Issues in Derivatives

Transcription

1 Competition between securities trading platforms Issues in Derivatives M.4267 Deutsche Börse/Euronext BIICL workshop, London, 27/2/2007 Disclaimer: This presentation reflects only the views of its author. It may not be taken to represent any view, express or implied, on the part of the European Commission. NOT FOR CITATION

2 Structure of Presentation I. Market definition II. III. IV. Qualitative product characteristics Demand-side substitution Supply-side substitution Horizontal issues Competition in (quasi-)identical goods Competition in differentiated goods Innovation markets Barriers to entry Vertical issues V. Conclusions 2

3 Foreword These reflections are based on issues raised in a preliminary market investigation in a case that was withdrawn before the end of Phase I. They are therefore necessarily inconclusive and not intended to state or imply either any likely conclusion in that case or any precedent for the future. 3

4 I.1 What is an Exchange-traded Derivative (ETD)? A standardized contract created, managed and monitored by the exchange (discrete strike dates, strike prices and fixed contract terms incl for settlement) CCP is counterparty to the contract over its whole lifetime Position can be closed out at any time on exchange Some market data 4

5 Growth of ETD volumes Monthly derivatives trading volume on Liffe, Oct 82 - Oct ,000,000 90,000,000 80,000,000 70,000,000 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000, /82 11/84 08/87 05/90 01/93 10/95 07/98 04/01 01/04 10/06 07/09 Source: Euronext.liffe 5

6 Growth in ETD trading by trade value Monthly value traded on Liffe, billion, Oct 82 - Oct 06 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5, /82 11/84 08/87 05/90 01/93 10/95 07/98 04/01 01/04 10/06 07/09 Source: Euronext.liffe Since 1998, growth +75% relative to OTC IR+equity derivatives (note: comparison of open interest statistics misleading, because of netting on exchange) 6

7 New contract introductions Eurex product introductions <- EUREX/DTB New contract introductions on CME, CME -> Sources: Deutsche Börse, CME 7

8 Growth in value traded per contract Value traded per contract, bn, Liffe Introduction of single stock options Source: Euronext.liffe 8

9 Conclusions as to market dynamics Exponential market growth (+33.4% in values p.a.) Exponential growth in new contract introductions More than constant year-on-year growth in volumes on existing contracts Growing faster than the corresponding OTC market (+75% in 2005 relative to 1998) Very high ROCE High barriers to entry (see later) Very attractive market to be in 9

10 ETDs vs OTC ETDs Reduced search and contracting costs Possibility of algorithmic & arbitrage trading Trade anonymity Reduction in counterparty risk Post-trade processing efficiencies (trade confirmation, clearing, settlement, cashflow and collateral management) Contracts under exchange rules Access to a wider group of customers whose credit standing excludes them from OTC Exit at any time at fair market value not bound to initial counterparty (particularly when trading for non-hedging purposes) Assumption of best execution Investment firm bylaws Multilateral margin netting Corporate action adjustments Hedge OTC structured derivatives OTC Block trades with more limited market impact Non-standard strike dates and terms Non-standard settlement and other contract specifications Tailor-made / structured hedges More suited to wholesale environment 10

11 But the picture is a little less clear The term «OTC» is ambiguous Non-exchange electronic trading platforms Exchange-run platforms that take up at trade confirmation stage (Bclear) and afterwards treat as exchange product, including margin offset 11

12 I.2 Demand-side substitution Synthetic positions usually not cost-effective However : Euribor packs and bundles Competition for mobile capital Imperfect hedges (basis risk vs liquidity) eg EuroMTS index future vs Bund future; different stock indices; strike dates Futures vs options Warrants Derivative vs cash (LTIR)? OTC market is also offering demand-side substitutes (closer aligned on basis risk but more illiquid) => competition in product characteristics? => monopolist would risk cannibalizing existing revenues? Conclusion: demand-side substitution seems to work for some applications and some asset classes, full picture however is intrinsically difficult to construct. 12

13 I.3 Supply-side substitution An exchange with a similar client base may be able to launch a competing product within a few months to a year But network barriers to entry mean this is NOT true of providers of similar services in general, therefore that we cannot simply broaden the product market based on supplyside considerations For derivatives on particular asset classes, supply-side substitution might widen the product market Liffe is certainly better placed than other exchanges to compete with Eurex in instances where supply-side substitution might be considered; it may be uniquely placed to do so. 13

14 II.1 Head-to-head competition Liffe vs Eurex French and Dutch equity options, soon to add UK equity and gilt derivatives Single stock futures Less successful but still attempted: EONIA FTSEurofirst index No fungibility in clearing, contract must still be closed out on the exchange where it was entered into Eurex US / CBOT and Liffe / CME 14

15 II.3 Dynamic competition Product innovation Significant investment in new product design Demand for new products Race to market? Technology and service innovation Link between system performance and liquidity New services such as BClear 15

16 Merger impact on innovation Negative factors : Less pressure to get to market? Loss of potentially cannibalizing product innovations Loss of service competition : costly with fewer benefits Limited ability for competitors to enter the market and launch alternatives (see next slide) Monopsony power vis-à-vis external innovators Positive factors : Merging of client base (present degree of overlap?) Post-innovation monopoly rents vs IP leakage (Schumpeterian argument) Economies of scope in innovation VI may avoid double marginalization of innovation profits and investment coordination problem 16

17 III. Barriers to entry Economies of scope (trading back office, collateral) Network effects (presence of those you wish to trade with on the same platform) Economies of scale, however several players already present realize sufficiently Liquidity (where s the exit?) Regulatory requirements and spill-overs Access to clearing, VI may exacerbate 17

18 US entry? General barriers to entry as above SEC-regulated exchanges are impaired by legislation CME/CBOT : No history of competition in European products (but they do sell US products to European customers) Organic growth opportunities domestically and in emerging markets «Large trader reporting» rule No tech advantage Contestability may be asymmetric Coordinated effects post-merger 18

19 IV. Vertical aspects Foreclosure of competition in trading? Loss of competition in clearing? OCC model (imposed fungibility) // dynamic effects? CBOT -> CME Clearing (avoided fungibility) Relaxation of OTC constraint and heightening of barriers to entry? With or without elimination of competition in clearing? 19

20 V. Conclusions Combination raised difficult issues of : Product market definition Horizontal overlaps Dynamic efficiencies / inefficiencies Possible vertical issues Possible remedies Notification was withdrawn, so impossible to investigate further Similar issues are also likely to be raised in respect of the CME/CBOT combination which is currently under review at the DOJ 20