Oct 29, 2009
Executives
John Peschier – Managing Director, IR Craig Donohue – CEO Jamie Parisi – Managing Director and CFO Rick Redding – Managing Director, Products & Services Phupinder Gill – President Terry Duffy – Executive Chairman Kim Taylor – Managing Director and President of Clearing House Division
Analysts
Roger Freeman – Barclays Capital Howard Chen – Credit Suisse Mike Vinciquerra – BMO Capital Markets Rich Repetto – Sandler O'Neill Chris Allen – Pali Capital Ken Worthington – JP Morgan Daniel Harris – Goldman Sachs Michael Carrier – Deutsche Bank Dan Fannon – Jefferies Donald Fandetti - Citigroup Jonathan Casteleyn – Susquehanna Rob Rutschow – CLSA Justin Schack – Rosenblatt Securities Patrick O'Shaughnessy – Raymond James
Operator
Good day everyone, and welcome to the CME Group third quarter 2009 earnings call. As a reminder, this call is being recorded.
At this time for opening remarks and introductions, I'd like to turn the conference over to John Peschier. Please go ahead sir.
John Peschier
Thank you and thank you all for joining us. Craig Donohue, our CEO; and Jamie Parisi, our CFO will spend a few minutes outlining the highlights of the third quarter and then we will open up the call for your questions.
Also joining us here today for the Q&A session are Terry Duffy, our Executive Chairman; Phupinder Gill, President; Kim Taylor, who runs our Clearing House; and we have a sick Rick Redding, our Head of Products and Services also who made it in today. Before they begin, I will read the Safe Harbor language.
Statements made on this call and in the accompanying slides on our website that are not historical facts are forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. More detailed information about factors that may affect our performance may be found in our filings with the SEC, including our most recent Forms 10-K and 10-Q, which are available in the Investor Relations section of our website.
During this call, we will refer to GAAP and non-GAAP pro forma results. A reconciliation is available in our press release, and there is also a file on the Investor Relations portion of our website that provides detailed quarterly information on both a GAAP and pro forma basis.
With that I would like to turn the call over to Craig.
Craig Donohue
Good morning and thank you for joining us today. During the third quarter, we saw increasing stability in the macroeconomic climate as evidenced by multiple factors.
The LIBOR-OIS spread has further tightened to its lowest level in almost two years, indicating a lower risk premium on credit due to greater economic stability. Long-term funds flows continue to move into mutual funds, primarily fixed income products.
Hedge fund assets under management rose for the second quarter, and hedge funds net asset flow was positive for the first quarter this year. Finally, after extremely reduced activity in the third and fourth quarters of 2008, mortgage originations have shown sharp upturns in every quarter this year.
While many of these metrics are below historical highs, the sustained nature of the trends as well as the indication that market participants are seeking higher risk in return are promising for the overall economy and for CME Group's business. CME Group’s volume also demonstrates area of stability and improvement.
Third-quarter overall average daily volume was 10.1 million contracts and exploring the details by product area there are some promising trends. Additionally, October average daily volume was approximately 10.7 million contracts.
It will be the best non-roll month volume of the year, and open interest is currently up 18% from year-end 2008 and the combined CME, CBOT, NYMEX product lines. The interest rate complex posted its highest quarterly volume since Q3 ’08 with average daily volume of 4.4 million contracts.
Within rates, Eurodollars continued to see growing activity in contracts in the second and third year of the yield curve. In the third quarter, these contracts contributed 53% of overall Eurodollar futures volume versus only 44% for the same quarter a year ago.
Changing expectations around interest rates are a key driver of CME Group's interest-rate volumes and this shift in Eurodollar activity indicates that market participants see more likelihood for changing interest rates further out on the calendar than in the near term, which is in line with current federal reserve policy and with prevailing economist views on the timing of potential Fed moves. While we certainly are not in the business of trying to predict interest rate moves, we highlight this volume trend as one example of how interest-rate expectations affect CME Group’s volumes.
Another metric impacting interest rates that we closely follow is cash market penetration of treasury futures. Our treasury complex has shown growing cash penetration or treasury futures activity as a percent of cash treasury trading activity over the course of 2009 ending the quarter at 56%, up from 53% at the end of the second quarter, and from 46% at the end of December.
Increased cash market penetration at a time of heightened treasury issuance positions CME Group well to capture hedging activity when interest-rate expectations start to shift. Energy volume in the third quarter was in line with year-to-date average daily volume of 1.5 million contracts.
However, on a revenue basis the energy complex generated 161 million, which is up 11% from the prior quarter and is a record for quarterly revenue. Both crude oil and natural gas revenues were up from recent quarters.
FX also had its highest quarterly volume of the year, trading 660,000 contracts per day and October volume is also strong at 700,000 contracts per day. The equities complex traded 2.7 million contracts per day in the third quarter, down 11% from the prior quarter.
This shift is primarily due to cyclical impacts from decreased volatility in this asset class, which were affecting other equity index futures and options markets globally. We are pleased to see ongoing results from our globalization effort.
One measurable example of these efforts is our international incentive program, which provides fee incentives for high-volume participation by international customers. NYMEX energy products were added to this program in April, and since then we have seen average daily volume in energy products traded through this program increase from 9,000 in April to 42,000 contracts in September.
