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Google Invests $1 Billion in Exchange Giant CME, Strikes Cloud Deal: I remember the day Amazon announced its acquisition of Whole Foods in June 2017. I was sitting at my desk at work when breaking news flashed on a nearby TV showing CNBC, causing everyone on my floor to stop & watch. There was a level of awe in the air that bordered on bewilderment - no one saw the news coming or thought Amazon wanted to get into the brick-and-mortar grocery business. Everyone did agree, however, that the industry had been forever changed by Amazon’s entry.
I feel similar Amazon/Whole Foods energy from the above headline - Google is getting into the market technology business with a sizable investment in CME and a 10-year partnership to transition CME’s infrastructure to the Google Cloud. Here are the specifics:
“CME Group and Google Cloud today announced a 10-year strategic partnership to accelerate CME Group’s move to the cloud and transform how global derivatives markets operate with technology.
Under the agreement, CME Group will migrate its technology infrastructure to Google Cloud beginning next year with data and clearing services, and ultimately moving all of its markets to the cloud.
To help facilitate the cloud migration for CME Group, Duffy has appointed Ken Vroman to a new role as Chief Transformation Officer.
Google has also made a $1 billion equity investment in a new series of non-voting convertible preferred stock of CME Group.”
Google’s $1 billion equity stake aside, that middle bolded sentence is the key piece of this press release. CME Group, like any exchange, is first and foremost a technology company. Exchanges build massive, secure, lightning-fast platforms to trade securities & house these platforms in military-grade data centers that are extremely expensive to upgrade & maintain. CME alone spends ~$200 million per year in CAPEX mostly focused on keeping its technology refreshed & state-of-the-art. To access this system & interact with CME’s markets, institutions & high-frequency traders pay a combined ~$100 million per year in colocation & connectivity fees. Succeeding in the market infrastructure business is no small endeavor.
Over the next decade, CME is telling the world that it plans to outsource nearly all of this business to the Google Cloud. Alex Osipovich of the Wall Street Journal added on Twitter that the ultimate plan is to move everything - even CME’s core matching engine - to the cloud at some point. “The cloud” in this case means Google’s data centers & infrastructure rather than CME’s on-prem system in Aurora, Illinois. Does this mean CME’s technology costs are set to decline significantly over the next decade? Will Google now control the colocation business? How does this affect the futures markets CME operates? Will Google start to have influence over financial markets & the valuable data they generate? These are all questions that have yet to be answered.
I’m a bit perplexed by this partnership as I digest the initial details. It looks like CME is ceding some level of power & control to Google in exchange for lower technology costs. Google wouldn’t have invested $1 billion in CME if this was a normal, run-of-the mill cloud services contract. There’s a larger transaction going on here & it involves Google becoming the exchange technology provider CME & the other exchanges act as today.
As a CME shareholder I like to see management supporting creative ways to lower expenses, but I think the exchange is giving up too much to achieve their goal. If CME doesn’t control every part of their own market structure, its last real competitive advantage is the liquidity of its markets. I view this deal as CME’s bet that its liquid futures markets are all it needs to keep its high-margin, monopolistic business model intact. While they may be right, I’m not sure I would want to take that risk by inviting a technology behemoth like Google into my backyard. As we hear more details about this transition in the coming quarters, I want readers to understand how big of a deal this partnership is not only for CME, but for the entire exchange industry.
The Big Tech giants have begun their invasion.
Biggest derivative exchanges back ex-Deutsche Börse chief’s fintech buyout: This is the kind of story that gets me fired up about the exchange industry. You could read the above headline & think “Okay, cool, a few exchanges backed a private equity firm to buy a random software provider. Big deal.” Those who aren’t familiar with the intricacies of order routing - particularly futures order routing - may have never heard of Trading Technologies, the target of 7Ridge’s $500 million acquisition. Why is this deal important?
