Few in the industry can boast of such a glowing reputation as Phupinder Gill, the new chief executive at the CME Group. However, taking over the world’s largest exchange group during an unprecedented time of regulatory change in the industry and global crises outside it, will challenge the man like nothing he has done before.
Finding someone with a bad word to say about Phupinder Gill, or Gill as he is universally known due to constant mispronunciations of his first name, is nigh-on impossible. The new chief executive of the CME Group has an unrivalled reputation in the industry as a smart, determined all round nice guy.
At the height of the fraught negotiations over the merger between the Chicago Board of Trade and the CME in 2007, the board of the CME had reached a deadlock. A key shareholder in the CBOT was holding out demanding a higher price. The deal hung in the balance.
According to Erika Olsen, author of Zero Sum Game, the definitive book on the merger, there was only one place CME had left to turn. The board wheeled out their “secret weapon”, the “boisterous and shooting-from-the-hip” unofficial chief-of-staff, Phupinder Gill.
Their confidence in Gill’s powers of persuasion was well placed. Gill is said to have negotiated the deal and appeased all the shareholder’s concerns. Gill claims not to have read the book and, with typical modesty, underplays his role in the deal but his charm and diplomacy are renowned across the industry.
He will need them as he faces the monumental challenge of leading the world’s largest exchange group through an unprecedented era of change. He is armed not only with charisma: his background in clearing, his global outlook and his experience of former crises will all stand him in good stead for the challenge ahead.
Climbing the ranks
Born in Malaysia and educated in Singapore, Gill started his career in Chicago on the floor of the Chicago Board Options Exchange on October 19 1987, Black Monday. For someone who would go on to pursue a career in clearing, there was no better a lesson of its importance.
He moved to the CME in 1988 working as a price reporter on the floor before joining the fledgling clearing business later that year. Around that time, Gerry Roberts and his team of economists were finalising the blueprint for SPAN margining, which did to risk calculations what Black Scholes did to options pricing. Gill cites the development of SPAN as one of the most important moments of his career.
“The world did not have a risk based margining system in 1988. Everything was strategy based. There was no apples and apples comparison, it was very hard to compare and contrast different risk exposures,” he says. “Because of SPAN, the world can look at risk in a more consistent way. It was one of the early moments when I realised the scope of CME’s zeal for innovation.”
SPAN was soon followed by the launch of Globex. The time that it took to launch Globex and the struggles that CME had in selling the benefits to a hostile floor, is well documented. “For a floor based exchange it took a lot of persuasion and development to get that going,” remembers Gill.
Aside from the launches of SPAN and Globex, Gill says his experience of crises has also formed his outlook. The baptism of fire on Black Monday set the tone and Gill lists the shocks he has worked through like tracks on a favourite album: “the 89 crash, the Drexel Burnham Lambert bankruptcy, the Barings default, the LTCM collapse, Refco and more recently MF Global”.
It was the last of these crises that had the biggest impact on the reputation of the CME. The others tested the crisis management systems of the exchange, however, the revelation that $1.6bn of customer money was missing in the wake of the collapsed institution drew the fire onto CME.
“Each of these crises taught us something,” says Gill. “However, MF Global turned our model around. We realised that we did not cover for fraud, we did not cover ourselves for theft.”
As the dust settles on MF Global and regulators grapple with a response, Gill has his sights on moving on and focusing on growth for the CME. He is clear on where that growth will come from: “We have a world-class trading engine that has a reach far beyond any of the other exchanges. We have a state of the art clearing engine. These assets along with the staff we have around the world will define my term as CEO here.”
Gill’s international background has been supplemented with constant globe-trotting – he travels to Asia half a dozen times a year. It is therefore perhaps no surprise that Gill identifies international growth through the Globex platform as a key opportunity for the CME.
Few can doubt the success of Globex, which Gill hails as “the Bloomberg of the futures markets around the world”. Proposed in 1987 and finally launched in 1992 as the first global electronic market for futures trading, Globex hosts CME contracts and contracts from partner exchanges in Mexico, Brazil, South Korea, Malaysia, Dubai and the US and is traded on in over 100 countries worldwide.
CME’s global strategy has been to take small stakes in its partner exchanges and then put their benchmark contracts onto Globex. It is a strategy that has served the exchange well, says Gill. “We have helped traditionally closed markets that would not allow platforms into their country to expose the markets to a global audience.
