Terry Duffy is the chairman and CEO of CME Group, the world's biggest derivatives exchange and a trading behemoth whose name is synonymous with Chicago's financial industry. In this wide-ranging interview, Duffy talks about the big risks in the market he's seeing right now and how the CME is preparing for them. He discusses everything from complaints over a lack of liquidity in Treasury futures, to the impact of the debt ceiling on CME's risk management, interest rate hedging trends in the aftermath of the recent banking crisis, and the exchange's expanding suite of crypto offerings. We also talk about how Duffy is viewing the CME's future in Chicago and, finally, his take on the onion futures debate. This transcript has been lightly edited for clarity.
Key insights from the pod:
What’s going on with banks and interest rate hedges? — 2:10
Improvements to Treasury futures liquidity — 7:41
What volatility means for the CME’s business — 9:59
FTX proposal for direct access — 14:35
Competition with the LME — 17:06
The impact of a US default — 19:43
CME’s risk management for debt ceiling drama — 24:08
AI and the transition from open outcry to electronic trading — 26:37
The CME and its position in Chicago — 29:12
The CME’s approach to return to office — 33:14
Risks from commercial real estate — 36:54
Terry Duffy on onion futures — 39:02
Duffy’s take on crypto — 40:01
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Tracy: (00:12)
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe: (00:17)
And I'm Joe Weisenthal.
Tracy: (00:18)
Joe, I can't remember, did you live in Chicago at one point?
Joe: (00:21)
I lived in Joliet, Illinois. Age two to 12.
Tracy: (00:25)
Oh my gosh. That's so funny. So I lived in Chicago for middle school.
Joe: (00:30)
We were probably here some of the same years.
Tracy: (00:31)
Yeah, we probably overlapped. It's a great city.
Joe: (00:33)
I love coming here.
Tracy: (00:34)
And from a finance perspective, it is also an important city.
Joe: (00:38)
It's an interesting and important city. Absolutely. And so obviously yes, when I think of Chicago, I think of trading and commodities in particular.
Tracy: (00:47)
Yeah. And I feel like there's a lot of trading and financial infrastructure located in Chicago that has a great line of sight over what's happening in the rest of the system and the rest of the country. And so since we are here in Chicago at the ISDA AGM, we would be remiss if we didn't try to understand the perspective of the Chicago sort of trading market and what's going on in finance right now.
All right. So I am very pleased to say that we have the perfect guest for this episode. We are going to be speaking with Terry Duffy, chairman and CEO of CME Group. Terry, thank you so much for coming on Odd Lots.
Terry Duffy: (01:24)
Tracy. Joe, thank you very much for having me. Welcome to Chicago.
Tracy: (01:27)
Thank you. Appreciate it.
Terry: (01:28)
Welcome back Joe.
Joe: (0:129)
Thank you.
Tracy: (01:29)
Yeah, it's been about 20 years since, since I've actually been here. So it's weird because I'm walking around. I see some buildings that I recognize and other things like this area where we are right now are completely new. Why don't we start with some of the things that have been happening in markets recently, because there is no shortage of headlines.
You have the debt ceiling ongoing, you have the banking crisis, you have the Fed raising rates, although maybe it's on pause for a while now. Let's start with the banking crisis. What's going on there? What do you see from the CME perspective? Because of course you deal with interest rate derivatives and hedges. So this is sort of ground zero for some of the asset liability mismatches that we've seen in banking.
Terry: (02:10)
So the -- I don't know if I want to call it a banking crisis because a banking crisis is traditionally systemic throughout the whole organization. This is something that's affecting mostly these second and third tier banks. So the other only one that has gone away in recent times is Credit Suisse, which was a major bank, but they, again, Credit Suisse has been, you know, advertised as having issues for many years.
So I don't think that was a giant surprise to a lot of participants in the banking world. As far as the third tier banks especially, we’ll zoom in on a couple, I guess, you know, one of the couple things that I've said about especially Silicon Valley – SVB — is it's really amazing to me that the banks who are in the interest rate business in lending business, I'm in the interest rate trading business, in hedge risk management business of interest rates. And they're in the business of making loans to participants, and deposits for their clients, that they should have a better understanding of the rate market just in general.
I mean, the Fed has telegraphed here in the United States that we're going to have a prolonged tightening series of events. And we did so. We went from essentially zero to just over 5% in the last year or so. And still they hedged long duration on their books with their client money to get a yield. And in return the rates continue to go up and we know what happened. That was an unhedged position. So you would have to ask yourself, you know, where is the risk management associated with some of these banks that are taking money from participants on deposit or fiduciaries? They should have a better understanding of the business that they're in.
So I was quite surprised by that. I don't like to see the banks continue to dwindle. We went from roughly 30,000 banks back in 1950 to less than 4,300 today. So that's not a good trend for the financial sector. So I don't like to see that activity. So I would hope that they people would continue to manage their risk in a smart way. And I'm not saying that from a self-interest proposal. Most second and third tier banks, because of some accounting rules, can't even use futures. But they can use swaps and I'd like to see 'em just use the swaps.
I said in a meeting earlier today that I'm a big believer in the ecosystem. Because if the ecosystem continues to grow, then CME will do just fine in that ecosystem. So, you know, I'm a little surprised by some of this activity with the banks, and it's frightening. The regular participants, listen, they're looking just to keep their money in a safe place. And when you lose the faith of the banks, it's a very troubling event. So the bigger ones get bigger, the smaller ones go away in return. You could say that, the consumers pay for that.
