Commodity exchanges have blossomed across the world to satisfy the needs of traders. These traders are lured to one exchange over the other based on preferences that include jurisdictional bias, settlement rules, currency denominations, quality differentials, seasonal attributes, and so on.
The emergence of these exchanges leads to competition among themselves. This inter-exchange competition gave a fillip to new product launches. The outcome of such a market-based solution resulted in diverse client trades from rubber in Tokyo, pepper in India, to soyabeans in Brazil.
In my opinion this unconditional burgeoning of exchanges has created another need for eliminating inter-exchange inefficiency.
Apart from a flippant argument that this is the age of connectivity from society to space, it is important that inter-exchange connectivity is addressed by both the market and regulators.
First, connectivity should reduce cost of operations for the participants, as barriers to trade will be seamless. Settlement, margins, netting, etc. can be achieved in a single window.
Second, connectivity will eliminate regulatory arbitrage between exchanges. Position limits imposed by different regulator bodies are specific to exchanges. This leads to crowding in or crowding out by passive investors distorting markets.
Third, connectivity will bring greater transparency to markets on a real time basis. This will aid in shocks being absorbed in one market to another without any friction. Fourth, barriers to access will be lowered for traders.
Currently, there is either a jurisdictional benefit or a barrier imposed by lack of connectivity. This should enhance liquidity and reduce entry costs for market participants. Fifth, non-performing products will be eliminated.
In a disconnected world, inefficient products listed on different exchanges thrive on implied subsidies. Sixth, connectivity will bring standardisation of exchange trading across the world. Currently, rules and mechanisms under which each individual exchange operates are many; let alone the products listed on these exchanges.
This creates huge operational risk and burden for market participants.
Seventh, data generated across the world will be void of geographic and regulatory biases. This should help build a repository of global client participatory behaviour.
What about data?
Currently, each exchange has control on the data that is generated everyday across the globe. In addition, they monetise this data by selling it to the clients who, in the first place, participated to create such data.
In my opinion, connectivity across these exchanges makes the data accessible more readily, and it should help in data be open sourced. The cost to access data will be lowered and in a digital world, clients can benefit from cutting edge analytics. Data will also help in predicting new products that will be needed in the future by the clients. Innovative solutions can be devised for clients that are in sync with the client’s need.
An example of multiple exchanges/multiple products was launching ill-fated non-USD derivatives for Mexican/Brazilian clients.
In a crisis, settlement issues, pricing anomalies, and currency-commodity mismatch force either the client to take a loss or the originating institutions to bear the cost. The take away is that it was an inefficient risk transfer that could have been avoided if one could have predicted that coming with the relevant data.
What can future look like?
I see a world where exchanges in the future will perform operational tasks such as settlements, cash transfers, collateral risk management, delivery management, etc.
Global traders will achieve price discovery on the cloud using data generated and crunched by them.
The challenge in such a futuristic environment will be integration risk between the cloud and the exchange.
Machines will run the cloud, men will run the exchange, and machines take over men.
The writer is based in London and is the founder and Managing Director of OpalCrest.