Dubai 'could emerge as derivatives trading hub'

Dubai: James E. Newsome has been president of the New York Mercantile Exchange (Nymex) since August 2004. Prior to that, he served as chairman of the Commodity Futures Trading Commission (CFTC) beginning in December 2001. In addition to his responsibilities at the CFTC, Newsome served as a member of the President's Working Group on Financial Markets and on the President's Corporate Fraud Task Force to coordinate corporate fraud investigations.

Along with Newsome's board responsibilities at Nymex, he serves on the Board of Directors of the Dubai Mercantile Exchange (DME), Nymex Europe, and the National Futures Association.

In an exclusive interview to Gulf News, Newsome said, in the context of global consolidation of derivatives exchanges, he sees big opportunities for the DME and huge potential for Dubai emerging as derivatives trading hub of South Asia, Middle East and Africa region. Excerpts

GULF NEWS: DME is nearing its first anniversary, how do you rate the performance of the exchange? Has it lived up to the expectations?

James E. Newsome: We have been very happy with the progress of the exchange. In fact if we look at the volumes that have been traded on the DME, they are very similar to the volumes of the WTI (West Texas Intermediate, the benchmark of the Nymex) and the Brent contracts when they were launched. It took three years for the WTI contract to become a substantial oil futures contract.

DME is set to launch two new cash settled contracts and planning for a third one. What is the significance?

These are two brand new contracts on the DME. Our original goal was to launch the Oman physically settled futures contract and stabilise it. Now we have achieved that target, now we looking at the launch of new contracts.

As we had discussed last year at the launch of the exchange, we will be increasingly looking at contracts that have demand and market acceptability.

With these new cash settled contracts we will be able to bring in new market participants who want to trade the Oman physical or Brent but they are not players in the physical market.

We are excited to start trading in these contracts to bring in a whole new class of market participants and much more liquidity and vibrancy into the exchange. A cash settled contract on the WTI has been approved by the CFTC. Our original goal was to launch two spread contracts, one on the Oman and the other on Brent.

While we were going through the regulatory process, we thought it made sense to include the WTI. At the moment Brent spreads commands the highest demand followed by the Oman.

The WTI, although used as a global benchmark, it is more an American domestic benchmark and the Brent is used more actively as a global benchmark. In the future if we see WTI delivers value to investors on DME we will list it.

How has been the competition from ICE's sour crude contract launched almost at the same time as DME's Oman contract?

There is no comparison. They are virtually trading zero every day. I think, for the calendar year 2008 they traded 280 contracts compared our 180,000. There is no competition, which we knew would be the case right from the beginning.

Is the regional market sophisticated enough for oil futures and other derivatives trading?

The Middle East market is fast maturing with market participation from a wide range of institutions. The listing of the Oman contract has certainly helped to add to that trend.

When you look at the financial markets across globe and the difficulties that are taking place, people are concentrating very closely on commodities, particularly commodities that are traded globally.

Many financial traders are hedging the decrease in the value of dollar against commodities. All lot of institutions from the region is also doing the same to cover their currency and other investment risks by taking positions in oil and other commodities.

DME is a commodities exchange, so far we have seen only three oil related contracts. Are you planning other commodities contracts in the near future?

Yes, we do. And we think we will expand the listing capabilities of the DME from commodities to derivatives. That would permit us list index contracts and metal contracts on the DME. These are definitely within the plans of the DME.

Primarily we will focus on commodities derivatives. But under the current regulatory scheme, if you list indices, even if they are made up of commodity indices you have to have broader regulatory approvals that also cover financial derivatives.

From the regulatory standpoint we want to give DME the maximum flexibility to list any contracts in the future.

There have been talks about the possibility of DME listing other commodities contracts such as steel and gold. Is there any move in that direction?

They are both in the planning stages. I think we are much closer to a gold contract than a steel contract. Steel has been a very difficult commodity for exchanges to capture.

Gold is one of the most actively traded commodities in the world and with the experience in Dubai with regards to precious metals we think it is natural to trade in a gold contract in the near future.

Although I am hesitant to give a time frame for the launch of the contract, I can confirm that there have been formal communications between DME and Nymex on this contract. Nymex has a lot of experience in trading gold we will be providing technology support to the DME.

Do you expect other regional oil exporters such as Saudi Arabia to join DME to create other regional benchmarks?

Everyone continues to look at the amount of trading volumes and liquidity on the DME. We are comfortable that the volumes are growing at a proper phase. I think when others get comfortable they will join and we are confident that they will eventually join the DME.

What are the implications of Nymex's proposed merger with CME Group on the DME?

I don't see any complications. As when the merger takes place, the CME group will take over the Nymex's equity interest in the DME.

The people involved from the Nymex side will remain somewhat similar as now. If and when that transaction is finalised that will have no negative impact on the DME. I think it will have a very positive impact on the DME as one of their equity holders becomes the largest derivative exchange in the world. Naturally the combined entity's expertise will be available to the DME.

Futures trading and speculation are often blamed as the root cause of oil price hike, what are your views?

The reports on the role of speculators on oil prices are grossly exaggerated. If you look at the data on who is actually trading, the level of commercial participants remains 70 to 72 per cent on the Nymex.

The level of participation from speculators at any given point is less than 30 per cent and that percentage has not changed over the last year even as oil prices have continued to increase. We also find that speculators as a group are not price makers.

They are price followers and they rely heavily on the commercial market participants to determine the trend and they typically follow that trend. Secondly, if you look at the positions of the speculators they are evenly split - long versus short.

So, even speculators together are not pushing prices higher, while about half of them are betting on a potential fall in oil prices.

What are your views on exchange consolidation? Are the commodities derivatives markets heading towards huge monopolies?

I continue to believe that the growth will come from the continuing trend of global consolidation and I think when you look at potential monopolies, in many ways monopolies can be good. But it is the monopolistic power that can be negative.

For the CME combining with the Chicago Board of Trade (CBOT) created tremendous economies of scale while they haven't used their monopolistic power. I believe they joining forces with Nymex would create immense opportunities for all stakeholders and markets participants.

Banks and financial institutions have not been very happy about the idea of CME's merger with Nymex. As many as 12 institutions forming a new futures exchange, Electronic Liquidity Exchange (ELX), plan to take on CME-Nymex combine head-to-head. How do you see this development?

The banks and the exchanges compete. So that they don't want larger and larger exchanges that they will have to continually compete against. The banks push for fungibility of exchange contracts from one exchange to another. (By making contracts more fungible, investment banks try to remove the exchanges' hold on clearing. This will allow the banks trade one exchange versus another and skim off the spread).

Then they use the securities model for comparison which is an apples and oranges model of comparison. Securities trading are same on all exchanges.

With the futures contract there is the intellectual property that goes along with the development of contracts and, nobody in the exchanges world think that we should have to make it fungible.

I think the moment one exchange makes its contract compatible with other exchanges the contract loses its competitive edge resulting in drastic reduction in the volumes traded. It is like the banks not wanting to share their customer list with another bank; same is the case with asking for fungibility from exchanges.

On the contrary to their claims what we know is that exchange consolidation has brought about great efficiency and benefits to all market participants and in particular for banks. With the combining of clearing mechanisms the amount of margin capital the banks has to set aside has been cut by half. So we do know that it has created great capital efficiencies for the banks.