Foo-shiung Ho used to be in charge of getting Asians to trade on the Chicago Board of Trade (CBOT). Now, as head of the Taiwan Futures Exchange (Taifex), he’s one of a dozen or so Asian exchange bosses trying to bring American trading volume to Taiwan, Hong Kong, Singapore, South Korea —— and even Japan and Sydney.
No easy task, as Far East exchanges don’t have the marketing budgets of American and European exchanges and have a greater regulatory burden. But those obstacles have melted as everyone, it seems, discovered the world outside their own. Retail-dominated exchanges are suddenly courting institutional traders, and institutional exchanges are bending over backwards to meet the needs of the little guys.
Exchanges in smaller markets need foreign trading business to make up for paltry domestic populations. Some of them could almost be described as benign parasites living off mainland Chinese products trading offshore — a niche that will evaporate when China finally opens for real. Despite such obstacles, the Korean Exchange’s (KFX) Kospi 200 index options remain the world’s most actively-traded contract, with volume of more than 2 million round-turns per day. Though often dismissed for its low notional value, the Kospi is also a good example of how the mechanisms that enable Asian exchanges to build heavy volume from sources close to home have so far failed to build the kind of global user networks these markets seem destined to enjoy.
WHO MARKETS THE MARKETS?
“There is a key structural difference between Asia and the United States or Europe, and it has to do with how an exchange’s products are marketed,” says Bucky Isaacson, a California business consultant and former commodity trade advisor (CTA) who now acts as a liaison between American and Asian businesses. “In Asia, the FCMs (futures commission merchants) market the exchanges’ products, but in the United States and Europe, the exchanges market their product themselves, while the FCMs market access to that product.”
Towards that end, several Korean FCMs have begun to build a base of U.S. business, even as the Kospi remains off-limits to American retail traders. Korean giant Woori Investment & Securities recently set up a U.S. hub to handle hedge fund business, and Good Morning Shinhan Securities provides execution in Korea for several U.S. hedge funds. Michael Sung-Soo Kim oversees Good Morning’s America project. A native of Korea, he attended high school in Pennsylvania and then landed a job at Refco in Chicago. “I add value by knowing both the U.S. and Korean regulatory regimes, and by advising Korean regulators,” he says, adding that roughly half the company’s customers come from the United States, most of them hedge funds and CTAs, with 30% coming from Europe and the rest from the Pacific Rim.
RETAIL-FRIENDLY
Except for Japan, which is evolving out of three distinct regulatory regimes, and Australia, regulators in Pacific Rim countries can be described as retail-friendly but institution-adverse. Most East Asian regulators became allergic to foreign institutions in 1998, when hot speculative funds swept into and then out of South East Asia. To prevent a repeat, regulators implemented a flurry of stifling reforms. Chief among them: bans on FCMs opening omnibus accounts; bans on speculation by foreigners; tight position reporting requirements for institutions; and hefty “transaction taxes” on futures contracts.
All the countries surveyed, with the exception of Australia, have either overhauled their regulatory regimes or are undergoing that process to lure more institutional business. For now, however, retail traders account for between 65% and 85% of volume in the Asian market. While that could be viewed as a sign of popularity, it also indicates speculative excess — echoing developments in India and China, where speculation drives markets devoid of hedging.
Fred Grede, former head of the Hong Kong Exchange (HKEx) and now an independent consultant who also represents the Futures Industry Association (FIA) in Asia, sounded the alarm years ago. Now, however, he says more and more sophisticated players are entering the market.
“When I left the Hong Kong exchange in the 90s, three of the top 10 customers were arcades, while virtually none of the volume was coming from money managers,” he says. “Now we are seeing more understanding of the larger economic benefits among users and among regulators as well.” Most Asian exchanges, with the notable exception of the Singapore Exchange (SGX), have been electronic since the mid 1990s, but many failed to upgrade their systems until recently.
Prior to this past year, many Asian platforms couldn’t communicate with independent graphic user interfaces or proprietary trading systems. And why should they have? With position limits commonly set at between 5,000 and 10,000 contracts, the kinds of users who would have demanded such functionality in the late 1990s weren’t in the market.
It’s a different story in Japan, where commodity futures are just beginning to be taken seriously, and where financial futures and securities exchanges are just beginning to take retail traders seriously. The growth of the retail segment was a driver on the Tokyo Stock Exchange’s (TSE) high-profile glitches in late January and early February.
