Exchanges & Order Execution

Transcription

1 Industry Update Niamh Alexander Nassime Ruch-Kamgar, CFA Alim Shaikh Exchanges & Order Execution September 6, 2011 Summary-- We expect the CFTC may finalize and even implement aspects of its proposed position limit regime on futures markets in the next few months. We consider implications for exchanges, ICE and CME, and we lay out the key issues industry participants are grappling with, potential timing of full implementation and (with some qualifications) our estimate of the impact from the limits. Implementing position limits across the OTC markets is a big challenge and could have far-reaching implications across the industry, but neither we, nor, we believe, the regulators, have enough data to accurately assess the implications. See PDF for our full report. Key Points-- The CFTC intends to establish position limits in the energy, agricultural commodity and metals markets. We see risk that some large market participants may be required to reduce their positions in the market and, potentially, their trading activity, though we expect the volume effect to be lower than the open interest impact. The CFTC indicated in its January 2011 proposals that it will implement position limits in two sets, spot month limits first and single-month/all-month limits at a later date. We expect spot month limits to be finalized at either the September 22, 2011, or October 4, 2011, CFTC meeting. We don't expect limits on single-month and all-month contracts to be finalized until As volume in spot-month contracts makes up ~5% of volume across the 28 markets targeted by position limits, we do not believe any material negative impact on the exchanges will occur until 2013 at the earliest. Analysis: Based on the current proposals and using data released by the CFTC, we estimate the range of impact of position limits could eventually be a 5-12% reduction in open interest in total across the 28 markets. Including exemptions, we believe the negative impact to ICE and CME EPS will be less than 5% starting in Excluding exemptions, we estimate the range of impact on 2014 EPS to be 3%-8.5%. We note position limits are unlikely to impact volume from high-frequency traders as these participants tend to be net neutral by day's end. What's Different About Proposed Limits vs. Current Position Limits. There are currently limits on the spot month contract in most markets, but the spot month limit will now be aggregated across exchanges instead of by exchange. It will also apply to certain OTC contracts. There are currently accountability limits, but no hard position limits on single-month and all-month contracts. We Outline Key Objections of Market Participants to the CFTC's Proposals. These include: whether the CFTC has the mandate to impose position limits, exemptions are too strict, exemption process is too onerous, positions in accounts not commonly controlled should not be aggregated, netting between listed and OTC derivatives should be recognized and that the CFTC is failing in its mission if it implements rules that shift trading activity abroad. Please refer to important disclosures and analyst certification information on pages

2 Position Limit Debate to Heat Up This Fall The Commodity Futures Trading Commission (CFTC) proposed limits on the size of open positions could affect commodities trading volume, which could have implications for complexes at ICE and CME that made up 43% and 37% of their revenue in 2010, respectively. If the European Commission (EC) imposes similar position limits as the current CFTC proposals, we estimate EC and CFTC position limits would apply to contracts that generated 65% of ICE s earnings. We address what issues market participants appear most concerned about with respect to position limits and the extent to which we believe proposed limits will negatively impact trading activity in futures, option on futures and swaps in the energy, agricultural commodity and metals markets. A lack of information on over-the-counter (OTC) positions in commodities contracts and how CFTC-proposed position limits will impact the OTC market means we cannot fully quantify the risk to exchange earnings with any degree of certainty. While it appears from available data that CFTC position limits may only impact large open positions and a relatively small portion of futures volume, we also believe exchanges would not have been so keenly active in dialogue with regulators if there weren t potential negative consequences to their businesses. We see key risks to futures volume in how or who qualifies for exemptions from these limits, whether similar limits are adopted in Europe, and how these limits are applied to the positions of market participants. CFTC Chairman Gensler recently stated the CFTC is targeting early fall 2011 to finalize (though not necessarily implement) its position limit proposals and the CFTC has previously stated the agency s first step could be to impose spot month position limits. Key takeaways below: We believe a key question lies in to whom and how the CFTC will grant exemptions from limits. The proposed exemptions are much narrower than current exemptions. Dealer facilitation of client trades that are not considered bona fide hedgers would no longer be exempt. Bona fide hedge exemptions would be awarded by trade, not participant. OTC positions will be limited for the first time, and could reduce OTC trading activity. This could also have a negative impact on futures volume as we would expect less OTC trading would translate to less hedging of these positions in the futures market. Assuming the CFTC s proposed limits for single-month and all-month contracts were put into effect by mid-2013, these would really only impact market participants holding large positions. CFTC released data indicates that changes in large positions make up ~10% of aggregate volume in the 28 targeted markets: 5-10% of the energy volume, 7-30% of metals and 12-50% of agricultural volume. However, we expect some of their trading activity would qualify for exemptions from the limits as bona fide commercial hedging. In aggregate, we don t anticipate this would impact volume or revenue by more than 5% standalone for either ICE or CME. However, the uncertainty around exemptions and the impact on traders OTC activity could make the impact on earnings higher. Please refer to important disclosures and analyst certification information on pages

