Trading goes back several centuries

Press, 27 November 1986, Page 33

Trading goes back several centuries

While the trading of negotiable contracts for later delivery of commodities can be traced back several centuries in European and Japanese history, futures trading in its modern highly organised form developed in connection with grain trading in Chicago in the middle of last century. In subsequent years, exchanges have been established in a number of other centres in North America and elsewhere — London, Paris, Sydney, Japan, Singapore, Hong Kong — although Chicago has retained its pre-emi-nence.

The range of commodities covered by futures contracts has also expanded considerably, with the development, in response to increased financial volatility, of currency futures from 1972, interest rate futures from 1975, and share price index futures from 1982, being particularly significant in terms of the expansion of futures trading volumes.

Futures trading in New Zealand started in June, 1980, when provision was made for trading by telephone conference-call for

a London-based contract for crossbred wool. This contract had been altered in January of that year, and prices were quoted in New Zealand dollars, rather than in sterling,

from that date. While the enthusiasm of a few individuals was important to the establishment of futures trading in New Zealand, there was also a fundamental economic reason. Over the course of the 19705, New Zealand wool exporters increasingly had become principal traders, rather than commission brokers. That is, for a rising proportion of their business they bought and sold wool on their own account, making a profit or loss depending on whether their selling price exceeded their costs, including the cost of purchasing the wool at auction.

Most of the selling by wool exporters on their own account is done through contracts for forward delivery at a price fixed in a currency other than New Zealand dollars. The reason for the move towards New Zealand wool exporters actting as principals was the greater volatility of major currencies following the breakdown of the Bretton Woods agreement in 1971. While the New Zealand dollar was not floated until 1985, under the various

regimes for determining its value employed during the 1970 s and early 1980 s it still fluctuated sharply against the currencies of major importers of New Zealand wool, as these

currencies fluctuated against one another. Thus, overseas buyers Of wool purchasing at auction in New Zealand through a wool broker, and hence in New Zealand dollars, faced a sharp increase in currency risk from the early 19705. Because New Zealand exporters were generally in a better position than overseas buyers to manage the risks of fluctuations in the value of the New Zealand dollar against major currencies, the outcome was a move away from New Zealand wool exporters acting as brokers towards their selling wool forward as prin-

cipals at prices fixed in United States dollars and other major currencies. While wool exporters could use forward foreign exchange contracts to manage the increased currency risks this move away from wool broking to wool trading caused, these were no use for managing the increased risks of New Zealand dollar wool prices fluctuating that the change also placed on them. The development of wool futures trading in

New Zealand dollars, and the susbequent establishment of facilities to trade them in New Zealand, close to the major potential users, was the response.

At its establishment in New Zealand, the wool futures market incorporated two innovations for the operation of markets worldwide: because those who promoted the market were scattered throughout New Zealand, and were reluctant to establish offices in one centre, trading was conducted in New Zealand by telephone conference-calls linking brokers twice a day, rather than on a centralised floor; and, the same contract could be traded in two time-zones — New Zealand and London. Not long after wool futures began trading in New Zealand, those re-

sponsible for developing the market looked at other areas where futures might serve a useful role. After considering, and rejecting for various reasons, timber products, kiwifruit and fat lambs, they settled on financial futures — a major growth area for futures trading overseas, and an area of considerable price volatility in New Zealand. Realising that for financial contracts to be a success, major financial institutions would have to

be involved directly, those trading wool futures invited the trading banks, merchant banks, and major sharebrokers to apply to join them in establishing a New Zealand domiciled Exchange. Eventually, new members were selected from the applicants to join the existing seven ’ local brokers on the wool futures market. The resulting organisation, now known as the New Zealand Futures Exchange, began operating in January, 1985, with a contract for United States dollars, and in the following May started trading a 90-day interest rate contract. On July I, 1985, the exchange took over from the London based company the contract for cross-bred New Zealand wool that had been trading in New Zealand, as well as London, since 1980. At the same time, trading of that contract in London ceased. In February. 1986, the exchange introduced a five-year Government stock interest rate contract, and in July, 1986, following an approach from the New Zealand Wheat Board, added a milling grade wheat contract. A new 90-day interest rate contract for Bank Accepted Bills was introduced in November, 1986. The exchange has planned the introduction of a New Zealand share price index contract since its inception, but this project has been delayed by difficulties in obtaining a suitable index of the New Zealand sharemarket. By Dr Brent Layton in an Egden Wignall and Co. Futures, Ltd, publication.