The CME's Terry Duffy on the Big Risks He's Seeing Now

we have the perfect guest for this episode. We are going to be speaking with Terry Duffy, chairman and CEO of CME Group. Terry, thank you so much for coming on all thoughts.

maybe it's on pause for a while. Now, let's start with a banking crisis. What's going on there? What do you see from the CME perspective, because of course you deal with interest rate derivatives and hedges, so this is sort of ground zero for some of the asset liability mismatches that we've seen in banking.

affecting mostly these second and third tier banks. So the other only one that has gone away in recent times is Credit Swiss, which was a major bank, but they, again, Credit Swiss has been, you know, advertisers having issues for many years, so I don't think that was a giant surprise to a lot of participants in the banking world. As far as the third tier banks, especially, well, it's

zooming in a couple I guess. You know. One of the couple things that I've said about, especially Silicon Valley SVB, is is it's really amazing to me that the banks who are in the interest rate business in lending business. I'm in the interst rate trading business, hedge risk management business of interest rates, and they're in the business of making loans to participants and deposits for their clients, that they should have a better understanding of the rate market

just in general. I mean, the FED has telegraphed here in the United States that we're going to have a prolonged tightening series of events, and we did so we went from essentially zero to just over five percent in the last year or so, and still they hedged long duration on their books with their client money to get a yield, and in return the rates continue to go up. And we know what happened that was an unhedged position.

So you would have to ask yourself, you know, where is the risk management associated with some of these banks that are taking money from participants on deposit their fiduciaries. They should have a better understanding of the business that they're in. So I was quite surprised by that. I don't like to see the banks continue to dwindle. We went from roughly thirty thousand banks back in nineteen fifty to less than forty three hundred today, so that's not

a good trend for the financial sector. So I don't like to see that activity. So I would hope that they people would continue to manage their risk in a smart way. And I'm not saying that from a self interest proposal. Most second and third tier banks, because of some accounting rules, can't even use futures they but they can use swaps, and I'd like to see them just use the swaps, I said in a meeting earlier today. That.

I'm a big believer in the ecosystem, because if the ecosystem continues to grow, then see them will do just finding that ecosystem. So, you know, I'm a little surprised by some of this activity with the banks, and it's frightening the regular participants listen, they're looking just to keep their money in a safe place. And when you lose the faith of the banks, it's a very troubling event. So the bigger ones get bigger, the smaller ones go

away and return. You could say that the consumers pay for that.

And you know, eventually when farmers wanted to borrow money from the banks, the banks said to them that they need to have a hedging program in place in order to get loans from the banks. No, not all, but some. So I think that was something that you know, helped bolster their industry and in return, you know, risk management became more of a popular tool for the agricultural community, like it with financial services. So what does that mean for the banks and the second and third tier banks?

You know, I think that they can continue to do the swaps, as I said, and in return, companies like mine can benefit because most of the banks who do the swaps with the second and third tier banks historically do the layoff in derivatives on CMA groups. So for us, it's again, it works for us either way.

up to this? I mean, I'm also thinking of some of the deposit moves where it does seem like there was the sort of nonlinear steps, Suddenly people want to be in money market, mutual funds, et cetera. Was there some notable reaction among banks and after the SVB collapse in terms of their hedging activity.

including some of the largest. There becomes a situation where the market has a precipitous move because of an unknown event or that happened to pop up that caught everybody off base, where you're going to have pockets of illiquidity. That's called volatility. So I think sometimes people mistake illiquidity with volatility, and that's just what makes markets move at times. So I don't believe that, you know, everything we've done

has been proper for the marketplace. We continue to keep our engagement with our clients to see if there's something that they would like us to do differently. And again, I just think it's just a combination of you know, ill liquid times because of events that are happening in the world.

high rate vall regime has helped CME's business. And if we were to go to some just sort of like normal I don't know, twenty seventeen some year that we all kind of forget for some reason, like what does that mean for a business like the CMA.

risk are people who have energy risks. Whatever the risk may be associated with the asset classes that I trade. Volatility is only a component of it because volatility never announces itself. You have to remember that this is because the VICS goes up or down, doesn't mean volatility is announcing itself. Volatility shows up when the FED makes a

decision that no one saw coming. That's unannounced volatility, right, So you have to be prepared because if you're trying to manage your risk after the event has been announced or disclosed, whatever it may be, you're not going to be able to do so. Joe, So I think that's when people say volatility, you know, seeing me is based on volatility, it's not. It's a component. Risk management is critically important through all times of the cycle, no matter.

