DEVELOPMENT OF EXCHANGE-TRADED DERIVATIVES MARKETS IN CENTRAL EUROPEAN COUNTRIES

Transcription

1 DEVELOPMENT OF EXCHANGE-TRADED DERIVATIVES MARKETS IN CENTRAL EUROPEAN COUNTRIES Iwona Sobol Institute of International Business, University of Gdansk, Armii Krajowej 119/121, Sopot, Poland, Abstract. Derivatives are instruments that are designed to help financial institutions, enterprises and individuals to take and manage their risks. During the last years their turnover grew so fast that their market has become the largest in the world. The aim of this paper is to analyse the development and the present state of exchange-traded derivatives markets in Central Europe. It must be noted that research deals only with former centrally-planned economies. This is the reason why there is nothing written about Prague. Hungarian and Polish exchange-traded derivatives markets are the most developed in the region. The factors that have contributed to the rapid growth of derivatives in those countries in recent years include: a greater focus on risk management, the growing comfort of retail and institutional investors in using derivatives and an accommodating regulatory environment. Keywords: derivatives, exchange market, Budapest Stock, Warsaw Stock. 1. Introduction Financial derivatives market is the largest and the fastest growing market in the world. In the situation of volatilities of interest rates, share prices and the adoption of floating exchange rates by most of the developed countries, the financial risks are inherent in activities of most of enterprises. The most effective way of managing those risks is using of derivatives. It is also necessary to add that derivatives are commonly used not only as tools of hedging, but also as tools of speculation and arbitrage. There are different definitions of derivatives. One of the most commonly used is that a derivative is an instrument the value of which is derived from the value of an underlying asset. There are two main kinds of underlying assets: commodities and financial instruments. Derivatives based on commodities have a very long history. They were already known a few hundred years ago. Their real development started when the first derivatives exchange, Chicago Board of Trade was established in At first the task of the exchange was to standardise the quantity and the quality of the grains. A few years later, the first -type contracts, called to arrive contracts were introduced. Currently, apart from agriculture products the most popular underlying commodities are: metals such as gold or copper and energy (oil, coal). But it is not the commodities derivatives that are currently the most popular instruments. The most traded derivatives are based on financial instruments such as: interest rates, foreign exchange rates, stock indices or equities. Their history is much shorter than the history of commodity derivatives. They have been present on the market since the beginning of the 1970s of the 20 th century when the system of Bretton Woods collapsed and floating exchange rates were introduced. The first exchange that launched financial derivatives was Chicago Mercantile. In 1972 it opened a separate pit for currency trading called International Monetary Market [1]. In the 70ies other American exchanges launched derivatives ( and options) based not only on exchange rates, but also interest rates and indices. The demand for new, sophisticated instruments was generated by the increasing volatility of interest rates, shares and other instruments prices. European exchanges launched derivatives in the 1980s. However until the middle of 1990s their share in the world market was insignificant. It was American exchanges such as Chicago Board of Trade, Chicago Board Options and Chicago Mercantile that dominated the market. At present, also other markets, including European exchanges Eurex and Euronext.liffe, belong to the largest derivatives markets in the world (Table 1). 308

2 Table 1. Top 10 exchanges with the highest and options volume in 2006 [2] Rank Trading volume (number of contracts) 1. Korea Eurex Chicago Mercantile Chicago Board of Trade 5. Euronext.liffe Chicago Board Options International Securities Sao Paulo Stock (Bovespa) 9. Bolsa de Mercadorias y Futuros 10. New York Mercantile Derivatives can be traded not only on organised exchanges but on over-the-counter market (OTC market) as well. OTC derivatives (forwards, swaps and some options) started to be extensively traded in the 1980s. They are privately negotiated and tailormade to suit the requirements of the parties involved. In contrary to OTC instruments, derivatives traded on exchanges are standardised when it comes to underlying assets, contract sizes and dates of settlement. As a result exchange-traded derivatives tend to be more liquid than OTC instruments. The default risk is lower in case of exchange-traded derivatives since a clearing house guarantees the