Tracy: (05:02)
Do you see anything changing in terms of trading volume of some of these interest rate products now? Can you see banks starting to react more to this risk here?
Terry: (05:11)
I think what could happen is back in the seventies, even before I was in the marketplace, a lot of the agricultural communities when farmland was really suffering -- actually just south and west of where you spend some of your early years, Joe -- south of Joliet, some great farmland in, you know, mid-to-southern Illinois, was in trouble.
And, you know, eventually when farmers wanted to borrow money from the banks, the banks said to them that they need to have a hedging program in place in order to get loans from the banks. Now not all, but some. So I think that was something that, you know, helped bolster their industry. And in return, you know, risk management became more of a popular tool for the agricultural community, like it was with financial services.
So what does that mean for the banks and the second and third tier banks? You know, I think that they can continue to do the swaps, as I said, and in return, companies like mine can benefit because most of the banks who do the swaps with the second and third tier banks historically do the layoff in derivatives on CME Group. So for us it's, again, it works for us either way.
Joe: (06:23)
But did you see, and I get that your point is not to advertise or promote CME specifically or necessarily out of self-interest, but when we had, and I guess it started with SVB and people are like, “oh, why did they not take better care of their duration risk?”
If we looked at a chart, could we see something in the data that other entities woke up to this? I mean, I'm also thinking of some of the deposit moves where it does seem like there was the sort of non-linear steps. Suddenly people want to be in money market mutual funds, etc. Was there some notable reaction among banks and after the SVB collapse in terms of their hedging activity?
Terry: (07:00)
I wouldn't be able to see it, as I said, because most of those banks would do swaps and I don't see the swap activity. I would only see the layoff from the larger dealers. So their activity is always pretty active, Joe. And I wouldn't see that coming in.
Tracy: (07:15)
Since we're just throwing out risks in the market, let's do the debt ceiling and the Treasury market. And we can get into debt ceiling specifics, but even before this latest showdown, I heard complaints from dealers about liquidity in Treasuries and often in Treasury futures, which you wouldn't necessarily expect. What's going on there. And is there anything that the CME can do to improve liquidity in that market?
Terry: (07:41)
Well here we, I think, we have continually run the largest, you know, futures exchange in the world, especially when it comes to rates and the Treasury complex. The liquidity in our markets has been outstanding, especially through this entire tightening process.
When people talk about liquidity, there's always going to be pockets of illiquidity, Tracy. It's just a nature of any market in the world, including some of the largest. There becomes a situation where the market has a precipitous move because of an unknown event that happened to pop up that caught everybody off base where you're going to have pockets of illiquidity. That's called volatility.
So I think sometimes people mistake illiquidity with volatility, and that's just what makes markets move at times. So I don't believe that… You know, everything we've done has been proper for the marketplace. We continue to keep our engagement with our clients to see if there's something that they would like us to do differently. And again, I just think it's just a combination of, you know, illiquid times because of events that are happening in the world.
Tracy: (08:49)
This is like, illiquidity is another word for a price move that I didn't like.
Terry: (08:53)
Pretty much, that can be that case. You said that, not me. But that's sometimes what happens, Tracy. Yes.
Joe: (08:58)
You know, [over] the last year we've seen extraordinary high rate volatility in general, and maybe it's come down a little bit, but of course, I'm just curious, obviously [it] seems like volatility across any market is probably going to increase demand [for] any of the products that are traded on your exchange. You know, how much are you able to quantify, how much this sort of like high rate vol regime has helped CME’s business? And if we were to go to some just sort of like normal, I don't know, 2017 some year that we all kind of forget for some reason, what does that mean for a business like the CME?
Terry: (09:38)
Well, I guess what you're trying to ask the question, not trying, you are asking a question is, well how much does volatility play into the CME's average daily volume? Is that a fair way to assess it?
Joe: (09:50)
That’s, yeah, I unironically, I always appreciate when the guest understand…
Tracy: (09:55)
When the guest rephrases the question in a better way?
Joe: (09:57)
Understands what I'm trying to ask better than even I did.
Terry: (09:59)
I did. So, Joe, no, I mean, it's a great question and I get it a lot, especially from a new investor community, but I tell people, and this has been the historical effect, volatility is a component of what we do. It's not what we do. So risk management is critically important. Margins are very thin across the board. You need to manage your risk in order to survive.
In today's world, it's a very competitive world. So people that have interest rate risk or people who have energy risks, whatever the risk may be associated with the asset classes that I trade, volatility is only a component of it because volatility never announces itself.
You have to remember that just because the VIX goes up or down doesn't mean volatility's announcing itself. Volatility shows up when the Fed makes a decision that no one saw coming. That's unannounced volatility, right?
So you have to be prepared because if you're trying to manage your risk after the event has been announced or disclosed, whatever it may be, you're not going to be able to do so, Joe. So I think that's, when people say volatility, you know, “CME is based on volatility,” it’s not. It's a component. Risk management is critically important through all times of the cycle. No matter what.
Tracy: (11:13)
What does volatility actually mean for your own risk management? Because I imagine, you know, there are times you wake up and suddenly you have to start collecting more margin on something and as an exchange, that must be a challenge in the current environment.
