Post on 17-Dec-2015
FUTURES & OPTIONS
Shayna Hutchins, Nermin Jasani, Regina Malta, & Kim Thrun
Agenda
What are Futures & Options? Regina
Current Regulation Kim
Exchanges vs. Over-The-Counter Shayna
Clearing Houses Shayna
SEC vs. CFTC Nermin
Other Proposed Regulations Nermin
F&O in BRIC Countries Regina
The Original Futures Market
The futures/forward market began in the mid-19th century with the establishment of central grain markets
Farmers could sell their products either for immediate delivery (spot market or cash market) or for forward delivery
Trading began with floor trading of traditional commodities such as grains, meat, and livestock
Forward and Futures Contracts Forward contracts were private contracts between
buyers and sellers and eventually evolved into today’s futures contracts
Both forward contracts and futures contracts are legal agreements to buy or sell an asset on a specific date
Forward contracts are negotiated directly between a buyer and a seller and settlement terms vary from contract to contract
A futures contract is facilitated through an exchange, and is standardized according to quality, quantity, delivery date, and place The only remaining variable to be determined is price
Although some futures contracts result in the actual delivery of the asset, others require cash settlement in lieu of delivery Most futures contracts are liquidated before they are delivered
Today’s Futures Market
Today exchange traded futures have expanded to include metals, energies (crude oil, gasoline heating, natural gas and oil), currencies (U.S. and foreign), interest rates, equity indexes (U.S. and foreign), and treasuries
The majority of trades are now made electronically, but are still made on the floor of the exchange
At any moment some traders are willing to buy and other traders are willing to sell, making the futures market very efficient
Oversight of Futures Contracts In order to ensure the integrity of the
market, all futures contracts are reviewed by the Commodity Futures Trading Commission (“CFTC”)
The contract must comply with the requirements of the Commodity Exchange Act and the CFTC’s regulations
The CFTC conducts daily market surveillance, and can order specific action to be taken to ensure the financial and market integrity of the exchange
Who Trades Futures?
Most of the trades made in the futures markets are done by hedgers or speculators
Hedgers Use the futures markets to reduce their exposure to
adverse price movements by transferring their risk to others Their goal is long term price certainty
Include agricultural companies, mining firms, banks and others that want to protect themselves against rising prices of products that they need to sell
Other hedgers are manufacturers, food processing companies, financial firms and others that want to protect themselves against rising prices of products that they need to buy
Who Trades Futures?
Speculators Include hedge fund managers, banks,
proprietary trading firms and individual traders
They accept price risk in the hope that they will profit from correctly anticipating the market’s price movement and direction
What are Options?
The holder of the futures option gives them the right, but not the obligation, to buy or sell a futures contract at a specific price, called the strike price or exercise price
The reason why someone would buy an option is because they think that the price of the futures contract will be higher or lower in the future
Types of Options
Call Option Gives the holder the right to buy the futures
contract at the strike price If you think that the price of the futures contract
will be higher in the future then you would purchase a call option
Put Option Gives the holder the right to sell the futures
contract at the strike price If you think that the price of the futures contract
will be lower in the future then you would purchase a put option
Options Pricing & Maturity
The price paid for the option is called a premium
Options have an expiration date If the option is an American Option you can
exercise the option on any day up until the expiration date
If the option is a European Option it is only exercisable on the expiration date
FUTURES & OPTIONS:CURRENT
REGULATION
Kim Thrun
Federal Regulation
Commodity Exchange Act (CEA) (1974) Creates and defines role of Commodity Futures
Trading Commission Authorized creation of National Futures
Associations Significantly amended by: Commodity Futures
Modernization Act of 2000 Fundamental aim of regulation
Help protect market users and the public from fraud and manipulation and to ensure fair and orderly markets
Important Historical Regulations & Legislation
1981 CFTC requires exchanges to set speculative position
limits in all futures contracts in reaction to the attempt by William Herbert and Nelson Hunt to corner the silver market
1991 CFTC grants a “bona fide hedging” exemption which
allows hedgers with a legitimate business commodity to not be constrained by positional Limits
2000 Commodity Futures Modernization Act, exempts most
OTC derivatives from regulation (this provision coined ‘the Enron Loophole’)
Eventually blamed for contributing to the meltdown of the US financial markets
Federal Regulation
Commodity Futures Modernization Act of 2000 (CFMA) Amended the CEA Excluded trading of most OTC financial derivatives and
transactions between sophisticated counterparties (i.e. eligible contract participants & excluded commodities)
Exclusion of hybrid instruments that are chiefly securities (Predominance Test)
Repealed the ban on single-stock futures & implemented regulations for the products
Created a three-tiered structure for the trading of derivatives that distinguishes among markets based on the types of contracts traded and the sophistication of the market participants.
