Board of Trade Clearing Corp.’s E-Commerce Initiative

READER ROI

* Learn how almost going out of business sparked an organization’s IT renaissance

* Explore how changes in the global financial industry affected one long-standing player

* See why a B2B exchange would look to partner with an existing clearinghouse

The Chicago Tribune headline was ominous: “Clearing Corp. Clears Its Decks for Looming Demise,” the business page screamed on July 14, 1998. At that moment, the Board of Trade Clearing Corp., the back-office operation that had cleared transactions for the Chicago Board of Trade futures markets for 73 years, seemed as good as dead. And there was little Tom Hammond or Brett Paulson could do about it. n The reasons were simple. After more than six years of talks, the Chicago Board of Trade was finally getting serious about merging the Clearing Corp., where Hammond was the number-two business executive and Paulson the CIO, with a similar organization at the nearby Chicago Mercantile Exchange. The merger would cut costs because the Clearing Corp. and the Mercantile Exchange’s clearing organization served the same function. Plans called for the liquidation of the Clearing Corp. in favor of a new, independent organization using the Clearing 21 system the Mercantile Exchange was developing. That made the Clearing Corp.–already the subject of critical reviews for allegedly inflexible and outdated information systems–redundant.

The Clearing Corp. operates separately from the Chicago Board of Trade in a setup designed to protect traders and the integrity of the market. Yet the Board of Trade was, until recently, the Clearing Corp.’s only customer, and it’s the 93 member companies conducting business at the Board of Trade that fund and govern the Clearing Corp. (Other clearinghouses are subsidiaries owned by the exchanges they serve.) This all meant, in 1998, that executives at the Clearing Corp. would learn their fate from the Board of Trade leaders conducting merger talks with the Chicago Mercantile Exchange. That word came in September 1998 when the merger talks unexpectedly died. The Board of Trade nixed the deal after the Chicago Mercantile Exchange announced an alliance with Cantor Fitzgerald, a New York City-based electronic exchange that intended to compete with the Board of Trade. At the offices of the Clearing Corp., Hammond and Paulson and their staff set about turning what had been a “looming demise” into an opportunity. They had survived, but a struggle to redefine their organization had just begun. And it would be two years, until fall 2000, before they could roll out their plan to strengthen their position in Chicago and set the stage for new sources of revenue with a B2B e-commerce play.

Newspaper headlines signal snapshots in time; they can also be a call to action. In August 1997, one year before the “clear the decks” bulletin, the Tribune carried another article spelling out the findings of a report from Andersen Consulting (now called Accenture). According to the newspaper, this report charged that the Clearing Corp. “can’t meet the strategic needs of the exchange [at the Chicago Board of Trade] because of inflexible systems” and that “its technical plans are ill-defined.”

“We kind of swallowed hard and took that one,” Paulson says of the media report. Paulson says he feels the coverage was harsh, but acknowledges it carried some truth. The evaluation cited above came during the long merger negotiations between the two Chicago institutions when, Paulson says, the Clearing Corp.’s leadership felt its hands were tied. It wasn’t time to pump IT investments into an organization that was facing extinction. At the same time, though, the world around them was changing.

The signs were all around. The Chicago Mercantile Exchange’s Clearing 21 system, under development, had given that body an upper hand in merger talks with the Board of Trade. Entire exchanges in London and Paris had gone electronic, and electronic exchanges like Cantor Fitzgerald were popping up to compete with the Board of Trade. Member companies, meanwhile, wanted real-time information and access to back-end systems that the Clearing Corp. could not provide. They also wanted the Clearing Corp. to adopt more flexible systems that would ease communication between the clearinghouse and its members. The Clearing Corp.’s systems used a form of batch processing, instead of real-time processing, that slowed the process of accepting and recording trades at member companies. “The systems and tools they had were very adequate and met requirements,” says Bernard Dan, CEO of Cargill Investor Services in Chicago. “What we as users saw was that historic approach [to IT] was not going to be a recipe for success in the future.”

Hammond, the executive vice president for clearing services, and Paulson say they recognized the need to modernize their operation and decided not only to rectify their problems, but to set out in a new direction. They began an overhaul using money from the IT operating budget that would not only bring the Clearing Corp. to the technological forefront of its field but would, for the first time, offer its services to customers outside the Board of Trade–specifically, B2B exchange websites. After doing one activity for the same customer since 1925, the Clearing Corp. would branch out into the dotcom world, like a 75-year-old startup.

Art Deco Origins

The visitor who strolls into the Chicago Board of Trade building on West Jackson Boulevard in Chicago might have a hard time believing that a budding e-commerce player is located within. The imposing building is an anchor in Chicago’s stately financial district. Outside, it is a fortress of concrete and steel, the ultimate brick-and-mortar setting. Inside, the building’s Art Deco lobby, with its clean lines and symmetrical curves, brings you to its 1930 opening. It’s gorgeous, but it does not scream “e-commerce.”

