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Crossed Wires

Cross-listing established contracts in Asia has proved harder than anybody thought.

By John Thackray

Everyone older than 30 will remember the heady predictions of global round-the-clock trading of a decade and more ago. The airwaves were filled with prophecies of this new immanent reality. Buckminster Fuller's metaphor of the "global village" was about to be manifest in a nonstop electronic marketplace that would vanquish times zones and link the United States to Europe and Asia by the hip.

The derivatives world had its own version of that fantasy: a network of electronically linked exchanges that would connect the established U.S. contracts with the hot new Asian markets. The newly liberated contracts would be freed from their dependence on crude trading pits and allowed to serve traders anywhere in the world at any time of day.

Cut to the present day. The only interlisted market linkage that is an unequivocal success, in Asia or anywhere, is also the oldest-the Chicago Mercantile Exchange (CME)/Singapore International Monetary Exchange (SIMEX) hookup that joins the CME's Eurobond products and SIMEX's Euroyen products. In the rest of Asia, what stands out is the total absence of other interexchange linkages with volume worth counting.

It's not for want of trying. A number of attempted linkages between Asia and more established markets have flopped. A decade ago, the CME and SIMEX duet tried to link gold and currency contracts, but the Singaporeans failed to generate enough volume. During the same period the Sydney Futures Exchange (SFE) had links with COMEX on gold trading and with LIFFE on T-bonds and Eurodollars, which were also discontinued for lack of local volume.

Where then is the Fullerean dream? Although it still endures as a twinkle in the eyes of Asian listed exchanges, they now realize that implementing linkages across the oceans is typically difficult and the creation of a me-too market in an Asian location a slow process. These obstacles notwithstanding, in the last couple of years some Asian exchanges have continued to plug away at this idea.

  • The Sydney Futures Exchange in December 1995 became linked to the New York Mercantile Exchange's (NYMEX) Access after-hours trading system with energy contracts; in the spring of 1996, the deal was extended to such metals contracts as gold, silver and copper.
  • The Hong Kong Futures Exchange (HKFE) signed the details of a similar arrangement with NYMEX last September. Two years ago the HKFE also signed an agreement (currently awaiting U.S. regulatory approval) to trade the Philadelphia Stock Exchange's (PHLX) currency options.
  • In 1995, London's International Petroleum Exchange (IPE) struck a deal with SIMEX, allowing the latter to trade its IPE Brent crude-oil futures contract.
  • That same year, the London International Financial Futures Exchange (LIFFE) opened a link with the Tokyo International Financial Futures Exchange (TIFFE) to trade its Euroyen contracts in London.
  • A year ago a representative of the New York Cotton Futures Exchange traveled in Southeast Asia, looking for a link for its FINEX currency futures-that is, contracts on the Singapore dollar, the Malaysian ringgit, the Thai bhat and the Indonesian rupiah. Of the various exchanges approached, the Malaysian Monetary Exchange appears to have expressed the most enthusiasm.

If all of the existing arrangements hummed along as their planners had initially hoped, untold millions would be made. The economics of linkages offer exchanges in the developed world the possibility of incremental revenues with little additional costs. Most of the attempts to capture nonlocal trading business via after-hours trading have proven costly for the exchanges, and even costlier for their members, who were forced to maintain a duplicate infrastructure handling insufficient volumes.

"The primary goal of linkages is to broaden the distribution and customer base and therefore the potential pool of liquidity, by attracting participants who are located outside the traditional time zone of the exchange concerned," notes Leslie Hosking, chief executive of the Sydney Futures Exchange. "Linkups provide a wider and more accessible range of already liquid financial derivatives."

Slow nights

Yet in practice, local market conditions often frustrate this logic. In Hosking's own exchange, the NYMEX Access link has generated no frisson of excitement. After the first year of operation, NYMEX's energy products had done only 2,643 contracts in Sydney. What could have been an embarrassing failure was mitigated by the addition of NYMEX metals, which in five months traded nearly twice the volume that energy had registered all year. Despite a small surge in recent months, the incremental business is negligible, amounting to less than 1 percent of annual volume on the NYMEX. "It has been slow to start up. But it does trade every night: 1,000 contracts some nights, 10 on others," says a Sydney-based NYMEX spokesman.