This activity highlights the success of our globalization efforts, and we look forward to continuing to build on the strong performance to date, especially with the addition of COMEX metals products to the program in the first half of 2010. Looking beyond product performance to our customer segmentation, we saw numbers in the third quarter largely in line with the August and September detail provided at our recent Investor Day.
Proprietary buy-side traders contributed 43% of overall volume, hedge funds accounted for 7% of volume, showing a slight increase in contribution for the second quarter in a row. Bank proprietary trading accounted for 14% of volume; other member activity was 20%, and non-member activity at 16%.
This segmentation is for legacy CME and CBOT products only. Overall, though volumes continue to be challenged, we are pleased with the volume activity in relation to macroeconomic conditions, and we believe that the ongoing signs of economic recovery will continue to exert potential positive influences on CME Group volumes.
I would like to talk now about CME Group's strategic accomplishments in the quarter. NYMEX integration continues to progress on schedule with the full clearing integration completed in early October.
Equally important, the cultures, employees and strategic goals of our two firms are meshing well, and as a combined company we are emerging from the integration and building phase with a highly talented, dedicated staff that is able to bring expertise, vision and scalability to all of our growth initiatives. Beyond the ongoing efforts to promote, expand and cross-sell our core exchange traded business, a key focus for CME Group our OTC efforts.
We continue to make excellent progress on these with a target date of year-end for participants in the CDS buy-side pilot program to begin clearing. Efforts and cleared interest rate swaps and FX also continued to advance.
In September, we signed an agreement with Bursa Malaysia under which we will provide Globex, order routing and matching services for their derivatives business. Additionally, CME Group will receive a license to use their settlement prices for the development of a CME listed crude palm oil futures contract.
This partnership with others such as BM&F Bovespa in Brazil help further CME's strategic goals of increased global distribution and product expansion. Following the CFTC’s approval of the Ibovespa index for US-based trading accounts in late August, BM&F Bovespa north to South order routing saw 85,000 contract sites trade in September and 144,000 contracts sites trade in October to date.
On October 27 the volume reached an all-time high record of 219,000 contract sites. The percent of BM&F Bovespa’s total volume coming from north to south order routing was nearly 3% in September and continues to grow in October.
For BM&F Bovespa this partnership is bringing a completely new incremental volume from the previously unreached customers set, which is US based algorithmic proprietary traders. Over and above charging for transaction processing, CME Group is the single largest shareholder, benefits from the stock price increases seen year-to-date as BM&F Bovespa grows, the liquidity of their markets through this new arrangement.
In addition to all of this, we have been working diligently on the regulatory front providing input and feedback as legislators and regulators work through various financial reform proposals. There has been a significant amount of recent advancement in these efforts and on the whole, we believe these outcomes to date contain net positive impacts for CME group.
First, a key conclusion of the SEC-CFTC Harmonization Report is that the futures in cash markets are indeed distinct in both product concept and market function, and one size fits all regulation is neither desirable nor appropriate. The areas where recommendations were made are largely technical and relatively modest in nature, and can be enacted with minimal disruptions to the markets.
Secondly, the bills passed out of the house agriculture and finance committees reflect significant feedback from market participants, and with their focus on using the advantages of central counterparty clearing to reduce systemic risk, acknowledging the value of CME Group's model in the overall markets. Finally, the discussion of position limits in energy is ongoing, and CME Group continues to take an active role here.
On this topic, the language in Chairman Peterson’s bill that prevents the CFTC from placing hard position limits on regulated US exchanges until they are simultaneously placed on the OTC market in foreign boards of trade, and the call for the CFTC study on the impacts of position limits reinforces the views expressed in our recent White Paper regarding the potential for inappropriate position limits to have unintended consequences. While we have not seen convincing evidence, the factors other than fundamental supply and demand influenced commodity pricing and while we are not in favor of position limits as a tool to manage price volatility, we are working closely with market participants and the regulators to ensure that any action taken does not negatively affect the liquidity and efficiency of our markets.
There are several more steps involved before any regulatory or legislative changes are made to any of the previously described issues and timeframes will remain beyond our control. As we have for many years, we will continue to leverage our experience and relationships in Washington to both educate and inform key policymakers on the critical factors affecting our markets.
In summary, during the third quarter CME Group's core business showed stability and strength and improving open interest trends. Financial reform efforts advanced and currently show minimal potential for negative impacts to CME Group, and in fact are likely to be positive influences if enacted.
Finally, we continue to invest and see results from our global expansion efforts and our cleared over-the-counter efforts. All of these factors, we believe position CME Group well as the economy finds new ground post credit crisis.
With that let me turn the call over to Jamie.
Jamie Parisi
Thank you, Craig. CME Group turned in a solid third-quarter financial performance, despite what is normally a seasonally slower July and August.
Our GAAP results are summarized in the press release. Today I am going to focus on the details for Q3 on a pro forma basis as if we own NYMEX for all periods considered.
On an after-tax basis, the pro formas also exclude a $19 million impairment charge related to IMAREX as outlined in the press release, $2 million of CBOT and NYMEX merger-related items as well as the impact of earnings on deferred compensation balances. During Q3 average daily volume was down 23% compared to an extremely active third-quarter of 2008 as a result of the credit crisis.
