FIA Asia Derivatives Conference
Keynote Presentation and Exchange Leaders Panel
Wednesday, August 10, 2005
Thank you for that kind introduction. It is truly an honor to address you at this first Asia-wide Futures Industry Association conference. This important event is a chance for global exchanges to share information and discuss a topic that is on all of our minds: the tremendous potential that Asiaholds for global futures trading. Further, I commend the FIA for choosing Beijingas the location for this meeting, as it is one of several epicenters of growth within our industry.
Exchanges around the world are clearly aware of the opportunities that abound in Asia– all of us have read the stream of headlines announcing trans-Pacific alliances and cooperative efforts. The CBOT has been a leader in this trend, developing several memoranda of understanding with Asian exchanges, among other targeted initiatives. Members of the CBOT staff and I have traveled here many times in the last year, largely because we believe that you are critical to the future of this great industry.
This is not the first time I have spent considerable time in Asia. About 10 years ago, I lived and worked in Singapore. What I’ve noticed is impossible to miss – the landscape of the Asian futures industry has changed considerably in the last decade. For example, according to the FIA, in 1994 Asian exchanges made up 12 percent of global futures volume. Last year, that number reached 36 percent. I believe a large part of that expansion is due to a greater focus on encouraging international participation in Asia’s capital markets – with efforts in a variety of areas, including regulatory changes, distribution agreements, meaningful MOUs with strategic partners and implementation of new technology across Asia.
Amid this explosive growth, challenges inevitably ariseindustry-wide. The fine program the FIA has put together for this event addresses many of these issues. What I noticed upon reviewing this week’s conference schedule is that exchanges in Asiaare facing many of the same issues that we in the U.S.and Europehave had to overcome in the not-so-distant past. With that in mind, today I will spend some time discussing the elements that have driven success for international exchanges around the world during the past several years.
I believe that there are five different common elements that have consistently laid the foundation for growth among international futures exchanges, particularly in the last decade: connectivity, standardization, reliable clearing practices, effective market oversight, and transparency. Each of these elements has contributed to the most important driver of any business’ success – that is, customer satisfaction.
CONNECTIVITY
First on the list is connectivity, largely because without it, there would be little impetus for us even to have gathered here this week. Connectivity has made it possible for Asian market participants to trade dollar-denominated products while we in the U.S.are fast asleep. And the opposite is true as well – connectivity allows overseas customers to trade some Asian markets nearly around-the-clock. And connectivity, driven by cutting-edge technology, has allowed exchanges to deliver customers a higher level of efficiency, convenience and reliability that did not exist 20 or even 10 years ago.
At the CBOT, a heightened emphasis on connectivity is ongoing. For example, in June we announced plans to establish a telecom hub in Singapore, providing our customers in Asiawith a cost-effective, efficient method of connecting directly to the CBOT, located some 9,000 miles away. The bottom line is pretty simple: if market participants can’t connect to our market, they are not able to participate.
Global exchange’s volume numbers reinforce the importance of connectivity. For example, in the last four years, screen-based trading of futures at the CBOT is up three and a half fold – with similar growth echoed at other exchanges internationally. The expansion has been driven by the increased acceptance of electronic trading, as well as the ability for customers located anywhere in the world to connect to distant exchanges and execute business.
STANDARDIZATION
Standardization of electronic trading platforms used globally has also played a significant role in that growth. What I mean is that many of the world’s most vibrant futures exchanges are accessible via the same electronic trading system. The widespread use of the LIFFE CONNECT® platform by exchanges internationally is a perfect example of this trend. The consolidation of markets in Europewith the formation of Euronext.liffe brought derivatives markets in various European cities all on to a single system. It is interesting to note that Euronext was first formed about a year and a half before the euro became the predominate currency throughout most of Europe. Despite the different currencies accepted in Amsterdam, Brussels, and Paris, customers still benefited from the consolidation and reduction in fragmentation of the marketplace.
Further, today LIFFE CONNECT is used across three different global time zones. TIFFE utilizes the platform in Japan, while the CBOT’s electronic trading platform is powered by LIFFE CONNECT®. This global standardization of platforms provides a higher level of service to customers.
The ability to access multiple markets via a single platform has become more than a convenience – it is a necessity. CBOT customers, across all profiles of users, have conveyed this sentiment to us. With that demand in mind, earlier this year the CBOT executed its hosting agreement with three of the largest grain exchanges in North America– the Kansas CityBoard of Trade, MinneapolisGrain Exchange, and WinnipegCommodity Exchange. Today, all of these exchanges’ electronically traded contracts are available exclusively on the CBOT’s system. However, each exchange maintains its own identity with different open and close times for its markets.
We are likely to see this type of arrangement replicated internationally, and with greater frequency, even in the near term. Hosting agreements provide the level of standardization that our customers require, decreasing, or even eliminating the fragmentation that is synonymous with small, regional exchanges. These agreements are designed so customers need only have one connection to access multiple marketplaces, while still allowing those marketplaces to retain the unique characteristics that distinguish them from the competition.
Global futures markets have gone beyond standardizing the electronic platforms they offer customers – exchanges are using the concept to create a more vertically-integrated market model. Many of the futures industry’s best customers are also trading a variety of other products – options, securities, and OTC markets, to name a few. Customers prefer the ease of what can be called one-stop shopping – that is, everything they need is available on a single platform.
