N.Z. futures pioneering

Press, 12 May 1984, Page 22

N.Z. futures pioneering

The new futures market in New Zealand, whose first contract will be traded on September 1, will pioneer a computerised trading system. The hectic, loud, and colourful trading floors oi Chicago, New York, and London, will never be emulated in this country. The general manager oi the New Zealand Commodities Market, Ltd, Mr Len Ward, told a seminar in Christchurch this week that the traditional floor would be replaced by an electronically controlled ordermatching system.

Traders will enter their transactions by computers. Probably the only time they will meet in the flesh will be at annual conferences, no doubt at Wairakei or Wanaka. This automated trading system was not a new idea, but attempts overseas had bogged down in difficulties. However, the organisers had concluded that the overseas problems were related to the complexities of their systems rather than to the concept itself. Mr Ward told the seminar, organised by New Zealand’s biggest wool-futures broker, John Marshall and Company, Ltd, of Christchurch. “We believe, therefore, that the system which is being developed for our exchange will become a world first in this area and probably lead to a number of major innovations in the marketplaces of New Zealand and elsewhere,” Mr Ward said. All trading members of the new exchange will also be members of the International Commodities Clearing House, Ltd, This is a branch of the London Clearing House, which is owned by a consortium of clearing banks. A clearing house guarantees the performances of contracts between its members. It matches buyers and sellers, enables one settlement each day by brokers, and can counteract any attempt at market manipulation. The exchange will trade three contracts at first: a sliding interest rate contract; a United States dollar contract; and a contract on the Reserve Bank shareprice index. The contract unit for the interest rate contract will be a 90-day commercial bill of exchange with a face value of $200,000. Mr Ward gave two examples of those who might use this contract to hedge against changes in interest rates. A large retailer, “cash rich” from Christmas trading, might traditionally invest surplus cash in 90-day bills at this time of the year so that it would have the use of this money about March. In a year when the firm expected interest rates to fall significantly, the accountant might use the futures market to fix in June the rate at which he would be able to invest the $2 million in December. The second example was of a company whose budget showed a need for borrow-

ing in the future when interest rates were expected to have risen. “This company, too, can use the futures market to pre-determine the interest rates it will have to pay for future borrowing,” Mr Ward said. Importers and exporters would be the two groups to use the United States dollar contract for hedging. Wool exporters for years had been hedging currency transactions, although until now they had been restricted to using the forward currency market, Mr Ward said. An exporter who was expecting to be paid for goods to be exported in the future or goods already exported on a credit basis would be able to protect himself against a drop in the value of the United States dollar by selling United States dollar futures. Of the third new contract, Mr Ward said that the first trading in share-index futures was in the United States in 1982. “They provide a means by which portfolio managers, underwriters, and others can reduce the risks of price fluctuations in the sharemarket. “Such risks are faced by those who hold shares, since a market decline would reduce their value, and by those who are expecting to have funds to invest in shares, for whom a shortterm market would be a disadvantage.” Share-price-index futures were a mechanism by which those exposed to sharemarket risks could obtain protection, and they fostered “price discovery.” “That is,” Mr Ward said, “they provide a consensus of opinion and expectation about future sharemarket movements, distilled into a price for a particular future time.” Market risk — the risk that the sharemarket as a whole would fall — could be reduced by the appropriate use of these futures. A portfolio manager expecting a market fall could reduce the risk by selling futures contracts equivalent in value to the dollar value in his portfolio. If the market fell, the value of the portfolio would be protected since losses would be offset by futures-market gains. If the market rose, a loss in the futures market could be offset by a gain in the value of shares. “In most cases the loss or gain on futures will not exactly match the fall or rise in portfolio value, but

will only give protection against a major portion of the market’s movement. Sometimes, for example, the futures market will have already discounted an expected fall in the sharemarket,” Mr Ward said. The futures contract provided an excellent means for institutions such as lifeinsurance companies which had large, highly diversified portfolios of shares to obtain temporary protection against potential market declines. Faced with a falling market, there was little a portfolio manager of an institution could do now to protect shareholdings but sell all or part of them. Mr Ward described this as “an expensive course of action due to transaction costs and the downward effect this would have on prices of individual shares.” “He can, however, take a sold (short) position in share-price index futures, so that losses in the sharemarket will be approximately offset by gains in

the futures market.” A major use of the market is expected to be the replacement of an expected sale or purchase in the future with a sale or purchase of futures “now”. “An example of this strategy is that of the portfolio holder who expects tc receive funds, in say, six months, which will be used to increase the portfolio investment. “In the meantime, the sharemarket dips and the portfolio-holder’s opinion is that it is cheaper now than it will be in six months when the funds will be received. By buying futures, the investor can take advantage of current depressed prices.” The new exchange alsc expects that the share-index contract will attract many individual investors whe will be able to obtain significant participation in the movement of the share market at a much reduced cost. This is because of the leverage, or deposit system of buying futures.