ClearPort powers ahead

In the year covered by FOW’s Awards, CME Group began clearing 60 over-the-counter electricity contracts through its OTC clearing house, CME ClearPort. They are day-ahead locational contracts, the first time these have been centrally cleared by an exchange.

The contracts are designed to give power and utilities firms liquidity and price transparency, when trading electricity in the very short term. They represent the market for energy 24 hours in advance of a given time in any day, and use locational nodes to allow commercial end-users in a given region to fine-tune their exposure at a particular place.

Responding to growing user demand (not to mention price volatility in the wholesale energy markets), CME’s latest additions mean the group now offers more than 200 short term electricity contracts.

By having these contracts cleared through ClearPort, users gain protection from counterparty credit risk as well as risk management options.

The continuing expansion of ClearPort’s services has never been more relevant to the wider derivatives market. ClearPort is now one of the leading exponents of clearing OTC derivatives – the third way between pure OTC and exchange-traded instruments that has emerged as a big winner from the regulatory upheavals caused by the financial crisis.

The fact that ClearPort and other clearing houses such as ICE can handle such complex and specific instruments in the energy markets could undermine the argument that only simple, standardised derivatives are suitable for clearing.

ClearPort now provides an interface where transactions can be posted and margin requirements calculated for more than 700 OTC contracts, most of which have no on-exchange equivalent. The clearing house has more than 10,000 members and clears about 500,000 contracts a day.

Judges gave CME credit for continuing to innovate to meet the needs of a volatile energy market. As one North American panellist put it: “You have to be pretty innovative in that space, but they’ve done it.”

Dividing Stoxx from dividends

Dividends paid by companies in the index can change the way it performs and create uncertainty. Index dividend swaps have become a popular way for investors to strip out this cashflow and make it tradable, helping their risk management and focus on fundamentals.

Eurex estimated in May 2009 that Eu1bn of such swaps were changing hands over the counter every day, as investors hedged out their dividend exposure or took on dividend risk as part of an investment strategy.

In June 2008 Eurex launched the first exchange-traded and centrally cleared version, its Dow Jones Euro Stoxx 50 Dividend Futures. Buy and sell side market participants can now trade dividend risk with all the ease, speed and cost advantages of an exchange environment.

NYSE Euronext has since followed with futures on the FTSE 100 Dividend Index in May 2009 and new dividend indices for the CAC 40 and AEX in July, which will later serve as underlyings for futures.

But if the headline index is as popular as Euro Stoxx 50 derivatives, investors will tend to sit up and take notice of innovations in the same field.

In September 2009, Eurex’s Euro Stoxx 50 Future was the world’s third most actively traded equity index derivative. The related option was fourth, and also has the highest open interest of any contract in this asset class, with 51m contracts.

The Dividend Futures are catching up, with steady growth in both volume and open interest. Some 286,000 contracts were traded in September, and more than 400,000 contracts of open interest.

A close second for this award was the Italian Derivatives Energy Exchange, launched in November 2008 by Borsa Italiana with the clearing house Cassa di Compensazione e Garantia.

Although Italy has a liquid spot market for electricity, IDEX is its first regulated power derivatives market, designed to enable power companies to hedge the risk deriving from volatile spot prices. It is cash-settled so as to attract financial players.

RTS catches the currency zeitgeist

RTS had hoped the euro/dollar and euro/rouble future, complementing its seven year old dollar/rouble future, would thrive as Russia’s international trade grew.

In the event, economic and market conditions at the time of the launch in February 2009 were dire – but unusually, that actually helped the product.

Since November 2008, Russia had let the rouble devalue gradually by 20% against its target basket of dollars and euros. The stress on Russia’s economy and currency produced great volatility in the rouble, which meant there was keen interest in hedging and betting on currencies.

The contracts were sized at €1,000 and launched at the European Central Bank’s exchange rates, with an initial margin of 4%.

Roman Goryunov, RTS’s chief executive, said at the time of the launch that the exchange’s primary target was investors hedging against risk. “With the help of currency and money products offered on Forts, investors can optimise their defensive strategy,” he said.

