The competition worldwide is getting cutthroat. In order to have any chance at competing in this global environment, U.S. exchanges have had to look toward consolidation in order to survive the monolithic power of mergers like the NYSE Euronext and the aggressive move by Eurex to enter the U.S. market. While this activity looks exciting on the surface, the move of the big fish to eat the little fish leads to many casualties. The floor brokers and traders are clearly seen as being impacted by these consolidation moves, which are driving the markets to become electronically traded, but all of the support staff is being adversely affected as well, many of whom have been doing their jobs for years with little prospect of being properly retooled and retrained at this point.
The most high-profile merger of commodities exchanges has been the CME and CBOT merger. This merger has brought together under one roof the United States’ two oldest exchanges. The combined power of these two exchanges will allow the CME Group to compete in today’s new environment. It will be able to reduce costs, transition to electronic trading, and use the might of the merged exchanges’ combined capital to acquire competitors, like NYMEX, and to increase its ownership position in joint venture partners, like the Singapore Exchange (SGX).
From humble beginnings, the CME and the CBOT not only have made themselves relevant for the twenty-first century, but they also are considered serious players. Smaller exchanges, such as the Kansas City Board of Trade and the Minneapolis Grain Exchange, will find it difficult to continue their exchange life quietly and without disruption. There is no doubt that in the near future they will be absorbed in some form or fashion in order to stay competitive.
Critical Worldwide Commodity Exchanges
At an unprecedented speed since the 1990s, futures exchanges have been popping up around the world in the most unlikely places. From China and India, both countries that banned futures in the 1950s, to places like Dubai, futures exchanges are exploding. This worldwide growth in the development of the commodities markets has been a major contributing factor to the global renaissance in commodity prices. As countries all over the world begin to use the futures markets as a form of price discovery, disparities in the value of goods around the world quickly begin to dissipate. Large profit margins, which were once the domain of aggressive importers and exporters willing to traverse the world to find bargains, are becoming more difficult to find as electronic markets are linked up around the world.
In China there are two prominent commodity exchanges. There is the Dalian Commodity Exchange and the Shanghai Futures Exchange. They each comprise 50 percent of the Chinese marketplace in terms of dollar volumes in trading. In the Dalian exchange alone the total trading volume for 2007 reached U.S. $1.67 trillion. The Futures Industry Association recently reported that the Dalian exchange has been the dominant futures exchange for the past eight years. With only 110,000 investors in a nation of 1 billion people and a growing middle class, the Dalian exchange is poised to be the largest exchange in the world. Currently, the exchange has been limited to trading soybeans, soy meal, soy oil, corn, palm oil, and linear low-density polyethene. These limits have been put in place by the Chinese government in large part to control the rampant fraud and unscrupulous behavior that existed in the early years of the reintroduction of commodity trading in China. The Dalian Commodity Exchange has stated on its web site that it intends to release a hog/pork belly futures contract, a coal futures contract, and a commodity index futures contract within 2008. The Dalian exchange also plans to launch options on its actively traded soybean and corn futures contracts.
The only question is “What took them so long?” Dubai, one of the jewel cities of the United Arab Emirates, has finally established its own gold, commodities, and energy exchanges. With only 6 percent of its revenue generated from oil, Dubai has a long history of encouraging free trade in the region. With multiple free trade zones in media, technology, and manufacturing, Dubai is one of the most ethnically diverse and business-friendly cities in the world. Established in 2005, the Dubai Gold and Commodities Exchange is fast becoming one of the region’s most important exchanges. Located right in the middle between Europe and the East, this exchange helps provide for the continuous trading that a 24-hour marketplace needs in order to thrive. As of this writing, the market trades in gold, silver, euro, British pound, Japanese yen, Indian rupee, and fuel oil futures. The exchange is expected to develop product offerings in steel, jet fuel, and cotton.
A second exchange, the Dubai Mercantile Exchange, is set to be the first energy exchange of the Middle East. Created as a joint venture of Tatweer, NYMEX, and the Oman Investment Fund, it is poised to be an international competitive powerhouse for the region.