Trading Technologies holds a key strategic role in the flow of electronic futures trading. The company sells trading software to a long list of institutional customers, letting them connect to every major global futures exchange & see all markets on a single platform. This software is the singular window through which its customers view & interact with the futures market - a role that gives Trading Technologies significant influence. Entire markets can live or die based on the placement & design of TT’s interface. If an exchange owned TT’s product, for example, it could keep competing markets from showing up on hundreds of institutional trading screens, killing competition before it even has a chance to form. The owners of Trading Technologies are a big concern to banks & exchanges around the world for this reason.
In October 2020 Trading Technologies hired bankers to consider selling the company. A couple months later, Goldman Sachs emerged as a potential buyer but quickly backed off after other investment banks fussed that its primary trading screen would be controlled by one of its biggest rivals. The firms who would consider buying Trading Technologies were the very firms who would spoil its un-biased role - its own customers.
On Halloween we saw a deal finally get done - 7Ridge, a PE firm led by former Deutsche Boerse CEO Carsten Kengeter with limited partners including CBOE & SGX, bought Trading Technologies for $500M. The deal is a win-win for all parties involved - TT’s platform stays independent, 7Ridge provides funding & will determine strategic direction, and the group’s limited partners get to participate in any future upside. Look for more headlines out of Trading Technologies in the coming months as new management takes over & potential M&A elevates their market structure influence even further.
Coinbase is testing a subscription service with zero trading fees and prioritized support: This week Coinbase finally signaled how it plans to deal with fee compression, a big (and I believe a positive) headline for the stock.
A few months ago I wrote a post titled Let's Talk About The Coinbase Fee Problem where I made two arguments about the exchange:
Coinbase’s retail revenue capture is massive - it charges upwards of 1% on every trade that flows through its system. Retail trading makes up an overwhelming portion of Coinbase’s revenue, raising questions about the long-term sustainability of its current business model.
I believe Coinbase can squeeze fees out of its retail customer base for longer than the market may expect. Coinbase Pro is a lower-priced alternative to Coinbase retail, offers better functionality & is free to switch, and yet does not see adoption from most retail users. If retail doesn’t care enough to trade with Pro over Coinbase’s more expensie retail app, is fee compression really a risk in the short or even medium term?
That post dealt with the short & medium-term outlook for Coinbase; what about the long term? This week Coinbase announced it’s testing a subscription fee plan for certain customers that offers unlimited free trading & priority customer support services for a monthly fee. The service achieves two goals - first, it targets high-volume customers and rewards them for staying with Coinbase. While this sacrifices transaction revenue by giving top customers a discount, it should promote loyalty to the exchange & keep valuable retail flow on its platform for institutional customers to trade against.
Second, this subscription service helps to diversify & lock in long-term revenue growth for the exchange. Sure, moving customers who are trading a lot today to a subscription model hurts revenue, but in 3-5 years when crypto trading is less frenzied than it is today, those same customers likely aren’t trading as much but are still paying monthly fees. My guess is Coinbase’s subscription service considers the lifetime value of a retail app user & is priced to maximize this LTV over the long term. I’m looking forward to this service’s expansion as it’s tested & rolled out.
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Other Stories I’m Reading
Chart of the Week
I continue to be impressed by Tradeweb’s results this year. The company reported October volumes this week & announced a record $25.6 trillion had traded hands on its exchange across US Treasuries, swaps & corporate bonds. This record came from broad-based growth rather than success in one particular product - management gave more details during Q3 earnings:
Electronic swaps market share grew from 10% to 14% YoY.
US Treasuries share grew from 15% to 20%.
Investment Grade corporate bond share grew from 8% to 13%.
High Yield corporate bond share grew from 2.5% to 6%.
Why is this happening? Tradeweb has put together an all-star lineup of tools & liquidity sources to give banks & institutions as many ways to trade as possible. Prefer RFQ protocols? Direct streaming? A central limit order book? What about net spotting? Portfolio trading? Tradeweb has a liquid market no matter what avenue you prefer to use. Because most institutions trade swaps, Treasuries and corporate bonds at the same time, new Tradeweb customers enter the market for most or all asset classes at once rather than a select few.
I’m still long Tradeweb after starting a position earlier this year and will happily keep my shares as long as market share & volumes continue to look like the below chart:
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Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, NDAQ, COIN and VIRT. I am also long Solana.