Terry: (11:26)
It is a challenge and it is a critical component to what we do. Since we don't participate in markets, Tracy, we manage the risk for others, which makes it a lot easier to do so on margins and other things since we're not involved economically as far as that. So we're agnostic to the market, whether it goes up or down. Our focus is strictly on managing that.
And we have parameters on our margin capabilities of what we will move them. And we go with what, we have SPAN and now we have a new system called SPAN 2, which is, systems that, first of all SPAN was licensed to multiple exchanges around the world for their risk management protocols in order to set margins. And we continue to run that and now are just introducing a more advanced system coming up at the end of this year.
So listen, we look at it and we don't deviate from the formula. We don't speculate on the margins just thinking, “well this is a good customer so maybe we will let that margin go a little bit.” So we don't do that. We go right by the letter of the law when it comes to margins.
I think sometimes people say that, an example being during the Ukraine war, I talked about earlier today on a panel with [ISDA Chairman and former CFTC Commissioner] Scott O’Malia, when you looked at what's going on with the price of energy and then ultimately the price of wheat was really affected because of the bread basket and the Baltic there. We raised margins significantly because the price, you know, you're talking roughly a third of the European nations are counting on that wheat for their survival. Most of the African nations are counting on that wheat as a staple for their survival.
And all of a sudden that's getting trapped or not being allowed to come out of that region. You know, the market really took off on that and we'd trade both soft and hard wheat. So we trade the baker's wheat and we also trade feed wheat. So those are things that we have to be very, very careful of because we don't want to get into a situation where we don't have enough margin on deposit or breaches of margin where, Tracy, I'm not able to pay you because Joe didn't have the money to pay me to pay you. So we're very careful about that.
Joe: (13:53)
Since we're talking about your market structure, we talked about this earlier at the ISDA meeting with CFTC Chair Benham, but you know, last year around this time, there was a considerable fight [or] debate over this idea put forward by FTX about changing how futures are regulated and traded in the United States to allow direct access to the exchange. Setting aside what happened with FTX, do you see eventually any merit or possibility that the US will go in something that direction where there is more direct access to the futures exchanges as opposed to having to go through a broker?
Terry: (14:35)
Well, I don't know the ultimate answer to that, but I do know that if there's going to be a path forward like that, then everybody needs to be involved to make sure that we all understand the process. Because the last thing we want to have happen is people who are hedging risks associated with the food in this country don't understand the risk management of it.
So it all sounds great when we talk about crypto because who cares, right? But when you're talking about if you're going to eat or not, or what the price of that product is, all of a sudden we care. When we talk about not allowing energy companies to manage their risk, or not understanding how their risk is managed, then all of a sudden we care because ultimately when the markets become inefficient that the cost does not born by the trader or the exchange that is born by the or by the consumer.
The consumer absorbs those costs associated with inefficiencies in the marketplace. So I think whatever it is going to be going forward, whether it's a direct model or something else, needs to be, make sure everybody understands we bring all sectors along and we write rules associated with to make sure that people understand the rules of the road.
Joe: (15:47)
I mean, that, that definitely makes sense. But just to push on this a little bit further, if we were to go in that direction in this country, how would the CME adapt to such a model? Or what does that mean? What would that mean potentially for the CME’s business?
Terry: (16:01)
Yeah, you're asking me to speculate Joe on what the CME would do and I won't do that. We're just not going to speculate on a what-if scenario. I'm prepared for any outcomes that may or may not arise, and that's just good prudent risk management on our part to make sure we we're ready for those. But again, we're not going to comment on what our strategy would or would not be.
Tracy: (16:24)
I have a bunch of crypto questions that I want to get into…
Terry: (16:26)
What about the debt ceiling? You guys kinda glanced over that.
Joe: (16:28)
We’ll go back to that.
Terry: (16:29)
You talked about it and you blew it off.
Tracy: (16:30)
Wait, wait, wait. I want to ask one other thing just on commodities because I had dinner with a bunch of commodities traders last week and I said I was going to interview you, what should I ask? And…
Terry: (16:40)
Oh boy.
Tracy: (16:41)
Yeah, they had a bunch of unprintable stuff to ask.
Terry: (16:46)
Those are good friends
Tracy: (16:48)
<Laughs> One question that I thought was really good is one of them asked, why aren't you more active in LME-style commodities management? You know, the LME has had a series of scandals at this point. A lot of traders have lost trust in that business. Isn't this a giant market opportunity for the CME?
Terry: (17:06)
Again, I think we look at markets, and I said this earlier, I'm not rooting for anybody to have problems like LME has had. I don't believe in growing my business at someone else's despair because that despair costs participants money. And that's not healthy for markets in general, right? So I don't like that.
We are competing with LME. I don't mind good old-fashioned competition. We are competing with them in aluminum and some other products. But the product you're referring to is nickel. Nickel is a much smaller market. It also has a host of warehouses that are associated with that market that you would have to replicate. It's not just let's list nickel and not have the facilities to make certain that the deliveries on the nickel are facilitated properly so someone doesn't get delivery of a box of rocks, which actually happened versus nickel.
So again, I think from our standpoint, I don't like seeing what's going on with LME but at the same time, we're going to continue to be competitive in areas that we think we can do well at. And I've already said that right now we're in a strong position on some of these metals products that we're competing in. Nickel is something that I have not, I have said that I am not looking to list at this moment. You never say never, but at this moment I'm not looking to list it. I think it's got a lot of issues in and of itself. So we'll have to see how that market progresses. But again, it's a much smaller market than some of the other ones they have.