3 Exhibit 1: If Limits Curb Trading Activity of Large Traders, We Estimate Less Than a 5% Negative Impact on ICE and CME Earnings in 2014 IF Large Trader Volume Declines By CME EPS Reduced by: ICE EPS Reduced by: If European Position Limits Also Imposed ICE EPS Reduced by: 20% 1.5% - 2.5% 1.8% - 2.2% 2.5% - 3.0% 40% 3.0% - 5.0% 3.0% - 4.0% 5.0% - 6.0% 60% 4.5% - 7.5% 5.0% - 6.0% 7.0% - 8.5% 80% 6.3% % 7.0% - 8.0% 9.5% % 100% 8.0% % 8.5% % 12.0% % Note: analysis excludes effects of limits on OTC positions Source: CFTC data, KBW Research CFTC Balancing Political Pressure to Impose Limits vs. Potential Litigation Risk vs. Inadequate Support Within Commission. We believe the CFTC, which is overseen by the Senate Agriculture Committee, is currently caught between some Democrats (who do not feel as if it is moving quickly enough) and Republicans (who feel it is moving too quickly and encourage more deliberation). Eight, primarily Democratic, Senators introduced a bill on June 14, 2011, to force the agency to crack down on oil-price speculation, while Republicans have introduced legislation to slow down implementation of Dodd-Frank rules. We also believe the CFTC is balancing the threat of potential litigation from market participants if it imposes regulations without proving the existence of speculation. The CFTC is currently short of the necessary three votes from the Commissioners to approve final rules for position limits. Republican Commissioners Sommers and O Malia are against the current proposals and with Commissioners Gensler and Chilton in favor. Expected new Commissioner, Mark Wetjen, could break the deadlock. He was approved in early August by the Senate Agriculture Committee and is expected to be confirmed by the full Senate this month. Position Limits May Not Be a Negative. ICE CEO Sprecher has said that energy markets may work better with limits in place. It's not necessarily a bad thing for exchanges to prevent one large player from having concentration, he said. Sprecher said since ICE imposed their own version of position limits in their markets, volume has actually increased and, he said, a healthier market with more, smaller players has formed. A lot of people don't like the thought of being limited in any way, but the reality is, the evidence so far at ICE, is that we've grown very well during a position limit regime. Please refer to important disclosures and analyst certification information on pages

4 CFTC Position Limits on Single-Month and All-Month Contracts Most Likely Won t Be Implemented Until 2013 at the Earliest We believe the CFTC is unlikely to implement position limits on 95%, and maybe 100%, of volume until mid-2013 at the earliest as the limits are to be based on data that has not yet been collected. The CFTC proposes three sets of position limits: 1) A limit on position size in spot month contracts of each commodity. 2) A limit on position size in contracts for any single month of each commodity. 3) A limit on position size in all contracts for a given commodity. September 6, 2011 In the past year and a half, we calculate that approximately 5% of volume across the 28 markets has been transacted in the spot month contracts; therefore, we estimate the spot month limit applies to ~5% of volume, while the single/all-month limit to ~95% of volume. While the CFTC could potentially finalize spot limits in the near term, the Commission needs open interest data on the swaps market to set the single-month and all-months-combined position limits, and it cannot begin collecting this data until its position-reporting rule becomes effective. The CFTC hopes to finalize its reporting requirement rules in early 2012, after which we estimate it will allow at least 60 days, maybe more, for implementation before the rule becomes effective. Therefore, we believe it will be at least another year before the CFTC starts collecting the open interest data necessary to set the single-month and all-months limits. Assuming that the CFTC will want to monitor and collect at least six months of data before finalizing its position limit proposal, and that it will take three months to rewrite the final rule, followed by 60 days or more for implementation, we believe mid-2013 could be the earliest before the single-month and all-months-combined position limits (as well as potentially the spot month limits) are implemented. Likewise, we do not expect European position limits to go into effect until 2013 given proposals are still in early stages. Position Limit Timeline: January The CFTC released the most recent position limit proposal. March 28, The comment period for the proposal ended. This Fall: o o o CFTC Chairman Gensler stated on August 4, 2011, that the CFTC is likely to continue progress on final rules for position limits at either the September 22 or October 4 meeting. We expect the CFTC to release a proposed rule outlining the process by which significant price discovery swaps can be identified so that the market knows which swaps qualify as these and are therefore subject to position limits. September 22 or October 4 CFTC meeting: In its January 2011 position limit proposal, the CFTC intended to relatively expeditiously adopt spot month limits, ahead of the single-month and all-months-combined limits. However, we see the potential for the final rule on spot position limits to be delayed until the single-month and all-months-combined limits are established as well since spot month limits also apply to swap instruments on which the CFTC does not yet have complete data. Mid The CFTC intends to establish single-month and all-months-combined limits only after it has collected data on physical commodity swaps so that it can determine the total size of the swaps and futures market. We do not expect this to occur until mid-2013 at the earliest. European position limits. The draft legislative proposal of MiFID II is expected to be published in October 2011, after which it will be put to the European Parliament for a vote. The first reading of the draft consultation document by the European Parliament may now not take place until the end of 2011, making MiFID II unlikely to go live until Please refer to important disclosures and analyst certification information on pages

