Exchange strategies at CME

CME Group Inc. has hired former Allstate Insurance Co. executive Pacy Ostroff as director of corporate strategy. Ostroff, 43, will help lead initiatives across existing and new lines of business, presumably including the clearinghouse CME is developing for credit default swaps, those over-the-counter derivatives that insure against default.

Ostroff's appointment comes as the world's largest derivatives market looks to offset declines in its core trading businesses. Interest rate contract trading has been the hardest hit -- down 41% in the fourth quarter -- as the near-zero benchmark interest rate has eliminated the need to hedge with futures. Fourth-quarter profit at CME tumbled 69% to $62.1 million over the same period in 2007. Overall trading volume in 2008 rose 4%, helped by the acquisition of Nymex Holdings Inc., operator of the New York Mercantile Exchange. But that wasn't enough to buoy CME's stock, which lost about 74% of its value.

To turn things around, the credit-default-swap clearing market holds the most promise. While CDS volume fell in 2008, the market is still valued at more than $28 trillion. And, with four exchanges developing clearing facilities, competition for contracts will be stiff. A clearinghouse from NYSE Euronext Inc. has already begun a clearing service on its London-based Liffe exchange. Eurex Clearing AG hopes to launch its service later this year, while clearing facilities from CME Group and its partner Citadel Investment Group LLC, and another from IntercontinentalExchange Inc. and a consortium of CDS dealers, are awaiting regulatory approval.

With CME banking in part on CDS clearing, Ostroff's expertise developing new products in the insurance industry made him a more attractive candidate. Credit default swaps are, after all, a form of insurance. And there are some important parallels between the industries.

For one, assessing and pricing risk into new products is fundamental in insurance. The same will be true when it comes to developing pricing for CDS clearing. And regulation will likely be a factor in the CDS market as well. Congress is set to consider legislation that could force all credit default swaps through a clearing facility and/or require investors trading the derivatives to own the underlying bonds.