fulfilment of the obligations arising from the transaction whereas for OTC derivatives, the exposure is to default by the counterparty. In Central European emerging economies derivatives as most of the financial instruments appeared in the 1990s after the change of political and economic system. The aim of this paper is to analyse the development and the present state of exchange-traded derivatives markets in Central Europe. Currently financial derivatives are traded on four exchanges in the region: Budapest Stock, Warsaw Stock, Warsaw Commodity and Prague Stock. That is why those markets are presented in the paper. The very important thing about the subject chosen is that it has not been researched deeply before. When it comes to the literature devoted to the derivatives, it mostly concerns the following issues: theoretical issues, such as definitions and types of financial risks, methods of risk management, valuation of derivatives, etc., application of derivatives in practice, market research (either global research or research mainly concentrated on the markets of developed countries). It is very uncommon however to find any international publications which deal with derivatives markets in different Central European countries. And this is one of the reasons why this paper has been prepared. The main methods applied while conducting the research include description and statistical data analyses. 2. Budapest Stock The first derivatives in Hungary, based on USD/HUF and DEM/HUF exchange rates, were launched by Budapest Commodity (BCE) in March Two years later in March 1995 derivatives were introduced by Budapest Stock (BSE). These were USD/HUF and DEM/HUF, index future on BUX (the index covering shares of Hungarian companies of the highest capitalisation and volume) and 3-month treasury bills [3]. Two main derivatives marketplaces in Hungary, BSE and BCE were going to merge in 2000 which could lead to the establishment of the internationally recognised, competitive exchange and could lower the transaction costs. The parties, however, were unable to reach a compromise and the plans to merge two institutions were postponed for a few years. Fortunately they were not completely abandoned and the integration of those two exchanges took place in As a result BCE was liquidated and derivatives listed on BCE were introduced by Budapest Stock. 28 of October 2005 was the last trading day on Budapest Commodity [4]. The integration of two main Hungarian centres of derivatives strengthened the exchangetraded derivatives market in Hungary and made BSE one of the main derivatives centres in Central Europe. It should also be noted that since 28 April 2004 when the demutualisation of the exchange took place Budapest Stock has been operated as a public company thus it should generate profits for its shareholders. Since May 2004 BSE has been controlled by a consortium of Hungarian and Austrian financial institutions. In November 2007 the main shareholders of the exchange were: UniCredit Bank Hungary Zrt. (25,20271 %), Wiener Börse AG (12, %) and Österreichische Kontrollbank AG (12, %) [5]. It is worth mentioning that Wiener Börse and Budapest Stock support establishing the federation of Central European exchanges. Collaboration of the exchanges in this region could contribute to the growth of their competitiveness on the European market and would enable them better meet global challenges. Derivatives represent a very important segment of BSE floor. In 2007 the following derivatives were listed on the exchange: currency, index on BUX, index on BUMIX (Budapest Stock Mid- and Small Companies Index), single stock, on 5-year treasury notes. 309

3 interest rate based on 1-, 3- and 6-month BUBOR, currency options, option on BUX index, single stock options. The exchange has an exceptionally wide range of currency derivatives. In November 2007 BSE offered on the following rates of exchange: EUR/HUF, USD/HUF, JPY/HUF, CHF/HUF, GBP/HUF, PLN/HUF, TRY/HUF, CZK/HUF, EUR/USD, EUR/JPY, EUR/CHF, EUR/GBP, EUR/TRY, EUR/RON, USD/JPY, USD/CHF, USD/TRY, USD/RON, GBP/USD, GBP/JPY, GBP/CHF, CHF/JPY, EUR/SEK, EUR/NOK, EUR/PLN, EUR/CZK, USD/SEK, USD/NOK, USD/PLN, USD/CZK, GBP/SEK, AUD/USD, USD/CAD, CAD/JPY, EUR/HRK, EUR/RUB, USD/RUB, USD/BRL, USD/MXN, EUR/CSD, NZD/JPY, AUD/JPY. Apart from typical contracts, contracts with one week settlement date are available as well. The BSE offer was extended to those contracts after the merger with BCE. The underlying rates for one-week are as follows: EUR/HUF, USD/HUF, GBP/HUF, EUR/USD, EUR/JPY, EUR/GBP, USD/JPY, USD/CHF, GBP/USD, GBP/JPY, GBP/CHF, EUR/PLN, EUR/CZK, AUD/USD, USD/CAD. The demand for currency is very high. Since 2003 they have been the most popular derivatives listed on BSE. With over 10,85 million contracts traded in 2006 (40 % more in comparison with 2005), they represented 80 % of total trading volume (Tables 2 and 3). The most liquid contracts are