Competition between the Notifying Parties to introduce new products (560) In the decision opening the proceedings, the Commission outlined that the Notifying

Parties, in particular as concerns the European financial derivatives, may be each other's closest competitors in respect of various types of innovation. The response of the Notifying Parties to the decision opening proceedings, and the further market investigation, nonetheless clarified that the scope of innovation within which the Notifying Parties primarily compete against each other rather than against other platforms is less extensive than initially considered in the decision opening proceedings and comprises product adjacencies and upgrades only, not unrelated product launches. This is reflected in a comment by ICE, which has indicated that the Notifying Parties "compete on innovation in product areas which are closely related to both of their activities as well as at technology level".512

(561) The remainder of this Section therefore discusses product innovation in respect of product upgrades and product adjacencies only ("Type I" and "Type II" innovations). Competition in technology, process and market design is discussed in the next Section.

11.2.1.3.3.1. Competition to introduce new products

(562) New ETD contracts are constantly introduced on exchange platforms513 and range from adding new exercise and settlement dates for an existing contract series (a rather routine product upgrade) to launching a completely new suite of products, whether adjacent or

510

Replies to questions 56, 57 and 58 of Q1 – Questionnaire to Customers. The calculations are based on the non-confidential replies only.

511

See section 11.2.1.7 of this Decision for the analysis of barriers to entry.

512

Minutes of a teleconference call with ICE of 14 September 2011, paragraph 5 [...]*.

513

The importance of the introduction of new products in the derivatives space is also evidenced from the documents provided by the Notifying Parties, for example in a document of 2008 provided in response to the Commission's RFI of 1 July 2011 ([…]*). DB outlines that "Eurex launched nearly 200 new products and functionalities in 2007 and already more than 180 products and functionalities in 2008".

unrelated, in response to significant changes in customer demand, market structures, market regulations, and macroeconomic changes.

(563) The fact that product innovation is a significant dimension of competition between the Notifying Parties is attested by DB internal analysis taken from a recent DB strategy document: "[DB and NYX are] [m]ajor competitors on exchange level with similar business model, competition focuses on new products and services, less on existing benchmark products."514

(564) The current economic context seems, if anything, to have made this aspect of competition between the Notifying Parties more important. DB states that: "The need for continued new product innovations around the core products is more urgent than ever given the opportunities to migrate OTC business to exchange and clearing platforms. […]*".515

(565) The importance of the introduction of product upgrades and adjacencies has been made clear during the market investigation.

(566) According to Nasdaq OMX, "Product innovation is an important competitive force in derivatives markets because derivatives exchanges may gain additional business … through the launch of new products appealing to their members. Competition between Eurex and Liffe to attract liquidity in newly launched products by either party is based primarily on fees, technology solutions, and margin efficiencies. Depending on the individual product there will be some sort of campaign to attract liquidity, most notably special rebates on trading fees."516

(567) According to CME, "exchanges offer products that compete on product design, trading conventions such as tick size narrowing, changing of notional size (for instance make the contract bigger to appeal to institutional investors), technical parameters, type of collateral accepted, etc."517

(568) There are numerous examples of past and recent competition between Liffe and Eurex to attract liquidity for new suites of products, such as the EuroBund contract, contracts on Eurozone equity indices (EUROSTOXX and EuroFirst) and contracts on Euro STIR. Each of these particular instances is reviewed below for the light which it sheds on potential competition. As a more general matter, however, competition in product innovation between the Notifying Parties can, of course, not be confined to instances observed in the past but equally concerns instances which would otherwise occur in the future and which, necessarily, cannot be predicted today.

(569) During the initial market investigation, market participants confirmed the existence of a product innovation race between derivatives exchanges, and between Eurex and Liffe in particular. In this respect, one respondent indicated that "the exchanges engage in a continuous process of competing in innovation and attempt to improve existing products and offer new products to better serve their users and gain trading volumes.

514

See DB internal document provided in response to the Commission's RFI of 1 July 2011, […]*.