5 Key Objections from Industry Participants The CFTC Does Not Have the Authority to Impose Position Limits. There is some uncertainty as to whether the legislation actually mandates the CFTC to impose position limits and even if it does, whether the current situation requires the imposition of position limits. Many comment letters (e.g., CME, GFIG, GS, ISDA, BlackRock, PIMCO) begin by stating up front that the CFTC has not provided evidence of excessive speculation in the commodity markets and therefore does not have the authority to impose position limits. The Dodd-Frank bill mandates the imposition of position limits by the CFTC only if they are necessary, which the CFTC has not yet proved. Additionally, the Dodd-Frank bill requires that position limits be appropriate. Many participants argue that the CFTC proposed position limits are not. For example, Dodd-Frank states that the CFTC s goals in setting position limits should be to: 1. Diminish, eliminate or prevent excessive speculation. 2. Deter and prevent market manipulation, squeezes and corners. 3. Ensure sufficient market liquidity for bona fide hedgers. 4. Ensure that the price discovery function of the underlying market is not disrupted. 5. Avoid shifting the price discovery function to FBOTs. Many participants feel the CFTC proposals are focused only on the first goal and directly go against the next four. We believe this could leave the CFTC open to the threat of litigation from market participants. Exemptions from Position Limits Too Strict and Filing Process to Gain Exemption Too Onerous. The exemptions proposed by the CFTC from position limits are narrower than the exemptions included in the previous position limit proposal as well as current exemptions. The new proposed position limit exemptions are also stricter than the exemptions included in other CFTC proposals related to end-user exemption to mandatory clearing of swaps. More specifically, the bona fide hedging/commercial end-user definition is narrower and may not include all industry participants and all trades entered into for hedging purposes. Bona fide hedge exemptions in the current position limit proposal would be awarded by trade, not by participant. There are no blanket end-user exemptions, whereby any trade done by a commercial end-user would be exempt from position limits. Each individual trade would have to qualify for exemption and would have to be a substitute for a trade done in the physical market or be a counter-party to one of these trades. Additionally, many participants are concerned that the proposed process to file for hedge exemptions will be incredibly cumbersome. The CFTC is proposing that bona fide hedgers must file a report with the Commission every day they enter into or maintain a position in excess of position limits, instead of the current status quo of once a year. There would be fewer exemptions for swap dealer trades. Dealer positions would no longer be exempt if the position is to hedge exposure to a trade facilitating a client that was not a bona fide hedger. Excess end-user position limits would also no longer be permitted to be passed-through to swap dealers; counterparties to end-user hedging trades would no longer be able to apply the extra position available to end-users under the limits to their own limits. New Account Aggregation Rules Increase Likelihood That Large Participants Will Have to Reduce Positions. The position aggregation method proposed by the CFTC in its most recent position limit proposal is stricter than previous and many participants, such as CME, Hess, Deutsche Bank, ISDA, BlackRock, and PIMCO, have objected in their comment letters. The CFTC s longstanding policy has been to disaggregate positions in accounts that were separately controlled, though commonly owned. The most recent position limit proposal requires a trader to aggregate positions in all accounts of which the trader owns more than 10%. The trader s aggregated position must now be below the position limit rather than the trader s position in each account. Please refer to important disclosures and analyst certification information on pages

6 Netting Positions Across Classes Not Currently Allowed. The CFTC has proposed two sets of single-month and allmonth limits depending on whether the position is in swaps or futures. The separation of these positions does not allow for netting across the two, which effectively lowers the limit. Industry participants such as CME, ICE, Shell, Deutsche Bank, GS, ISDA, BlackRock, and PIMCO argue that since the swaps are economically equivalent to futures, traders should be allowed to net the two positions. Where the CFTC comes out on this has important implications for ICE s OTC energy complex as well as CME s interest rate swap offering. If the CFTC does not allow netting for position limits, we would expect it to be consistent and not allow it for clearing either. Differences in Position Limits in the U.S. and Europe Could Drive Volume to Europe. One key question is position limits in Europe. If Europe fails to establish position limits, it could be positive for ICE, but negative for CME. We estimate if European regulators impose similar position limits as in the U.S., in total, contracts that generate 65% of ICE's earnings could potentially be impacted, up from 43% otherwise. If Europe fails to establish position limits, it could be negative for CME. CME commented that market players may flee WTI crude oil trading in favor of the Brent crude oil contract, which wouldn't have limits. Position Limits Could Prevent the Creation of New Products. Since smaller, newer markets tend to be more concentrated, the formula for single/all-month position limits has the potential to prevent the success of new futures products, which are already very difficult to introduce. This is because large players will be a higher portion of the open interest of a new, small market. Although, the smaller the market, the higher the limit as a percent of the market due to the way the single/all-month formula is constructed (see Exhibit 2). Current Proposal Contains a Loophole for Certain Commodity ETFs. Some ETFs invest in physical commodities instead of commodity derivatives. Therefore, the CFTC position limits would not apply to these funds as they are not regulated by the CFTC, yet holdings of physical commodities most certainly impact the market s supply-demand dynamics. The CME argues in its comment letter from March 28, 2011, that market participants looking to establish larger positions could simply shift their investments to these funds, which would serve to drive up commodity prices and undermine the CFTC s efforts. Since these funds are regulated by the Securities and Exchange Commission (SEC), the CFTC would have to coordinate with the SEC so that position limits also apply to them. Spot Month Limits Should Not Be Implemented Before Single-Month and All-Month Limits. Certain market participants, as well as Commissioner Sommers, believe that spot month limits should not be implemented before relevant data on the OTC markets is collected. Other market participants believe the proposal for the spot month limit is too low as it takes the current spot month limit in effect at each exchange and applies it to positions across all the exchanges as well as OTC products. Another concern is that the limit is too low because the formula for calculating deliverable supply does not take into account all deliverable supply. For example, supply that is committed for long-term agreements (and therefore would not be available to fulfill delivery obligations arising from current trading) would not be included. Lastly, certain market participants such as CME are against the conditional spot month limit that grants a 5X higher limit in cashsettled contracts as long as any position in corresponding physically settled contracts are exited. Please refer to important disclosures and analyst certification information on pages