Regulating Bodies
Commodity Futures Trading Commission (CFTC) Regulates all US futures Exchanges
Exclusive jurisdiction over contracts for the sale of an asset for future delivery and options on such contracts
Growth of the Futures Market and Financial Derivatives have tested this exclusive jurisdiction & Futures/Securities regulation line became muddied
1981: Shad-Johnson Accord/Futures Trading Act of 1982
Regulatory Agency with the power seek Criminal Prosecution by the DOJ
Senate and House Agricultural Committees oversees the CFTC
Executive Structure: 5 Commissioners, elected to 5 year terms by the President,
with advice and consent of the Senate, President designates one to serve as Chairman, with confirmation from the senate
Regulating Bodies
National Futures Association (NFA) Congressionally authorized self-regulatory organization subject to
CFTC oversight Individuals and firms that engage in futures business with the
public are required to be members of NFA : Futures Commission Merchants Introducing Brokers, Commodity Trading
Advisors, and Commodity Pool Operators Responsible for registration as required by the CFTC, including
exchange floor brokers and traders Brokers and Traders must be separately licensed to trade in
commodities Regulates – The Parties: protect investors from fraud – mediation
and arbitration for consumer complaints The Exchange
Sets own requirements and rules, similar to the stock-exchanges Violation of Exchange Rules can result in fines, suspension, or
expulsion
Clearing Organizations
Clearing Organizations Entity that clears and settles futures and
derivatives transactions Also, assures the proper conduct of each
contract’s delivery procedures and the adequate financing of trading
May be a division of a particular exchange, an affiliate, or a freestanding entity
Required to register with the CFTC in order to clear transactions
Ongoing compliance with 14 core principles
Intermediaries
In general, intermediaries must register with the CFTC
Subject to a wide range of disclosure, reporting, recordkeeping, and ethical requirements, depending on the nature of their activities
Futures Commission Merchants (FCM) Introducing Brokers Commodity Pool Operators Commodity Trading Advisers Floor Brokers and Floor Traders
Risk-Based Tier Structure Regulations
Multi-tiered approach to oversight based on the nature of the underlying commodity, the participants trading, and the manner of the trade
Market Categories Designated Contract Markets Derivatives transaction execution facilities, and Exempt markets
Product Categories: Excluded Commodities Exempt Commodities Agricultural Commodities
Excluded Commodities
Financial Commodities Interest rates, currency prices, credit rating, debt instrument;
any economic or commercial index other than a narrow-based commodity index or commodities that have no cash market
Not susceptible to price manipulation because of large scale No cash market
Commodities are called excluded because they are not subject to regulation if they are (1) between Eligible Contract Participants and (2) are not traded on an official trading facility
Because many of these products are large in scale, such as derivatives on economic indicators or weather, they are considered beyond the influence of interested investors
Exempt Commodities
Definition: “The term “exempt commodity” means a commodity that is not an excluded commodity or an agricultural commodity.” 7 U.S.C.A § 1a
Primarily metals and energy commodities This is the provision referred to as the “Enron
loophole” – recently closed: Farm Bill HR 2419 (2007) The transaction in the exempt commodity must be
entered into (1) between Eligible Contract Participants an not traded on a Trading Facility or (2) between Eligible Commercial Entities on a principal-to-principal basis through an Electronic Trading Facility
Still subject to fraud and manipulation provisions
Agricultural Commodities
All derivatives based on farm commodities must be traded on a CTFC-regulated exchange Concerns about price manipulation
Readily identifiable cash market Limited Supply Significant Price Discovery function
Eligible Contract Participants Eligible Contract Participants
Whether a transaction qualifies for an exclusion under the CFMA often depends on whether the transaction is between “Eligible Contract Participants”
Based on regulated status or amount of assets Financial Institutions Insurance Companies Investment Companies Commodity pools with assets over $5 million Business that (1) has assets over $10 million, (2) transactions are guaranteed by another eligible
contract participant, OR (3) if the transaction related to the business, the businesses net worth is over $1 million
Employee benefit plans with over $5 million and have investment decisions made by independent advisers
Government entities that (1) transact with other eligible contract participants (2) own and invest on a discretionary basis over $25 million, OR (3) regularly enter into transactions with respect to the underlying commodity
Broker-Dealers Futures Commission merchants Individuals with total assets over $10 million – or $5 million when the transaction involves risk
management Any other person determined eligible by the CFTC Those acting on behalf of an Eligible Contract Participant
Eligible Commercial Entity An Eligible Contract Participant OR other entity approved by the CFTC
Designated Contract Markets (DCMs)
Highest Level of CFTC Regulatory Oversight Characteristics:
The traditional organized futures exchanges or boards of trade – physical or electronic
Offer the widest range of products – essentially on any type of asset, index, or instrument
Open to all types of market participants: institutional & retail Regulations:
Exchanges must apply for the DCM designation. Qualifications: the ability to prevent market manipulation, rules to
ensure fair and equitable trading, rules for operation of the trade execution facility, financial integrity of transactions, public access to rules and contract specifications, and the ability to obtain the information necessary to perform required functions.