Our focus is strictly on managing that, and we have parameters on our margin capabilities of what we will move them, and we go with what we have SPAN and now we have a new system called SPAN two, which is systems that first of all, SPAN was licensed to multiple exchanges around the world for their risk management protocols in order to set margins, and we continue to run that and now are just introducing a more advanced system coming

up at the end of this year. So listen, we look at it and we don't deviate from the formula. We don't speculate on the margins. It's thinking, well, this is a good customer, so maybe we'll let that margin go a little bit. So we don't do that. We go right by the letter of the law when it comes to margins. I think sometimes people say that an

example being during the Ukraine War. I talked about earlier today on a panel with Scott o'melio, when you looked at what's going on with the price of energy and then ultimately the price of wheat was really affected because of the bread basket and the Baltic there. We raise margins significantly because the price you know you're talking about. You know, roughly a third of the European nations are

counting on that wheat for the survival. Most of the African nations are counting on that wheat for this as a staple for their survival, and all of a sudden it's getting trapped or not being allowed to come out of that region. You know, the market really took off on that, and we trade both soft and hard wheat, so we trade the baker's wheat and we also trade

to feed wheat. So those are things that we have to be very very careful of because we don't want to get into a situation where we don't have enough margin on deposit or breaches of margin where Tracy, I'm not able to pay you because Joe didn't have the money to pay me to pay you. So we're very careful of that.

Setting aside what happened with FTX, do you see eventually any merit or possibility that the US will go in something that direction where there is more direct access to the futures exchanges as opposed to having to go through a broker.

this country don't understand the risk management of it. So it all sounds great when we talk about crypto bec who cares, right, But when you're talking about if you're going to eat or not, or what the price of that product is, all of a sudden we care when we talk about not allowing energy companies to manage their risk,

are not understanding how their risk is managed. Then all of a sudden we care because ultimately, when the markets become inefficient, that the cost does not born by the trader or the exchange that is born by the or by the consumer. The consumer absorbs those costs associated with inefficiencies in the marketplace. So I think whatever the whatever is going to be going forward, whether it's a direct model or something else, needs to make sure everybody understands.

We bring all sectors along and we write rules associated with to make sure that people understand the rules of the road.

with them in aluminum and some other products. But the product you're referring to is nichol is a much smaller market. It's also has a host of warehouses that are associated with that market that you would have to replicate it. It's not just let's list nickel and not have the facilities to make certain that the deliveries on a nickel are facilitated properly so someone doesn't get delivery of a

box of rocks, which actually happened versus nickel. So again, I think from our standpoint, I don't like seeing what's going on with l and ME. But at the same time, we're going to continue to be competitive in areas that we think we can do well at and I've already said that right now we're in a strong position on some of these metals products that we're competing in. Nichola is something that I have said that I am not

looking to list at this moment. You never say never, but at this moment, I'm not looking to list it. I think it's got a lot of issues in and of itself. So we'll have to see how that market progresses. But again, it's a much smaller market than some of the other ones they have.

Because it's not just the treasuries. It could be a default or slowing a payment on Social Security, it could be slowing a payment on veterans affairs, which they need that money to survive. These are veterans that fought for our country. There's a whole host of things that payments need to go out to do so, not just the treasury market. So you also look at probably sixty other countries that are holding US debt. And I'm not referring to just China, because the easiest thing to say is China.

Sometimes I think China wouldn't even care of the US defaulted, because that would only maybe bolster their long term view about where they put themselves in the financial system. And again, their view is in hundreds of years. Ours is in nanoseconds. So you've got to remember the difference between how they

think about it. What I am very concerned about, and I hope our government unsands there's a lot of smaller nations, especially European nations, who own US debt that if it ever deful they could put them into a world of hurt, So not just the US, So that's a big concern here. I don't believe we'll see a default in the United States. I think we'll see a lot of frightening aspects to it.

I mean, you got to remember it took US fifteen rounds to elect the Speaker of the House from its own party ago, and I think that was a bit of a proxy to show what's going on right now. People kept extracting what they believe they wanted in order

to give the vote to then now Speaker McCarthy. So when you're looking at that, you have to say to yourself, what are people looking at to extract on cost cutting measures from an administration that's got not just this one, but prior administrations, that has the United States of America thirty one point five trillion dollars in debt. How do we start to address it? And then some of these fringe participants of either party might say, this is a

great opportunity or a horrible opportunity, let's borrow more. The point is they don't have the votes right now for a debt thing, and so there'll be multiple rounds of this. You saw just two weeks ago the House passed the bill by five votes, still raise the debt SLENE by one and a half trillion, but in return or the cuts they asked for over ten years were pretty dramatic, and obviously the President and the Senate wouldn't even discuss

