Risk Markets And Politics

Monday, May 29, 2006

Effective spreads

Chris Masse and JC Kommer agree that traders' demand for liquidity destines futures markets towards monopoly, and that once a market is entrenched, it's almost impossible for another exchange to successfully launch a competing contract. JC Kommer, however, offers a possible counter-example in which Eurex managed to steal away the bund future from LIFFE, and points-out that it was only able to do so because of "technology". Eurex is an electronic platform whereas LIFFE was committed to open outcry floor trading. Degree of transparency has an effect on liquidity, and is an important issue in the competition between futures markets. Physical open outcry markets may be very deep, but lack of transparency can cause effective bid-ask spreads to widen. Floor traders who work side-by-side on a daily basis have quite a "bandwidth" advantage versus traders submitting orders remotely. (Official trading fees could make a difference too, but exchanges that have captured a market should have pricing power anyway.)

These kinds of concerns strongly apply to NYMEX, whose website has for some time begrudgingly proclaimed that "evolution is inevitable". Among US futures exchanges, NYMEX has been the most die-hard in support of floor trading. This stance was the main reason cited when merger talks collapsed with the CME in January. Days later, the largest NYMEX clearing firm initiated legal action against ICE, claiming they had engaged in anticompetitive behavior. Meanwhile, CME seemed poised to launch its own energy contracts, and rumors swirled that the Chicago exchange had takeover interest in ICE. Then, suddenly, in early April, NYMEX and the CME agreed that NYMEX energy and metal contracts would be listed on Globex, the CME's electronic platform. The Globex agreement marked a capitulation of sorts by the New York exchange, but a good one, as the pact staved off competition from both rivals. NYMEX seems to have benefited from the example of the LIFFE/Eurex bund contract. Now some are saying that ICE is increasingly "out in the cold". Others are speculating that ICE might have interest in acquiring or competing with the LME, which is the last European futures exchange to retain a trading floor.

While we're on the subject of liquidity and network effects, one hesitates to say anything at this very early stage, but the lack of trading in the first week of CME's housing futures was surprisingly low. Granted, it was hardly the best week for liquidity and the kind of risk-seeking that would encourage bids, but it seems like more interest on both sides should have been lined-up ahead of the markets' opening day. Here is a good Futuresource link to track the daily activity of all the contracts.

2 Comments:

  • I am part of a recent battle for an extablished market, a battle that we lost very publically.

    What to make of the cash currency market in this framework? The CME has just teamed up to provide a common clearing for this market, and this may be the support it needs to do this. What I can't understand is why Eurex hasn't leveraged its advantage to do something similar and on a far larger scale with clearstream.

    By Blogger Mickslam, at 3:41 PM  

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