Must demonstrate ongoing compliance with the 18 established principles
Exempt Commercial Markets/Electronic Trading Facilities
Least Regulated by the CFMA – exempt from most requirements of the CEA (except still subject to antifraud and manipulation provisions)
Highest Restrictions on the types of commodities that may be traded and who may participate – Exempt Commodities on a Principal-to-Principal Basis between Eligible Commercial Entities Metals & Energy
Must notify the CFTC of the intention to operate within the exemption
No clearing requirement, but many choose to have/provide a clearing function
Generally – these are the platforms for the trading of OTC derivatives
Regulation of Electronic Trading Facilities/Exempt Commercial Markets
This is the market where the “Enron loophole” allowed energy companies to trade without positional limits – recently limited: Farm Bill HR 2419 (2007) Amended CEA, providing for the CFTC regulation of Electronic
Trading Facilities that offer “significant price discovery contracts” in commodities Price Discovery: The process of determining the price level for a
commodity based on supply and demand conditions. Price discovery may occur in a futures market or cash market.
Essentially, if the supply and demand functions serve to determine the price of the underlying commodity or contract, or effect other market prices
Can happen when the ECM’s prices are routinely disseminated or quoted
If the contract meets any of the criteria, the electronic trading facility becomes subject to exchange-like regulation, meaning the facility will have to comply with exchange-like regulation
Price Discovery, Hedging, & Speculation
Price Discovery is an important function of the Futures Market – by influencing demand and supply for futures contracts the price is determined – transparency is important in this respect
Economically, Futures Trading is a zero-sum game for participants – someone wins and someone looses Fundamentally, hedgers may be “happy” to lose because this loss is
the cost of the insurance function Default is less likely when futures are used in an insurance function Also – in this respect, futures provide stability in a volatile market
Speculation also plays an important role in the market While hedgers come to the market to alleviate risk, speculators come
to the market to take on that risk Often compared to gambling because phenomenal fortunes have been
made and lost CFMA has provisions that preempt state laws that would classify futures as
gambling Speculation , while often evoking a negative connotation, actually adds
liquidity to the market
Speculation
Competition among speculators provides an efficient market – moves closer to the prefect competition model: liquidity in the market drives down spreads Allows hedging to occur at a lower price and alleviates
much of the counterparty search problems Information is incorporated swiftly and leads to
efficient price discovery Reason why stock-index futures are attractive, they
move in tandem with the underlying stocks and are cheaper to buy and have a lower tax structure in some cases
Extreme efficiency is demonstrated – stock-index prices often change before the underlying stock prices do
Speculation – Negative Aspects Speculation can cause prices to deviate from the intrinsic
value if speculators are trading on misinformation Speculation can lead to the Creation Positive Feedback
Loop – (Creation of an Economic Bubble): price rises due to speculation can cause further speculative purchasing
Too many speculators demanding push the price of the underlying commodity upwards Blamed for recent (2007-2008) increases in food and oil
prices Change in traditional producer-consumer hedging transaction
to current producer/consumer/speculator-speculator is blamed for causing unnatural multiples in the market (market much larger than necessary to successfully hedge) *
Fueled by non-delivery settlement – not required to deliver the underlying commodity
Convergence-demand effects
Importance of Closing the Loophole Fundamental Fairness Ability of Regulators and the Market to
Stop/Regulate Bubbles
Regulations
Margin Regulations Futures Contract
Initial usually around 5% to 15% based on volatility Maintenance usually 75% of the Initial Mark to Market rule does not apply to Hedging Transactions Margin rules differ across the various option exchanges: For the Chicago Board of Trade and the Chicago Mercantile Exchange,