Expenses were down 10% compared to the same quarter last year and up slightly from the prior quarter this year. The overall pro forma rate per contract for all CME Group volume increased 6% to $0.834 compared with $0.79 in the third quarter of 2008, primarily due to our energy and metal increasing from 13% of total a year ago to 17% this quarter.
Sequentially the rate per contract increased $0.011 from $0.823 due mainly to an increase in our ClearPort and energy rates driven by a lower percentage of low-priced PJM electricity contracts, which accounted for 16% of ClearPort portfolio volume down from 21% the prior quarter. We also saw a slight benefit from the pricing changes implemented during the third quarter, which lifted the RPC by the three-tenths of a cent and from a higher percentage of FX in energy contracts in that product mix.
Partially offsetting these positive rate shifts was a 0.6% increase in the number mix. Market data revenue of $81 million for the quarter decreased 11% versus last year and is down 1% sequentially.
At the end of the third quarter users subscribed to 400,000 base devices across CME, CBOT, NYMEX, down 2% or 7,000 versus Q2 of this year, reflecting the impacts of reduced staffing at the larger banks. During the third quarter, one-time vendor audit assessments were about $700,000 higher than Q2, which resulted in revenue dropping only 1% sequentially.
We have announced a professional screen [ph] fee increase from $55 to $61 per month beginning in January of 2010. I will now take a few minutes to review expenses.
Pro forma operating expenses were $244 million for Q3, up $1 million sequentially and down 10% versus Q3 last year. We continued our significant efforts to capture the NYMEX synergies and reduced discretionary expenses where possible.
Starting with our largest expense, compensation and benefits was down $1 million sequentially to $84.5 million due primarily to lower stock-based compensation. Our combined headcount at the end of Q3 stood at 2,250 basically flat with the prior quarter.
Our third-quarter bonus expense was $8.8 million, virtually flat relative to the second quarter. Stock-based compensation was $6.8 million in the third quarter, down 1.4 million from Q2 of this year.
We moved our stock option grant date from mid-June to mid-September and the prior year grants rolled off in June resulting in lower Q3 expense. Based on our grant in September, we expect stock-based compensation to increase by approximately $3 million to $10 million in the fourth quarter.
Non-compensation expenses of $159 million were down $19 million, versus last year, and up $2 million sequentially. Comparing to the prior quarter, we had a decrease in our professional fees and outside services expense line, which partially offset increases in marketing and other, along with several technology related lines, including depreciation, which increased following the start-up of our new data center during the third quarter.
We realized NYMEX related expense synergies of $12.4 million in Q3 or approximately $50 million annualized, and we're virtually complete in terms of the 60 million annual rate expense synergies we had identified at the time of the acquisition. We completed major milestones with the clearing immigrations for metals in September and energy products in early October.
We expect to be done with the NYMEX integration in the next few weeks. In terms of our expectations for full year expenses, based on volumes near current levels, we expect annual pro forma expenses to come in close to $1 billion, which is below the guidance we gave last quarter.
Giving some further color on the fourth quarter, we expect compensation expense to jump due to the stock-based compensation increase I had already mentioned. Our non-comp expenses, we expect an increase in technology lines based on the new data center and increase in professional fees primarily due to the intensity of our OTC activities from a legal and consulting basis, and increases in marketing and other with a significant amount of international travel in our ongoing efforts related to activity in Washington DC.
Q3 pro forma operating income was $407 million, down 21% from the third quarter last year and slightly higher than Q2. Our revenue was down 17% versus the same quarter a year ago, while expenses dropped by 10%.
As a result, we were able to maintain a very strong pro forma operating margin of 63%, down from Q3 of ’08 and unchanged compared to last quarter. In the non-operating income and expense category, on the investment income line we received a $4.8 million dividend from BM&F Bovespa.
They had recently updated their dividend policy, and going forward we expect them to pay a dividend each quarter with the amount varying based on their performance. During the quarter we paid down $450 million in debt.
As of the end of the quarter, we had $2.5 billion of debt and $300 million of cash and marketable securities. For the quarter, our pro forma effective tax rate was 41.4% bringing us to 41.1% year-to-date.
Capital expenditures, net of leasehold improvement allowances, totaled $28 million in the third quarter and $94 million year-to-date driven primarily by data center, software equipment and facilities cost. We expect full-year 2009 CapEx to total approximately $140 million.
This reflects the reduction from our previous guidance, which is driven by deferrals from data center spend and some office construction as well as lower capacity needs. So far in October we are averaging 10.7 million contracts per day.
This is higher than any first month of a quarter so far this year. Also we expect to have positive growth versus October last year in all of our commodity product lines along with foreign exchange.
In summary, as you can see from our results we have been focused on expense discipline, while continuing to invest in growth opportunities. Given the initiatives we are undertaking and the firming up of the economic environment as highlighted by Craig, I'm looking forward to a bright future for CME Group.
As we reminded you last quarter, in order to get to everyone we are limiting all of you to one question and one follow-up, and then feel free to get back in the queue for an additional question if time permits. With this in mind, we will now open up the call for your questions.
Operator
(Operator instructions) Our first question comes from Roger Freeman with Barclays Capital.
Roger Freeman - Barclays Capital
Hi, good morning. I guess few questions here.
All right, I guess only two. But maybe on the interest rate swap opportunity, if you look at how that product has evolved over time, can you help us think about that a bit because I guess my understanding is it started out more as a futures contract, has evolved to a cleared swap contract, and why that might be significant for users?
