Futures, Futures, Everywhere
As China was lobbing missiles into the Taiwan Strait in March, Beijing Commodity Exchange Chairman Qiao Gang was attending to business on another shore. Sipping Pepsi by the pool at a swank Florida resort, Qiao networked at his first Futures Industry Assn. trade show. He's convinced that futures can help his country grow. "I believe in market forces," he says.
From Thailand to Turkey, emerging-market nations are launching futures exchanges. In the next year or so, an estimated 18 developing countries will be trading futures, up from seven today (table). Besides providing prices and risk-management for local users, the new markets aim to attract hard currency from foreign investors. With many emerging economies expanding at double-digit rates, multinationals need better ways to manage financial and commodity risks. And money managers want more products, too: Indexed emerging-market equity funds have attracted $5 billion, up from $200 million in mid-1993, according to the International Finance Corp. "The establishment of futures markets is a badge of credibility," notes Whitney MacMillan, retired chairman of agribusiness giant Cargill, based in Minnetonka, Minn.
Yet even as these new bourses sprout up, some question how successful they will be. Western investors salute them with one hand while gripping their wallets with the other. Third World markets suffer from backward laws and regulations. Firms default, governments change rules arbitrarily, and fragile financial systems sometimes melt down. Traders speak of "roach-motel" markets, where investing is easy but getting out is tough. At the biggest emerging-market exchange, Brazil's Bolsa de Mercadorias & Futuros (BM&F), no more than 15% of the business comes from industrialized countries. In China and other countries, foreign participation is nil.
Still, the potential is there. And some U.S. exchanges are trying to preempt the startups. Encouraged by its successful launch of Mexican peso futures in April, 1995, the Chicago Mercantile Exchange plans to list debt, currency, and equity-index contracts on as many as a dozen emerging markets over the next few years, says Chairman John F. Sandner. The Chicago Board Options Exchange has launched indexes on Latin American and Israeli stocks. Telefonos de Mexico is among its most active equity options.
TOP PRIORITY. To get a piece of that action, exchanges in emerging markets are doing business differently; all the bourses slated to open in 1996 and '97 will be electronic. Brazil, which opened for business in 1986, uses both open outcry and electronic systems. Screen-dealing is easier to set up and monitor than the open-outcry system common in big U.S. markets, which requires well-capitalized floor traders. And it's safer: At the two-year-old Beijing Commodity Exchange, each trade is checked for adequate margin before the computer system accepts it, says Qiao.
Providing a tamperproof trading operation is the top priority for the new exchanges. "You may be robbed walking down the street, but in this place, you won't be robbed," says Andre A. Cappon, a New York-based consultant to Sao Paulo's BM&F, the world's third-busiest exchange. To avoid trouble, the BM&F performs all back-office trade-clearing and processing--a task done by member firms in developed markets. "There is typically much more volatility and much more risk, so it has to be a very tough place," Cappon says.
That volatility provides great trading opportunities for experienced players who can cash in on out-of-whack prices. "Competition in emerging markets tends to be less sophisticated and less well-capitalized," says Eric Noll, head of strategic planning for Susquehanna Management Group, an arbitrage trader overseas. And Peter Marber, managing director of Wasserstein Perella Emerging Markets Group in New York, who currently trades individual stocks on foreign over-the-counter markets, looks forward to being able to trade an index that represents a basket of stocks on local futures exchanges instead. In less transparent OTC trading, it's easier to get stuck with an illiquid holding, he points out.
CHINESE CRACKDOWN. Yet launching a new exchange is risky. China had more than 40 loosely regulated exchanges trading commodity and financial products before a government crackdown last year pared the number to 15. Experts say only a handful are needed. New contracts are risky, too. While the Chicago Merc can afford to trade dozens of contracts, most startups should list only a few, advises Azizah M. Jaafar, a general manager at the Securities Commission of Malaysia. In Kuala Lumpur, palm-oil futures retain a much bigger following than nascent stock-index contracts. "We are developing our own local products for our own local needs," Jaafar says.
Will the exchanges in the industrial world preempt the local exchanges? No one knows for sure. But if they do, the local exchanges could have a tough time recovering. Once established, a liquid futures market rarely migrates from one exchange to another in the same time zone. Some traders say the U.S. versions of Mexican contracts have become so entrenched that Chicago is likely to remain their primary market.
In contrast to the Merc, the Chicago Board of Trade, its crosstown rival, seems to be hedging its bets. It's forming joint ventures with new exchanges in countries such as Poland and Argentina. Once new contracts develop locally, CBOT members could trade them. "These exchanges are going to happen with us or without us, so we're trying to [participate] in as risk-free a fashion as possible," says Board of Trade Chairman Patrick H. Arbor.
No doubt some of these new exchanges won't work. But the winners will offer a safe harbor to investors who see big opportunities in seemingly uninviting places.