Joe: (18:37)
Actually, I was going to go into the debt ceiling, but now I'm curious, what is it about nickel specifically when you say…
Terry: (18:42)
I dunno.
Joe: (18:44)
<Laughs> Oh. So it definitely has issues, but it's…
Terry: (18:45)
Well, it has issues because… I don't know if it's the warehouse system, I don't know if it's the cash market associated with it. There's a whole host of things that maybe we need to modernize in cash markets to make the derivative much more efficient as well. Sometimes we're trying to have the derivative make the cash more efficient. You need to have a strong cash market if in fact you're going to have a strong derivative market.
Tracy: (19:05)
We're going to have to do an episode on commodities collateral management soon. And I think I have the perfect guest for that too.
Joe: (19:11)
I am looking forward to that.
Terry: (19:12)
Me too.
Joe: (19:14)
All right. Let’s go to the debt ceiling. How big of a deal would it be if the US were to miss a coupon payment, in your opinion?
Terry: (19:21)
Well, here, I don’t, that again is speculation.
Joe: (19:25)
You're the one who said bring it back to the debt ceiling. So now I'm just going to…
Terry: (19:28)
The only reason I said that is because you said I wrote down markets, debt ceiling, Fed, FTX and you hopscotched over two of them.
Tracy: (19:35)
Oh, we're getting to them. We're not going in a linear order.
Terry: (19:37)
I'm sorry. I'm sorry. My bad. Most people go in the order they say they're going to go in, but that's okay. Joe and Tracy Bloomberg.
Tracy: (19:43)
Sorry.
Terry: (19:43)
I got it. I'm teasing you. So anyway, so on the debt ceiling here, I think talking about a potential default and what it would mean, I think you'd have to be hard pressed because I think that that could be catastrophic to say the least, because it's not just the US which is a huge, obviously, participant in the United States that could, if we had a default because it's not just the Treasuries, it could be a default or a slowing a payment on social security. It could be slowing a payment on veterans affairs, which they need the money to survive. These are veterans that fought for our country.
There’s a whole host of things that payments need to go out to do. So not just the Treasury market. So, you also look at probably 60 other countries that are holding US debt. And I'm not referring to just China, because the easiest thing to say is “China.” Sometimes I think China wouldn't even care if the US defaulted because that would only maybe bolster their long-term view about where they put themselves in the financial system. And again, their view is in hundreds of years, ours is in nanoseconds.
So you gotta remember the difference between how they think about it. What I am very concerned about, and I hope our government understands this, there's a lot of smaller nations, especially European nations who own US debt, that if it ever defaulted, they could put them into a world of hurt. So not just the US. So that's a big concern here. I don't believe we'll see a default in the United States. I think we'll see a lot of frightening aspects to it. I mean, you gotta remember, it took us 15 rounds to elect a speaker of the house from its own party.
Joe: (21:18)
Oh yeah, that was just a few months ago too.
Tracy: (21:20)
I know. It feels so long ago.
Terry: (21:21)
And I think that was a bit of a proxy to show what's going on right now. People kept extracting what they believe they wanted in order to give the vote to then now Speaker McCarthy. So when you're looking at that, you have to say to yourself, what are people looking at to extract on cost cutting measures from an administration that's got, not just this one, but prior administrations that has the United States of America, $31.5 trillion in debt. How do we start to address it?
And then some of these fringe participants of either party might say, “this is a great opportunity or a horrible opportunity, let's borrow more.” The point is, they don't have the votes right now for a debt thing. And so there'll be multiple rounds of this. You saw just, two weeks ago, the house passed a bill by five votes, deliver, raised the debt ceiling by one and a half trillion. But in return, the cuts they asked for over 10 years were pretty dramatic. And obviously the president and the Senate wouldn't even discuss that particular piece of legislation.
So they met yesterday, they're going to meet again Friday, and we'll have to see where it goes. Secretary Yellen says we have enough to pay our bills to June 1st. I think people believe that's a bit of a fudge. And really, we'll probably get into August before we're really going to have some major concerns. And, listen, I saw the debt ceiling go in 2011 down to the 11th hour, literally the 11th hour with President Obama and then Speaker John Boehner. And we're talking about some pretty rational people back then in 2011. You would have to say, what are we dealing with today? And so could it go longer?
What does it look like? I think you could see some delays on some of these payments, but not a default. So you could see delays on some of the coupons that are expiring this summer or maybe even fall. So you could see some delays on the payments. You could see some delays on Social Security and other benefits. But if that's the case, what does that do to the marketplace?
So I can tie this all back in to, we could be in for, you know, again, when I talk about volatility and it doesn't introduce itself, here's a situation where you better pay attention because this could introduce itself in a very ugly way. And that is something that people need to pay attention to because if in fact we have someone make the reference that the payment that you were supposed to get on Tuesday will be here the following Tuesday, people will take that as it's never coming. And the markets will take that as it's never coming. Not that that's the case, but that's how markets anticipate.
And then it happens all of a sudden. And now we go into the liquidity issue, Tracy, that you referenced earlier, because of an event of volatility. Then we have illiquidity, what it appears to be, because of the event.