Rick Redding
Roger, this is Rick. You are absolutely right.
We got into the marketplace and really started talking to both buy and the sell-side and trying to figure out what their needs were. One of the things that became evident to us is that product needs to be cleared more as an OTC product rather than as a futures contract.
And that for a lot of reasons for the risk is very different than what a traditional futures contract is. So a lot of the efforts that we have been undertaking on the clearance side is to really look at these as OTC contracts, and we think that is the right way, and we think that is the way both the buy and sell-side want to clear these products.
Roger Freeman - Barclays Capital
Okay, great, and then I guess my second question would be OTC-related, since your Investor Day, I think one thing that has popped out in all of the regulatory rhetoric is again for now suggesting that hedge exemptions for dealers should be eliminated for non-commercial swap transactions, and I'm just wondering from your perspective, how do you think if that happens in taking the deterioration of the market fall that will likely create. How do you think that would impact volumes for you if financial counterparties like hedge funds and buy-side (inaudible) effectively couldn’t do credit swap with the Street, do you think that volume would just come directly to you in futures volumes?
Craig Donohue
It is Craig. Let me make a couple of comments on that.
I think first of all I think that's not likely to affect the end-user, the end-user would likely distribute its business across a larger number of swap dealers in order to deal with that potential restraints that would be imposed, but I think maybe more fundamentally I think it's important to say that you know, there is no outcome yet on that topic and there is a diversity of views on that topic. I actually believe that the commission is still you know, evaluating the best way to deal with that issue, and I think it is relatively clear that various other commissioners I think don't necessarily favor that approach, even the language in the current bill sort of been put through I think is still in flux in terms of how that will work.
So I wouldn't jump to the conclusion that a wholesale you know, elimination of the swap dealers hedge exemption is very likely.
Roger Freeman - Barclays Capital
Okay, great. Thanks.
Operator
Your next question comes from Howard Chen of Credit Suisse.
Howard Chen - Credit Suisse
Good morning everyone.
Craig Donohue
Hi, Howard.
Howard Chen - Credit Suisse
Hi. There was a meaningful shift in interest-rate RPC this quarter.
Was curious if you could provide a bit more color there, and I know it is early, but are you seeing any changes in customer behavior with the fee schedule adjustments, i.e., you know, customers stretching for the new tiers?
Craig Donohue
On the interest-rate (inaudible) from $0.525 down to about $0.505 cents quarter-over-quarter, and that the key drivers there were that nonmember volume mix did drop somewhat quarter-over-quarter and then we also saw a decline in some of the EXPIT [ph] transactions which are at a higher rate. So the mix of EXPIT fell as well.
So those are the key drivers there.
Howard Chen - Credit Suisse
Okay, thanks. And then Jamie did debt paid down was a bit faster than anticipated.
It is $450 million outsized in anyway or should we assume if you generate a similar amount of cash flow that you could pay a similar amount of debt on a quarterly basis?
Jamie Parisi
Well, you notice that in the prepared remarks we talked about our cash balance – cash and investment balance being around $300 million. Typically in the past we've had that around $500 million.
So there was some reduction in, you know, cash on hand to bring that debt further down you know, as time goes on and we get more comfortable with you know, with the debt and managing it, we're able to manage that cash balance down. So it was a little bit outside this quarter.
Operator
Your next question comes from Mike Vinciquerra of BMO Capital Markets.
Mike Vinciquerra - BMO Capital Markets
Thank you. Good morning.
Craig Donohue
Good morning Mike.
Mike Vinciquerra - BMO Capital Markets
One last question on Brazil, certainly you have seen a very nice up-tick in volumes with your relationship there over the last just two months. Just wondering if, you know, is the momentum continuing as we move through October.
Do you think that it's going to be a big impact when you get the Ibovespa product up and running, and one follow-up question on this is why do look at it in terms of single-side rather than round turns like you do in your domestic business?
Craig Donohue
Mike I'll take the first part of that and ask my colleagues to comment on the latter question, but you know, we are continuing to see very strong month-over-month growth in north to south order routing. We just set a new record yesterday on that.
Right now we have three clients that are particularly active, but we have a large number of other additional clients that are in the pipeline of setting up their capabilities to execute orders in the BM&F products through the order routing linkage. So we do see, you know, continued opportunity for growth in that.
The Ibovespa index approval was actually received in August and so that actually has contributed to the significant increase month-over-month between September and October as US-based customers can now also trade the Ibovespa index through that linkage verses our non-US customers that were doing that before. So that has been a very positive growth vehicle for us.
Rick Redding
In Mike, to your second part about why they are accounting it inside. There is an order routing.
So we are only seeing the one side of the trade that goes down there. It will get matched with you know, someone trading from –
Craig Donohue
We could be on both sides but we're not always on both sides.
Rick Redding
We can't see what the other side of that trade is.
Mike Vinciquerra - BMO Capital Markets
Terrific, okay. Thanks for that explanation and then one separate question.
Co-location services have come up, a number of times people questioning the appropriateness of them, maybe it's only in the securities market but can you talk about whether or not there is going to be any pressure on the way you offer co-location and could there be any changes coming?