the Futures margin is determined by the SPAN margining system, which takes into account all positions in a customer’s portfolio
Standardized Contracts Type, Quality, Quantity
Non-delivery settlement Until 2000, futures transaction were required to occur on
registered or regulated exchanges – off-exchange trading of futures were banned NOW: Risk-based tiered approach to regulation
New Regulations
Greater transparency in Exempt Markets Including Intercontinental Exchange (an ECM) contracts in the
Commitments of Traders Reports “The Commitments of Traders (COT) reports provide a breakdown of
each Tuesday’s open interest for market reports in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC.” - http://www.cftc.gov/marketreports/commitmentsoftraders/index.htm
Regulation of off-shore contracts based on US products CFTC & UK Financial Services Authority reach a deal to tighten
oversight of energy markets Raised Capital standards for commodity brokers & requiring
firms to incorporate OTC derivatives positions into their risk-based capital calculations (CFTC rules finalized Dec 31)
Consequences for Failure to Follow Regulations
Violation of the NFA rules of professional ethics and conduct, failure to comply with financial and recordkeeping requirements – Can result in a permanent bar from engaging in any futures-related business
FUTURES & OPTIONS:EXCHANGES VS. OVER-THE-COUNTERCLEARING HOUSES
Shayna Hutchins
Exchanges
Futures Contracts Standardized
Underlying asset Contract size/units Place Maturity Counterparty
Contracts between intermediaries, separate buyer and seller
Deliver to the exchange, not to a specific party Used for short term hedging
Exchanges
Party 1Corn Farmer
ExchangeCBOT
Party 2Ethanol
Producer
CME Group CME – Chicago Mercantile Exchange CBOT – Chicago Board of Trade NYMEX – New York Mercantile Exchange
CBOE – Chicago Board Options Exchange
Over-The-Counter Markets
Forward Contracts Individually tailored to a particular risk Direct contract between buyer and seller Prices derived from exchanges
Price discovery on exchanges keep OTC markets and forward contracts in line with futures prices
Good for hedging against long-term investments Ex) Stream of foreign currency
Over-The-Counter Markets
Party 1Corn Farmer
Party 2Ethanol Producer
Broker
Exchanges vs. Over-The-Counter
Exchanges High liquidity High transparency Low risk
OTC More flexible Low liquidity Low transparency* Higher counterparty
risk* High risk
Problems with OTC Markets
Transparency Availability of information
Price, volume, contracting parties Evaluating and managing risk
Counterparty credit risk default risk Systemic risk
Interconnections and contracts between firms The Domino Effect
The Domino Effect
Speculator
Corn Farmer
Corn
Farmer Ethano
l Produc
er
Corn Farmer
Kellog’
sSpeculat
or
Orville
Problems with OTC Markets
Counterparty risk OTCs deal with counterparty risk by setting
privately negotiated collateral requirements Not standardized Doesn’t take credit risk or exposure into account Because no transparency/availability of information Difficult to evaluate
Actual risk depends on actual deals being done Possibility of certain firms cornering the market
Market Concentration Creates systemic risk
Market Concentration (OTC)
Orville Redenbach
er
Ethanol Producer
Corn
Farmer
(seller)
Livestock Farmer
Kellog’s
Market Concentration (Exchange)
Orville Redenbach
er
Ethanol Producer
Corn
Farmer
(seller)
Livestock Farmer
Kellog’s
Speculator
Hedger
Proposed Solution: Centralized Clearing
When OTC markets become large enough to significantly impact the overall financial system, they need to have centralized clearing in order to aggregate the information on outstanding deals and risk exposures for the benefit of regulatory authorities and other market participants
3 different types of central clearing offer different levels of market integration
and transparency
Types of Centralized Clearing 1. Deals Registry
Most basic arrangement Registry of deals in which counterparties report
trades Public disclosure of trading information Leads to more accurate pricing and safer
collateral requirements Creates incentive for sellers to limit risk exposure Investors, regulators, and financial institutions
can better analyze and hedge “true” risk Reduce systemic risk
Types of Centralized Clearing 2. Clearing House as Central Counterparty
Stronger form of clearing Takes on the role of counterparty and guarantor of
all contracts Similar to clearing house for a formal exchange