7 Laying Out Potential Impact of Position Limits The CFTC plans to establish position limits in the energy, agricultural commodity and metals markets. Though there will be exemptions to the limits for the hedging needs of commercial players, the risk is that position limits require some large players to reduce their positions in futures, options on futures and swaps in the market. This could result in lower trading activity in these instruments, which could negatively impact the futures exchanges as well as the inter-dealer brokers that transact in OTC commodity derivatives. Instruments CFTC position limits will apply to: The CFTC has proposed position limits in 28 core physical delivery futures contracts in the agricultural, metal, and energy commodity markets. Specifically, 19 agricultural commodity contracts, 5 metals contracts, and 4 energy contracts, as well as the options and swaps linked to these. Two types of swaps are considered linked and therefore position limits apply: Swaps that are economically equivalent to futures and options. Position limits for these must be established at the same time as the position limits for futures and options. Significant price discovery function (SPDF) swaps. Position limits for these don t have to be established at the same time as futures and options. The CFTC first plans to release a rule proposal for the process by which swaps that perform or affect a significant price discovery function with respect to regulated entities can be identified. Current CFTC proposals for position limits: The CFTC has proposed two sets of position limits: a limit on any open positions based on deliverable supply for the spot month contracts, and a limit based on open interest for the single-month and all-month contracts. The formulas are set, but the deliverable supply and open interest figures on which limits will be based are not as the CFTC doesn t have all positional data on swaps yet. The Commission only has limited positional data for cleared swaps that are significant price discovery contracts (under part 36 of its regulations) and limited positional data on certain swaps that are cleared, but not traded, by registered derivatives clearing organizations. Spot month limit: The limit on position sizes in spot month contracts is set at 25% of estimated deliverable supply and adjusted annually thereafter. The proposal is for the limit to be in aggregate, across markets. The current spot month limits set by exchanges are also set at 25% of deliverable supply, but at each exchange, rather than in aggregate. Referenced contracts that are based on the price of the same commodity, but where the delivery location is different would not be subject to spot-month position limits. Spot-month limit would apply separately to cash-settled and physically-delivered contracts. Additionally, the proposed limit for cash-settled spot contracts increases to 5X higher than for physically settled contracts as long as any position in the physically settled contract is exited. Single-month/All-month limits: The limit for positions in contracts for any single month is proposed to be the same as the limit in all-months, which includes spot month contracts. Currently, exchanges enforce accountability levels, but not hard position limits, for single-month/all-month contracts. The limit formula will be set at 10% of the first 25,000 contracts included in aggregate open interest (of swaps, futures and options on futures) and 2.5% of open interest above 25,000 contracts. Limit formula: 10% * 25, % * (total open interest 25,000) Legacy all-month position limits to be adopted for corn, wheat, soybean, cotton and oats contracts. There will be three different limits for single-month and all-month contracts: 1. A limit for listed derivatives (futures & options on futures). 2. A limit for OTC derivatives (swaps). 3. A limit on listed and OTC derivatives combined. Please refer to important disclosures and analyst certification information on pages

8 Analysis of Impact of Proposed Position Limits September 6, 2011 Single-Month and All-Month Limits. The single/all-month limit is the limit on positions in all contract months, including spot contracts. It will therefore apply to 100% of trading activity. The CFTC has proposed that the all-month limit be the same as the single-month limit for simplicity purposes. Our conclusion is that we would not expect more than the largest ten market participants to even potentially have to reduce positions in any market. In Exhibit 2, we show the limits the CFTC is proposing to impose in the 28 core commodity markets relative to the size of total open interest of each market. At current open interest levels, the single-month and all-months position limits would both be set at 3% of open interest for the largest 14 markets. As the limits are on position size, measured by open interest, they will not impact the trading activity of traders that close out positions by the end of each trading day and do not hold positions overnight. We estimate that on average, the limits could impact the participants with the largest four positions in each market and these are not necessarily the participants that do most of the trading. In the largest 12 markets by open interest, the position of each of the largest four market participants on average amounts to less than 5.5% of the total. We note we do not yet have complete data for the entire swaps market, which could be more concentrated. As shown, concentration is much higher in smaller markets with less trading activity, but a reduction in trading activity in these would have less impact on the exchanges. Overall, excluding exemptions, we estimate the worst-case reduction in total open interest across the 28 markets would be 12%, and the best case, 5%. This reduction in open interest could have the impact of reducing future volume. However, we would expect many of the positions of the largest market participants to qualify as bona fide hedging positions and therefore be exempt from limits. By type of commodity, at worst, we estimate open interest would have to decline by 11% in the energy markets, 20% in the metals markets and 12% in the agricultural markets. However, we believe the realistic outcome is more likely to be less than 5% unless OTC positions are far more concentrated that we expect and have a knock-on effect in the futures market. In Exhibit 3, we layout out both the best-case and worst-case scenario in each of the 28 markets assuming none of the positions in any of the markets were exempt from position limits. Taking the largest market by open interest, natural gas, the worst-case scenario is that position limits would require a 15% reduction in total open interest. The best case would be a 7% reduction in open interest, although considering exemptions, we believe there is a possibility that the potential required reduction in open interest could be much less. Additionally, a 7% reduction in open interest does not necessarily mean a 7% reduction in trading activity. Additionally, data suggests that market participants with the largest positions account for a disproportionately smaller portion of volume. We looked at data the CFTC recently released on July 5, 2011, on the net position changes of large traders, defined as traders that compose 70-90% of total open interest. We found that the net position changes of this group compose ~10% of volume across the 28 markets. Therefore, even if the worst-case scenario that open interest across all the markets is required to be reduced by 12% occurs, the impact on volume could be closer to 2%. Net position changes of large traders compose the lowest percentage of volume in the energy markets, which are the largest as a group: 5-10% of volume in the energy markets, 7-30% of volume in the metals markets, and 12-50% of the volume in the agricultural commodity markets. We interpret this to mean that a large portion of volume in these markets is from highfrequency traders and day traders. These traders tend to close out their positions at the end of the day and would not be impacted by position limits. Please refer to important disclosures and analyst certification information on pages