515

See DB internal document provided in response to the Commission's RFI of 1 July 2011,: "[…]*

516

Reply to question 40 of Q10 – Questionnaire to competitors, phase II [...]*.

517

The merging parties are by far the two most active and relevant participants in this competitive process."518

(570) Competition between exchanges to introduce new products is often prompted by regulatory or market changes bringing about new opportunities and creating demand for new derivatives contracts. In this respect, NYX noted in its internal documents that "History suggests that changes of market structure provide opportunities, and that political and regulatory pressure can be significant in determining the outcome."519 UBS states in the context of the G20 reforms520that "we would expect Deutsche Boerse and NYSE Euronext to be key competitive innovators on the market landscape for this new business"521.

(571) Whilst there are therefore many intrinsic reasons why exchanges innovate, the tendency of liquidity in a particular contract to aggregate on a single trading venue, discussed in Section 11.2.1.2.3 above, creates a strong incentive to be first to the market or to come to the market with clearly a superior product for a given purpose.

(572) Table 2 above illustrates that Eurex and Liffe are de facto the only exchanges offering ETDs in European equity and interest rates (outside certain national equity markets) and by extension are also best placed to compete for liquidity in new contracts of these types when they are introduced given the cross margining opportunities arising from the risk correlation between the same product types (see also Section 11.2.1.7.1.2)522. As a result, they are each other's closest potential competitor in this area of contracts when it comes to the introduction of new ETDs of the type in question.

11.2.1.3.3.2. Pricing behaviour in relation to new product launches

(573) As concerns transaction fees and rebates, competition is particularly in evidence when the Notifying Parties compete to attract liquidity in new contracts or in those instances when contracts providing the same economic exposure are available on competing platforms, notwithstanding the general tendency, absent fungible clearing, for it to aggregate on one or the other.

(574) At the stage of the introduction of a new contract, in order to attract customers and hence liquidity on their platforms, the Notifying Parties carefully design their per- transaction trading and clearing fee structure by benchmarking themselves to their competitors, which in practice, at least for the asset classes where they overlap, primarily means the other Party. Thus NYX states that: "For new contracts, fee levels are proposed by the responsible product development teams having gathered relevant

518

See ICAP's response to question 48 of Q 1- Questionnaire to customers [...]*.

519

See NYX internal document provided in response to the Commission's RFI of 1 July 2011, Project Blackhawk – Fixed Income derivatives, p.3.

520

For more on the Commission G-20 driven reforms, see Section 11.2.3.2.4 of Decision.

521

Reply to question 75 of Q 1- Questionnaire to customers [...]*.

522

In this regard the relevant counterfactual is the best risk margining model which the merged entity could introduce; existing observed offsets do not always reflect the "best" that the exchange could do in order to render a new product more attractive.

market intelligence and taking into consideration the prices of comparable and competing products".523

(575) Equally, when a particularly immediate competitive threat arises, they tend to respond rapidly. For instance, at the time of the EuroBund battle, one Liffe board member pointed out[…]*524[…]*525

(576) The role of pricing at the stage of introduction of a new contract can also be understood from an internal analysis made by NYX reflecting a few years later on the EuroBund battle: […]*526

(577) The Commission therefore considers that customers view that the Notifying Parties compete on pricing to attract new business. For instance, one respondent indicated that the Notifying Parties provide "aggressive pricing and marketing to win new customers. A merger of the two would potentially reduce the need for aggressive pricing."527 Another respondent stated that: "They both try to react quite quickly to each other´s new move, trying to offset the impact on the new launching price wise; a good example has been the listing of the universal stock futures in both exchanges"528.

11.2.1.3.3.3. Response of the Notifying Parties to the SO

(578) In their response to the SO, the Notifying Parties dispute the findings of the Commission on new products and product innovation,529offering four main arguments, namely:

(579) The Notifying Parties first argue that for interest rates, CME is at least as great a constraint on them for product innovation as they are on each other530. In the context of equity index products, the Notifying Parties claim that the constraint is formed by third party venues to which users could, if they wished, direct flows.531

(580) The Notifying Parties also argue that except for a "broad claim" that “given the cross margining opportunities” arising from the risk correlation between the same product types, the SO does not put forward any evidence for the "assumption" that the Notifying Parties are each others' closest competitors in respect of product innovation532.