Craig Donohue
Well, you're right. That is a topic that people are expressing a lot of interest and you know, we ourselves are moving in that same direction but our policies have always been to have very transparent you know, offerings in terms of pricing and the structure of the services that we provide.
We also provide for, you know, kind of level playing field in terms of customer's ability to access those types of facilities, and so I'm very confident that we shouldn't have any constraints or restrictions on our ability to do that. We will work collaboratively with the CFTC to make sure that they understand the nature of the services and how we are intending to offer them, but I don't view that as being any kind of impediment to our moving forward.
Mike Vinciquerra - BMO Capital Markets
Great, thanks guys.
Operator
And next we have Rich Repetto of Sandler O'Neill.
Rich Repetto - Sandler O'Neill
Yes, good morning Terry, Craig, Rick, Jamie, how are you doing?
Craig Donohue
Great.
Jamie Parisi
Very good, Rich.
Craig Donohue
You forgot Susan.
Rich Repetto - Sandler O'Neill
And Susan and John. The question using your term, Craig, new ground, post credit crisis.
Can you give us an update on the FX clearing, you know, just the OTC clearing and the CDS clearing efforts like you know, we haven't heard anything, any update with regards to the relationships with the dealers.
Craig Donohue
Right, you know I'm happy to do that. I mean we are really – we are very pleased and I think excited about the progress that we're making.
We have you know, an extremely large level of engagement from your know, not only our buy-side founding member firms, but, you know, a large number of significant dealers who are working across you know, a large number of work streams with us right now, and who are committed to meeting you know, operational and other key project milestones in order for us to be positioned to begin clearing trades by mid-December. That includes, you know, a lot of work being done not just on the operations side, but also in terms of legal documentation.
So we're making I think very good progress, very sincere engagement and commitment from all market participants and a high degree of collaboration between the buy-side and the sell-side as they look to get ready to interface with the CME clearing house on CDS. We're also continuing to advance the ball with respect to interest rates and FX.
But I would say at the moment most people's attention is really consumed with the CDS initiative.
Operator
And the next question is from Chris Allen of Pali Capital.
Chris Allen - Pali Capital
Good morning guys.
Craig Donohue
Hi, Chris.
Jamie Parisi
Hi.
Chris Allen - Pali Capital
I just wanted to actually ask outside of earnings on the news that is hitting the tape above the Saudis moving away from pricing on WTI, and how that would potentially impact CME, was there any plans for new product launches to offset that and how that would work?
Craig Donohue
Yes, thanks Chris for the question. I mean I think it's very clear what we said in our article that we do actually intend to launch the new products based on this.
I mean, obviously the Argus Sour Crude Index is something that we've been focused on. This is something that was not unexpected in the marketplace, and something we've been anticipating for quite some time.
And I think it's important to understand a little bit of history here, and how they use the benchmark. Typically this is for physical oil sales.
So what they've been using has been the Platts WTI price that's actually based on a 315 [ph] price. It's actually by the moving away helps us because it will force us, force them to move the WTI future settlement price at two o'clock because all those grades of oil are going to trade at a differential to WTI.
So when you think about the Sours in the US, the three main components of the Argus index are Poseidon, Green Canyon and Mars. All of those right now trade at the differential to WTI.
So that's not going to change. So in some aspects this actually helps us get them to use the two o'clock settlement price on our futures contract right now.
So we view this actually as a positive, and now it also gives us a chance to, you know, do some other product development things around it to actually fortify this and this is, you know, in a weird way I think a benefit for the product.
Chris Allen - Pali Capital
Got it. Thanks a lot for the color.
Operator
And next, we have Ken Worthington of JP Morgan.
Ken Worthington – JP Morgan
Hi, good morning. Just one question, Brazil just implemented an IOF tax of 2% last week really directed at foreigners.
How do you think that impacts the north-south volume going forward? I know you just had a record day, but is there – are there any implications for that north-south business?
Craig Donohue
Ken, it's Craig. I think there shouldn't be any impact there.
The tax is not actually applicable to derivatives contracts. So we're not expecting any impact.
I would say more broadly if you're familiar with tax policies and tax rules in Brazil, they tend to change fairly frequently, and I know that the impact of the tax as it relates to the securities products, Ibovespa is something that the exchange leadership there is very actively involved in talking with the government about. It is not that unusual, not that I'm predicting it.
But is not that unusual for these kinds of taxes to be put in place and then taken back if they're deemed to be counterproductive, and I think you know, my judgment is that the Brazilian government is you know, very oriented right now towards, you know ensuring that Sao Paulo is a major financial center and certainly a regional center in Latin America. So I do think they'll be sensitive to those concerns as they see you know, negative impacts on Bovespa, but it should have no impact on our north-south order routing.
Ken Worthington – JP Morgan
Great, thank you very much.
Operator
And next, we have Daniel Harris of Goldman Sachs.
Daniel Harris - Goldman Sachs
Hi, good morning guys.
Craig Donohue
Hi, Daniel.
Daniel Harris - Goldman Sachs
Just want to focus maybe a little bit outside of Brazil, but on the other international opportunities you have. You mentioned on the international incentive program that's been having a positive impact, I think you said something like 42,000 contracts today.
What kind of penetration rate do you think you have in terms of that international opportunity? How high can that number go, whether that's nominal or any other way you want to think about and what products are they trading largely.