The contracts took off like rockets. Combined trading volume for the two on their first day in the market was 41,516 contracts, and by September, the euro/dollar future had reached a cumulative volume of 10.5m contracts, worth €10.5bn, over eight months.

Although in March and April it had actually out-traded the dollar/rouble future, by September it had settled into a pattern of trading about a third as much as the older contract.

That still made it the 11th most traded FX contract on the world’s derivatives exchanges, and the most active contract anywhere on a currency pair that does not include the exchange’s home currency.

The euro/rouble contract has smaller, but steady volumes of 30,000 to 100,000 trades a month.

Forts says around 70% of its forex transactions are made by individual investors – the combination of futures on rouble, euro and dollar offering excellent arbitrage opportunities.

Sowing the seeds of advanced equity investment

In November 2008 Nasdaq Dubai launched the first equity derivatives market in the United Arab Emirates, and the first offering multi-currency contracts in the Gulf Cooperation Council states.

Single stock futures on 20 firms from the United Arab Emirates are listed, as well as an index future based on the FTSE Nasdaq Dubai UAE 20, which rose by 54% over the first eight months of 2009.

The index constituents are chosen in conjunction with the UK’s FTSE, and include some of the Gulf’s largest firms, each of which meets liquidity, transparency and market capitalisation requirements.

The individual stocks are listed on the UAE’s three exchanges, the local Dubai Financial Market, the Abu Dhabi Securities Exchange and the international Nasdaq Dubai itself. Most of them are in the UAE 20.

The launch came the day after the Dubai International Financial Exchange rebranded itself as Nasdaq Dubai. Building the exchange from scratch had taken just under a year, an impressive achievement in a region in which the financial services industry is still developing.

Pushing ahead with the launch of a new bourse amid the worst recession for decades, and when some in the industry voiced doubts, is to be applauded. The resulting platform offers greater risk management scope for investors in the region, at a time of extreme market volatility.

The group sought regulatory approval from the Dubai Financial Services Authority, and Middle Eastern investment bank Arqaam Capital became its first derivatives trading member. Dublin-based Susquehanna International Services became the first market maker.

Since then, more brokers have asked to become trading and clearing members. Nasdaq Dubai has also engaged in an extensive education programme for investors and the media, using help from the US Options Industry Council and hiring a London Stock Exchange derivatives specialist to operate an order placing service for brokers.

By September 2009, monthly trading volumes were reaching 12,115 contracts, while 55,307 futures have been traded on the bourse since its launch.

The exchange’s strong progress paves the way for a more substantive equity derivatives market in the Gulf, as well as the launch of contracts based on other Middle Eastern indices.

Buoyed by another year of high commodity prices, exchanges around the world have been keen to offer new agricultural derivatives.

In January 2009, the Johannesburg Stock Exchange group reached an agreement with CME Group to offer a Chicago Corn Future and Option, based on the Chicago Board of Trade’s corn prices. Maize, known as corn in the US, is South Africa’s most important grain crop.

The contracts, which will be cash-settled, are traded on the Agricultural Products Division of JSE’s South African Futures Exchange (Safex), alongside existing South African wheat, maize, sunflower seed and soybean contracts. Safex, acquired by JSE in 2001, will offer the contracts in lots of 100 tonnes via its automated trading system.

The move will allow domestic producers to manage price risks more effectively, JSE suggests, and provide much-needed liquidity to domestic maize markets.

The contracts, though priced in rand, will allow growers greater access to the international markets, through the use of CBOT pricing. This could help them to spot short and long term cyclical price patterns, gain insight into future demand and price movements, and hedge against market volatility.

Interest from investors is said to be strong too, with arbitrage and spread opportunities between American corn and South African maize easily tradable through JSE’s electronic trading platform.

The contracts were an immediate success, with 175 traded on the first day, rising to 2,200 in the month of June, though volume has ebbed since.