The Multi Commodity Exchange (MCX) is extending its footprint across the globe. While operating an exchange in India, it is also a significant partner of the Dubai Gold and Commodities Exchange. Based in Mumbai, the exchange has taken a policy of working with both the spot and futures markets in key agricultural products. This has led it to retaining 72 percent of India’s market share. With India being the number one importer of gold worldwide and currently importing over 3,000 tons of silver annually, it is not surprising that MCX ranks number one and number three in silver and gold futures trading. Couple that with India’s consumption of 2.4 million barrels of oil a day (according to www.cia.gov), and it is no wonder that MCX is number two in the world for natural gas futures contracts and number three for crude oil futures.
The Brazilian Mercantile and Futures Exchange (BM&F) is the fourth largest exchange in the world, according to the Futures Industry Association. It is also the number one exchange of Latin America. With an average daily volume of 1 million contracts and its recent partnership agreement with the CME Group, the exchange is poised to play a significant role in all of North America. Without a doubt it is a major player in the futures market, providing futures contracts on gold, feeder cattle, live cattle, arabica coffee, robusta coffee, cotton, crystal sugar, corn, and soybeans.
Dalian Commodity Exchange, Shanghai Futures Exchange, Dubai Mercantile Exchange, NYMEX, Oman Investment Fund, Multi Commodity Exchange, MCX, Brazilian Mercantile and Futures Exchange, BM&F
What Does This Mean for the Market?
With the constant merger of exchanges from around the world, new and more interesting products are constantly being created. There is a greater effect of settling commodity prices in China or Brazil and how they impact the opening of commodity prices in India or the United States. The rules and regulations for stocks, commodities, and indexes quickly become the concern of an international marketplace.
Various forms of trading and contract types that are considered over-the-counter in one country, that may be illegal in another, and that may be caught in limbo in yet another country are still owned by the same corporation. This brave new trading environment leads both to a world of opportunity and to a world of land mines and problems, both legally and logistically.
As the CME Group aggressively begins to flex its financial muscle in the acquisition arena, industry operators become increasingly skeptical and worried about the implications of a monolithic, all-encompassing exchange. The CME Group, NYSE Euronext, the U.S. Futures Exchange (formerly Eurex US), and ICE face a multitude of hurdles in offering their exchange and clearing services. Banks and industry experts are wising up to the consolidation efforts. They are beginning to see that the concentration of both clearing and exchange services may lead to higher pricing for them in the long run.
Where once before traders could rely on competition to minimize their transactional costs, it has become apparent that when one group owns 10 percent in one exchange, owns 35 percent of another exchange, and is about to acquire another, the competition that allowed them to search for the best price possible is slowly evaporating. Add to the simmering rebellion from the banking and brokerage community the fact that many of these acquisitions involve exchanges that were once involved exclusively in either stocks or futures, but rarely both, a recipe for disaster is on the horizon. So while the push to merge and develop one worldwide electronic exchange is an inevitable conclusion to all of this activity, the regulators are light-years behind in how best to operate in this cross-border community.
New products are constantly being developed all across the globe, and either various rules and regulations will have to be adjusted to accommodate them or a whole generation of regulators will need to be retrained in their auditing duties. Cash markets all around the world are being affected by stock and commodity exchanges in far-flung regions simultaneously using price discovery to determine the true value of various underlying assets. In this environment, a growing schism of what activity is acceptable or not acceptable and what regulator or regulators have jurisdiction over what is happening is on the horizon.
A prime example of this regulatory schism is the contracts for difference (CFDs) and the single-stock futures (SSFs) fiasco that occurred in the United States. An antiquated law, the Shad-Johnson Accord, separated the joint efforts of the stock and futures markets for almost two decades. By the time the Commodity Futures Modernization Act of 2000 had kicked in to allow SSF trading, the rest of the world had already passed it by. Currently South Africa hosts the world’s largest SSF exchange at 700,000 contracts daily, which dwarfs the 26,000 contracts traded by the last SSF exchange in the United States, OneChicago.
In contrast, CFDs are experiencing tremendous growth. They are utilized in at least 12 different countries, with more countries joining daily. Unfortunately, since the U.S. Securities and Exchange Commission maintains strict regulations on OTC trading of financial instruments, the products cannot be offered in the United States, although traders outside the country can purchase CFDs of U.S. companies and indexes. How U.S. regulators will react to the pan-global commodity exchanges that will want to increase revenues by offering CFDs to their customer base is unknown, but the question will arise a lot sooner than later.