Tracy: (23:59)
This is exactly what I wanted to ask you, which is are there technicalities that the CME is now on the lookout for in terms of missed coupon payments and things like that?
Terry: (24:08)
We are, and we just did a presentation -- and I can't share all that information -- that I gave to my fiduciaries, my board of directors with my team last week here in Chicago about what it would look like in lieu of maybe a technical default and where we stand from our makeup of margin.
You gotta remember, we're holding $250 billion that we pass through into either the Federal Reserve on our cash because we have the ability to do that as a SIFMU or we're holding Treasuries. We hold roughly 10% to 20% of other collateral, whether it's gold warrants, corporates or other small, we haircut things dramatically already -- including government debt. So the only thing we don't haircut is cash.
And so we are in a strong position. We're holding roughly over $130 billion today in cash against our margin positions. So roughly almost half in cash. So we're in a strong position right now, but we do have some Treasuries. The only ones we would need to worry about are the durations that are expiring in a period that we think could be an issue, which is, you know, maybe that August to October period. And again, that's a very small portion of the margin we're holding today.
Tracy: (25:13)
I'm scared to deviate from our list of talking points…
Joe: (25:17)
I’m looking over Terry’s shoulder to look at his list…
Terry: (25:19)
I didn't get anything ahead of time. I just got my little sheet here that I wrote down.
Tracy: (25:23)
Can I pivot slightly to AI, which is the big talking point at the moment. And it feels like everyone's freaking out over the possibility of losing their jobs. Joe and I have joked that ChatGPT could easily replicate one of these episodes with a guest. And I would love to hear
Joe: (25:40)
They’d never replicate Terry
Tracy: (21:41)
Never replicate, Terry! I would love to hear from your perspective though, the CME is an entity that has gone through significant rounds of technological change. We all remember open outcry, pit trading, you had human traders actually shouting out their trades and things like that. That went away. So how are you thinking about AI now and what advice do you have for people who might be grappling with the potential of this new technology?
Terry: (26:07)
I don't know about the market so much, but boy, Michael Bloomberg's gotta be just really thinking close about this AI. You guys are replaceable, you know that?
Tracy: (26:16)
Thank you.
Terry: (26:18)
I'm sorry, I'm teasing. Sorry, listeners.
Tracy: (26:21)
We’ll do a chat GPT-generated version of this interview and see how it does.
Joe: (26:25)
Compare and contrast, we'll do one every year guys.
Terry: (26:28)
Yeah, remember the information that ChatGPT has is only up through 2021.
Joe: (26:32)
We have like two years. We just gotta keep racing ahead of it.
Terry: (26:37)
<Laughs> I think that, there's always pain and there's always gain as we progress. So, Tracy, you gave the analogy of markets as open outcry transitioning to markets electronic, there was a tremendous amount of pain for people who could not make that transition from the floor-traded model to the electronic model.
Now, the [floor] model could not distribute markets around the world like the electronic model can. So there were so many more benefits, the efficiencies that the electronic model created. Now, a lot of people were able to adapt to the new model and there was some that couldn't. So that's the pain part of it, because you can't bring everybody along. The gain part of it was the market got much, much larger, due to the technology that the markets now use today and continue to evolve in each and every day.
So when you look at artificial intelligence, you know, there might be some short term pain, but I think that long term there could be a tremendous amount of activity. You know, I teased a moment ago, Tracy, about you and Joe, but I think that there's many opportunities for all fields as it relates to artificial intelligence. And the question is, we just gotta make sure we don't deploy it in a way that no one understands it.
I'll go back to my crypto answer is, as long as the rules of the road are well understood by all participants, we have an opportunity to participate in new technology, including artificial intelligence. So that being said, I hope that it increases the job market, not decreases it in the long run, but in the short term, it could have an impact where people see this as a major cost savings to, you know, what you referenced as displacing people from their jobs. I think ultimately it creates jobs.
Joe: (28:22)
Since you mentioned and since in the context of no longer having that physical trading floor, I'm curious about the future of Chicago and your role here. And we have seen some financial firms leave, like Citadel, I don't know if, I assume they still have some offices here, though I'm not sure. The city elected a new progressive mayor who has talked at times about a tax higher tax on hotels, a higher tax for large employers, and even a financial transaction tax, which I imagine goes straight to the heart of your business. Have you talked to the mayor elect?
Terry: (28:56)
No, I have not spoken to him.
Joe: (28:58)
How much, you know, were some of these proposals to go through? How much would that, you know, what do you, what would that mean for the CME and how committed, would you, is there a future in which the ‘C’ isn't in ‘Chicago’?
Terry: (29:12)
First of all, I think that there's a huge difference between a campaign, the rhetoric associated with campaigns. And once somebody assumes in office, whether it's Mayor of Chicago, whether it's president of the United States, a lot of people say a lot of things during an election process. Now, what they can do, and get accomplished are two different things.
I gotta imagine that if you run for president of the United States, the day you walk into that White House, it's got to be absolutely the most awesome experience in your life. And it's also gotta be the biggest burden you've ever seen in your entire life, right? Saying you are the leader of the free world. What I said on a campaign trail, now, okay, that was interesting, but now I'm sitting here, now I gotta make decisions on behalf of 335 million people that make sure we're doing the right thing.
