Innovation is Key

CEO Craig Donohue wants the Chicago Mercantile Exchange (CME) to be the fairest, fastest, most reliable and most liquid exchange for trading options and futures. He envisions it as a place where buyers and sellers can interact whether they’re individual or institutional investors, and regardless of their credit profile. He also wants the exchange to provide superior clearing, settlement and risk management capabilities for its customers, who rely on its systems every day to trade an average of $2.5 trillion worth of contracts for futures and options on currencies, commodities, interest rates, equity products and even the weather.

“We want to be the market leader in terms of using technology to become faster, more robust, and to improve our functionality and customer service,” says Donohue.

To transform Donohue’s vision into reality, the CME has developed software programs to increase trading activity in financial markets, to protect securities dealers from financial risk, and to enable new services, such as trading options electronically. Over the years, the CME has also invested hundreds of millions of dollars in IT to increase the speed, flexibility and reliability of Globex, the groundbreaking platform for electronic futures trading that it launched in 1992.

Those IT investments have put the CME on a steady path toward achieving Donohue’s goals. The CME is known in the industry as the “Avis” of financial exchanges—the marketplace that tries harder to develop and deliver the products and services that its customers want. “The CME has always been viewed as the hungrier, more innovative, more progressive and generally more customer-friendly exchange compared to the other derivatives exchanges,” says Michael Gorham, director of the Illinois Institute of Technology’s Center for Financial Markets, who worked for the CME for 18 years.

Today, the CME, which was founded in 1898 as the Chicago Butter and Egg Board, is one of the world’s largest financial exchanges, second only to the Eurex in Frankfurt, Germany, in the number of contracts traded annually. In 2005, the CME traded more than 1 billion contracts while the Eurex exceeded 1.2 billion, but the CME is catching up: It grew by 34 percent last year compared with the Eurex, which grew by 18 percent. The CME’s trading volume has skyrocketed almost 500 percent since 2000.

Technology propels the CME’s growth. Almost every major technology upgrade has increased trading activity. And the more trades the CME can match between buyers and sellers, the more money it makes. Donohue understands that if the CME’s systems sputter or don’t offer the functionality customers need to execute certain trading strategies, those traders will find another exchange. To satisfy his customers, he has authorized tens of millions of dollars’ worth of IT spending during his two-and-a-half-year tenure as CEO. In 2005 alone, the CME spent close to $58 million to maintain its hardware, software and communications infrastructure. “The vast majority of our expenses and capital investments relate to technology. We view ourselves as a technology company because technology is the main way we distribute our products,” says Donohue, who joined the CME as an attorney in 1989. He and CIO Jim Krause both rose through the ranks of the exchange and have worked together on every major technology initiative—from the development of Globex to the creation of software to facilitate trading options electronically, and everything in between.

Donohue spoke with Senior Writer Meridith Levinson about technology’s role at the CME, his expectations of IT, the CME’s investment in IT and his relationship with his CIO.

CIO: Describe the extent to which your company relies on technology to operate.

Craig Donohue: We operate 24 hours a day, so we have to have very reliable infrastructure and platforms. We also need extraordinary capacity because markets can become very volatile, and when they do, trading activity spikes. Our system has to be able to handle each message, order and trade. We process trades in less than two-tenths of a second. We rely on technology to provide us with the speed, reliability and capacity to serve our customers, who are primarily major banks, hedge fund managers and pension funds who traded $638 trillion worth of financial instruments through our systems. This is not like shopping for books online.

Given the CME’s profound reliance on technology to operate, what do you expect from IT?

IT needs to contribute to our overall financial performance. In the last eight years, we’ve invested more than $1 billion in technology. We’re a $14 billion company, so that’s a significant investment. Our [IT] spending has the ability to very dramatically affect our financial performance.

IT also needs to be customer-focused. Technology has become much more customer-facing for us. I can no longer send marketing people who have tremendous financial product or market knowledge but no understanding of technology to meet customers because our customers also want to discuss the technology, the interface and their concerns about speed and functionality. So we send technology people out with our marketing people to meet customers. They’ve become a critical part of our marketing effort. These meetings give our technologists the opportunity to get a better understanding of what a trader wants to see.

How do you measure IT’s contribution to your bottom line?