“Outside the US we have taken an alliance approach because it serves the client base best. Experienced as we are around the world, we aren’t aware of all the nuances in all of the countries we work with, so it is better for us to have these partnership arrangements with these exchanges. We build relationships that will endure over time. They are self-reinforcing and we have been very successful in doing that over the years,” he says.
CME recently expanded its stake in the Dubai Mercantile Exchange to 50%. The move differed from the usual smaller investment and, according to Gill, reflected the CME’s confidence in the ability to build a benchmark out of the Oman oil contract.
“The CME will be as opportunistic as we can be,” he says. “The small stake approach aligns our interests with that of our partners. With the DME, we are convinced that there is room for a third benchmark for crude oil.
“The DME trades a sour crude contract that is more similar to what is traded and used in Asia. Increasing our stake in the DME enhances our ability to develop the contract. Oman sour crude could be a benchmark for Asia, that is what we are focusing on and we are investing the time and the effort to make sure it becomes a reality.”
The sleeping dragon
Another place that CME, along with a number of other exchanges, has been focusing time and effort is China, the sleeping dragon of the global derivatives industry. For global exchanges, the opening up of the Chinese markets represents an unprecedented opportunity for growth. However, it is as yet unclear what the benefits of the raft of MOUs that have been signed with Chinese exchanges will bring to international exchanges.
Despite this, Gill is clear on the CME’s strategy for China. This strategy involves working with the market to educate it on derivatives trading – in March it signed an MOU with the Bank of China for this purpose - working with the regulators on risk management, and working with the exchanges on product development.
However, as yet there is no clear opportunity on the table. There is no timeframe in place for when a Chinese exchange will join the Globex network, for example. “There are a lot of things that have to happen before something like that can happen such as the convertibility of the Renminbi,” says Gill.
“China is not a short term project, it is a long term commitment. We are very committed to China in terms of our education of the market, the risk management we share with the regulators and the product development with the exchanges.”
A decade ago, the CME Group had two employees in Asia, one in Singapore and one in Tokyo. Today the exchange has over 40 and the majority of their time is spent focusing on the group’s educational efforts in China, Gill says.
“Chinese exchanges have world class trading engines and clearing. The MOUs are very much focused on product development. We focus our commercial assets on education,” he says.
China will be crucial in the diversification of revenues away from the US and Europe but Gill is also focused on expanding the exchange’s London operations. CME has had a base in London for years now but that was significantly expanded with the launch of CME Clearing Europe last year. Today CME has more employees in London than Liffe and the London office accounts for 95% of all the group’s international revenues.
“We opened CME Clearing Europe in recognition of the fact that OTC clearing was going to become more prevalent in Europe. We also wanted to meet the needs of our European clients that were unable or unwilling to clear trades in the US as well of those of our Asian client base for whom the European timezone is more convenient than the US’s,” says Gill.
Recent press speculation has touted the possibility of CME launching an execution venue in Europe. The exchange group recently missed out in its bid to acquire the London Metal Exchange - “the LME missed out on us actually,” Gill quips – and, while Gill insists that no decision has been taken, he says the exchange will seize any opportunity that presents itself.
“When we see a need to expand outside clearing in Europe, we will take that opportunity very seriously. If the opportunity for a London-based exchange presents itself, we will look at it but right now we are extremely focused on the clearing side of the business,” he says.
CME Clearing Europe launched last year clearing OTC commodities contract in competition with ICE Clear Europe and is set to expand into interest rate swaps, which would most likely be the asset class that any execution venue is launched to trade.
In this respect, its biggest competitor on European soil will be Eurex. Like Eurex, CME is focused on the client clearing market, like Eurex, it believes that the margin offsets are optimum when OTC and ETD contracts are netted off.
This is a model that CME has pioneered in the US with great success. Last month it announced that $500bn of OTC derivatives had been cleared since launch. Gill is confident in the CME’s model: “I think that aligning the OTC open interest with the exchange traded liquidity that we have will make us a natural choice to park the swap side of the trade with us.”
In March, CME decided not to take up the approved registration of CME Clearing Europe as a DCO. The move would have put it under the regulatory framework of the CFTC. Gill says that the decision was taken following client feedback that they would rather clear through an FSA only regulated CCP, rather than a dual regulated one. “This is not to say that we won’t become a DCO but we have shelved the registration for the time being,” he adds.