A quick glance at volume figures shows not a dramatic surge in volume, but rather a gradual rise in volume driven by a surge in the number of small trades by online retail traders.
A similar change in market composition slowed reaction times at the Osaka Stock Exchange (OSE), but the OSE ordered a new trading system from technology giant Hitachi before any major glitches occurred. Growing retail demand is also leading to an explosion of liquidity providers, some reputable and some not. “There are hundreds, if not thousands of dark horses who could emerge as the Asian Jack Carl or Lind-Waldock,” Grede says. “There are brokerages you’ve never heard of...giants in hibernation.”
REGIONAL ROUNDUP
The Asia Pacific markets certainly have their similarities, but every country or republic or region we’ve touched on here is progressing in its own unique way. Korea’s Kofex, for example, merged with the Korean Stock Exchange to form the Korean Exchange (KFX) early last year, and KFX is in the process of organizing a public offering. “The securities and derivatives systems are not yet integrated,” Kim says. “Everyone hopes the public offering will fix that.”
In March, the Korean government finally brought its disclosure regime into line with that of the United States, meaning American retail traders may be able to trade Kospi products by year-end. Some fear an influx of foreign capital and competition will steamroll smaller Korean banks, leaving a handful of major players, such as Daewoo, Samsung, and Hyundai, as well as a gaggle of newcomers at the top of the roost. To smoothen that transition, the country is putting the finishing touches on its Capital Market Consolidation Act, which is designed to enable Korean firms to compete on the world stage and to make it possible for Korean banks to participate in a more diverse range of financial instruments.
Meanwhile, commissions on the Kospi 200 are lower than ever, thanks to a ferocious bidding war on incoming traffic. In Kong Kong, however, the growth seems all to be on the cash side.
“Hong Kong has no appetite for derivatives,” says Mark Ho, head of Phillips Commodities there. “Although the stamp duty on cash stocks favors the futures, the low position limit (10,000 contracts on Hang Seng) is a deterrent to institutions.”
Grede says, “They are especially impacted by the hangover from ’98. On position limits, for example, their restrictions are absolute: nobody can exceed them. Even someone who owns a large portfolio of stocks traded in Hong Kong can’t adequately hedge this because of very strong restrictions on the derivatives markets.”
China, however is set to issue guidelines for mainland brokerages looking to do futures in Hong Kong, which should bring more volume to the Hang Seng futures and options. In Taiwan, a slew of reforms have allowed omnibus trading, reduced the infamous transaction tax (still 0.01% of notional value for futures), and lifted the ban on foreign speculation.
Foo has launched an ambitious plan to triple the percentage of volume coming from outside the country, which last year was just 5%. In February, JP Morgan became the first foreign broker in Taiwan to provide clearing services on Taifex, and at least four other FCMs are lined up to follow suit. Despite that monster surcharge, which comes to about $12 per round-turn, Taifex has posted a few million-contract days, and looks set to deliver more positive surprises.
Singapore’s stock exchange (SES) and futures exchange (Simex) merged in 1999, and have been ahead of the curve on several fronts since launching the mutual offset arrangement with the Chicago Mercantile Exchange (CME) in 1984, but it dragged its feet on the technology front, and that has hurt. Although that once lucrative trading link has been renewed, volumes slowed to a trickle with the advent of 24-hour electronic trading at the CME, leaving SGX with just one viable contract, the Nikkei 225.
“They have completed their technology upgrade and the challenge now is to find product,” Grede says. “Because of their size, they’ve been looking to other markets in the region for product offerings, which is why you see their listed products are either based on Taiwanese, Japanese or Indian underlying.” In December, the exchange announced details of a 50/50 joint venture with the CBOT to establish a commodities exchange called the Joint Asian Derivatives Exchange (JADE) targeted to launch later this year.
JAPAN RISES
The giant among the bunch is Japan. Whatever the country’s reputation for technology, its commodities markets were among the most cliquey and old-boy dominated on the planet until just a few short years ago. A fragmented regulatory regime banished the country’s commodity futures to a separate galaxy from its financial futures and securities markets, each of which also were — and largely remain — in their own separate regulatory silos.