And so I think that when you look at, you know, Mayor-elect Brandon Johnson, I don't know him. I know he is very progressive and he's made a lot of comments as it relates to taxes. I'm hopeful that he reaches out to folks. I don't care if it's me or whoever, and talks about these things.
I have, first of all, let's make one thing perfectly clear for your listeners. Mr. Johnson has no legal authority to impose a transaction tax on my business. He just doesn't have it. The city of Chicago doesn't have the ability, it's not him, it's the city of Chicago. The state of Illinois is somebody that can propose a transaction tax, and then the federal government are the only two entities that can do so.
So on the hotel tax, I'll leave that to the people that run this hotel to determine how they're going to deal with that. I don't think it's healthy for tourism. That's one of the things we rely on in this great city is tourism. So you hate to chase people away over a silly cost. You'd rather, you know, maybe take the Walmart model and bring in more and charge less.
So I'm hopeful that he deals with some of the issues that are of concern. And most of those are around crime and safety. So I'm hopeful that the new mayor focuses on those issues and doesn't get too bogged down on how he's going to short-term think he's going to raise taxes on certain people in order to fit his agenda. We have a problem in Chicago, and I think there's other cities here. It's not just a crime, it's the community. You need to create community amongst your city if you're going to survive in the future.
Meaning we need to have businesses open, we need to have people walking into those businesses. You need to have commerce, you need to have people living in here. You can't chase everybody away. Everybody is afraid right now because of whether it's the crime issue or whatever. So I think layering on additional cost as you're trying to fix one problem would be a catastrophic mistake.
As far as CME’s future in Chicago, CME, we have sold all of our, property in the state of Illinois, in the city of Chicago. We don't own anything any longer. We put ourselves into a very strong position many, many years ago. Actually, in our leases, we have a language in there that says if there's something that's ill-conceived from the city of the state, that our leases are null and void. So we we're in a really strong position. We have options coming up on our long-term leases already.
So that doesn't mean we're leaving. We like Chicago. As I said earlier today on a panel, I think Chicago's been on its back foot before and it can get back on its front foot, but it takes all of us to do so. So I want to be a part of the solution, not a part of the problem. And that's how I look at Chicago. So again, we're in a strong position from a whole host of reasons, from a risk management, as I talked about earlier to real estate. And if there's any Ill-conceived taxes, you know, we're in a very strong position. If we had to leave, we could leave.
Tracy: (32:57)
Yeah. A lot of these dynamics apply to New York as well. Does the CME feel a responsibility to get people back into the office and into the city? If we're talking about crime, it would help to have people walking around and businesses open, as you said. So do you feel that you're part of that?
Terry: (33:14)
So Tracy, that's an excellent question and it's been an issue as you can all can imagine. Everybody has been locked up or they've done things a certain way for three plus years and it really gets hard to say, “okay, that's over with. Now come back to work.”
Everybody is like, “Well, why? I'm doing just fine doing it the way I'm doing it now.” You know, I think it's up to, and I said this to our governor, I said to him, I said, you know, when Covid, when you shut down the state of Illinois and certain businesses had to stay open because they were essential to the lives of others, some banks and exchanges were part of that as being essential. Not just grocery stores, not just big box stores and others, but they, we were essential. Nobody thought about how do we get 'em back now? You know?
So why isn't government getting involved with saying, “We need people back, we need people back in cities and communities.” You know, I'm a big believer that if you're a steward or a fiduciary of other people's money, that you need to be there to be on top of it. And to sit at home and monitor that off a screen to me is not the appropriate thing to do. You should always have somebody, you know, involved in an office setting as you're relying on someone to keep your money safe for you.
So there's a couple different ways I'm looking at that, Tracy. But I will say that, you know, from our standpoint, I've met with my people. I'm not a big fan of the hybrid, but at the same time you have to, it's a competitive world out there. So you have to do what you have to do.
I will say that my risk and clearing people are in five days a week. And that's not negotiable. And they know that. And I've had meetings with them and they're comfortable. They understand my concerns around risk and clearing. I outlined them for you all on sitting here, how volatility can come up very quickly. So I'm very committed. I understand that certain people in finance and legal and other parts of my company may come hybrid a little bit. But again, I'm holding everybody accountable. I have shareholders that are holding me accountable.
So, we'll see how this all pans out. But I do believe there's a role in, not only federal government, but state government, to help rebuild these cities. And listen, we have a massive problem with vacancies in office buildings around this country, especially in New York and Chicago and LA and that's not healthy.
I mean, that's a massive shoe to drop because all these buildings are levered up. I mean, there's loans against them that are going to be refinanced at much higher rates and there's no occupancy. What's going to happen to them. So I’m not an economist, I'm a realist. I look out the window and I can, you see certain things. And again, I think it's upon not only executives like myself, but of course people in elected offices to make sure that we put these pieces back together. And it's hard.
Joe: (36:16)
You mentioned office vacancy is a problem. And the other issue that a lot of banks have run into, besides their duration risk is this perception that many of them have significant potential losses related to commercial real estate. We talked about this in our recent episode. Real estate is one of these areas which sort of seems somewhat impervious to robust hedging instruments or futures related to indices. Have you, can you talk to us as, as someone in this business of these instruments, what is it about real estate or commercial real estate that has made it difficult to build instruments that would allow for hedging activity?