The ostensible benefit of a linkage is that it introduces a mature and seasoned product at little or no introductory costs. The problem is that the maturity earned in New York or London may be quite inappropriate for local Asiatic conditions. This is the common explanation given for the lackluster results of the IPE-SIMEX hookup, where the Brent contract no more fits local tastes than do Texas-based energy products in Sydney. "End-users need more education in their use," observes Ralph Liu, head of the Singapore-based Advanced Risk Management Solutions. "The Brent contract poses substantial basis risks for Asian users. A local index would be more suitable."

Cynics might be excused for thinking that linkages' real value is that they make for great public relations since they cast the exchange heads as visionaries, men with their eyes fixed on the future. In reply, exchanges in Asia argue that even linkages with poor volumes can be catalysts to local product development. That's why NYMEX has an Asian committee researching what products might best fit the needs of the region. "Links aren't going to work for every contract. There has to be demand to trade the product outside the home time zone for it to be considered," says Phil Bruce, LIFFE's managing director of strategic business development. "So there is a relatively small number of contracts for which linkages apply."

Evolutionary steps

In reality there are many different types of Asian links, some deep and some shallow. An elementary type is that adopted by LIFFE on its Japanese government bond futures contract since 1987. It is cash-settled in London daily to the opening price of the bonds on the Tokyo Stock Exchange. "While this is not a clearing link as such, if you use the contract in a specific way it acts as a proxy for the Tokyo contract," says LIFFE's Phil Bruce. "It is very simple to set up. We have permission from the TSE to use its prices, but it is not a strict license."

A higher step up the evolutionary ladder is the one that applies to the LIFFE/TIFFE alliance, which is closer to a true clearing link. A Euroyen trade executed on LIFFE becomes part of the day's open interest and is automatically transferred to TIFFE for clearing by a local. "If you do a trade on LIFFE and do nothing else, then automatically it will end up as a contract at TIFFE," says LIFFE's Bruce. But this link has not been anything to write home about, even though TIFFE boasts the largest of all short-term interest rate markets in yen. "It has not been terribly active. For us it is a long-term investment," says Bruce. He notes that local appetites in yen interest rate products are down throughout Asia. "We'll just have to be patient and wait for volume to pick up," he says.

Then there is the most highly evolved Asian linkage, the oldest and the closest because there is mutual clearing. Under the CME/SIMEX interexchange arrangement, there is a mutual offset, so that there is fungibility between the two. And aside from the IPE/SIMEX link on Brent crude oil, it is the only Asia-linkage that has this feature. "There is a reason why you don't see many of them-they are complex to set up," says CME President Rick Kilcollin. Kilcollin adds that from time to time the CME has considered planting similar or companion links on the Eurodollar in Europe, but these proposals always run up against the fact that the time break between open hours in Singapore and Chicago is but 80 minutes in Midwest time. "The CME and SIMEX, pretty well cover the globe in terms of trading hours," he says.

Having a mutual offset machinery in place, both exchanges are clearly motivated to add further product links. But they are inhibited by the local flavor of derivatives markets. Over the years the CME and SIMEX have toyed with the possibilities of doing Nikkei contracts together. The trouble is that both trade Nikkeis: Chicago takes in a dollar-denominated contract, while the highly successful Singapore product trades in yen. To be fungible, a link would have to have a common currency. That would entail the CME switching to a yen structure. "But we have a very nice business that we do in dollars for institutions that are dollar-based. They like it in dollars," says Kilcollin. "If we move it to yen, that makes it less useful to our established customer base."

From the historical perspective, the linkage movement has had two phases, pre- and post-GLOBEX. Although the CME/SIMEX mutual offset was the outstanding success of all the pioneering links of the 1980s, it was viewed as not successful enough. Hence the argument for GLOBEX as a utility that would serve all exchanges' linkage appetites.