Deals are still individually negotiated, but are then split into 2 separate contracts and required to be registered with the clearing house in the middle of the transaction
Clearing house sets standardized margin requirements for all contracts
Still offers access to multiple trading platforms
Types of Centralized Clearing 3. Formal Exchange
Strongest and most centralized form of market organization
High transparency Offers highly visible prices and volumes
Allows broad market participation Minimizes counterparty risk through standardized
margins and contract guarantees supported by the capital of both the clearing house and independent market makers
Creates problem of standardizing complex instruments Not a one-size-fits-all solution Compromises flexibility of the contracts
High cost of setting up and running an exchange Not suitable for thinly traded instruments
Policy Recommendations
Trade disclosure to promote transparency Balance information with confidential trading
strategies Centralized organization
Assume role of counterparty and guarantee trades
Reduces risk and increases transparency Importance of non-standardized instruments Compromise: Clearing House as Central
Counterparty is the favored solution
Clearing Houses
Acts as an intermediary between buyer and seller Guarantees both buyers and sellers will
receive what they’ve contracted for Seller doesn’t have to worry about financial
stability of buyer Buyer doesn’t have to worry about product
of sellerParty 1Corn
Farmer
Firm 1Local Agri. Bank
Clearing House
Firm 2JP
Morgan
Party 2Ethanol Producer
Clearing Houses: Risk Minimization Margin requirements
Amount due varies based on market fluctuations Clearing house tallies up daily trades/contracts Mark to market daily Parties holding contracts that have fallen during the day are
required to pay the clearing house a sort of security deposit “Margin calls” Investors must be able to fulfill immediately
When the contracts are closed out at maturity, the clearing house pays the parties who contracts have gained in value
Futures trading is a zero-sum game: for every winner, someone loses an equal amount Ensures that risk associated with highest possible cost of closing
out a contract the next exchange day is completely covered Assumes most unfavorable change in the market of the positions
held
Clearing Houses: Risk Minimization Additional security measures
Instead of standing between 2 traders, the clearing house stands between 2 member firms
Each firm monitors its own customers and makes margin calls when necessary If a customer can’t fulfill the margin call, the firm closes
the account, sells off the positions, and may take a loss Firms pay attention to the credit of their customers Clearing house pays attention to the credit of the
firms Clearing house will only have to make good on a
trade if the losses are so great that the firm itself fails
Public vs. Private Clearing Houses Public Option
Government run May be more highly monitored Possibility of a government run monopoly
Private Option Used in Europe as a profit making business
Many institutional banks operate their own clearing houses
Each exchange in the U.S. has its own clearing house
Possibility of high fees injected into the OTC market Risky because they need to turn a profit
The Future of F&O Markets
Academic debate No current proposed regulation to set up
a mandatory clearing house for futures and options
Current action on clearing houses for derivatives Played a larger role in the financial crisis Viewed as riskier instruments
Wait-and-see approach
A Caveat: Where does the risk go?
Transfer of risk from banks to clearing houses
Either option will have to be backed by the government and has the possibility of becoming a “too-big-to-fail” institution if it is the sole clearing house
Option of creating multiple clearing houses that are in competition with one another
Competition can fuel risky behavior
Final Thoughts
Is this idea an example of the herding effect?
Does it create another moral hazard by passing off risk?
Party 1Corn
Farmer
Firm 1Local Agri. Bank
Clearing House
Firm 2JP
Morgan
Party 2Ethanol Producer
FUTURES & OPTIONS:THE SEC AND THE CFTCOTHER PROPOSED REGULATIONS
Nermin Jasani
Merging the SEC and CFTC
Why merge the SEC and the CFTC? Mainly because there is overlap between
both organizations with respect to products like OTC derivatives and their function in regulating the futures market and the stock market
What are the benefits of a merger?