those based on two cross rates (exchange rates between two currencies, both of which are not the official currencies of the country in which the exchange rate is quoted) - EUR/USD and GBP/USD. Table 2. Futures trading volume (number of contracts) on Budapest Stock in years [6] Currency Index (until BUX, since 2004 BUX and BUMIX) Single stock Interest rate Table 3. BSE trading volumes in 2006 [6] The contract Trading volume volume (in %) The share in the total Currency ,49 Index ,76 Single stock ,73 Interest rate ,02 Total ,00 It should also be noted that BSE is the fourth exchange in the world with regard to currency trading volumes. It must be admitted though that it is still far behind two leading exchanges, Chicago Mercantile and Bolsa de Mercadorias y Futuros from Brazil [7]. Not only currency contracts, but currency options as well, are available at Budapest Stock. These are European-style options based on the following rates: EUR/HUF, USD/HUF, CZK/HUF, PLN/HUF, EUR/USD, EUR/JPY, USD/JPY, EUR/CZK, EUR/PLN, USD/CHF, GBP/CHF, GBP/JPY, CAD/JPY. In 2006 the number of traded options increased four times to contracts from contracts in 2005 [6]. The growing demand for currency derivatives and hence their growing liquidity is driven mainly by three factors. Firstly, it is supported by foreign exchange regime applied by Hungary which is characterised by a 30 % wide fluctuation band (+/ 15 % around central parity). Such a regime is the reason why currency risk is taken into account by traders and hedgers in Hungary. Secondly, the increasing trading volumes of currency derivatives are the consequence of decision of Hungarian Financial Supervisory Authority which in 2003 permitted trading on cross rates derivatives. Thirdly, next few years the market will still be affected by the merger between BSE and BCE, the result of which was the introduction on BSE of the contracts with one week settlement date and the influx of new investors. Derivatives based on equities rank second on BSE. Among them index reached the highest volumes in Until 2000 on BUX index had been the most liquid derivative of BSE. In the following years however its volumes stayed on approximately the same level. The index turnover increased in 2005 again. And the year 2006 was especially good for this instrument. This year contracts changed hands, 3,5 times more than in Such a dynamic growth made index the second most liquid instruments of BSE. Single stock are also traded on BSE. In the years those derivatives were the most popular derivatives of BSE. In 2003 they lost the first position to currency derivatives, the reason for which was the introduction of cross rates and the widening of the fluctuation band of forint to 30 % around the central parity. It must be indicated how- 310

4 ever, that the demand for single stock is still quite high and it increases systematically from year to year. In 2006 the growth of its trading volume was noted as well. That year contracts were traded, over 24 % more than in Polish exchanges In Poland derivatives are traded on two exchanges: Warsaw Stock (WSE) and Warsaw Commodity (WCE). In 2007 the following derivatives were listed on WSE: index on WIG20, index mwig40 (the index that covers shares of 40 mid-size companies of WSE), index TechWIG (the index of shares of innovative technologies companies), currency on USD/PLN and EUR/PLN, single stock, treasury notes. option on WIG20 index, single stock options. The most popular contract is index on WIG20. The underlying WIG20 index is a price index covering shares of 20 Polish companies of the highest capitalisation and volume (blue chips). The contract was launched on 16 January Since the law frames for short sale trading of shares was not set until 2003 it was the first instrument in Poland that allowed a trader to be present in the market during increasing as well as decreasing trends. In a very short time the contract gained popularity and its trading volumes grew rapidly (Table 4). Since December 1998, the WIG20 trading volumes have exceeded volumes of the Vienna-listed on PTX index (index containing the most attractive Polish blue chip stocks). And since 2001 the value of the WIG20 contract turnover has exceeded the turnover of the underlying shares. Table 4. WIG20 trading volumes and number of trades in [8] Year Trading volume (number of contracts) Number of trades , , , , , , , , ,96 Average number of contracts per trade It is worth mentioning that in 2001 which was a very unfavourable year for Polish capital market and especially for Warsaw Stock, the popularity of WIG20 contract did not suffer at all. In May of that year it had a 57 % share in turnover of Warsaw Stock, while in August 1999 its share was only 5 % [9]. The WIG20 trading slowed down only in 2002 and Other years were characterised by the dynamic growth of this instrument trading volumes. The WIG20 is not only the most popular derivative in Poland, but it