FEX offers a new twist on Australian derivatives competition

A new derivatives exchange in Australia could spark a liquidity rush and drive down trading prices through quasi-competition with established venues, according to one industry expert.

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A new derivatives exchange in Australia could spark a liquidity rush and drive down trading prices through quasi-competition with established venues, according to one industry expert.

Australian commodities exchange FEX is seeking approval from Australia’s market regulator, but will not compete in instruments listed on the Australian Stock Exchange’s derivatives venue ASX 24, which handles most derivatives trades, and its equities platform ASX Trade, which offers limited derivatives products.

But, if a licence is granted by markets regulator the Australian Securities and Investments Commission (ASIC), FEX could compete by stealth, creating instruments similar to those traded on ASX 24, according to David Jenkins, head of business development, APAC, for trading solutions firm Fidessa.

“If FEX is granted a licence and offers similar contracts to ASX 24, it could lead to an increase in liquidity for Australian listed derivatives, drive prices down and offer arbitrage options,” Jenkins said.

FEX, which operates an OTC derivatives platform and owns half of an energy-based securities exchange, submitted a licence application to ASIC in August 2010 to operate an exchange market for energy, commodity and environmental derivatives. It cited a focus on China and a need for more commodity-based derivatives products as factors setting it apart from established exchanges in the country.

FEX will likely avoid head-on competition with ASX 24 (formerly the Sydney Futures Exchange), which would incur greater regulatory changes and costs, as ASIC would assume a broader supervisory role as it has done in equities for the ASX and Chi-X Australia.

To facilitate the introduction of competition in equities, ASIC was forced to augment its operations and create a market surveillance department. This cost an estimated A$27 million, which the regulator has attempted to recoup by introducing an equities trading fee.

Presently, ASX 24 is largely self-regulatory and ASIC has said this model would be transposed for FEX with minor amends if granted a licence.

Overall, market participants would benefit from greater liquidity in listed instruments and institutional investors in particular would have more derivatives trading options.

“For the buy-side, the impact of FEX depends largely on how they tailor their strategies around the products listed on the new venue, but at the very least it will offer more options to balance risk through use of derivatives,” he said.

FEX will run on Nasdaq OMX exchange technology, which Jenkins says contrasts to ASX 24’s bespoke trading infrastructure. Equities-focused ASX Trade, however, employs OMX technology.

“FEX will offer a level of standardisation by using OMX technology and will attract market participants linked to other OMX-based derivatives venues. Although it’s difficult to predict, this would suggest a positive sign for liquidity,” he said.

Jenkins also believes an agreement between FEX and global clearing giant LCH.Clearnet to clear and settle trades executed on the exchange could lead to lower costs for firms already engaged with the clearing house.

This equates to a major difference to the clearing landscape for derivatives compared to equities. In February, Australian Treasurer Wayne Swan called for a two-year ban on competition in equities clearing, effectively delaying a licence application by LCH.Clearnet. Swan cited the impact of other market changes occurring for the ban, which will force clients of Chi-X Australia to continue clearing trades through the ASX at least until the ban ends.

ASIC has consulted at length on FEX’s application for an Australian market licence, releasing an initial consultation paper in March 2011 and most recently market integrity rules for ASX 24 and FEX in November.

A spokesperson for ASIC told theTRADEnews.com the regulator would provide financial services minister, Bill Shorten, with advice on the granting of a licence before he makes a decision as per the Corporations Act.

“This advice will typically consider all relevant aspects of the application, including whether FEX has sufficient financial, technological and human resources to operate the market properly,” the spokesperson said.

It is not known when the minister will make a final decision.