An elevator ride to the 14th floor, however, reveals a much more functional environment. There, among cramped cubicles and walls painted neutral colors, the Clearing Corp. operates. Back on ground level, trading action rages in the pits of the Board of Trade’s exchanges. Frenzied traders in vests of green, red and yellow point, scream and gesture, moving millions of dollars in the process. At the behest of clients, they buy and sell futures–bond and other financial futures in one pit, agricultural futures in another–often using nothing more than eye contact or a nod of the head to seal a deal. With one stroke of the hand, a trader might buy into a 30-year bond or sell 10,000 bushels of corn.

Since 1925, the Clearing Corp. has kept score on that frenzied action (about 70 percent of trades still occur in the pits). Every trade has a buyer and a seller, and every sale must match a corresponding purchase. The match has to be exact to the penny, and unlike other markets such as the stock market, the difference between sell and buy must be zero by the end of the day. The Clearing Corp. records every trade and sends information about each trade to the companies involved, wherever in the world they are located. More important, the Clearing Corp. performs a risk-management function, guaranteeing the completion of every trade and protecting against defaults by any of the clearing members. In other words, the Clearing Corp. stands behind every transaction. If a party in a transaction defaults on a contract, the Clearing Corp. steps in and completes the deal.

Rebuilding I.T., Piece By Piece

By October 1998, the Clearing Corp. was ready to expand on its legacy and create its new identity. Hammond and Paulson brought in consultancy Deloitte & Touche to evaluate the Clearing Corp.’s technology capabilities. Together, the organizations set priorities for the Clearing Corp.’s IT initiatives. The first step was to conceptualize the ideal clearing system and compare that with other systems around the world.

“We figured out what the perfect system would be based on what [Deloitte & Touche has] built at other clearinghouses,” Paulson says. “We did a clearinghouse-by-clearinghouse straight comparison. We wanted to look by component at what we did well, where we needed new technology and where we had to enhance functionality. We were taking things that may have possibly been entrenched in mainframe technology, and where appropriate, we brought in distributed technology and object technology and browser-based technology.”

The Clearing Corp. began by building three new systems, each of which is in use now. The first is called Allocation and Claim Transactions (ACT), which is a real-time system that distributes information about a trade to member companies involved in the trade. Once a trade is placed, the pertinent details of the deal reach brokerage houses without having to be rekeyed by an employee on the broker’s end. The broker can automate the process of accepting trades, again removing an employee–and the chance for error–from the process. All parties involved in a trade know immediately whether the proposed sale price matches the proposed purchase price.

This application answers member companies’ demand for faster information, says Jerry Crowley, senior vice president of operations at ED&F Man International in Chicago. “My system takes a message and reads it; it then sends a message back to the Clearing Corp. that says ’Accept the trade.’ I don’t have an employee that keeps going in and looking through these screens. We’ve been able to automate some of the processes that are more manual in nature. That’s a cost savings,” Crowley says.

The Clearing Corp. also addressed the problem of letting member companies track trading summaries in real-time. With a pay/collect system the Clearing Corp. developed, member companies can check their “positions”–how much money they’ve proposed to spend or receive–in various trades. The pay/collect system’s real-time capabilities are important because managers at these companies need to know when they are going to owe an outstanding debt at the end of the day. Plus, managers can keep a lookout for traders who might be spending or buying too much in a day–altering positions more than the company would like.

The Clearing Corp.’s third system, called Meta-Clear, is the basis for the e-commerce strategy. It’s designed specifically for different e-commerce platforms that trade products on a cash, futures or options basis. Meta-Clear allows B2B exchanges and marketplaces to record and confirm transactions, to manage assets, check market players’ credit and settle trades.

The leap from helping member companies to being a budding e-commerce service provider starts here. Member companies can access these two new applications through the Clearing Corp.’s website (www.botcc.com) or through systems of their own, via application programming interfaces (APIs) Clearing Corp. programmers built to match the new functionality. Since most members already have proprietary systems for managing trades, APIs were critical for usability, Paulson says. Building those APIs was also a springboard for the Clearing Corp.’s e-commerce strategy. Hammond says that while the effort was a new one for the Clearing Corp., it did not tax the organization’s resources too heavily. He says the Clearing Corp.’s success in building applications for members led the organization’s leadership to believe it could do the same thing for paying customers.

“Those were significant events that kind of happened as a whimper,” Hammond says. “When you took what we had with ACT, our APIs, our communications network, our real-time ability to clear data, it was straight-through processing. It allowed member companies to manage their trades 24 hours a day. We’re getting the benefit of developing applications that provide that functionality–over time [the needs of members and the strategies of e-commerce customers] are going to converge.”

The Clearing Corp. currently generates 95 percent of its transaction revenue from the Board of Trade, but Hammond would like to see it establish its independence more firmly by diversifying its revenue base. “When you go out into corporate America, organizations don’t like to see [even] 30 percent of their revenue coming from one source,” he says. That’s where the e-commerce strategy is supposed to make its mark. The Clearing Corp. is now out to provide its basic, historic clearing function–as well as complimentary services such as risk management, banking and settlement, and perhaps even applications hosting–to burgeoning new B2B exchange websites.