is also the most traded index derivative in Central Europe and it ranks 5 th when we take all the European exchanges into consideration (Table 5). The data in table 5 include not only blue chip indices (in case of WSE mwig40 and TechWIG are included as well) but still the data are reliable since blue chip contracts are the main index derivatives of these exchanges. On WSE WIG20 has almost 100 % share of index trading volume. Table 5. Stock index on European s [10] Trading volume (number of contracts) Eurex Euronext.liffe OMX BME Spanish s Warsaw SE Borsa Italiana Athens Derivatives Oslo Bors Budapest SE The nominal value of one WIG20 contract is contract size multiplied by 10 PLN (the basic characteristics of this contract are demonstrated in table 6). It is considered to be quite low. Hence there are some opinions that the nominal value of the contract should be increased. The supporters of this idea argue that the higher value of one contract would lower the transactional costs which are mostly fixed costs independent of the value of the contract. Besides the increased value would enable day traders to achieve higher profits. On the other hand, the low value of the contract attracts smaller investors to the market and up to now mainly the small traders have maintained the market liquidity. Table 6. Index contracts basic characteristics [8] Multiplier PLN 10 Contract value Product of multiplier and contract price Quotation unit Index points Contract delivery Three nearest months of the following cycle: March, June, Sep- months tember, December Last trading day The trading day on the third Friday of the delivery month Expiry date The same as the last trading day Since the WIG20 index appeared to be a very big success, the WSE decided to launch other contracts currency based on 311

5 USD/PLN and EUR/PLN, two other index contracts based on Techwig and Midwig indices, single stock and treasury notes. However, none of these instruments turned out to be so successful as on WIG20. In 2006 its trading volume exceeded 6,2 million contracts which accounted for almost 98 % of total volume (Table 7). Futures contracts are mainly used as a tool of speculation for small investors. And they consider the very liquid market of WIG20 index as the only one which cannot be easily influenced by bigger players. The other contracts are too sensitive to movements of even little amounts of capital. And that is the reason why WIG20 gain even more significant advantage over the other contracts. It is a bit of a vicious circle which could only be broken if more professional market makers entered the market. Market makers are responsible for quoting both a buy and a sell price of a financial instrument and in this way they maintain the market liquidity. Table 7. WSE trading volumes in 2006 [8] The contract Trading The share in the total volume volume (in %) Index on ,75 WIG20 Index on ,21 TechWIG Index on ,03 Midwig Stock ,77 Treasury notes ,20 Currency ,05 Total ,00 From 22 September 2003, investors may also trade options on WSE. On that day the exchange launched call and put European options on WIG20 index. And on 17 October 2005 single stock options were included in the offer of the exchange. The options are instruments that create more opportunities for traders than contracts. But because of their high complexity and high costs Polish market of options is still at the beginning stadium of development. In index options and equity options were traded on WSE. Financial derivatives are also traded on the Warsaw Commodity. The following financial derivatives were listed on WCE in 2007: currency based on USD/PLN, EUR/PLN, CHF/PLN, NOK/PLN, SEK/PLN, EUR/CZK, EUR/HUF, EUR/USD, EUR/CHF, EUR/JPY, EUR/GBP, EUR/SEK, EUR/NOK, USD/CAD, USD/CHF, USD/JPY, USD/NOK, USD/SEK, AUD/USD, GBP/USD, interest rate based on 1-month and 3- month WIBOR rates, 2-year, 5-year and 10-year treasury notes, options on currency, options on interest rate. None of derivatives listed on WCE is so liquid as the WIG20 contract. The highest trading volumes on WCE are reached by currency derivatives. In currency and options were traded on the exchange [11]. The most liquid are those based on EUR/PLN and USD/PLN exchange rates. The liquidity of interest rate and options is low. Virtually no turnover on those instruments can be observed. 