Last week, ratings agency Standard & Poor’s Ratings Services (S&P) downgraded the long-term issuer credit rating (ICR) of CME Group Inc. (CME - Analyst Report) to “AA-” from “AA”. Additionally, S&P gave a “Negative” outlook to the rating, thereby indicating the possibility of a further downgrade in the near future.
The move came on the back of S&P’s concern over the $100 million fund announced by CME to protect the interest of farmers and ranchers affected by the crash of MF Global. Under the Family Farmer and Rancher Protection Fund, expected to be in effect by March 1, 2012, farmers and ranchers using CME Group products will be eligible for up to $25,000 per account in case of losses resulting from the future insolvency of a clearing member or other market participant.
Last year, the exchange had also announced a guarantee of $250 million to the estate trustees of MF Global, following the collapse of the commodities firm, in order to make the process of returning customers’ funds more rapid.
CME, as the regulator of MF Global, announced the guarantees to protect consumers’ interest as well as boost its sagging trading volume subsequent to the company’s collapse. Nevertheless, S&P views the move unfavorably.
While the ratings agency concedes the financial risk posed by the guarantees is minimal and can be covered by CME from its free operating cash flow within six months, it believes that the move will raise customers’ expectations regarding future guarantees.
S&P is also apprehensive about CME’s increasing exposure to credit default swaps, as the exchange has limited experience in managing the product. The ratings agency opines that some of the counterparty risk of the off-exchange businesses gets transferred to the clearing house. Nevertheless, CME’s ICR is still strong, with only 21 companies in the S&P 500 having equivalent or better ratings.
CME’s main competitors are CBOE Holdings, Inc. (CBOE - Analyst Report) and Nasdaq OMX Group Inc. (NDAQ - Analyst Report). The shares of CME carry a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. However, considering the fundamentals, we maintain our long-term ‘Neutral’ recommendation on the stock.