The Land of the Rising Sun is finding itself in a sort of shadow when it comes to futures trading. It is surrounded by go-go economies and countries with vibrant derivative industries that are pushing ahead while Japan’s industry -- and economy -- struggle.
To its west is Korea, with the Korean Exchange (KRX), home to the most actively traded options product in the world. The Kospi 200 options trades on average 11 million contracts a day. No doubt that will continue to grow as the KRX is planning to go viral with it later this year. In March, the KRX announced that the contract would be traded on Eurex in Europe during off hours in Korea. In a sort of Rube Goldberg technical wonder, the KRX and Eurex will be trading the Kospi 200 options nearly all day, transferring contracts to the other each day at the end of each trading period.
Further west is the leviathan known as China, which has moved into a market-based economy with the speed of a cheetah. Despite its on-again/off-again sometimes too hot to handle derivatives exchanges, the potential coming from this giant could overshadow anything else in Asia for decades to come. Already the Shanghai Futures Exchange leads in former Japanese staples: rubber and base metals, while its cousins, the Dalian Commodity Exchange and Zhengzhou Commodity Exchange have captured the soybean complex markets and sugar.
Southwest of Japan is Taiwan, which has aggressively pushed the growth of its exchange, the Taifex, which houses the Taiex stock index options, the fifth largest stock index options product in the world, trading about 286,000 contracts a day.
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Beyond the Himalayas lies India, where financial products have gained a foothold with the National Stock Exchange’s Nifty 50 contract, one of the top four contracts in the world in terms of volume of all stock index futures products. Linking with the CME Group and another Asian engine, Singapore, and its exchange, the NSE’s growth -- at least in the financial arena -- promises to continue. The Singapore Exchange (SGX) has always been international, and with its relatively new CEO Magnus Bocker, whose OMX pedigree gives him intricate technology knowledge, the exchange and its commodity-based sister, the Singapore Commodity Exchange, have promise for a resurgence.
Japan has another worry with Singapore: its tax rules and regulations are attractive to many Japanese traders who have moved there, set up shop and developed a colony of talent.
None of the above is to say the derivatives industry in Japan is dead. After all, the Osaka Securities Exchange’s Nikki 225 mini futures contract trades more than 400,000 contracts daily, making it one of the most popular in the world. Although its larger contract competes nose to nose with the Singapore contract in volume, it actually is twice the size of the SGX contract.
Elsewhere, the Tokyo Financial Exchange’s (TFE) three-month euroyen trades over 50,000 contracts a day, making it one of the most active short term interest rate contracts in the world, while the TFE’s suite of currency contracts trade in some cases more than 60,000 contracts a day. In fact, the decision to move to trade these products over-the-counter is said to have saved the exchange.
Although there is much to be done in growing the financial business in Japan, that side isn’t the problem; it’s commodities that struggle. That’s perhaps surprising, as Japan is credited with giving birth to the futures markets. However, due to questionable practices, stringent regulations or just the lack of size in the business, commodities trading in Japan is at a crossroads, which could force mergers of exchanges that 10 years ago were unthinkable.
Around the world, blending the financials and commodities on one exchange isn’t ground breaking. In most of the developed countries, these products are on the same exchange or are owned by the same parent. But in Japan, which has taken baby steps to evolve its derivatives business, placing of these seemingly apple and orange communities is a breakthrough. For it not only would mean the merger of two areas that have remained separated for decades, it would mean a realignment of the regulators. Today, Japan still has three regulators. For commodities, there are the Ministry of Economy, Trade and Industry (METI) and Ministry of Agriculture, Forestry & Fisheries. For financials, it is the Financial Services Agency, which regulates the securities and other financials.
The commodities industry in Japan, with double-digit percentage volume drops the past two years, has gotten so weak, even the regulators know something needs to change. Tadashi Ezaki, president and CEO of the Tokyo Commodity Exchange (Tocom), understands his challenges. He points out the reality he lives with: Tocom had record volumes in 2003-2004, and since then, volumes have dropped to a third of what they were (in 2009, almost 29 million contracts traded on the exchange). He recognizes his competitors, especially in the Asian world, all have grown dramatically while Tocom deteriorated. His main objective, he says, is to stem the flow. He says there are three key reasons why his competitors have done better: ease and accessibility with faster technology, Japan’s revision in the legal framework in customer protection, which has been good for the retail trader but not so much for the professional, and Tocom’s list of products seems not as attractive as other exchanges.
His plan for recovery includes the new computer system that uses the Nasdaq platform, speeding up trading and hopefully attracting those algo and high frequency traders exchanges woo. He also wants to add remote memberships, allowing U.S. traders direct access (a “no-action” letter is in the process). Next he wants higher position limits for investment trusts to be able to trade on the exchange, and finally, he’s planning on extending trading hours. Last year, Tocom introduced a night session until 11 p.m. Tokyo time to grab some European interest, and they are looking to expand it further, to 4:30 a.m.
Metals contracts are the cornerstone of the exchange -- it boasts the most active gold contracts in the region -- but Ezaki seeks to grow an energy suite of products. He also hopes the rubber contract can rebound. But he looks to the launch of the Nikkei Commodity Index, which is made up of all products listed at Tocom in conjunction with the OSE, as something that will aid the exchange and bring new players into the fold. Finally he hopes the SPAN introduction in June will bring Tocom to the forefront in global trading and risk management.
But something might happen before he can realize his plans: with the move of ending the separation of commodities and financial exchanges, no doubt one of Tocom’s larger financial relatives will make a run at the exchange. The OSE might make a more attractive match for Tocom, as they’ve already paired on some products including exchange-traded funds on metals and the commodity index. However, the Tokyo Stock Exchange has worked with Tocom on an emission contract.
With the synergy of combining exchanges, it’s possible Japan’s commodities industry has seen its darkest days. New blood in terms of members, as well as newly merged exchanges, could be Japan’s best hope in recapturing some of its past glory. Japan may be an island, but it is amidst a burgeoning archipelago of countries that have rewritten the rules, making Asia the fastest growing region in the world. Attention must be paid.