4. Prague Stock Since 2006 derivatives have been traded on Prague Stock (PSE). There were plans to introduce derivatives on PSE in the 1990s. On 30 September 1999 rules concerning and options Standarisation of Options and Futures Contracts, Trading Rules Applicable to Options and Futures Contracts and Settlement Rules Applicable to Options and Futures Contracts were accepted by PSE Extraordinary General Meeting. The clearing system of derivatives was also prepared that year [12]. And finally in 2001 Czech Securities Commission gave approval to establishment of derivatives section on PSE. Nevertheless derivatives were not launched at that time. One of the reason for this were frauds and abuses that occurred on Czech OTC derivatives market. Eventually PSE introduced derivatives in On 5 October 2006 on PX index (price index covering shares of highest capitalisation) had debut on PSE. The demand for the new instrument in first months however was rather small. In the period October-December 2006 only 208 contracts were traded [13]. On 11 December 2006 PSE introduced warrants written by ECM Real Esteta Investments A.G. and on 27 January 2007 single stock on CEZ Ersted Bank shares were launched. Introduction of derivatives by PSE, gave access to those instruments to individual investors. It can be expected that the demand for derivatives in Czech Republic will systematically grow. 5. Conclusions Derivatives are instruments that are designed to help financial institutions, enterprises and individuals to take and manage their risks. During the last years their turnover grew so fast that their market has become the largest in the world. Not only does the use of derivatives help mitigate risks at the microeconomic level, but it also translates into greater stability at the macroeconomic level. Derivatives can be traded on OTC market and on organised exchanges. In European emerging economies exchanges were established after the change of political and economic system. Initially they organised only shares trading, later on some of them launched derivatives. Hungarian and Polish exchange-traded derivatives markets are the most developed in the region. The factors that have contributed to the rapid growth of derivatives in those 312

6 countries in recent years include: a greater focus on risk management, the growing comfort of retail and institutional investors in using derivatives and an accommodating regulatory environment. The main derivatives centres in Central Europe are Budapest Stock and Warsaw Stock. Although both exchanges offer a wide range of derivatives only some of them are characterised with high demand and hence high liquidity. On BSE foreign exchange derivatives are the most traded products while on WSE turnover is mainly concentrated on on WIG20 index. Although derivatives volume has increased a great deal in Central Europe during the last few years, there are still some impediments to their development. They are considered to be risky not only by enterprises and individual investors, but also by supervisory authorities. Supervisors view derivatives as instruments which threaten the capital of the insured which can result in lowering their future pension benefits. s oppose to this statement and argue that derivatives should be used at least as tools of hedging. Naturally if they were, it would have a positive impact on the development of the market. Concluding, it should be recapitulated that despite of some barriers exchange-traded derivatives market in Central European countries is anticipated to develop well in the future. It is needed by both enterprises and individual investors. According to the author of this paper the key factors that should contribute to the development of the market are: a growth of consciousness of financial risks and knowledge of derivatives among executives and in consequence higher demand for derivatives from enterprises, a growth of knowledge of derivatives among individual investors and hence higher demand for derivatives as tools of speculation, a further development of the underlying instruments markets, an increased activity of institutional investors, especially investment funds, an increased competition between financial institutions offering derivatives. References 1. WALMSLEY, J. New Financial Instruments. John Wiley and Sons, Inc p. 2. Futures Industry Association, Annual Volume Survey 2007, [Electronic resource] Read 31 September 3. PIETRZAK, E. (editor). Projection of development of capital, foreign exchange and derivatives markets until 2004 (Projekcja rozwoju rynków: kapitałowego, walutowego i pochodnych instrumentów finansowych do roku 2004 ). IBnGR, Gdańsk, p. (in Polish). 4. BCE and BSE Press Release, 9 September Budapest Stock, [Electronic resource] Read 15 September, 6. BSE Annual Statistics IOMA Derivatives Market Survey 2006, World Federation of s, May p. 8. Warsaw Stock, [Electronic resource] Read 31 October, 9. PRZASNYCKI, R. Contracts are a threat to stocks (Kontrakty zagrażają akcjom). Parkiet, 26 June 2001 (in Polish). 10. World Federation of s. Annual Report and Statistics Monitor Biuletyn Informacyjny Grupy Warszawskiej Giełdy Towarowej, October 2007, [Electronic resource] (in Polish). 12. PIETRZAK, E.; SŁAWIŃSKI, A. (editors). 2005Projection of development of capital, foreign exchange, derivatives and money markets until 2005 (Projekcja rozwoju rynków: kapitałowego, walutowego, pochodnych instrumentów finansowych i pieniężnego do roku). CeDeWu, Warszawa p. (in Polish). 13. Prague Stock, Fact Book