Allow both the CFTC and the SEC to share information and prevent a future financial breakdown
Stronger oversight Eliminating turf wars Reducing delays in launching derivatives Eliminates the overlap Save on government expenditure with the SEC
and CFTC – proposed CFTC budget for 2010 is $177.7 million, and the proposed SEC budget for 2010 is $1.13 billion
Why shouldn’t they merge?
Merging them would be inefficient – SEC’s function to level the playing field, and CFTC’s function of hedging risk
Time consuming for Congress to re-write both the SEC and CFTC regulation
If there was a merger, SEC’s policies would prevail over the CFTC’s, which would be unsuccessful in regulating the futures market
Will the SEC and CFTC actually merge, or is this simply coffee talk?
Not anytime soon, they may merge some of their activities, but a complete merger is unlikely anytime soon
September 2009 – Geithner stated that he does not plan on merging these regulators, and it is not a priority
The House Bill and Senate Bill mention nothing about merging these regulators
Politics - Senate Agricultural Committee is unlikely to relinquish its power
Regulations proposed by CFTC to regulate F&O
POSITION LIMITS
What are position limits? Position limits are created for the purpose of maintaining
stable and fair markets. Contracts held by one individual investor with different brokers may be combined in order to gauge accurately the level of control held by one party
Purpose of position limits? Reducing volatility in the markets Reduce speculation Increasing transparency with respect to actual demand Limiting the number of futures/options contracts that one
party can hold – preventing corner’s in the market
Limits on energy futures and options
What includes “energy”? Natural gas, heating oil, crude oil and gasoline
Why have energy as the first position limit imposed by the CFTC? Increased energy prices in summer 2008 led Congress to
believe that energy traders were driving up the cost of energy This position limit is intended to reveal what actual demand for
energy is, which will provide a more accurate price for energy CFTC estimated that if the limit were adopted today a trader
could hold no more than 98,200 contracts of crude oil Will there be any exemptions for energy position limits?
Airlines and other companies who are hedging for business purposes will receive an exemption for this requirement
Will there be additional position limits?
CFTC is having a meeting on metals in March to begin discussing positional limits
H.R. 4173
What does the House bill have with respect to futures and options? Taxing futures and options transactions
Purpose of the tax? Fund the CFTC
Flaws of this proposed tax? Drive trading to less regulated and less
transparent markets (overseas), severely curtail market-making activity, and drive up the costs of hedging price risks
H.R. 4173
Requires the CFTC to establish hard limits on commodity trading both on and off exchanges
Already seeing it in the form of position limits
Forcing the SEC and CFTC to work together in creating rule-making authority. If they do not meet statutory deadlines, the Treasury will prescribe the rules. This threat is intended to force these agencies to work together, for once.
H.R. 4173
Futures Held in a Portfolio Margin Securities Account Protection: The bill attempts to extend SIPC insurance
to futures positions held in a customer portfolio margining account under a program approved by the SEC.
Regulating the foreign exchange market
Forex limits: Leverage in retail forex customer accounts would
be subject to a 10-to-1 limitation, which means 10:1 leverage would be the maximum amount allowed for forex traders in the U.S.
This means that before you can purchase a lot of say 100k yen, you have to have a higher margin – i.e. pay 10k instead of 1k as a margin requirement.
Disadvantages – traders are not fond of increasing the margin requirements, which will reduce their yield; already discussing moving to off shore sources.
Flash orders in the options world Reducing flash orders in the options world:
While most attention has focused on flash trading on stock exchanges, such practices appear to be more prevalent on options exchanges, according to industry participants. On options exchanges, flash orders commonly go by different names, such as "step-up" orders.
High-frequency traders have increasingly been moving into the slower options-trading universe, traders say.
Hybrid Agency Liaison mechanism. Trades that go to the CBOE, which accounts for about one-third of all option-trading volume, can be frozen for about one-tenth of a second. That brief moment gives other traders on the exchange the opportunity to match the order at the national best bid offer, or NBBO, before it routes to another venue.