9 Natural Gas Crude Oil, Light Sweet Corn Sugar No. 11 Gold Soybeans Wheat (CBOT) No. 2 Heating Oil, New York Harbor Live Cattle Soybean Oil Gasoline Blendstock Cotton No. 2 Lean Hogs Soybean Meal Coffee Wheat, Hard Winter Silver Copper Grade #1 Cocoa Wheat, Hard Red Spring Milk Class III Feeder Cattle Frozen Concentrated Orange Juice Platinum Palladium Rough Rice Oats Sugar No. 16 Proposed Position Limit as a % of Total Open Interest Natural Gas Crude Oil, Light Sweet Corn Sugar No. 11 Gold Soybeans Wheat (CBOT) No. 2 Heating Oil, New York Live Cattle Soybean Oil Gasoline Blendstock Cotton No. 2 Lean Hogs Soybean Meal Coffee Wheat, Hard Winter Silver Copper Grade #1 Cocoa Wheat, Hard Red Spring Milk Class III Feeder Cattle Frozen Concentrated Orange Juice Platinum Palladium Rough Rice Oats Sugar No. 16 Average % of Open Interest Held by Biggest 4 Market Participants Open Interest (mn of contracts) September 6, 2011 Exhibit 2: Analysis of Limit on Positions in Single-Month and All-Month Contracts: Concentration Is Relatively Low, Particularly in the Largest Markets We See Potential for the Largest Participants to Be Required to Reduce Positions, but Impact on Volume Should Be Less Size of Market (Open Interest) Concentration 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% % 20% 20% 17% 15% 10% 5% 3-4% 6% 14% 11% 7% 7% 7% 8% 0% Source: CFTC, KBW Research Please refer to important disclosures and analyst certification information on pages

10 Natural Gas Crude Oil, Light Sweet Corn Sugar No. 11 Gold Soybeans Wheat (CBOT) No. 2 Heating Oil, New York Harbor Live Cattle Soybean Oil Gasoline Blendstock Cotton No. 2 Lean Hogs Soybean Meal Coffee Wheat, Hard Winter Silver Copper Grade #1 Cocoa Wheat, Hard Red Spring Milk Class III Feeder Cattle Frozen Concentrated Orange Juice Platinum Palladium Rough Rice Oats Sugar No. 16 Open Interest (mn of contracts) Required Reduction in Open Interest From Proposed Limits September 6, 2011 Exhibit 3: Required Reduction in Open Interest Due to Single-Month and All-Month Position Limits Best and Worst Case 5.0 Size of Market (Open Interest) Worst Case Best Case 30% % 26% 25% 22% 24% 25% % 19% 15% 17% 15% 19% 19% 16% 17% 15% 18% 18% 19% 16% 20% 15% % 8% 0% 9% 9% 6% 1% 11% 12% 7% 11% 10% 2% 12% 3% 12% 8% 0% 10% 9% 10% 9% 0% 6% 6% 6% 0% 5% 7% 0% 3% 0% 0% 0% 0% 0% 10% 5% 0% Source: CFTC, KBW Research Please refer to important disclosures and analyst certification information on pages

11 Crude Oil, Light Sweet Corn Natural Gas Gold Soybeans Gasoline Blendstock No. 2 Heating Oil, New York Harbor Sugar No. 11 Soybean Oil Silver Soybean Meal Live Cattle Copper Grade #1 Lean Hogs Wheat (CBOT) Cotton No. 2 Coffee Cocoa Platinum Feeder Cattle Palladium Frozen Concentrated Orange Juice Rough Rice Oats Milk Class III Total Avg Daily Volume (mn of contracts) % of Avg Daily Volume in Spot Month Contract Spot Month Limits. CFTC spot month limits will be lower than those currently in place. However, we estimate spot month position limits will apply to ~5% of volume as, since the beginning of 2010, ~5% of total volume in the 28 core markets has been transacted in the spot month contract. Below we show the portion of volume in each market that is transacted in the spot month contract. Only 2% of total volume in the largest market by volume, crude oil, is in the spot month contract and approximately 5-8% of transaction volume in energy futures. In general, the smaller markets like feeder cattle and palladium have a higher percentage of volume in the spot month contract, both over 20%. However, these will not have much of an impact on overall volume. Currently, position limits only exist for the spot month and many participants argue in their comment letters that this should remain the case as volatility, and therefore opportunities for market manipulation, are much lower in the outer months. The CFTC intends to set interim spot month limits in the near term and will potentially amend these when it sets its single-month/all-month limits. Though the interim spot month limits are proposed to be set at 25% of deliverable supply, same as the current limits, in most markets they will effectively be lower than current limits as the limit will be in aggregate, across trading venues, as opposed to a separate limit for each. The limit will also apply to uncleared OTC swap contracts. As a result, hypothetically, a market participant that is currently permitted to hold 5,000 swap contracts on ICE and 5,000 swap contracts on CME s ClearPort and unlimited uncleared OTC swap contracts will now be restricted to holding 5,000 swap contracts across ICE and ClearPort and must include all uncleared swaps under this same 5,000 contract limit. Many participants argue the proposed interim spot limits will be too low, but for varying reasons. The CME and National Grain and Feed Association argue the deliverable supply definition is too low. For example, it does not include long-term agreements. Shell, ICE (energy markets), Deutsche Bank, and ISDA feel the aggregate exchange limit should not be set at the same level as the current limit for each exchange, particularly as the aggregate limit will also now be for swaps as well and there is no accurate gauge as to the size of that market yet. GFIG and ISDA feel that spot limits should only be for physically settled contracts, not cash settled which don t have the ability to influence market prices. Exhibit 4: Spot Month Position Limits Could Impact 5% of Total Volume at Most September 6, % % 21% 20% % % 6% 6% 7% 8% 6% 7% 5% 5% 10% 7% 6% 11% 5% 7% 5% 12% 11% 9% 7% 10% 5% 0.0 2% 2% 3% 0% Source: Bloomberg, KBW Research Please refer to important disclosures and analyst certification information on pages