As a result, commodities in Japan were seen as disreputable and dangerous gambling toys. The industry seemed intent on living up to its reputation, with a network of boiler room sales offices acting as a critical liquidity provider, and so-called clearing and settlement amounting to little more than ledger entries. But a wave of Young Turks like Himawari CX veteran, and now the head of FIA Japan, Yasuo Mogi pushed for and achieved revolutionary reforms in the commodities sector, with the Tokyo Commodity Exchange (Tocom) acting as the bulwark against corruption and provincialism.
Tocom’s energy complex quickly attracted bona fide hedging, and its gold contracts proved a draw to money from outside the country — largely from Australia but also from the
United States. As part of reforms instituted last May, exchanges can now accept U.S. dollar-denominated deposits for margin.
In 2004, Tocom launched the nation’s first true clearinghouse, the Japan Commodity Clearing House Co. Ltd (JCCH), while also reaching out to independent software vendors (ISV) and non-Japanese FCMs. Last May the government, with the full cooperation of the exchange, launched a crack-down on boiler rooms and initiated structural overhauls designed make the exchanges more appealing to money managers and sophisticated retail traders.
JCCH now clears trades for all of the country’s commodity exchanges, and Mogi says the Japanese system is even better for investors than the American model because customer funds are deposited directly with the JCCH, as opposed to segregated funds in a bank under the custodianship of a brokerage house as in the United States.
“Suddenly, I am seeing a tremendous increase of interest from large-scale institutions, particularly from overseas,” he says. “This has not yet translated into a huge jump in business, but that is now only a matter of time, which I was not confident enough to say just two years ago.”
In the short-term, the crack-down on retail boiler rooms has cost the commodity exchanges.
Tocom’s volume dropped nearly 20% last year, but exchange boss Michimasa Hamada says the long-term results of a properly-functioning marketplace dwarf the loss of dirty business and says the percentage of volume coming from abroad has tripled to 15% today from 5% three years ago.
Tocom also has experienced growing pains — most noticeably when gold prices surged there in December relative to world prices. That distortion has become a major focus of debate in Japan with general agreement that Tocom itself contributed to the event by failing to provide clear delivery guidelines for institutions, which suddenly stopped selling in the futures markets despite an apparently tremendous opportunity to arbitrage. But there’s another interpretation: that retail customers from local retail giants like Daiichi Commodities, which alone channeled orders totaling more than 150,000 buy contracts into the market, proved bigger in mass than the big guys in unison.
But the big guys are still the focus of most exchanges. This March, Tocom announced that early next year it will stop listing positions of individual members, and will instead only list net positions by category of investor — an obvious attempt to bring more institutional business to the exchange by offering the kind of anonymity those players demand.
Tocom also joined the Tokyo Grain Exchange (TGE) as a Commodity Futures Trading Commission-recognized self-regulatory body. It’s a nebulous position TGE has held for more than a decade, and the Central Japan Commodities Exchange (C-Com) hopes to join them in a couple of years. Tocom and C-Com, an energy powerhouse, have been offering New York Mercantile Exchange products in Japan, with Tocom grabbing the lion’s share of volume generated by that deal.
“The big story from an operational standpoint is the implementation of their common clearing organization last year,” says Grede. “Now they are beginning to allow more of the kinds of activity that the rest of the world is used to.”
Specifically, omnibus accounts and the ability to execute give-up trades, which the exchanges promise soon.
“We’re also seeing Japanese financial exchanges reaching out to retail traders,” says Grede. “You could almost say they were retail hostile before, with contract sizes too big for most retail traders, and Japanese retail brokers not at all keen on futures and options.”
The shift, says Mogi, is a knock-on effect of Tocom’s drive to legitimize the commodities markets, which has in turn made financial futures less of a big boy’s game. The OSE plans to offer a mini (1/10) version of the Nikkei 225 — and they say the new trade-matching system can handle the surge in volume. If not, a still-to-be-announced joint venture between OSE and Eurex could provide a more robust platform.
But the big surprise could come from C-Com, whose ferrous scrap metal contract has become a runner across Asia. The exchange now has 34 non-Japanese members, more than any other Japanese exchange. The bulk of those are bona fide hedgers, and the exchange has made no secret of its desire to become a regional, if not global, player. It has plenty of competitors, each of whom has built a place to come play. But will we come? Or have we already arrived?