Terry: (36:54)
So I think there's a lot of things that are really difficult to provide what Tracy talked about earlier, which is liquidity for every single instrument. Because everybody who's in a certain business believes that they should have a risk management tool. There's other people that don't want to participate in it because of whatever that industry may or may not look like.
You also have to make sure that nothing is readily manipulable before you can go forward. So you have to have a strong cash market, like I referenced earlier. So sometimes the markets are just not, you know, I don't want to say centralized, but are just not -- customized. And that is the word I'm looking for. Customized enough to have for every single product. So in return, you know, when you look at, here's a great example -- jet fuel, you would think, boy, there's a lot of people flying. Why don't we have a jet fuel contract? Why? Because they use the West Texas intermediate to manage that risk in their jet fuel cost.
Why don't we have other contracts for other businesses? You know, I've had people come to me saying, “Terry, have you seen this lobster market?” I'm like, “excuse me? The lobster market?” You know, we need to have a futures market on lobsters because in Maine right now they're rolling. I'm like, oh boy, okay. I don't think they care in Kansas, but alright, whatever.
So you need to make sure that you have a natural buyer, natural seller in the market that's not readily manipulable. I'm not saying the real estate market is or the commercial market is, but the way you can deal with that is through interest rates and interest rate markets. So you can hedge those exposures on your cost. You're not going to be able to have a pure hedge on occupancy the way I look at it. But maybe somebody will, you know, Robert Shiller, as you know, created a Case-Shiller index on the home index. An that seemed like a real natural product, right? But it's…
Joe: (38:30)
There are some futures on there?
Terry: (38:31)
There are. And we had 'em. And we worked with Professor Dr. Shiller on the contract, but again, it's not a liquid contract because there's a lot of people [who] don't participate in that marketplace.
Tracy: (38:40)
Yeah. Joe, I was just thinking this was our opportunity to turn this into our long-awaited onion futures episode.
Terry: (38:46)
Onion? It's the only, it's one of the only products that's outlawed by United States government.
Joe: (38:52)
We've joked about this for years, but we've never done an onion futures [episode] and why it's banned. And we may never do an episode on it. We'll just keep joking about it.
Terry: (39:00)
You want me to give you a snapshot on it?
Tracy: (39:02)
Sure. Do it, do it!
Terry: (39:02)
The market was cornered on the onions and they dumped the onions in the Chicago River and kept the burlap sacks that they're in because of burlap sacks were worth more than the onions themselves. and the United States government stepped in and said, we will not have a futures contract on onions ever again. There you go.
Tracy: (39:19)
It's amazing that the US government was so active on the onion market in like, what was this? Like the 1920s or thirties? Thirties, something like that. And yet here we are today. Okay, speaking of government inaction, maybe this is my segue into crypto.
Joe: (39:33)
I was just going to say, it's impressive how long we went without really going to crypto. I'm glad. Anyway. You, you sure We
Terry: (39:38)
You sure we didn't talk about crypto. I thought you touched on it?
Tracy: (39:39)
A little bit with FTX, but let me ask the broadest crypto question possible. What is your take on crypto at the moment? Because you have voiced some concerns about the way the market functions and how it could fit into your business. But at the same time, you do have a big and growing suite of crypto offerings.
Terry: (40:01)
So again, I don't believe I've ever come out publicly and said that I don't believe in crypto. Cause I know I haven't said that. What I have said is, I do believe that people need to understand what they are participating in and for some reason people get a case of FOMO or they get a case of influencers who influence them because they're celebrity types or whatever, that this is something that you gotta have. And we live in an information age where people follow other people and it's just, you know, off to the races.
So what I believed with crypto was for an exchange like ours, a highly regulated entity that, you know, when we decided to list Bitcoin, it was going to be under our comfort level, for lack of a better term. And we did that. We did it with making sure that we have the functionality that we have in all of our other markets could apply to the Bitcoin, such as stop logic functionality, velocity logic functionality. Meaning if the market was to precipitously move so fast, it would stop, replenish liquidity, then start again. That's called velocity logic.
And then we would also make sure that the margins were a lot higher than they were charging at some of the cash exchanges like FTX and others, which was just a couple percent. We actually went into the high thirties, low forties when we listed that contract on margin. And then we listed an awful large size contract to make certain that we were attracting sophisticated participants. We did not want to attract, you know, retail participants who still didn't understand the product very well.
Now we have subsequently gone into smaller contracts on Bitcoin and Ether. So we have what's called micro contracts that trades more for the retail. What I will tell you, what's interesting about that, and this has happened in the last couple weeks, is our retail contracts are actually lower in volume now on a percent basis and our large contract is up in volume on a percent basis. Which tells me that the larger sophisticated participants who will trade the larger contract are in that one because it makes economic sense for them to be in that. In the smaller one, some of the retail participants are not trading that as often.
So what that can tell you as a proxy is retail getting a little worn out, you know, with the inflation, without the stimulus money and having to use that money for other costs associated with running their households. So I’m not saying that's a pure analogy, but I find it quite interesting.
So from my standpoint, I think crypto will, you know, you'll have a few of these cryptocurrencies going forward and as long as we continue to educate and prove out their use cases where people can use them and feel comfortable using them and not worry about losing their money to participants who are holding that for ‘em, remember the bigger issues with some of these exchanges is the cold wallet where you can get your own. But some people just trust that the exchange will do it for them. And that's been an issue.