12 Europe Has Not Yet Officially Proposed Hard Position Limits; We Expect an Update in October We believe European position limits will be similar to U.S. limits as regulators on both sides of the Atlantic are generally trying to align markets. However, preliminary proposals released on September 2, 2011, include several differences. Official position limit proposals are expected to be included in the draft proposals from the MiFID II review due to be published in October Timing of European Position Limit Proposals. The European Commission is targeting October 22, Though the publish date for the proposals stemming from the European Commission s MiFID review has been delayed multiple times, we note the European Commission is obliged to complete its review of MiFID before the end of Following publication of the draft legislative proposal, it will be put to the European Parliament for a vote. The first reading of the draft consultation document by the European Parliament may now not take place until the end of 2011, with final rules debated through 2012, making MiFID II unlikely to go live until Current European Proposals Differ from the U.S. The official first draft of proposals for MiFID reform is not due out until October. However, a pre-draft of the document is currently circulating around Brussels and was made public by the press on September 2. There are several differences: The European proposals would put a limit on the number of contracts that a market participant can enter into over a specified period of time, rather than a limit on the size of a market participant s open position. Each market (exchanges, multi-lateral trading facilities [MTFs] and organized trading facilities [OTFs]) would set its own limits with the goal of (1) supporting liquidity, (2) preventing market abuse, and (3) supporting orderly pricing and settlement conditions rather than the European Commission s setting aggregate limits across all markets. The limits have not yet been defined, but the European Securities and Markets Authority (ESMA) will develop draft standards for these limits and submit them to the European Commission for approval by an as-yet undefined date. We note that these proposals are subject to change before the official MiFID reforms are published on October 22. Before this, the European Commission had not gone so far as to propose hard position limits. The European Commission's consultation paper, released in December 2010, proposed reporting requirements for commodity derivatives as well as a new system of heightened position management, which would have let regulators make traders reduce their positions at any moment, but did not set hard position limits like the CFTC has proposed in the U.S. View of Various Bodies in the European Union. The UK s Financial Services Authority (FSA) opposes hard position limits and supports position management. Lord Turner, chairman of the FSA, does not believe that position limits will have a meaningful impact on controlling commodity prices and co-authored a study that concluded that the rise in oil prices from 2003 to 2010 could largely be explained by fundamentals. However, Alexander Justham, the FSA s director of markets, is concerned about inconsistencies in regulation between the U.S. and Europe and the potential for regulatory arbitrage. Justham feels it is important that the final version of MiFID II give regulators the authority to set position limits, as well as introduce formalized position reporting for EU commodities markets so that Europe will have a standardized set of information on the commodity markets. Though the U.K. favors a position management regime over position limits, this is not in-line with the other 27 members of the European Commission. In May 2011, Michel Barnier, European Commissioner for Internal Market and Services, said that EU reforms would likely include commodity position limits. He said that oversight of positions in commodity derivatives needs to be strengthened, and that the proposals due to be released in October will include the ability to impose position limits if needed. French President Nicolas Sarkozy is very much in favor of position limits, pointing to the value of trades in oil-market instruments 35 times greater than the global volume of oil, and trade in wheat derivatives worth 46 times annual wheat production in the US. Please refer to important disclosures and analyst certification information on pages

13 Companies Mentioned (priced as of the close, September 6, 2011): CME Group, Inc. (CME, $258.70, Market Perform) IntercontinentalExchange, Inc. (ICE, $112.53, Outperform) Please refer to important disclosures and analyst certification information on pages