523

NYX reply to question 15 of the Commission's RFI of 8 August 2011.

524

Deutsche Terminboerse, the forerunner of Eurex.

525

NYX internal document provided in response to the Commission's RFI of 1 July 2011, Memorandum, Bund team & Management Committee, 6 August 1997.

526

NYX internal document provided in response to the Commission's RFI of 1 July 2011, Memo to Executive Committee, From ,[…]*, dated 20 September 2001.

527

[...]*, response to question 60 of Q1 – Questionnaire to customers [...]*.

528

[...]*, response to question 60 of Q1 – Questionnaire to customers [...]*.

529

The Notifying Parties' arguments as regards actual and potential competition are dealt with in the respective sections relating to specific product markets below.

530

Notifying Parties response to the SO, Interest Rate derivatives, paragraph 172.

531

Notifying Parties response to the SO, Equity Index derivatives, paragraphs 23ff.

532

(581) The Notifying Parties argue that innovation takes place in the OTC space, not on exchange533 (although this claim is made in the context of the reply on equity index products, it seems to be intended to be of wider application).

(582) The Notifying Parties argue that "head-to-head competition between the Parties in launching new products is not a significant dynamic in the derivatives industry". This latter claim is based on the assertion that "the SO does not identify a single successful product innovation since 2000 that either one of the Parties has won".534

(583) The Notifying Parties also contest the relevance of the various individual examples of innovation contained in the SO. In respect of index products they make the additional argument that innovation takes place at the level of the index provider, not the exchange.535

(584) The Notifying Parties' arguments in respect of these individual examples and their claims regarding innovation in equity index derivatives are addressed in the respective Sections below.

(585) It should also be noted that the Notifying Parties devote a part of their response to the SO seeking to rebut closeness of competition in respect of entirely new and unrelated products (Type III innovation). Since the Commission had already specified in the SO that concerns did not arise in respect of this type of product innovation, it is unnecessary to analyse the arguments of the Notifying Parties further on this point.

11.2.1.3.3.4. Analysis of the Notifying Parties' claims in response to the SO

(586) The Notifying Parties' first claim, that the CME is at least as important a constraint for product innovation in interest rates, as well as their second claim in relation to closeness of competition, can largely be dismissed on the same grounds as those which establish that the CME does not constitute an equivalent constraint in terms of potential competition and the Notifying Parties are each other's closest potential competitors. Indeed, the reasons why a new and different product might be a success have much in common with those which explain the relevance of a more direct competitive challenge with a product which offers similar or identical economic payoff. Admittedly, the lack of an established liquidity pool in the former instance means that barriers to entry are lower. All the other factors which distinguish the Notifying Parties' competitive relationship to each other from their competitive relationship to CME nonetheless still apply, namely the scope for margin offset and membership considerations. Insofar as product innovation serves a defensive purpose in relation to the threat of actual and potential competition, it directly follows from the conclusions on potential competition that CME does not constrain the Notifying Parties to the same extent as they constrain each other.

533

Notifying Parties' response to the SO, Equity Index derivatives, paragraphs 23 et seq.

534

Notifying Parties' response to the SO, Interest Rate derivatives, paragraph 169.

535

(587) Positive reasons why the CME should be so considered are not advanced by the Notifying Parties. There do not appear to be any examples at all of the CME actually having successfully launched an innovative product in Europe adjacent to one of the products of the Notifying Parties. The example of the failure of CME's European Sovereign Yield Spread Future product (see footnote 422 above) is telling in this regard.

(588) It follows that these claims by the Notifying Parties must be rejected.

