CME Group’s 2017 acquisition of NEX highlighted the exchange giant’s desire to internationalize — an aspiration shared by other commodities exchanges in an age in which technology has expanded flows of goods and capital.
In seeking to grow their reach, however, exchanges have bumped up against paradoxes including mounting systemic risk in winner-take-all markets, the difficulty of internationalizing amid geopolitical disruptions, and the challenge of reconciling sophisticated derivatives markets with the on-the-ground realities of materials trading.
CME, the world’s largest exchange operator, suffered a three-hour outage two weeks ago owing to a technical error that halted trading in Treasuries, stock-futures and commodities. While volatility was minimal around the time of the outage, traders nonetheless characterized the event as “‘annoying’” and “‘frustrating’” and said the incident could weaken investor trust.
The outage followed a January incident in which CME-owned BrokerTec, the biggest Treasuries electronic trading platform, suffered an outage of more than an hour due to a technical issue.
Nevertheless, those events raise the specter of systemic risk in FICC — a seemingly inevitable outgrowth of the winner-take-all nature of liquidity-hungry derivatives markets.
Where futures are concerned, the outages also highlight the challenge inherent in offering global contracts. Nearly round-the-clock trading leaves exchanges with significantly more exposure to an outage — and less time for maintenance, testing, and upgrades — than the daytime trading schedule common to equities exchanges.
Escalating trade tensions between the US and all the other countries on planet Earth threaten the global relevance of existing futures contracts. When markets become disconnected, regional variance in commodities prices can increase.
Those differences create opportunities as well as risks for commodities exchanges, which can introduce new futures contracts with regional relevance. CME and ICE, the world’s two largest energy exchanges, introduced competing oil futures contracts in Houston late last year.
Those contracts seek to capitalize on a surge in US crude exports out of the southwestern port city on the back of an explosion in US shale oil production.
They also illustrate how disconnected markets can influence the introduction of new futures contracts. As US oil production has grown, the gap in price between West Texas Intermediate crude and Brent crude (which focuses on oil produced in the North Sea) has widened, demonstrating the existence of distinct markets.
The dynamics lending relevance to Houston-based oil futures contracts could have broader geopolitical implications as well. A recent International Energy Agency report suggests cheap US shale oil production will squeeze OPEC countries for at least five more years.
CME is meanwhile aiming to entice a wider audience of investors into trading futures by launching “Micro E-mini” futures linked to the the S&P 500, Nasdaq-100, Russell 2000, and DJIA. The contracts, a tenth the size of CME’s existing E-mini futures, will let active traders bet on equity markets “nearly 24 hours a day.”
Other exchanges are also introducing new futures contracts. The London Metals Exchange, which has lost market share to CME and the Shanghai Futures Exchange in recent years, launched seven new cash-settled futures contracts Monday in a bid to attract more business.
But while such offerings can boost revenues for commodities exchanges, they can also introduce market complexity and fragmentation, discouraging traders.
Exchanges can probably relate to that feeling. Where once they operated regionally in support of global flows of goods and capital, they’re now foraying into global operations to support regional trade flows — flipping the historical model on its head.
To manage internationalization under those conditions, they’ll need all the gadgets in their toolkits — “micro” and new futures contracts included — and likely some they haven’t thought up yet.
Administrative note: The Daily Brief will not contain a Curatia analysis on Friday, as we’ll be continuing to focus on enhancements to the news feed. We’ll return on Monday with bells on.