Is that the rates or the FX products?
Rick Redding
Daniel, this is Rick. You know, I think the growth that we talked about this morning shows that in a very quick time that those – that we can grow this business pretty quickly.
I mean and that's what a lot of these international incentive programs have been focused on. You've seen from us in the last couple of months additional programs go out there as we see opportunities.
One of the things that we've been doing in those programs too Daniel is, you know, we've started with the CBOT and CME products. You know, we've just recently included or including the NYMEX energy products, and then in 2010 you see us include the COMEX products in there as well.
So what we’re starting to see and it really varies by location of what products they're interested in. So the mix is very different from different countries, but you'll continue to see us roll products into those incentive programs, because we think there is still a tremendous amount of growth outside of the United States.
Operator
And next is Michael Carrier of Deutsche Bank.
Michael Carrier - Deutsche Bank
Thanks, guys. Just a question on the over-the-counter opportunities, it seems like by market or by product, you know, really just depends in terms of the client mix.
So, you know, when you look at this whether it is the FX business or the interest-rate business, it seems like the buy-side or the non-dealers you know, make up a pretty good you know, portion of that market, whereas on the CDS side it seems like it's still your know, dealer intensive. Just trying to understand from your guidance perspective, it seems like you're going after you know, the buy-side as maybe the – I don’t want to say primary, because you have the dealers too, but that's kind of your niche.
I'm just wondering like how that works versus like some of other platform job there, and then when you get to the other products, whether it (inaudible) equities, I mean it seems like that works, just wondering the differences between you know, the products.
Craig Donohue
You know, I'll start and maybe my colleagues will contribute, but you know, I think that most of the people that are focused on providing central counterparty clearing services for the over-the-counter markets are, I think converging in terms of their effort to your know, provide services not just to the dealer community but to the buy-side as well. I mean we certainly have a very kind of you know, neutral you know, role in terms of the way that we've tried to structure access to our clearing facilities that the product and service offerings themselves are really different you know, between the different providers with the exception that at least in CDS you know, we're trying to do both single lane as well as indexes, but I don't think the approach at this point is really that different.
We've had different starting places, each of us, but most of us are trying to address the needs of both the buy-side and the sell-side, and I would say we have a high level of engagement from – all market purchase depends on different offerings that we are looking to bring to market. Am I addressing your question?
Michael Carrier - Deutsche Bank
Yes, that's helpful. And then just one for Jamie.
Just on the expenses you know, the guidance on the fourth quarter is helpful. I guess just when you start looking you know, at 2010 a lot of new initiatives and still trying to squeeze out costs.
Anything there I know it's still early but you know, just relative to the fourth quarter going forward?
Jamie Parisi
It's a bit early. I think we'll have more to say on our February call.
Michael Carrier - Deutsche Bank
Okay, thanks a lot.
Operator
And next is Dan Fannon of Jefferies.
Dan Fannon - Jefferies
Good morning. Thank you.
When do you guys expect to launch your lending clearing house? You've talked about this and wanted to see what hurdles are there – out there from a regulatory perspective that you think might impede that or (inaudible)?
Phupinder Gill
Hi, this is Gill. The application is in and we expect to receive approval by the end of the year and begin all operations sometime in the early first quarter of next year.
Dan Fannon - Jefferies
Great, thank you.
Operator
And next, we have Donald Fandetti of Citigroup.
Donald Fandetti - Citigroup
Craig, in terms of the OTC as you negotiate with the banks. I mean there is the view that the banks have gotten more confident, and are sort of trying to drive a tougher deal.
I mean, are you still confident that the economics are attractive to CME and can you talk a little bit about how that may be progressing?
Craig Donohue
Yes, sure. I mean I think you know, first of all there is I think significant demand for central counterparty clearing services certainly from the buy-side, but in response to your comment, you know, I think given the state of the legislative efforts that are out there, you know, I think that the sell side in fact is working hard to not only try to you know, satisfy their customers but also be appropriately positioned in the event that ultimately the Congress determines to require central counterparty clearing for standardized swaps.
So I don't think this is a situation where you know, the providers of these services have you know, capability in terms of pricing. You know, we're trying to be partners with the over-the-counter trading community.
So we've embraced a model that you know, reflects that kind of a partnership approach with the sell-side as well as the buy-side, but our view is that you know, there is ample room for profitability for us to do this or we wouldn't be working as hard as we are to provide those kinds of services. It's pretty immature at this point to get into specific kind of pricing structures and methodologies, but I think we've struck a balance between you know, getting fairly compensated for the services that we are going to provide and yet recognizing that you know, in some sense this actually is a partnership between us and the OTC community.
Donald Fandetti - Citigroup
Thank you.
Operator
And next, we have Jonathan Casteleyn with Susquehanna.
Jonathan Casteleyn - Susquehanna
Hi, good morning. You alluded to ClearPort capabilities in your press release.
I'm just wondering if you have any specific products in mind or any timing for any launches.
Craig Donohue
You know, I think I'm not sure what you're commenting on, but you know, obviously you know, we are continuing to add a large number of products to CME ClearPort in our existing core space which is oil, gas, and power and in fact, you know, we are seeing significant revenue growth from new products that are being introduced, but beyond that as we've mentioned before we're are also leveraging you know, CME ClearPort into the financial derivatives OTC space in terms of you know, other offerings and rate swaps and foreign exchange. So that's all the stuff that we've been talking about.