that particular piece of legislation. So they met yesterday, they're going to continue, They're going to meet again Friday, and we'll have to see where it goes. Secretary of Ellen says, we have enough to pay our bills to June first. I think people believe that's a bit of a fudge. And really we'll probably get into August before we're really

going to have some major concerns. And listen, I saw the debt ceiling go in twenty eleven down to the eleventh hour, literally eleventh hour, with President Obama and then Speaker John Bayner, And we're talking about some pretty rational people back then in twenty eleven, you would have to say, what are we dealing with today? And so could it go longer? What does it look like? I think you can see some delays on some of these payments, but

not a default. So you can see delays on some of the coupons that are expiring this summer or maybe even the fall, So you could see some delays on the payments. You could see some delays on Social Security and other benefits. But if that's the case, what does that do to the marketplace? So I can tie this all back in to we could be in for you know, again, when I talk about volatility and it doesn't introduce itself, here's a situation where you better pay attention because this

could introduce itself in a very ugly way. And that is something that people need to pay attention to, because if in fact, we have someone make the reference that the payment that you were supposed to get on Tuesday will be here the following Tuesday. People will take that as it's never coming, and the markets will take that as it's never coming. Not that that's the case, but

that's how markets anticipate. And then it happens all of a sudden, and now we go into liquidity issues, Tracy, that you referenced earlier, because of an event of volatility. Then we have illiquidity what it appears to be because of the event.

move or we're holding treasuries. We hold roughly ten to twenty percent of other colaudalo, whether it's Gold, Warrens corporates or others small. But we haircut things dramatically already, even including government debts. So the only thing we don't haircut is cash, and so we are in a strong position. We're holding roughly over one hundred and thirty billion dollars today in cash against our margin positions, so roughly almost half in cash. So we're in a strong position right now.

But we do have some treasuries. The only ones we would need to worry about are the durations that are expiring in a period that we think could be an issue, which is, you know, maybe that August through October period, And again that's a very small portion of the margin we're holding today.

We all remember, you know, open outcry pit trading. You had human traders actually shouting out their trades and things like that that went away. So how are you thinking about AI now and what advice do you have for people who might be grappling with the potential of this new technology.

the electronic model created. Now, a lot of people were able to adapt to the new model, and there was some that couldn't. So that's the pain part of it, because you can't bring everybody along. The gain part of it was the market got much much larger due to the technology that the markets now used today and continue to evolve in each and every day. So when you look at artificial intelligence, you know there might be some short term pain, but I think that long term there

could be a tremendous amount of activity. You know, I teased a moment ago Chersey about you and Joe, But I think that there's many opportunities for all fields as it relates to artificial intelligence, And the question is we just got to make sure we don't deploy it in a way that no one understands it. I'll go back to my crypto answer. It is long as the rules

of the road are well understood by all participants. We have an opportunity to participate in new technology, including artificial intelligence. So that being said, I hope that it increases the job market, not decreases it in the long run. But in the short term it could have an impact where people see this as a major cost savings to you know what. You referenced it as displacing people from their jobs. I think ultimately creates jobs.

the heart of your business. Have you talked to the mayor elect?

I got to imagine that if you run for President of the United States, the day you walk into that White House, it's got to be absolutely the most awesome experience in your life, and it's also got to be the biggest burden you've ever seen in your entire life, saying you are the leader of the free world. What I said on a campaign trail, now, okay, that was interesting, But now I'm sitting here, now I got to make this on behalf of three hundred and thirty five million people.

Make sure we're doing the right thing. And so I think that when you look at you know, Mayor elect Brandon Johnson. I don't know him. I know he's very progressive and he's made a lot of comments as it relates to taxes, I'm hopeful that he reaches out the folks well, I don't care if it's me or whoever, and talks about these things I have. First of all, let's make one thing perfectly clear for your listeners, mister Johnson has no legal authority to impose a transaction tax

on my business. He just doesn't have it. The city of Chicago doesn't have the ability. It's not him, it's the city of Chicago. The State of Illinois is somebody that can propose a transaction tax on it, and then the federal government are the only two entities that can do so. So. On the hotel tax, I'll leave that to the people that run this hotel to determine how they're going to deal with that. I don't think it's healthy for tourism. That's one of the things we rely

on in this great city is tourism. So you hate to chase people away over a silly you'd rather take maybe take the Walmart model and bring in more in charge less. So I'm hopeful that he deals with some of the issues that are of concern, and most of those are around crime and safety. So I'm hopeful that the new mayor focuses on those issues and doesn't get too blogged down on how he's going to short term think he's going to raise taxes on certain people in