Other possible regulation
Treat futures like stocks and increase their transparency as the SEC requires
Heavier fines
Activity in F&O Markets
Total options trading volume for 2009 was 3,612,637,118 contracts. This surpasses 2008’s record year by 0.84
percent which saw 3,582,572,581 total options contracts change hands
Options Premium: $1.22 trillion, down from $1.9 trillion in 2008 as prices to buy options came down from the peaks seen at the height of the financial crisis
2009: total futures 587,977,047 2008: total futures 825,544,634
FUTURES & OPTIONS:EMERGING MARKETS(BRIC COUNTRIES)
Regina Malta
Futures in Emerging Markets BRAZIL
Exchanges: Brazilian Mercantile and Futures Exchange
(BMF) RUSSIA
Exchanges: Moscow Interbank Currency Exchange
(MICEX) Futures and Options RTS (Russian Trading
System) (FORTS)
Futures in Emerging Markets INDIA
Exchanges National Stock Exchange of India (NSE) Bombay Stock Exchange (BSE) Multi Commodity Exchange of India (MCX) National Multi Commodity Exchange of India
(NMCE) National Commodity and Derivatives Exchange
(NCDEX)
Futures in Emerging Markets CHINA
Exchanges: Dalian Commodity Exchange (DCE) Shanghai Futures Exchange (SHFE) Zhengzhou Commodity Exchange (ZCE) China Financial Futures Exchange (CFFEX)
Brazil: F&O Markets
Derivatives trading in Brazil began in 1917 on an exchange Most of the trades were in coffee and cotton
In 1997the three main derivatives exchanges merged to form a single exchange called the Brazilian Mercantile Futures Exchange (BMF)
Today, Brazil offers futures trading through both organized exchanges and over-the-counter (OTC) markets
The most actively traded futures contract in Brazil is the Interbank Deposits (DI) futures
Brazil: F&O Markets
The two main exchanges in Brazil are the BMF the Bovespa (Brazil’s stock and options exchange) The BMF is a self regulatory organization
The BMF derivatives exchange, located in Sao Paulo, is the 5th largest futures exchange in the world
The BMF decided to go public in 2007 and conducted an IPO
The Bovespa exchange, also located in Sao Paulo, is the 7th largest futures and options exchange in the world The Bovespa mostly trades options on single stocks and
options on stock indexes Both the BMF and the Bovespa offer electronic trading
Brazil: Clearing Houses
Clearing houses are used to clear exchanged traded futures contracts and also OTC traded derivatives (voluntary). The clearing house becomes the counterparty to every contract traded, and therefore fully assumes the credit risk of the contract.
The clearing house has AAA ratings because they are highly capitalized. Investors post collateral directly with the clearing house.
The clearing house has five-levels of capitalization which assures greater credit protection. 1. Customer margin2. The firm which brokered the trade.3. Clearing member to whom the broker is tied.4. Special Fund of Clearing Members.5. The BMF itself.
Margin requirements provide the greatest defense against contract default. Currently there are no collateral requirements in the OTC market, so most
transactions end up operating with no collateral at all, unless the parties chose to use the BMF clearing house.
The BMF clearing house has its own bank in order to facilitate the settlement and overall payment of the transaction conducted.
Brazil: OTC Markets
OTC markets are usually not very transparent due to lack of regulation on reporting and disclosure requirements. Brazil has established some reporting requirements for OTC markets trading. In order to be considered legally enforceable, every transaction must be reported to one of two central registration and confirmation organizations- the BMF or CETIP.
Because of the reporting requirements in the OTC market, Brazil has the most transparent OTC market in the world.
There are about 15-20 dealers in Brazil’s OTC derivatives market.
Unlike most markets, inter-dealer market transactions are conducted through the BMF instead of through OTC transactions. They then provide derivative instruments to their buys in OTC market. The result being that the markets are more interconnected and reduced credit exposure.
Brazil’s futures market allows for the price discovery for the real-dollar exchange rate and the interest rate.
Brazil: Hedging
One of the most important features of the market is that it allows for hedging the fluctuations in domestic market interest rates This is so important because Brazil has a
past history with very high inflation and high nominal interest rates
Hedging is also used to comply with environmental climate change requirements, by trading carbon futures contracts
Russia: F&O Markets
FORTS (Futures and Options on RTS) is the leading derivative market in Russia
Open Join Stock Company “Russian Trading System” Stock Exchange organizes trading on the FORTS exchange in Russia The clearing function for the derivative market is performed by the
Closed Joint Stock Company “RTS Clearing Center” FORTS is mostly run by the leading Russian brokerages and
investment banks Participants in the FORTS market are highly capitalized
investment companies and banks The range of futures contracts traded on FORTS is narrow
Futures contracts traded on the FORTS consists of the shares and bonds issued by major Russian companies, RTS Index, foreign currency, the average MosIBOR overnight rate, and MosPrime 3month rate
The commodities traded include Urals oil, gas oil, gold, silver, and sugar.