Jonathan Casteleyn - Susquehanna
Okay, but mainly you are saying that core asset class is still energy, or can you creep into other asset classes I guess is my question?
Craig Donohue
Yes, we are already offering products in other asset classes. For example, we do use CME ClearPort for a fairly significant number of agricultural commodity contracts, but again we are going to be leveraging CME ClearPort into all of the major asset classes including the financial derivatives.
Jamie Parisi
And Jonathan, we've just recently launched London Gold Forwards. So we've made a significant entry into the metals market as well.
Jonathan Casteleyn - Susquehanna
Okay. My follow-up question is does the harmonization of the CFTC and the FCC, does that really change or can it change the futures industry M&A perspective.
I mean, generally the futures industry tends not to want to look at other exchange properties because you know, potentially you could you know, be subject to different regulatory purview. Does that change at all as harmonization between these two agencies gets closer?
Craig Donohue
You know, I'll make two comments on that. First of all, the regulatory distinctions between the securities and the futures markets have never been for CME Group of barrier.
We look at more the kind of fundamental characteristics of those businesses in terms of whether we think they would be a good set for us, and whether we thought we could be successful as a competitor in those markets. So the fact that the securities markets have a different regulator, a different regulatory regime is not in and of itself a kind of barrier for us, and that's been a kind of position we've consistently taken for a long time.
I guess the other comment that I would make is that I think in the end if you look at the harmonization report, you know, as I mentioned during the prepared remarks, the areas of recommendation and convergence are largely, I would say technical areas that are not themselves very significant and not likely to actually impact the market structure or overall regulatory framework. So I don't think that should make much of a difference is my view.
Jonathan Casteleyn - Susquehanna
Okay, thank you.
Operator
And next is Rob Rutschow of CLSA.
Rob Rutschow - CLSA
Hi, good morning. My first question is on OTC rate swap clearing.
How are you positioning yourself versus the LCH given their pricing and does it matter where a swap is cleared geographically.
Rick Redding
Rob, this is Rick. I mean I think it's important to understand what the value proposition to each customer segment is to understand what our offering is versus what LCH.
I mean obviously coming to the Lehman situation, a lot of people are viewing the kind of safety and soundness of the US system to be much safer than some of the overseas, and so I think when you look at it from a customer side of this that there is a lot of attention on what the safety that we can provide in a clearing solution. Also out there in the market right now, the LCH solution is a D-to-D solution, dealer to dealer.
We think that as Craig mentioned that we have to get all sides of the trade end to make this successful. So, obviously the buy-side is important as well as the sell-side.
And I think you have to look at this across asset classes to see what the value is. You know, the other thing is in certain products you have to remember that you know, if capital efficiency is what people are after, having the underlying hedge in the futures product is critical.
I mean we can offer a lot more capital savings to someone that doesn't have the underlying hedge in their clearing house.
Rob Rutschow - CLSA
Okay, that's very helpful. Thank you.
Second question was on expenses and I sort of laid this off until next year, but if we were to have a weaker revenue environment what would sort of the triggers be for another round of cost-cutting and where might we look on the expense base for additional cuts?
Jamie Parisi
You know, Rob, this is Jamie. We are always looking to be as efficient as we can, right.
So we're going to continue to take expenses out where possible, and you know, just as before we'll focus on areas of discretionary expense, and if volumes or revenues were to go down dramatically, we would look in other areas as well. But I think given all the – as we said the growth initiatives in front of us and kind of the firming up of the economic environment, you know, feeling pretty good about the future here.
Rob Rutschow - CLSA
Okay, thank you.
Operator
And next, we'll go to Rich Repetto with Sandler O'Neill.
Rich Repetto - Sandler O'Neill
Yes, hi guys. I got Rob do my second question here.
But anyway I do have a follow-up, hopefully that'll be brief. But Terry and Craig, you've been very good at providing like foresight or looking into the future, being ahead of the sort of the regulatory curve here, and where things are going.
As things move from the house to the Senate, what is the color and what has your interaction been with those legislators, are they as reasonable and have you had the same interaction it appears to have had with the house?
Terry Duffy
Rich, it is Terry. I think that it is interesting as we are going to move into the Senate starting sometime next year.
There is a new chairperson of the Senate agricultural committee, which I think is very much engaged in our issues and that is Senator Blanche Lincoln from Arkansas. I think Blanche is going to be an excellent chairman of the committee.
So he is good to work with, and we are excited about the opportunities to do so. As you know right now, the Senate has not taken up any reg reform activity of any consequence as they have been focused on health care reform.
There has been some bills coming out of Senator Reed of Rhode Island and a few other folks, but to be honest with you, I think that the language that came out of the house bills will be very much in favor as it works its way towards the Senate, and as Craig said earlier, there is a lot of things that came out of both the Frank and the Petersen bill the CME Group is very happy with. So we are very much engaged in the process and look forward to working with Senator Lincoln and Senator Dodd on the banking committee also.
So again I think this is a great opportunity for us to get some clarity in the regulatory reform. And I think that is what the market needs.
I think the market needs regulatory clarity, and if you look at the harmonization report and Craig already commented on that, but there was a lot of things that were in that harmonization report that I think were very beneficial such as people commenting about the two different structures of the business and how CME Group’s open access approach for OTC is very beneficial. So I'm excited about working in Washington over the next several months (inaudible).