order to fit his agenda. We have a problem in Chicago, and I think there's other cities here. It's not just the crime, it's the community. You need to create community amongst your city if you're going to survive in the future. Meaning we need to have businesses open, We need to have people walking into those businesses. You need to have commerce, You need to have people living in here. You can't chase everybody away. Everybody is afraid right now because of

whether it's the crime issue or whatever. So I think layering on additional cost as you're trying to fix one problem would be a catastrophic mistake as far as seeing I mean's future in Chicago. See, I mean, we have sold all of our property in the state of Illinois and the city of Chicago. We don't own anything any longer. We put ourselves into a very strong position many many

years ago. I actually in our leases, we have language in there that says if there's something that's ill conceived from the city of the state that our leases are null and void. So we're in a really strong position. We have options coming up on our long term leases already, so that doesn't mean we're leaving. We like Chicago. As I said earlier today on a panel. I think Chicago has been on his back foot before and it can get back on its front foots, but it takes all

of us to do so. So I want to be a part of the solution, not part of the problem. And that's how I look at Chicago. So again, we're in a strong position from a whole host of reasons, from our risk management as I talked about earlier, to a real estate and if there's any ill conceived taxes, you know, we're in a very strong position. If we had to leave, we could leave.

And I said this to our governor. I said to him, I said, you know when COVID, when you shut down the state of Illinois, and certain businesses had to stay open because they were essential to the lives of others. Some banks and exchanges were part of that is being essential, not just grocery stores, not just big box stores and others, but we were essential. Nobody thought about how do we get them back now? You know? So why isn't government getting involved with saying we need people back, We need

people back in cities and communities. You know, I'm a big believer that if you're a steward or a fiduciary of other people's money, that you need to be there, to be on top of it, and to sit at home and monitor that off a screen, to me is not the appropriate thing to do. You should have always have somebody you know involved in an office setting as you're relying on someone to keep your money safe for you.

So there's a couple of different ways I'm looking at that, Tracy, But I will say that, you know, from our standpoint, I've met with my people, I'm not a big fan of the hybrid, but at the same time, you have to It's a competitive world out there, so you have to do what you have to do. I will say that my risk in clearing people are in five days a week, and that's not negotiable, and they know that, and I've had meetings with them and they're comfortable. They

understand my concerns around risk and clearing. I outline them for you all, and sitting here how volatility can come up very quickly. So I'm very committed. I understand that certain people in finance and legal and other parts of my company can hybrid a little bit. But again I'm holding everybody accountable. I have shareholders that are holding me accountable. So we'll see how this all pans out. But I do believe there's a role in not only federal government,

but state government to help rebuild these cities. And listen, we have a massive problem with vacancies in office buildings around this country, especially in New York and Chicago in LA and that's not healthy. I mean, that's a massive shoe to drop because all these buildings are levered up. I mean, there's loans against them that are going to be refinanced that much higher rates, and there's no occupancy. What's going to happen to them? So not an economist,

I'm a realist. I look out the window and you see certain things. And again I think it's upon not only executives like myself, but of course people in elected offices to make sure that we put these pieces back together. And it's hard.

hedging instruments. So are futures related to indicase? Can you talk to as as someone in this business of these instruments, what is it about real estate or commercial real estate that has made it difficult to build instruments that it would allow for hedging activity.

So you have to have a strong cash market, like I referenced earlier. So sometimes the markets are just not you know, I don't want to say centralized, but are just not customized. That is the word I'm looking for, customize enough to have for every single product. So in return, you know, when you look at here's a great example of jet fuel, you would think, boy, there's a lot of people flying. Why don't we have a jet fuel contract? Why because they use their West Texas intermedia to manage

that risk in their jet fuel cost. Why don't we have other contracts for other businesses? You know, I mean I've had people economies saying, Terry, we've seen this lobster market. I might excuse me, the lobster market, and we need to have a future's market on lobsters because in Maine right now they're rolling. I'm like, oh boy, okay, I don't think they care in Kansas, but all right, whatever. Uh So you need to make sure that you have a natural buyer, natural seller, and a market that's not

readily inipotable. I'm not saying the real estate market is what a commercial market is, but the way you can deal with that is through interest rates and interest rate markets, so you can hedge those exposures on your cost. You're not going to be able to have a pure hedge on occupancy the way I look at it. But maybe somebody you know, Robert Schiller, as you know, created the case Shiller index on the home index, and that seemed

like a real natural product, right. But it's some futures on that there are, and we had them and we worked with Profred Doctor Schiller on the contract. But again it's not a liquid contract because there's a lot of people don't participate in that marketplace.

