A Dimmer Future For Currency Futures?

With the dollar plunging, the Japanese yen and German mark soaring, and other major currencies gyrating, it would seem like boom times for exchanges that trade futures and options on currencies. But that's not the case. Business lags badly, with volume of Chicago Mercantile Exchange currency contracts down 17% in the first five months of 1995, after a 3% decline last year. At the Philadelphia Stock Exchange, the other major player in listed currency derivatives, turnover plunged 49% through May--on top of a 23% drop in 1994.

The immediate culprit is the treacherous currency market itself. Investors stung by last year's volatility are treading cautiously this year. The dollar's collapse this spring sent many smaller U.S. investors to the sidelines. But there's a more serious long-term problem: Stiffer competition from the much larger interbank currency market. With business ebbing after a decade-long boom, it has responded by stealing some of the exchanges' bread-and-butter customers--especially commodity-fund managers.

That won't put the Merc out of business. Volume in Eurodollar contracts, an interest-rate play, has tripled as currencies have stagnated, and stock-index futures are thriving. But if banks continue to grab currency market share, the Merc could lose its status as the most visible pricing benchmark.

ON THE SCENE. The Merc will fight back, vows Chairman John F. Sandner, who launched a rescue plan on June 12. The exchange will try to woo retail business by offering market-price data on the Internet. On the trading floor, currency brokers will don two-way headsets so customers can get information directly from the pits. A new block-trading system will help accommodate large orders, which increasingly have gone to over-the-counter markets. In a controversial move, the Merc intends to lift part of its ban on dual trading--letting brokers trade for their own accounts while filling customer orders. Supporters believe that practice enhances liquidity, though detractors say it invites fraud.

Watch for a slew of new products, too. Encouraged by the Apr. 25 introduction of Mexican peso futures, the Merc plans to trade the lira, peseta, and Brazilian real. It is mulling over Asian currencies as well, Merc officials say. The Philadelphia exchange also plans to trade lire and pesetas. And both exchanges will experiment with flexible contract formats that

imitate the customized products that are available in over-the-counter markets.

There's just one problem: Such efforts haven't worked in the past. The interbank market retains a virtual lock on structured products, and contracts on secondary currencies have limited potential. The exchanges haven't competed effectively with the 24-hour trading available at banks, and they can't always handle large orders: "It's like trying to land a jumbo jet in a municipal airport," notes Chase Manhattan managing director Gabriel Inoue. The bank market also benefits from less-onerous regulation. And now traders can get interbank margin accounts that provide the same leverage available through futures.

Dismissing the current malaise as cyclical, the Merc's Sandner is confident that currency activity at his exchange will recover when the dollar rebounds. He disputes bankers' claims that they've gained market share. But unless the Merc can become more competitive, its malaise could well become permanent.

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