It’s relatively easy. There’s a direct correlation between infrastructure improvements, such as enhancing speed or expanding distribution capabilities, or new technology-driven functionality and growth in our business. Of course, improvements in our marketing capabilities and things we’ve done strategically with pricing have also contributed to growth, but there is no doubt that the technology innovation that has occurred over the last five years has been a direct cause of much of the growth we’ve seen.

For example, about two years ago, we undertook a substantial commitment to making changes in the way we process data. We engaged in an extensive fine-tuning of systems and programs to dramatically improve the speed of execution on our CME Globex platform. [Once those infrastructure changes were implemented,] we saw the time it took to execute trades rapidly decrease while our trading volume and message traffic just about quintupled. Increasing our speed and capacity so dramatically had a huge and profound effect on our growth. It also enabled us to keep up with the growth in orders coming into the system. Today, we handle more than 8,000 transactions every second with an average response time around 40 milliseconds. Two years ago, we handled 1,000 transactions per second at an average response time of 140 milliseconds. This increase in transaction capability helps our customers better manage their positions in the marketplace and better manage their risk portfolio, both of which are critical to them.

IT clearly plays a critical role in the CME’s day-to-day operations. How is it helping you achieve larger strategic objectives?

Bringing electronic trading functionality to our options markets is a top strategic priority. We have to replicate the functionality that traders use to buy and sell options in the open outcry environment, or the call-around market, with computer systems. Close to 86 percent of our futures products trade electronically. Our options products trade almost entirely on the floor. Today, 8 percent of our options trade electronically, up from 3 percent a year.

Options contracts are not quoted in the same way as futures. There’s 50,000 or 60,000 different combinations of options across different strike prices and maturities that can be traded, which potentially makes electronic options less liquid. So if, for example, there’s a significant earnings disappointment in the equity market on the New York Stock Exchange that causes the whole market to tumble, your risk as an options trader is enormous. You need functionality that allows you to cancel all your quotes immediately and simultaneously. So the technology enabling the electronic trading of options has to be more sophisticated and complex. It’s been a big, multiyear effort for us, and one that will continue for the next several years.

You and CIO Jim Krause have worked together during the past 17 years. How has your relationship evolved?

We did sort of grow up together, although he’s a lot older than me. [He laughs.] It’s a funny thing: Jim is known for having a crusty demeanor. He had a pretty senior role in technology when I joined as a junior attorney. In the very beginning, my role was to support Jim’s activities and to provide [legal] services to Jim. To be honest, I was scared to death of him because he’s very smart and not necessarily warm and cuddly. I quickly developed a huge amount of respect for him. I’d like to think that I earned his respect in my capacity [as an attorney].

Jim is an extraordinarily unique CIO because he has evolved with our organization. It’s rare to have a CIO who knows the business in the way that he does. Jim built everything we operate: our clearing system, our Globex system, our distribution system and our market data system. He’s done it all. That’s not common in most large technology organizations where you typically have an enterprisewide CIO with tremendous depth in one area and not a lot of breadth in another.

If anything has changed, I think it’s just that I’ve increasingly taken on a very different role here over the years. Our relationship has become more a partnership of equals. Jim is an equal because he’s helping devise the business environment that makes the CME successful and profitable. He provides solutions that directly impact the customer and whether or not we make money.

Describe the reporting relationship between you and Jim Krause.

I don’t deal with Jim directly on the operational side. The president and chief operating officer, Phupinder Gill, does that. I spend a lot of my time as CEO of a public company traveling and meeting with institutional shareholders and analysts, and I spend time with customers and regulators. So it is not possible for me to stay on top of the day-to-day issues. But on the larger strategic issues of acquiring, licensing or developing technology, and creating flexibility for the company with respect to our ownership or control of technology, Jim and I have done all of that together over the last 17 or 18 years. Culturally, the CME isn’t a very rigid or hierarchical organization. Jim and I have very open lines of communication. If he needs to speak with me he can reach me and vice versa, whether that is in person, over the phone or via e-mail.

The Tokyo Stock Exchange came under fire last year for problems with its computer systems. Is that your worst nightmare?

That is my greatest fear. We are a vital part of the global economy. If our systems are not operable or we’ve got slowdowns, errors or malfunctions causing problems in the market itself, that’s a huge concern. We’ve struggled through those issues in the past, and we’ve had to build up the reliability of our systems and our processes. We do extensive testing before we implement new products or new trading models in the production environment. It’s something we have to be cognizant of every day, all day.