Eurex's rumored cash bond facility, of course, wouldn't hurt.

There's even talk that Euroboard will change its ownership structure from Deutsche Börse's quasi-public arrangement to a "de-nationalized” structure. The Deutsche Börse will decide sometime this month whether to offer the world's biggest investment banks a 50 percent stake in the new entity or launch an initial public offering.

Grand plans indeed. But as the inevitable onslaught of ECNs invades global markets, everyone in the exchange world has reason to worry. Perhaps the Deutsche Börse has learned from the CBOT that complacency, if not shaken off quickly, can lead to stagnancy.