14 IMPORTANT DISCLOSURES RESEARCH ANALYST CERTIFICATION: We, Niamh Alexander, Nassime Ruch-Kamgar, CFA and Alim Shaikh, hereby certify that the views expressed in this research report accurately reflect our personal views about the subject companies and their securities. We also certify that We have not been, and will not be receiving direct or indirect compensation in exchange for expressing the specific recommendation in this report. Analysts Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking. COMPANY SPECIFIC DISCLOSURES KBW expects to receive or intends to seek compensation for investment banking services from CME Group, Inc. in the next three months. KBW currently makes a market and/or acts as a liquidity provider in CME Group, Inc. securities. KBW expects to receive or intends to seek compensation for investment banking services from Intercontinental Exchange, Inc. in the next three months. KBW currently makes a market and/or acts as a liquidity provider in Intercontinental Exchange, Inc. securities. For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see the most recently published company report or visit our global disclosures page on our website at or see the section below titled "Disclosure Information" for further information on how to obtain these disclosures. AFFILIATE DISCLOSURES: This report has been prepared by Keefe, Bruyette & Woods Inc. ( KBWI ) and/or its affiliates Keefe, Bruyette & Woods Limited and Keefe, Bruyette & Woods Asia Limited all of which are subsidiaries of KBW, Inc. (collectively KBW ). Keefe, Bruyette & Woods Inc. is regulated by FINRA, NYSE, and the United States Securities and Exchange Commission, and its headquarters is located at 787 7th Avenue, New York, NY Keefe, Bruyette & Woods Limited is registered in England and Wales, no and its registered office is 7th Floor, One Broadgate, London EC2M 2QS. KBWL is authorised and regulated by the UK Financial Services Authority ("FSA"), entered on the FSA's register, no and is a member of the London Stock Exchange. Keefe, Bruyette & Woods Asia Limited is a licensed corporation regulated by the Securities and Futures Commission of Hong Kong ("SFC") (CE No.: AUI281). Its headquarters is located at 3101, 31/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong. Disclosures in the Important Disclosures section referencing KBW include one or all affiliated entities unless otherwise specified. Registration of non-us Analysts: Any non-us Research Analyst employed by a non-us affiliate of KBWI contributing to this report is not registered/qualified as research analyst with FINRA and/or the NYSE and may not be an associated person of KBWI and therefore may not be subject to NASD Rule 2711 or NYSE Rule 472 restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. Disclosure Information: For current company specific disclosures please write to one of the KBW entities: Keefe, Bruyette & Woods Research Department at the following address: 787 7th Avenue, 4th Floor, New York, NY The Compliance Officer, Keefe, Bruyette and Woods Limited, 7th Floor, One Broadgate, London EC2M 2QS. The Compliance Officer, Keefe, Bruyette and Woods Asia Limited, 3101, 31/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong. Or visit our website at KBW has arrangements in place to manage conflicts of interest including information barriers between the Research Department and certain other business groups. As a result, KBW does not disclose certain client relationships with, or compensation received from, such companies in its research reports. CME Group, Inc. (CME) Target Price: Risk Factors: Risks to our price target include the following: market conditions and events may not ultimately reflect our assumptions and/or projections. Volatility in the markets carries the potential for shifts in confidence among investors. Intercontinental Exchange, Inc. (ICE) Target Price: Risk Factors: Risks to our price target include the following: Market conditions and events may not ultimately reflect our assumptions and/or projections. Volatility in the markets carries the potential for shifts in confidence among investors. Investment in securities invariably involves risk and potential for loss of principal. RATING AND PRICE TARGET HISTORY Please refer to important disclosures and analyst certification information on pages

15 Rating and Price Target History for: CME Group, Inc. (CME) as of /17/08 MP:$325 11/26/08 MP:$240 02/04/09 MP:$205 04/06/09 MP:$225 06/09/09 MP:$296 10/16/09 OP:$360 02/05/10 OP:$350 04/15/10 OP:$360 04/30/10 OP:$365 07/09/10 OP:$345 10/14/10 OP:$ Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q /29/10 OP:$325 12/17/10 MP:$340 02/04/11 MP:$320 04/07/11 MP:$337 06/28/11 MP:$315 Created by BlueMatrix Rating and Price Target History for: Intercontinental Exchange, Inc. (ICE) as of /17/08 MP:$95 11/26/08 MP:$77 01/08/09 MP:$73 04/06/09 UN:$71 05/06/09 UN:$81 06/09/09 UN:$98 08/05/09 MP:$103 10/16/09 OP:$120 03/15/10 MP:$120 05/06/10 MP:$127 07/09/10 MP:$ Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q /02/10 MP:$125 12/17/10 MP:$133 04/07/11 OP:$147 06/28/11 OP:$140 08/04/11 OP:$137 Created by BlueMatrix Rating KEY: OP Outperform MP MarketPerform U Underperform S Suspended RS Restricted CNR -Covered -Not Rated Note: The boxes on the Rating and Price Target History Chart above indicate the date of Report/Note, the rating and price target. Each box represents a date on which an analyst made a change to a rating or price target. Distribution of Ratings/IB Services KBW *IB Serv./Past 12 Mos. Rating Count Percent Count Percent Outperform [BUY] Market Perform [HOLD] Underperform [SELL] Restricted [RES] Suspended [SP] Covered -Not Rated [CNR] * KBW maintains separate research departments; however, the above chart, "Distribution of Ratings/IB Services," reflects combined information related to the distribution of research ratings and the receipt of investment banking fees globally. Please refer to important disclosures and analyst certification information on pages

