Fishing trip: Canada’s markets luring investors

Canadian markets continue their upswing in 1998, despite a harsh winter. Performing impressively are the Montreal Exchange’s Bax futures and the Toronto Stock Exchange’s Toronto 35 Index futures. In 1997, the three-month Bax interest rate futures volumes leaped significantly in 1997 and Jan 1998, while average daily volumes in Toronto’s stock index futures have been on the rise since 1994, slipping only slightly in 1995. In 1997, the index increased its volume twofold.
Canada, known for drawing vacationers to its great outdoors, is getting visitors all over the globe these days. But this time, the attraction is the upswing in the nation’s financial futures markets in Montreal and Toronto.

Canada’s markets finally are catching on. After years of being the forgotten markets north of Chicago and New York, the Montreal Exchange (ME) and the Toronto Stock Exchange (TSE) are carving a niche in the global futures marketplace. The ME suddenly has found its stride on its short-term interest rate contract, the three-month Bax futures, while the TSE’s Toronto 35 Index futures is beginning to show signs it is a viable contract. Meanwhile, in Winnipeg, the agriculture exchange is streamlining costs by joining its Toronto and Montreal counterparts in Canada’s common clearing system. Canadians are not talking about overtaking the Chicago and London markets, but they are getting noticed in the United States and overseas.

What makes these exchanges different today is a combination of developments common to the industry worldwide. Even though the ME will remain an open outcry market, the inevitable changeover to screen-based trading in Paris at the Marche a Terme International de France has forced its locals to find work elsewhere. And what better locale than in French-speaking Montreal? Already a dozen locals have relocated to Montreal and more are expected. The TSE also is transforming itself into a fully automated market that surely will send some more locals to Montreal. The move also appeals to its institutional participants that crave an electronic exchange’s cost effectiveness and transparency. There is no question Canada’s derivatives markets still are developing, but the growth spurt in some of its most important contracts bodes well for coming years.

Vive le Montreal

Pounded by a freezing rain storm in January that virtually shut down Montreal, the ME defied the weather and ended up posting perhaps its most impressive gains in the Bax or three-month Canadian bankers’ acceptance futures (See “Short-term attention,” left). But exchange officials and market participants do not see this as a fluke. They are convinced the Bax contract, the first futures listed on the ME in 1988, has momentum and international support. At the end of January, an estimated 60% of the 239,258 open interest contracts were held by non-Canadian investors. Daily trading activity now is split 50/50 between Canadian and international participants.

But Bax volatility is the attention-getter.

“The market itself has narrowed its bid-ask spreads over the last four years, and now its a 1 [cent] spread,” says Barry Biniaris, head of Canadian derivatives at Refco Futures (Canada) Ltd., which accounts for 20% of ME volume.

“And we’re benefitting from the lack of volatility in the U.S. market,” he says. “Eurodollar spreads have tightened up to a half point on the front end, and you can go a whole week with the trading range in the 3 [cents]-4 [cents] range. In Canada, volatility is about 23% on the short end whereas in the U.S., its about 8% or 9%.”

That volatility is what has drawn investors in, and the liquidity is keeping them, says Jean-Pierre Gallardo, president and chief executive at Fimat Canada, based in Montreal.

“In the past, the liquidity in the Canadian markets was too poor,” Gallardo says. “But we’ve come from a vicious circle to a virtuous circle.”

Large futures commission merchants say much of the interest is coming from Chicago, New York and Europe as fund managers seek new markets. Additional locals from Paris, Toronto and even Chicago have contributed to the Bax’s liquidity. The ME has made it easy to get started. A local’s trading permit can be purchased instead of a seat that allows you to trade virtually free for six months. Even full seats, priced on the traditional auction basis at about C$85,000 ($59,500), are a fraction of Chicago or New York seat prices.

While the short-term contract is the top performer in the ME futures pits, the exchange also has high hopes for its CGB, the Canadian 10-year bond contract. Rivaled three years ago by a competing 10-year contract launched at the Chicago Board of Trade, the CGB in Montreal survived while interest in Chicago faded. Since then, the CGB futures contract slowly has grown with average daily volumes rising to 5,072 in 1997, up from 4,238 a year earlier and 4,091 in 1995.

Leon Bitton, ME director of research and product development, says the CGB may reap some volume from the Bax’s recent gains.

“It’ll probably be the next contract to grow, and some of that volume may be a spin-off from the Bax,” he says, adding that a two-year contract is in development to round out the yield curve products. Although the five-year contract is still illiquid, Bitton agrees the Canadian markets still have much potential with the country’s strong economy and market fundamentals.

“Derivatives have finally exploded in Canada, and the environment now is very favorable,” he says.

Technology in Toronto

Unlike the ME, the TSE is moving further into technology. By the summer of 1999, the TSE is expected to close its open outcry futures and options pits and move trading to the screen, following in the steps of its equity products, which already are traded electronically. Among the contracts that will be traded via computer is the Toronto 35 Index futures contract, which doubled its volume in 1997 from a year earlier (see “Take off!” above). While average daily volumes are still small by international standards, the strong volume push in 1997 provides exchange officials with some optimism.

“The board of directors and management recognize a successful equity derivatives market is really essential to the success of the equity market,” says Stephen Rive, TSE vice president of derivatives markets. “We’re very keen to build this up, and all the trends are moving in the right direction.”

Like many exchanges, the TSE is devoting much of its marketing budget toward stock index futures. A seminar series explaining the index products is being held across the country.

The Canadian market also is liberalizing the rules to listing its options. The Vancouver Stock Exchange, which exited the options business last year, effectively turned over options trading to the ME and TSE, which holds about three-quarter of the options listings. The two exchanges then agreed to scrap the old system that channeled listings randomly between the three exchanges. Beginning in May, the two exchanges will be able to vie for new options by allowing multiple listings of options. And on Jan. 1, 1999, the TSE and the ME will be able to launch competing options contracts on existing listings.

Given a more market-oriented options listing method and the changeover to an electronic platform, the TSE is turning its attention to outside Canada. The exchange plans to speak with the Commodity Futures Trading Commission and Securities and Exchange Commission about introducing TSE products in the United States. The TSE is aiming to follow the Deutsche Terminborse (DTB), which introduced remote memberships and trading screens in the United States in late 1996. The DTB now has more than 10 remote members in the United States who account for 18% of that exchange’s liquid 10-year bund contract and 14% of its 5-year bobl futures. Remote membership has hit snags, however. The German stock index futures Dax contract still is awaiting U.S. regulatory approval to be traded there.

One development that will aid all three derivatives markets in Canada is the integration of the Winnipeg Commodity Exchange (WCE) into the Canadian Derivatives Clearing Corp. (CDCC). The move is expected to lower clearing costs, but they don’t know by how much, and make the clearing function of the derivatives markets more efficient. The process of closing the Winnipeg Commodity Clearing Ltd. and folding the WCE into the CDCC system is expected to be completed in September.

Meanwhile, the WCE is looking to bolster its product mix after a somewhat lackluster year in 1997. Total volume slipped 3.6% in 1997 from a year earlier, which posted record volumes. The exchange now is developing a Canadian hog contract. The exchange, which currently trades futures and options only on grains, is attempting to get a commitment from the hog industry to support a futures contract. If a market is arranged, a contract could be launched in the next 12 to 18 months.

With new clearing ties to the hot ME and aggressive TSE, the WCE itself may begin attracting some interest from afar.

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