By the end of September, a total of 12,400 contracts had been traded, representing 1.2m tonnes of corn – over a 10th of South Africa’s annual production. Open interest at the end of September is 55,000 tonnes.

At the time, Rod Gravelet-Blondin, senior general manager of commodities at JSE, said: “The success of this first collaboration bodes well for a long and fruitful relationship with the CME Group.”

Following the successful launch of the products, JSE and CME have since strengthened their ties by agreeing to list crude oil, gold and platinum futures on the African bourse. South Africa is the world’s largest platinum producer.

SGX's equity derivatives trainer contract

Singapore Exchange’s extended settlement contracts, launched at the end of February 2009, are unusual winners of an FOW Award in two ways.

First, they are traded on SGX’s Securities Trading market rather than its derivatives segment.

And second, they were launched not so much because they fulfil a need in their own right, but rather as an educational tool – a stepladder to help investors become acquainted with equity derivatives.

Singapore’s institutional investors have been asking for a wide array of equity derivatives with which to hedge – something that has been of keen interest during the past year of volatile trading.

But the strong local retail market is all about conventional buying and selling of shares for cash. Investors are not used to making up front payments and receiving delivery later. The only successful equity derivatives traded on the securities market are structured warrants, which do not require margining.

So SGX consulted the industry and decided to customise a standardised intermediate product to get people used to margin trading.

The result was extended settlement (ES) contracts. These are actually short term, physically delivered futures, and are legally classed as such. They are traded in sizes of 1,000 shares.

Instead of buying shares on a certain day and then having a three day trading and settlement period before getting the shares and handing over the money, the investor can enjoy a longer trading and settlement period, generally 35 days from listing.

In exchange for this, the investor makes a flexible margin payment based on the underlying stock’s historic price movements – fulfilling SGX’s main aim of getting investors used to margin-based products.

Until now, this kind of forward contract has only been available OTC, without the protections of trading on an exchange.

Buyers pay a performance bond in tiers of 5%, 10%, 15% and 20% or more, depending on the volatility of the underlying stock. In the spirit of flexibility, however, exchange members can raise the margin requirements above those prescribed by SGX.

The inaugural batch of 28 contracts was launched at the end of February 2009, and about S$22m were traded in the first two months.

SGX hopes later to introduce more complex products, such as single stock or equity index options.

Shelter from the heat

Back in 1999, CME was the first bourse to offer exchange-traded weather derivatives, beginning with American cities. Ten years on, CME has temperature-based derivatives for 45 global cities: 24 in the US, 10 in Europe, six in Canada, two in Japan – and, since February 2009, three in Australia.

The latest additions were Melbourne, Sydney and Brisbane, where CME has begun futures and options on a local index of degree days.

These derivatives allow buyers to hedge the extent to which the daily average temperature deviates from 18C, either up (cooling degree days) or down (heating degree days).

The listings, priced in Australian dollars, are available either for individual months or in seasonal strips for summer and winter.

They were introduced in response to the prolonged drought of 2003- 2007, in which average rainfall for much of South Australia fell to its lowest levels for over a century. This was exacerbated by a prolonged heat wave, in which average temperatures rose to levels not seen since the 1950s.

Air conditioner manufacturers might be crowing, but electricity utilities faced with unexpectedly high summer costs for wholesale energy certainly were not. Several of them approached CME last year, interested in the possibility of transferring risks associated with extreme weather patterns to the capital markets.

Other market players that face such risks include governments, insurance firms and the tourism industry.

In terms of risk management, weather derivatives offer producers and service providers an advantage over conventional insurance, which require the claimant to prove a loss of earnings.

But it is not simply about protecting against a loss; many Australian power companies use weather derivative products such as degree day futures simply to smooth earnings in the event of a hotter than expected summer or colder than expected winter, for instance.

Felix Carabello, CME Group’s director of alternative investment products, has pledged that the exchange will “continue to innovate” in the field of weather products.

Besides its temperature-based derivatives, CME has products used to hedge against risk from extreme weather events including snow, frost and hurricanes.

Tom Osborn +44 207 779 8361 tosborn@fow.com