It is in its home market that the CME faces one of its most significant challenges. Since its launch in 2001, the IntercontinentalExchange has propelled itself from upstart to serious challenger. The launch last month of grain contracts on the exchange rattled cages at CME and led to a well publicised battle with its members over plans to increase grain trading hours.
No sooner had CME announced the extended trading hours, than grain associations from across America were up in arms. The associations, backed by a number of FCMs, argued that extended trading hours would put additional pressures on farmers and real end-users of the grain markets as well as increasing volatility.
The CME eventually compromised, extending the hours to 21 from 17, a reduction on the proposed 22 hours. In many ways, the spat reflected the CME’s history and the battles it has fought again and again as an exchange for the end users of the traditional physical markets adapting to a world of high finance and the rise of electronic trading.
Gill says: “The associations had some valid concerns. The comments that we got from the user groups we took very seriously. We went all the way to Washington and met some government officials. We said we would keep our markets open 21 hours. We listened. We have a history of listening to our client base.”
He adds that the exchange is taking the challenge from ICE very seriously. “We take all competition very seriously and remain focused on providing the deepest most liquid and efficient markets for all our clients. We have faced competition in our rates business, our metals business and other businesses. Competition is nothing new to us.”
But if the grain spat reflects the old CME pushing to react to challenges in a changing market, the launch of CME Direct is the exchange at its best: on the offensive and pioneering new market opportunities.
Billed as the first fully automated front to back platform to trade OTC and exchange traded derivatives on one screen, CME Direct was unveiled last month. As the market moves to more transparent trading of swaps, the creation of Swap Execution Facilities presents a significant new market for the CME.
The rules governing the execution mandate for SEFs are still being formulated in the US and, as such Gill says it is unclear whether CME Direct constitutes a SEF or a SEF aggregator. Despite this, the platform looks set to play an important part in the mandate to trade swaps on electronic platforms.
Gill sees CME Direct as an important part of seizing the opportunity enabled by regulatory change. He says that once the details are formed, including harmonising the current differences between the CFTC and SEC over execution methods, the mandate will be a stepping stone to innovation.
He says: “You can cross margin the back end but also co-list the front end just as CME Direct is doing for energy contracts. That concept will sprout more innovation and that will lead to more products being listed.”
However, while upcoming regulatory change has afforded the CME some opportunities, Gill is deeply concerned about the negative impact of the wave of legislation that is about to hit the industry. “A lot of the changes that are coming from Dodd-Frank are going to have an impact on our client base and an impact on the intermediaries that serve that client base and as such have an impact on the CME Group,” he says.
The CME has been working with Congress and the regulators to ensure that well-functioning markets are preserved despite the increased regulation. However, Gill is critical of how the process has been conducted since the passage of the Dodd-Frank Act.
“I believe that Congress has handed too much authority to the regulators. The regulators have not laid out a roadmap or adapted to the changing environment. When Congress came up with Dodd-Frank, they preserved the principles-based regulation that was put in place under the Commodity Futures Modernisation Act of 2000,” he says.
“This has worked well. Now, the CFTC is setting out a swath of prescriptive rules dictating how regulated entities must comply with core principles but also dictating how they must conduct their day to day business. These prescriptive rules are just one example of how the delegation of authority is having a negative result on what has been a very well-functioning marketplace. The CFTC has failed to meet its obligations to conduct an appropriate cost and benefit analysis.”
He cites the position limits ruling as a key example of this, enforcing the mandate with very limited scope for exemptions and imposing a rule “that makes no sense when you are looking a real hedges and real users of our marketplaces”.
Gill laments that such rules raise the price of business to the commercials operating in the market but says that the CFTC’s failure to enact cost and benefit analysis is not limited to this rule.
The next five years of the derivatives industry will be dominated by three trends: globalisation, the G20 mandate for OTC execution and clearing and global crisis. On the face of it, the CME Group is well positioned to benefit from the implementation of the G20 mandate to centrally clear and electronically execute standardised OTC derivatives. However, the MF Global debacle and, more recently, the spat over the grains trading hours, reveal in very different ways, the weaknesses in the CME’s armour. Both tough times and exciting opportunities lie ahead for the CME Group and Gill will need more than his undoubted charm to steer the exchange through them.