A positive byproduct of the new e-commerce strategy is the marriage of IT and the Clearing Corp.’s core business. The Accenture report and the IT investment lockdown during merger talks with the Chicago Mercantile Exchange brought some of the organization’s technological deficiencies into the light; they also sparked a recasting of IT’s role at the Clearing Corp. Business leaders like Hammond came together with IT, making Paulson a key player and technology a strategic part of the Clearing Corp.’s operations (see “Speaking IT Like a Native,” this page).

The 75-Year-Old Startup

Once they began fleshing out an electronic commerce strategy, Hammond and Paulson say, business-to-business exchange players contacted the Clearing Corp. before anyone in the organization began marketing its services; Hammond says that the Clearing Corp. has talked to more than 70 e-commerce companies about its services, though only one has finalized a deal so far.

It makes sense for e-marketplaces to seek the Clearing Corp.’s help, says Bruce Weber, associate professor of business at City University of New York’s Baruch College. “With all these B2B exchanges, there are probably a lot of credit issues that a clearinghouse can address in a low-cost way,” he says. “Instead of having to check out every potential participant in your B2B exchange, if there’s a clearinghouse that comes in and says, ’We’ll make good on any payment you expect to receive,’ [the clearinghouse] can perform a valuable role.”

Hammond and Paulson set out to create capabilities that they could sell to their newfound customers, but they ran into a few hurdles when trying to make those systems commercially viable. The Clearing Corp.’s in-house applications systems were not flexible enough to handle transaction processing for exchanges. Breaking tradition, the Clearing Corp. purchased a vendor’s product rather than develop in-house, choosing OM Secur to add capabilities to the Meta-Clear system. OM Secur is an exchange-processing tool that allowed Paulson’s IT department to create databases with more attributes than their in-house databases had. OM Secur comes from OM Group, a clearing organization for a Swedish exchange that is a major player on the global financial markets scene (it has sought to acquire the London Stock Exchange) and that develops trading and clearing systems for other exchanges and clearinghouses. But getting hold of the OM Secur product wasn’t easy. Secur needed a major scalability boost–the Clearing Corp. sees far greater trading activity than the OM Group does on the average day–and had to be ported to a Sun Solaris operating system environment from its native DEC OpenVMS platform. In fact, negotiations of the sale and OM Group’s development of the product have taken so long that the Clearing Corp. was not due to see Secur until late March 2001.

While OM Secur will meet a pressing flexibility need, the Clearing Corp. still faces other challenges to be a B2B player. Serving its same role since the days of Al Capone, the Clearing Corp. had tailored its systems to clear transactions made under the rigidly standardized contracts of the futures industry. Futures contracts tend to have uniform payment schedules and other characteristics that rarely change. But a cash exchange, such as an e-marketplace, deals with contracts of varying lengths and with varying terms. Adapting the Clearing Corp. system to handle those new contracts has not been easy; the process has required a combination of business-process expertise and old-fashioned recoding of systems. “We’re writing the code right now to support e-commerce,” Paulson says. But the Clearing Corp. does have a customer for its services already, and that customer is helping get the job done.

“This has been a massive overhaul” for the Clearing Corp., says Laura Craft, CEO of Opt4, a Berkeley, Calif.-based startup B2B site and the Clearing Corp.’s first customer. Opt4, which is scheduled to launch March 1, 2001, will provide a platform through which companies in vertical industries can customize derivatives trading (the right to buy fruit or steel or coal at a fixed future date and price). “The fundamental complexity of processing customized contracts is something the other clearing corporations have not undertaken,” Craft says. Opt4 and the Clearing Corp. signed an agreement in October that includes joint development of the Clearing Corp.’s system and a payment model through which Opt4 will pay the Clearing Corp. per transaction cleared, plus a flat fee.

Because the Clearing Corp.’s risk-management and consulting services help Opt4 to qualify buyers and sellers for the trading site, Craft sees its contract as critical to her company’s competitive success. “There is a limited number of recognized clearinghouses that are trusted by the financial community,” she says. “We felt it was extremely important that every aspect of our system be recognized as trusted and reliable.”

A Future Secured

Right now, the Clearing Corp. is looking for new customers for its B2B technology. A possible merger with the Options Clearing Corp. (OCC)–a Chicago-based clearinghouse for the securities market–failed last February. The Clearing Corp. and OCC would say only that they couldn’t reach an agreement that satisfied both parties and their respective constituents. But OCC Vice Chairman George Hender acknowledged that the Clearing Corp.’s technology was way ahead of his own. Had the merger taken place, Hender said, the entity would have been driven by the Clearing Corp.’s technology.

“Anything that they have would be a huge help,” Hender said. “Technology is expensive, and there’s no sense in spending money to re-create something someone already has developed.”

The Clearing Corp. says it won’t pursue another merger like that with OCC. Instead, Hammond and Paulson’s organization will focus on adding new clients like Opt4. And while that future may be uncertain, on the IT side at least, the Clearing Corp. is covered.