While palm oil may be the most consumed edible oil in the world, the volume traded for its futures contracts is much smaller than that of its competitor soyabean oil. Bursa Malaysia Bhd hopes this will change after its tie-up with CME Group Inc, the world’s largest and most diverse derivatives marketplace.
Last week, Bursa Malaysia signed a strategic partnership agreement with CME Group in an effort to develop the Malaysian derivatives market. The three-pronged strategic collaboration involves equity participation, licensing of Bursa Malaysia Derivatives Bhd’s (BMD) crude palm oil futures (FCPO) settlement price and the provision of the CME Globex trading platform.
The equity participation will see CME Group taking a 25% stake in BMD for RM55.6 million to be satisfied with RM1.9 million cash and 76,427 shares in CME Group.
The licensing of BMD’s FCPO settlement price will enable CME Group to develop US dollar-denominated cash-settled CPO futures contracts and related options for listing on one of its four exchanges — the CME, CBOT, Comex and Nymex. These products will be traded on the CME Globex trading platform.
The provision of the CME Globex trading platform to BMD means all existing and future BMD products can be listed on it.
“The idea is to put our FCPO and other derivative contracts on Globex so that they have greater visibility in the international community. The Globex platform is accessed by 150,000 terminals. Malaysia has 600 terminals. The visibility of our products will be greatly enhanced, and we expect this to create a lot more investor interest. Furthermore, Globex is widely regarded as a good trading platform, so we want to embrace that technology for our products,” says Datuk Yusli Mohamed Yusoff, Bursa Malaysia’s CEO.
Given BMD’s small product range, Yusli hopes this tie-up will lead to more products being developed. As for the brokers, with access to the Globex system, they will be able to trade other products which are available on the platform.
Subject to regulatory approvals, the listing of CME’s US dollar-denominated CPO futures contract is expected to commence in 1H2010. Meanwhile, the transfer of all BMD products to CME Globex is expected by 2H2010.
Joseph Kim, CME Group’s associate director for business development, says while the details of the US dollar-denominated CPO futures contract are being worked out, the contract specifications will likely be maintained. CME’s US dollar contract will be cleared at the CME clearing house while any Bursa Malaysia products traded via Globex will be cleared at Bursa Malaysia Derivatives Clearing Bhd.
“The goal of the US dollar contract is to internationalise the benchmark price that Bursa Malaysia has today, which is the most relevant price for palm oil. Because the final settlement of the contract points back to the Malaysian contract, which is physically delivered here, we believe there’ll be a lot of additional flow back to the ringgit contract as well,” says Kim.
C F Wong, managing director and head of Asia for CME Group, says there is a lot of interest in a liquid US dollar palm oil contract globally.
“We call ourselves a diversified exchange. Our bread and butter is interest rates, stock index, agricultural, forex, energy, precious metals and commodities. Palm oil fits very well into our soyabean complex,” he adds.
As to which of the four markets will list the US dollar-denominated CPO futures contract, he says it will likely be CBOT because of the product’s alignment with commodity products. However, the decision remains with the CME Group board.
Once the US dollar-denominated CPO futures contract is available on one of CME Group’s exchanges, the trading of CPO futures will not be limited to BMD’s trading hours of 10.30am to 6pm as CME Globex offers trading for 23 hours a day. As for the ringgit-denominated contracts, Yusli says Bursa Malaysia may look at lengthening the trading hours once they are available on CME Globex, but details have not been finalised yet.
“At the moment, only 20% of the volume of FCPO contracts is traded by foreigners, which is fairly low if you compare that with the growth of CPO’s usage worldwide. We believe by moving to a more visible platform, there’ll be more interest in our contract, and as CME develops its own CPO products, there’ll be more opportunity for traders to arbitrage,” Yusli explains.
Bursa Malaysia believes that its relationship with CME Group will bring palm oil futures to a level where there’s ample market depth and liquidity, and eventually narrow the spread between palm oil and soyabean oil.
Derivative products currently make up 15% of Bursa Malaysia’s revenue. This is expected to double to 30% over the next three years as contract volume rises. Bursa Malaysia will earn a licensing fee from CME Group for the use of FCPO settlement prices. It will pay CME Group a basic fee for listing BMD products on CME Globex.
Industry players view the development positively. A dealer at a brokerage firm in Kuala Lumpur says while the listing of CME’s US dollar CPO contracts may have an adverse impact on him personally, they will help enhance trading volume for CPO and provide arbitrage opportunities. A trader with a palm oil producer says the offer of liquid US dollar CPO futures benefits foreign buyers as currency risk will be minimised.
Palm oil producers with global operations will also benefit as they will be able to match the US dollar proceeds with US dollar raw material costs.
As for concerns over price volatility with more participants, this will be smoothed out and prices will move in tandem with that of other edible oils and even crude oil, says a Bursa official. With exposure to more participants, there will be increased liquidity, bringing about efficient price discovery and cheaper transaction costs. Furthermore, the exchange will provide greater transparency compared to the wide spreads and opacity in over-the-counter trading.
“We know that a lot of the participants that don’t trade the CPO on Bursa trade heavily on OTCs in Rotterdam, Hong Kong and Singapore. There’s a market need for an exchange contract where counter-party risk is mitigated,” says Kim.
Meanwhile, existing US dollar CPO contracts have been languishing, including BMD’s US dollar-denominated contract and the Joint Asian Derivatives Exchange’s (JADE) US dollar-denominated CPO futures contract, launched in 2007. JADE was a joint venture between the Chicago Board of Trade (now CME Group) and the Singapore Exchange (SGX). CME Group sold its stake to SGX in late 2007.
The existing US dollar-denominated FCPO contract will still be offered. Yusli says Bursa Malaysia will still look at improving the product while maintaining the objective of providing a family of palm oil products to suit investor needs.
As to whether the US dollar CPO futures contracts to be traded on CME later will succumb to the same fate as JADE’s dollar contracts, Kim says, “We’re not launching a brand new exchange with zero volume to start. Bursa already has liquidity in CPO. So that’s a huge difference.”
He stresses that CME is investing in a business that is already operational, has an established market and market participants and is liquid.
This article appeared in The Edge Malaysia, Issue 773, Sep 21-27, 2009.