So I think it's going to continue to evolve, and you'll have a survivor of one or two of these cryptocurrencies and then you'll have the blockchain technology being deployed in many other ways outside of just crypto. Maybe it's used with the stable coins or used with another means.
Joe: (43:30)
Just on crypto. One last question. You know, what would you look for in terms of other additions? So you have Bitcoin, Ether. Do you have some, I assume you have a team that sort of monitors other coins and sort of where the market is going. Do you have sort of benchmarks or things that you would see where like, “oh, maybe we'll add a third coin, maybe we add a fourth.” Types of things that sort of, okay, this is hitting a threshold where it might justify having a futures market for?
Terry: (43:56)
Yeah, and that's a great question. Because we do measure by thresholds on a lot of our products that we list. On crypto, one of the things that we've been successful doing is we have reference rates. And even prior to us listing the derivative of Bitcoin, we had a Bitcoin reference rate. Now we have listed several more reference rates and we'll see how those reference rates par go over the next, you know, several months to maybe a year and see if they start to participate more where people are actually using them. And then we may decide to go from there. So it gives us the ability to have a non-tradable product on a reference rate that to see how people are looking at it. And then if we decide there's enough interest, we could always list a futures contract on it.
Tracy: (44:37)
Just going back to liquidity real quickly, which is how we sort of started this conversation, it, there does seem to be, I don't want to say more of a concerted effort because it feels kind of disjointed, but there does seem to be more noise at the moment about regulating crypto and you have crypto futures.
And I guess the question is, are you concerned at all that a clamp down on crypto in the cash market would affect the futures business? Because as anyone in financial markets knows, in order to have vibrant and healthy futures contracts, you do also need vibrant and healthy markets in the underlying.
Terry: (45:14)
Yeah. And again, Tracy, I appreciate that question. I think when you look at the cash market as it relates to crypto, it's already been question asked, question answered as it relates to Bitcoin, that it is a futures contract. So there's no argument. I think as long as we're in that place right now and we have been since we listed a contract in both the SEC and CFTC obviously have agreed that that is the case.
So I don't think that harms Bitcoin. Now let's talk about some of the other cryptos. What does it do? There is massive uncertainty of what is the security and what is the derivative. As you know, both the SEC and CFTC have a difference in that definition and they both want to seek regulation of those products. So until there's clarity, markets hate uncertainty, and I think we gotta get clarity between the regulators about who is going to regulate some of these other cryptocurrencies and what are going to define them.
You know, I remember when the Shad-Johnson Accord was passed and that is basically saying what divides a broad versus a narrow based index. So what can be traded as a future, what can be has to be traded as cash? So, you know, I think it's 11 or under on the products can be determined as narrow and 11 or more is a broad based index so you can trade those as futures, like the S&P 500 we trade at CME and other security indexes are deemed as futures.
I'm not saying that's the way they're going to look at crypto, but they have to come to a decision one way or another if the market is going to have the ability to find its footing and grow going forward. But I don't believe, Tracy, that it's going to have a massive impact on Bitcoin and its liquidity or not. I think that'll be like every other product up to what's going on in the world today. Not the regulators. It does with the other products though.
Tracy: (47:17)
Alright, well, an absolute treat to be able to come back to Chicago after 20 something years and speak to Terry Duffy. So thank you so much for coming on Odd Lots. Appreciate it.
Terry: (47:28)
Tracy, Joe, thank you very much. Thank you and appreciate the opportunity to speak to you and your listeners and again, I hope you enjoy Chicago and stay safe.
Tracy: (47:36)
Thank you so much! Joe, I really enjoyed that conversation.
Joe: (47:54)
You know what I want to do, I want to have Terry back, but just for one where it's like we throw out like different commodity features and he tells us and…
Tracy: (48:02)
He just says something?
Joe: (48:03)
Why don’t we have jet fuel features? I never thought about that before, but that there's already an instrument that's like close enough.
Tracy: (48:08)
Yeah, or just like old war stories from running the CME. Because I remember also a few years ago when I was sort of more involved in this coverage, I remember there was like a cattle herdsman association that like went to Chicago to talk about the cattle futures contract. There are so many stories he could tell
Joe: (48:28)
The burlaps sacks, I had no idea.
Tracy: (48:29)
Yeah. I didn't realize that either. But there were a few things that were really interesting to pull out of there. I mean, one to hear how he's thinking about crypto liquidity was interesting. And also that they're thinking actively about Treasury market risk. I mean I guess that should be obvious, but it does feel to me like the debt ceiling drama is one of those things that could really materialize, like the risk could be there's some obscure contract language about delivery. So it's interesting that they’re looking for that at the moment.
Joe: (49:04)
Speaking of contract language, I thought it was interesting that he pointed out specifically that in the leases they have for their real estate in Chicago, that there are, and it'd be interesting to talk to like a real estate lawyer, what kind of leases companies have [if] they want to leave or move to Florida and they say, “oh, it's tied to political choices,” what that looks like. And the fact that he was kind of, he didn't say like, “oh, we're going to leave” or anything like that. But it's clearly something that if they…
Tracy: (49:32)
I think there was an implicit threat there. It's obviously something they have been thinking about.
Joe: (49:38)
Yeah. Implicit threat, a concern.
Tracy: (49:39)
All right, well on that note, shall we leave it there?
Joe: (49:41)
Let's leave it there.
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