In Europeand Asia, this type of asset class convergence and its positive results are easily apparent. Both Euronext.liffe and Eurex list multiple asset classes, including cash and derivatives products. Further, several exchanges in Asiahave embraced standardization, migrating multiple asset classes on to internationally used electronic platforms. Markets in Hong Kong, Singaporeand Koreahave each merged their futures and stock exchanges, and those distinct marketplaces also use a common technology provider. This type of standardization creates many possibilities, while also simultaneously creating an ease of access for customers of all three exchanges.
CLEARING SERVICES
Standardization has also driven benefits for customers when applied to clearing services – a third element common among successful exchanges globally. In the U.S., the CBOT and CME fully implemented the Common Clearing Link at the beginning of 2004. The result of this relationship delivered $1.7 billion in reductions of margin and capital requirements, as well as other efficiencies for customers of both exchanges. The results of this landmark agreement are ongoing for our customers.
Standardization of clearing is a trend that is already well on its way to taking hold in Asia, as evidenced by the new common clearing house that will be established for all commodity exchanges in Japan. An element of Japan’s new commodity law reforms, this change will bring results similar to other common clearing arrangements: reduce costs and increase efficiencies for market participants.
Common or centralized clearing is one step to lowering the barrier to entry for foreigners interested in trading offshore markets. By reducing margin requirements and expanding the size of a clearinghouse’s guarantee pool, an exchange’s markets become more attractive to overseas participants. This type of arrangement can extend a marketplace’s global reach, raise its international profile, and encourage volume growth.
The multitude of benefits created by standardized clearing solutions do not address a very basic element that is necessary for a clearinghouse to possess in order for an exchange to attract foreign, and even local, capital in the first place. The level of participation in a marketplace is determined by a very simple factor: investor confidence. High levels of investor confidence encourage capital to flow into a marketplace and convince those who control that capital to stay there, even during challenging circumstances.
To develop that level of trust, clearinghouses must have several internationally accepted standards in place, such as daily margin requirements, daily mark to market on all open positions, and position reporting and position limit rules for traders.
MARKET OVERSIGHT
In addition to clearing services, market oversight is another area that serves as a source of confidence for investors. In today’s trading environment, leading futures exchanges are overseen by a credible governmental body, with a defined charter, and rules and regulations to monitor market activity. The mission of those regulatory bodies is to protect market users and the public from fraud while fostering open, competitive, and financially sound futures and option markets.
Some exchanges, such as the CBOT, are a self regulatory organization, or SRO. There are a few key areas that we oversee: we audit firms and require them to meet minimum capital requirements, monitor actual trading activity, and we also oversee contracts as they move closer to expiration.
Exchanges that are SROs take on a tremendous responsibility, as an SRO is charged with developing and maintaining the investor confidence that no global market can function without. Overseeing a market as an SRO can also force an exchange to make very difficult decisions.
One example that comes to mind is an emergency order the CBOT issued in July 1989, requiring a trading firm to liquidate its positions in soybean futures, as the Exchange believed the firm was attempting to corner the market. This order was issued on behalf of all participants in order to preserve the integrity of the CBOT’s markets. Like any tough decision, this one was not popular with everyone, and one result was a lawsuit that lasted nearly 13 years. I am glad to say that the CBOT was vindicated last year, when an appeals court ruled in the Exchange’s favor, stating that the CBOT acted to facilitate futures trading in the market. This final ruling demonstrates the CBOT’s commitment to uphold the highest standards of market integrity and our determination to protect our markets – even at great cost – from those who misuse them. It also illustrates how critical market oversight can be in maintaining the international reputation of a global futures exchange.
TRANSPARENCY
The final element that I believe has driven success for futures exchanges around the world is transparency. In a transparent market, the flow of information is constant and equally accessible to all. Transparent markets draw all profiles of users, because participants know they each have the same opportunity to compete for existing bids and offers. Ultimately, transparency creates strong, viable and fair marketplaces. This is good for the entire industry, because it encourages overall confidence and increased trading of our markets.
Moving forward, we are likely to see expanded participation in Asian derivatives markets, particularly if international expectations for connectivity, standardization, reliable clearing practices, effective market oversight and transparency are met across this vast marketplace.
As long as Asian exchanges continue to promote foreign participation in their markets, I believe that a few trends could emerge:
- Tax burdens placed on foreign participants in Asian markets will likely be reduced.
- More trading firms will likely set up offices throughout Asia, increasing the amount of trading between various Asian countries and their respective marketplaces.
- We also could see a proliferation of risk management products targeted toward foreign investors, including more futures based on financial instruments.
Certainly, there are many well-founded concerns that might encourage a slow transition to allowing full participation of foreigners in some overseas markets. However, you need only look at the experiences of exchanges like the CBOT, which began as a regional grain exchange and has expanded into a global leader, to understand the benefits of broad market participation. Opening a marketplace to international participation has great potential to build liquidity, diversify the products and services an exchange offers, and spur volume growth. Ultimately, international participation helps an exchange meet the needs of its customers, which as I mentioned at the very beginning of my remarks, is the number one priority for all of us.
Thank you again to the FIA for inviting me to speak with you today.