Russia: To Develop or Not to Develop?
The main reason for the underdevelopment of the Russian derivative market can be traced to the legal risk associated with the lack of regulation in the market
In the beginning Russian courts refused to recognize net payouts as a legal contract, and therefore they were unenforceable In 2007 these contracts were made enforceable provided that at
least one of the parties involved in the transaction is a Russian bank or a recognized participant of the market
Although this solved part of the problem, a huge reason why the Russian market is still having trouble expanding is that they are unfamiliar with the concept of close-out, or liquidation netting.
In 2009 after much debate, Russia finally a set of standard derivative contracts. The posting of collateral was also introduced. Although this was a big step forward in growing the Russian derivatives market, it is unclear how the participants will react to the new system.
India: F&O Markets
Futures Markets evolved in India in 1875 with the opening of the Bombay Cotton Trade Association Ltd.
The earliest futures contracts traded were groundnut, castor seed, and cotton
Futures trading in oilseeds soon followed In 1945 the East India Jute and Hessian
Ltd. was formed to conduct organized trading in both raw Jute and Jute goods
India: F&O Markets
In December 1952 Forwards Contract Regulation Act was enacted, which provided for a 3-tier regulatory system: An association recognized by the government to provide
recommendations to the Forwards Market Commission Forwards Markets Commission. Central Government
The Forward Contract Regulation Rules were established by the Central Government in 1954. The rules divided commodities into 3 categories based on the extent of regulation: Commodities under which futures trading can be organized under a
recognized association Commodities in which futures trading is prohibited “Free Commodities” which do not fall under the first two categories.
The association trading these commodities must obtain a Certificate of Registration from the Forward Markets Commission
India: Futures Market Re-Emerges Trading was pretty much halted altogether in the
1970s Futures trading was slowly reintroduced in the 1980s In 1991 the Government of India liberalized industries
in both the domestic and external sectors. Soon after another Committee was introduced to help expand the futures market
The Committee recommended futures trading in: Basmati Rice, Cotton and Kapas, Raw Jute and Jute Goods,
Groundnut, Rapeseed/mustard seed, cotton seed, sesame seed, sunflower seed, safflower seed, copra and soybean, and oils, Rice bran oil, Castor oil, Linseed, Silver, and Onions
India: Futures Market Re-Emerges Today, there are no restrictions on futures
trading in any commodity However, options trading in commodities are
prohibited Futures contracts are available in 1month,
2month, and 3month terms, and are settled on the last Thursday of every month Contracts are traded in lot sizes.
The Securities and Exchange Board of India also overlooks the activities of the Futures market, as well as the stock market
China: F&O Markets
Futures trading was first introduced in 1990 Futures trading in China is governed by the Administrative
Regulations on Futures Trading The China Securities Regulatory Commission, part of the State
Counsel Securities Commission, is the main policy implementation body
The China Futures Association (CFA) was established in 2000 to promote market development The CFA is a non-profit self regulatory organization. The CFA is
supervised by the China Securities Regulatory Commission. The authority of the CFA lies in its collective members which
include: brokerage firms, futures exchange special members and licensed individual futures traders
The CFA acts as a bridge between the futures market participants and the Government of China It implements laws, regulations and policies for the futures market,
while also maintaining the transparency and fairness of the market
China: Futures Exchanges
A futures exchange can be organized as either a membership organization or a corporation
China currently offers futures contracts in 19 commodities, with various new contracts being proposed
There is no futures option trading Chinese futures exchanges are required by law to enforce futures
margins requirements, price limits, position limits, large account position reporting requirement, risk reserve requirement, etc.
There are 165 futures brokerage companies in China. Companies that participate in the futures market must have their
clients sign a risk disclosure document with a client agreement and must also deposit futures margin requirement before starting to trade. These companies are also responsible for completing delivery procedures on behalf of their clients.
In 2009 the China Futures Association reported a futures trading volume of 130.51 trillion yuan, up 81.5% from the past year The largest trades were in copper, natural rubber and soybean oil.
QUESTIONS?
Shayna Hutchins, Nermin Jasani, Regina Malta, & Kim Thrun
FUTURES & OPTIONS