16 Explanation of Ratings: KBW Research Department provides three core ratings: Outperform, Market Perform and Underperform, and three ancillary ratings: Suspended, Restricted, and Covered - Not Rated. For purposes of New York Stock Exchange Rule 472 and FINRA Rule 2711, Outperform is classified as a Buy, Market Perform is classified as a Hold, and Underperform is classified as a Sell. Suspended indicates that KBW s investment rating and/or target price have been temporarily suspended due to applicable regulations and/or KBW policies. Restricted indicates that KBW is precluded from providing an investment rating or price target due to the firm's role in connection with a merger or other strategic financial transaction. Covered - Not Rated indicates that KBW is not providing an investment rating and/or price target due to the lack of publicly available information and/or its inability to adequately quantify the publicly available information to sufficiently produce such metrics. North American Stocks are rated based on an absolute rate of return (percentage price change plus dividend yield).outperform represents a total rate of return of 15% or greater. Market Perform represents a total rate of return in a range between -5% and +15%.Underperform represents a total rate of return at or below -5%. European and Asian Stocks are rated based on the share price upside to target price relative to the relevant sector index performance on a 12-month horizon. Outperform rated stocks have a greater than 10 percentage point ( pp ) relative performance versus the sector, Market Perform rated stocks between +10pp to -10pp relative performance versus the sector, and Underperform rated stocks a lower than 10pp relative performance versus the sector. The 12-month price target may be determined by the stock s fundamentally-driven fair value and/or other factors (e.g., takeover premium or illiquidity discount). KBW Model Portfolio: "Model Portfolio Buy" - Companies placed on this list are expected to generate a total rate of return (percentage price change plus dividend yield) of 10% or more over the next 3 to 6 months. "Model Portfolio Sell" - Companies placed on this list are expected to generate a total rate of return (percentage price change plus dividend yield) at or below -10% over the next 3 to 6 months. The purpose of the Model Portfolio is to inform institutional investors of KBWI s short-term (as described above) outlook for a particular industry sector. The Portfolio is not available for purchase or sale, cannot be duplicated as shown, is hypothetical and is for illustrative purposes only. For a more detailed description of the selection criteria and other specifics related to the construction of the Model Portfolio, please refer to the January 5, 2010 Model Portfolio Primer and/or contact your KBWI representative for more information. The Model Portfolio should be viewed as a short-term outlook of a particular industry sector, not as individual security recommendations. The Model Portfolio uses a three-to-six-month time horizon and should not be considered when making longer term investments. KBWI Research publishes research with a 12-month outlook on each issuer of securities contained in the Model Portfolio. Investors who are interested in a particular security should request KBWI Research s coverage of such securities by contacting your KBWI representative. KBW research contains analyses of fundamentals underlying each issuer. KBWI s long-term recommendations may differ from recommendations made for the Model Portfolio. These differences are the result of different time horizons -- KBWI research has a 12-month outlook and the Model Portfolio has a three-to-six-month outlook. Although the model portfolio is based upon actual performance of actual investments, KBWI did not recommend that investors purchase this combination -- or hypothetical portfolio -- of investments during the time period depicted here. As this hypothetical portfolio was designed with the benefit of hindsight, the choice of investments contained in it reflects a subjective choice by KBWI. Accordingly, this hypothetical portfolio may reflect a choice of investments that performed better than an actual portfolio, which was recommended during the depicted time frame, would have performed during the same time period. Moreover, unlike an actual performance record, these results do not represent actual trading wherein market conditions or other risk factors may have caused the holder of the portfolio to liquidate or retain all or part of the represented holdings. Other Research Methods: Please be advised that KBW provides to certain customers on request specialized research products or services that focus on covered stocks from a particular perspective. These products or services include, but are not limited to, compilations, reviews and analysis that may use different research methodologies or focus on the prospects for individual stocks as compared to other covered stocks or over differing time horizons or under assumed market events or conditions. OTHER DISCLOSURES Indices: The following indices: U.S.: KBW Bank Index (BKX), KBW Insurance Index (KIX), KBW Capital Markets Index (KSX), KBW Regional Banking Index (KRX), KBW Mortgage Finance Index (MFX), KBW Property & Casualty Index (KPX), and KBW Premium Yield Equity REIT Index (KYX); KBW Financial Sector Dividend Yield Index (KDX); Europe: KBW Large-Cap Banks Index (KEBI), KBW Mid/Small Cap Banks Index (KMBI), KBW Large-Cap Insurance Index (KEII), KBW Miscellaneous Financials Index (KMFI), KBW Emerging Europe Financials Index (KEEI); and Global: KBW Global ex-u.s. Financial Sector Index (KGX), are the property of KBWI. KBWI does not guarantee the accuracy and/or completeness of the Indices, makes no express or implied warranties with respect to the Indices and shall have no liability for any damages, claims, losses or expenses caused by errors in the index calculation. KBWI makes no representation regarding the advisability of investing in options on the Index. Past performance is not necessarily indicative of future results. ETFs: The shares ("Shares") of KBW ETFs are not sponsored, endorsed, sold or promoted by KBWI. KBWI makes no representation or warranty, express or implied, to the owners of the Shares or any member of the public regarding the advisability of investing in securities generally or in the Shares particularly or the ability of its Indices to track general stock market performance. The only relationship of KBWI to Invesco PowerShares Capital Management LLC, ProShares and State Street Bank and Trust Company is the licensing of certain trademarks and trade names of KBWI and its Indices which are determined, composed and calculated by KBWI without regard to Invesco PowerShares Capital Management LLC, ProShares and State Street Bank and Trust, the fund, or the Shares. KBWI has no obligation to take the needs of Invesco PowerShares Capital Management LLC, ProShares, State Street Bank and Trust Company or the owners of the shares into consideration in determining, composing, or calculating the Indices. KBWI is not responsible for and has not participated in any determination or calculation made with respect to issuance or redemption of the Shares. KBWI has no obligation or liability in connection with the administration, marketing or trading of the Shares. Please refer to important disclosures and analyst certification information on pages