(589) In relation to the claim that innovation occurs in the OTC space before products are brought on exchange, and that this innovation will continue, the Notifying Parties rightly observe that the SO recognised the role of the OTC space in "incubating" new product concepts. However, it does not follow from this that such products make their way onto exchanges in a timely, much less automatic, fashion or that they do so under conditions which provide to customers the optimal benefit from competition.

(590) In order to standardize OTC products and make them suitable for exchange trading, significant investments are required, both at the development stage and, once a product is launched, in terms of incentives to liquidity providers to trade the product in order to overcome the adoption externalities, namely the fact that, in initially thin markets, the natural incentive to trade is lower.

(591) The costs of new product introduction are clearly set out by the Notifying Parties themselves in Annexes D.9 and D.10 to the Form CO. Even though the Notifying Parties concede that these estimates may be imperfect as some costs are not tracked systematically536, the information is nonetheless telling.

(592) NYX identifies three approximate cost categories for new product introductions, "low" (of the order of […]*), "medium" ([…]*) and "high" (in excess of […]*). It should be noted, moreover, that these investments are anything but risk-free, and, in general, the higher the spend, the more innovative the product and also the greater the risk that this product will not achieve volumes which offset the initial investment. In one of the apparently most extreme examples, trade entry and clearing through Bclear of commodity products was introduced in March 2009 at a cost of around […]*, but until the end of 2010 had achieved […]*. It therefore goes without saying that the incentive to make investments in innovation of this order of magnitude may be affected by the notified transaction, precisely as the Commission has outlined.

(593) In other examples, short and medium gilt futures were introduced in November 2009 at a cost which was "high". The competitive context of this introduction vis-a-vis Eurex is described in Section 11.2.1.4.3.3 below. The introduction appears to have been quite successful. Multi-Serial options on Euribor, which were introduced at "medium" cost in early 2010, have also been very successful537.

(594) As regards Eurex, little information has been provided at the individual contract level, but DB has estimated total yearly spend on product innovation at between Euro […]*

536

Form CO, Derivatives, paragraphs 8.80-8.84.

537

See Euronext press release of 29 March 2010, available at

and […]* for each of the three years 2008-2010, up on an estimate of Euro […]* for the two previous years.

(595) It follows that the fact of a product having been incubated in the OTC space is in no way determinative for that product's being launched on exchange, or for the timing, form and commercial conditions of such launch. This claim of the Notifying Parties must therefore also be rejected.

(596) Regarding the final claim, according to which there have been no "important" examples of products launched in competition between the Notifying Parties since 2000, and that therefore product innovation is a relatively unimportant dynamic, this claim cannot be reconciled with the evidence on file, whether from internal documents and public statements of the Notifying Parties or from responses to the market investigation.

(597) In this regard, NYX claims that "NYSE Euronext operates the world’s leading and most liquid exchange group, and seeks to provide the highest levels of quality, customer choice and innovation."538 Eurex even has a special website devoted to innovation, innovate.eurexchange.com.

(598) Indeed, Eurex articulates what seem to be very similar conclusions to those of the Commission when it states, in April 2008, that "Product innovation and introduction is thus significantly more costly on-exchange[than OTC], and exchanges have to be more selective in product development. Nevertheless, derivatives exchanges are highly innovative. Globally, the top three derivatives exchanges (Eurex, CME and Euronext.Liffe) have introduced more than 800 new products since the beginning of 2005, increasing the number of total products available to users by more than 80 percent."539

(599) High level innovations which date from later than 2000 include, for example, the launch of the FTSE EuroFirst index suite; EuroMTS Bond Index Futures and Euro-BTP Futures; Bclear and flexible options and futures; volatility and dividend futures, mid- curve options on Euribor, extensions of single stock derivatives into new geographies, and the Swapnote contract on Liffe, along with numerous more "incremental" but still significant innovations. Many of these are discussed below.

(600) The final claim of the Notifying Parties in this regard must therefore also be rejected.

11.2.1.3.3.5. General conclusions on competition in new products

(601) On the basis of the evidence on the file, the Commission therefore concludes that the