that this is something that you got to have. And we live in an age of where people follow other people and it's just you know, off to the races. So what I believed with crypto was for an exchange like ours, a highly regulated entity that you know, when we decided to list bitcoin, it was going to be under our comfort level for lack of a better term,

and we did that. We did it with making sure that we have the functionality that we have in all where other markets could apply to the bitcoin, such as stop logic functionality, velocity logic functionality, meaning if the market was to precipitously move so fast it would stop replenished

liquidity then start again. That's called velocity logic. And then we would also make sure that the margins were a lot higher than that they were charging in some of the cash exchanges like FTX and others, which was just a couple percent. We actually went into the high thirties low forties when we listed that contract on margin, and then we listed in an awful large size contract to

make certain that we were attracting sophisticated participants. We did not want to attract retail participants who still didn't understand the product very well. Now we have subsolutely gone into smaller contracts on bitcoin udeather, so we have what's called

micro contracts that trades more for the retail. What I will tell you what's interesting about that, and this has happened in the last couple of weeks, is our retail contracts are actually lower in volume now on a percent basis, and our large contract is up in volume on a percent basis, which tells me that the larger sophisticated participants who will trade the larger contract are in that one because it makes economic sense for them to be in

that and the smaller one. Some of the retail participants are not trading that as often. So what is that that can tell you as a proxy is retail getting a little worn out with the inflation without the stimulus money and having to use that money for other costs associated with running their households. So not saying that's a

pure analogy, but I find it quite interesting. So from my standpoint, I think crypto, well, you know, you'll have a few of these cryptocurrencies going forward, and as long as we continue to educate and prove out their use cases where people can use them and feel comfortable using them and not worry about losing their money to participants

who are holding that farm. Remember, the bigger issues with some of these exchanges is the cold wallet where you can get your own but some people just trust that the exchange will do it for them, and that's been an issue. So I think it's going to continue to evolve and you'll have a survivor of one or two of these cryptocurrencies, and then you'll have the block chain technology being deployed in many other ways outside of just crypto.

Maybe it's used with the stable coins or used with another means.

and sort of like where the market is going. Do you have like sort of like benchmarks or things that you would see were like, oh, maybe maybe we'll add a third coin, maybe we add a fourth like types of things that sort of like, Okay, this is hitting a threshold where it might justify having a future's market.

a bitcoin reference rate. Now we have listed several more reference rates, and we'll see how those reference rates go over the next several months to maybe a year, and see if they start to participate more where people are actually using them, and then we may decide to go

from there. So it gives us the ability to have a non tradable product on a reference rate that so to see how people are looking at it, and then if we decide there's enough interest, we could always list a futures contract on it.

we sort of started this conversation. There does seem to be I don't want to say more of a concerted effort because it feels kind of disjointed, but there does seem to be more noise at the moment about regulating crypto, and you have crypto futures, and I guess the question is, are you concerned at all that a clamp down on crypto in the cash market would affect the future's business because, as anyone in financial markets knows, in order to have

vibrant and healthy futures contracts, you do also need vibrant and healthy markets in the underlying.

some of the other cryptos. What does it do? There is massive uncertainty of what is this security and what is the derivative? As you know, both the SEC and CFTC have a difference in that definition, and they both want to seek regulation of those products. So until there's clarity, markets hate uncertainty, and I think we got to get clarity between the regulators about who is going to regulate some of these other cryptocurrencies and what are going to

define them. You know, I remember when the Shad Johnson the cord was passed, and that is basically saying what what devices a broad versus a narrow based index? So what can be traded as a future? What can be has to be traded as cash. So you know, I think it's eleven or under on the products can be determined as narrow and eleven or more is a broad based index, so you can trade those as the futures like the S and P five hundred we trade at

CME and other security indexes are deemed as futures. I'm not saying that's the way they're going to look at crypto, but they have to come to a decision one way or another if the market is going to have the ability to find its footing and grow going forward. But I don't believe, Tracy, that it's going to have a massive impact on bitcoin and it's liquidity or not. I think that'll be like every other product up to what's

going on in the world today, not the regulators. It does what the other products are.

about treasury market risk. I mean, I guess that should be obvious, but it does feel to me like the debt ceiling drama is one of those things that could really materialize, Like the risk could be there's some obscure contract language about delivery, and so it's interesting that they're sort of looking for that at the moment.

it's tied to political choices. What that looks like. And the fact that he was like kind of he didn't say like, oh, we're gonna leave or anything like that, but it's clearly something that like if.

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