Rich Repetto - Sandler O'Neill
Great. It just sounds like you are ahead of the curve there as well.
I will omit my second question just to the length there, but I will just say the expenses Jamie’s conservative guidance, I told you so.
Operator
And next we will go to Justin Schack of Rosenblatt Securities.
Justin Schack - Rosenblatt Securities
Hi, good morning. Thanks for taking my question.
Most of my questions have been answered, but I'm wondering if you can provide a little bit of color on the customer segmentation, and particularly on the buy-side prop category. It looks like it didn't move much in the quarter, but it has been growing quite a bit.
And two things there, is that because the aggregate volumes from that segment have been going up or is that everybody else's has been falling off or perhaps accommodation of both. And then what do you see in the trend going forward there, are there new people coming to you from this segment, interesting color [ph], things like that, where you think that is going to continue to grow over time?
Rick Redding
Justin, this is Rick. Now, we have seen a continual growth in the algorithmic proprietary trading segment, especially in the high velocity side.
This has been a trend we have been seeing for five, six, seven years now. We’ve always believed that that continues to get bigger.
What we are seeing now is people coming out of banks, people coming out of hedge funds, starting their own proprietary groups. So what you continually see is new ones coming into the marketplace, and one of the things that has really come up in the last six months or so and last year may be – have been the number of foreign groups that are participating in this.
People from remote parts of the world that have extremely good talent, but are beginning to trade algorithmically as well. You know, I think this is part of a bigger trend that has been going on in the industry for quite some time.
To even think about it from kind of buy-side firms that use more algorithms just to do order execution. So we think this continues.
We’ve, I think for the last several years been telling people that this is an area of growth for CME, and we think that that will continue.
Justin Schack - Rosenblatt Securities
Thanks. That is helpful.
Operator
And next, we have Roger Freeman of Barclays Capital.
Roger Freeman - Barclays Capital
Hi, just a couple of follow-ups here. I guess since you announced the partnership, the inclusion of a number of large buy-side firms for the CDS clearing.
What has been the impact in terms of other buy-side firms reaching out and how many have joined since then?
Rick Redding
I would say, generally, it has been extremely positive. We had a customer event in New York, where we had several hundred people, a large cross-section of buy-side and sell-side participants, and we have seen growth on both sides in terms of their interest in our offering as well as work that they are now doing to become operationally prepared to interface with us.
So, it is a broad cross-section of the industry now that is working with us, but we are focused primarily at least for this initial kind of first phase on the core founding group members for the buy-side and the sell-side, but we are working with and supporting other market participants to be operationally capable of processing trade with us.
Roger Freeman - Barclays Capital
Got it. Okay.
And then lastly, just on the interest-rate complex, the Fed is essentially finished with portion of QE that involves buying treasuries. And so as you think about the incremental buyer and their hedging needs, how do you see that shaping up?
Do you see banks as really kind of stepping in here as they build capital and put that into the treasuries rather than lending, and will they be incremental sources of volumes there?
Rick Redding
Yes, one of the things to think about is on quantitative easing, they made some announcements around that, but also keep in mind that there are programs in place to support mortgage-backeds and a lot of other things. To say that the Fed or the Treasury is out of that businesses, I think is a little premature, especially given the issuance that is coming up over the coming years.
So I mean they can affect that in several different ways then the 300 billion program they put out there. So – and I think your point is right, there is so much I mean what you have seen in this past week is as the supply concerns burning away [ph] on people, you have seen rates move around quite a bit.
Our volume has come back quite strong this past week, especially in the longer end of the curve. So I think that is correct directionally as the market finds a new equilibrium for (inaudible), it has provided a good tailwind in the past week or so for our volumes.
Roger Freeman - Barclays Capital
Okay, great. Thanks.
Operator
And next, we have Patrick O'Shaughnessy of Raymond James.
Patrick O'Shaughnessy - Raymond James
Hi, good morning guys. So, ELX is trying to get the DTCC to work with them, instead of just the exclusive working relationship with NYSE Euronext.
As far as cross-margining some of the interest rate products, is that something that you are also trying to work on yourself, so basically are you on the same side as ELX here trying to establish cross-margining with the DTCC.
Craig Donohue
I will ask maybe Kim Taylor who is with us to comment on that, but I would say that generally speaking we have been a leader in cross-margining arrangements with other clearing houses, and we are certainly looking at ways in which we could facilitate efficiencies for people who are active in both the cash treasuries as well as the treasury's futures market. Kim, if you're still on, it might be useful for you to comment.
Kim Taylor
I would agree with Craig that we are very open to seeking opportunities for efficiencies for uses of our markets, but I would also want to point out in answer to your question, we already have cross-margining arrangement in place with the fixed income clearing corp portion of DTCC. So if that was your question, if we would pursue something like that, we already have one in place and have had for some years.
Patrick O'Shaughnessy - Raymond James
Thanks.
Operator
That completes today’s question-and-answer session. At this time, I would like to turn the conference back to John Peschier for any additional comments or closings.
John Peschier
I would like to thank everybody for joining us today and we look forward to talking to you next quarter. Thank you.
Operator
That concludes today's conference. Thank you for your participation.