When GLOBEX was deemed a disappointment in the early 1990s, direct linkages became popular once more. "When they started to grow again they got much more specific, and more varied according to the business' needs," notes Ivers Reilly, president of the Hong Kong Futures Exchange. "Probably in most cases they will not be a major thing, but they can be very helpful in augmenting whatever strategies an exchange has."

Reilly is hoping to get some augmentation via the proposed link with PHLX. HKFE has created a local market in rolling FX over the last year and a half. "It is a modest success," says Reilly. "There are people who say our volume is minuscule and there are others who say 'Gee whiz, I wish I had that much volume in a currency product.'" There is enough volume anyway for Reilly to consider an FX options product as a companion. The only snag is the high failure rate. "The fact is that there have been many exchanges world-wide that have tried to do a me-too FX option product. But the fact is that only the CME and PHLX have successful currency options." So a link with one of the big boys seemed an appropriate way to execute HKFE's basic strategy of diversifying away from reliance on equity products."

The PHLX will gain a new Asian beachhead from this link. "They know they've not been successful in penetrating the Asian time zone," says Reilly, who remembers PHLX's aborted late-night trading initiative. "So from a business standpoint this linkage is probably a "'gimme.'"

Asian exchanges continue aggressive diplomacy about the possibilities of future linkages. "We get people dropping by and kicking the tires a lot," says Reilly. It is known that SIMEX has had discussions with LIFFE and with NYMEX. There are reports that a deal has been struck to put NYMEX Access terminals on the SIMEX floor, but so far no date has been set. From NYMEX's point of view, linkages may be a shrewd alternative to simply scattering electronic trading terminals to other financial centers, as has been done in London. LIFFE's Phil Bruce observes that regulators are a lot more comfortable when the electronic terminal is located on a regulated exchange floor than if it is merely in brokers' offices.

But while electronic trading may foster some linkages, it can also run afoul of strong passions about open-outcry. Sources suggest that SIMEX is dragging its feet on the NYMEX Access deal because of its commitment to open-outcry. Ideology is certainly a prominent factor in the fight between the CME and SIMEX over their Taiwan index products. The CME only trades its Dow Jones Taiwanese equity index on GLOBEX. SIMEX launched trading on rival MSCI Taiwan index the same week.

Hostile takeover

Which brings us to the last category of Asian linkages: the unfriendly or raided "link," of which the outstanding example is SIMEX's Nikkei 225, beloved by Barings' Nick Leeson. Last year both the CME and SIMEX perceived opportunity in Taiwanese government foot-dragging over permitting a local futures market. And both their preemptive strikes were sanctioned by their regulators, despite diplomatic maneuverings by Taiwan. SIMEX chairman Victor Liew has said that "as long as we offer this as an efficient and cost-effective hedging and trading instrument, the prospect for its further growth, like what we have seen in our Nikkei products, should be good."

Maybe so. But a previous SIMEX raided link did not pan out. About three years ago the Singaporeans launched a Hang Seng futures contract based on the MSCI Hang Seng and it was a bust. The same thing could happen after this year, when Taiwan is expected to get its futures market up and running. The question then will be how much traffic SIMEX and the CME's GLOBEX will lose. Because it is denominated in U.S. dollars, the CME product may continue to have a following.

Public reaction to the SIMEX and CME raids has been mixed. "SIMEX takes a devil-may-care attitude to all the other markets they trade," says one Salomon Bros. trader. "They have been very aggressive. It is good to see GLOBEX and the CME taking steps to get a piece of that Far East action." At the other end of the spectrum, the CME is clearly vulnerable to charges of economic imperialism-using its clout to influence issues that are, or should be, sovereign to Taiwan.

So what then does the future hold? Will Bucky Fuller be proved right in the end? Probably not. The fact is that nowhere is there an inexorable wave of economic globalization. The new buzzword is "glocal"-for global and local. Where local conditions permit, in Asia and elsewhere, interexchange linkages will emerge. But judging from the record to date, they will not be ubiquitous.

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