Derivatives markets in Europe are at a watershed moment. Not only are they experiencing regulatory changes, but many of those changes have spurred the development of markets in an unprecedented way. Match that with major geopolitical disruptions, central bank intervention and the ripples from oil price shocks, and you can see why derivatives, particularly commodity and foreign exchange markets, are growing quickly across Europe.
It’s an environment full of opportunity and challenges for a new exchange. That’s the position CME Europe is in after officially opening for business in 2014. Since then, the exchange has been busy launching products into recently disrupted markets, and introducing competition in areas previously dominated by one or two contracts.
After just 14 months, the exchange is seeing results. CME Europe FX Markets, which saw a few hundred contracts traded daily a year ago, is now seeing several thousand. The launch of natural gas, electricity and cocoa contracts in 2015 has the exchange eyeing progress in the commodities space, and back to back record overall trading days in late May suggest that the multi-asset class approach is taking hold.
As the exchange’s new CEO, Cees Vermaas is the man in charge of helping CME Europe navigate the new derivatives landscape. We spoke with him about his new role, where his exchange is headed and the challenges for European derivatives markets.
Before joining CME Group, you led the Amsterdam Exchange. What has been the biggest adjustment going from equities trading to a derivatives exchange?
I’ve been here four months now, and it’s exciting to learn new things every day, but in fact there are similar challenges to my past roles. I’m a business engineering and process guy with an IT background. My world is all about adaptation and the change is not such a big hurdle. Now that I’m in derivatives, some people have referred to the fact I’ve got an equities background, but when I was appointed as an executive at Euronext, some people tended to say I had an IT background! These days it’s all about the interface between business dynamics and IT/processes.
I was privileged to be involved in the first wave of exchange consolidation in Europe in 2000; hopefully some lessons from that time will serve me well. Since that time, the arrival of very accessible cheap technology has contributed, along with market structure changes, to a commoditization of equities, so I felt it was an exciting time to shift to derivatives with its wide range of asset classes, many at a much earlier stage in their business cycle in Europe.
Some asset classes have historically been their own rather unique worlds, and that’s still true to a considerable extent. But as I listen to clients, my feeling is that on dealing desks and in companies, we are seeing an increasing convergence in the approaches to trading across asset classes.
What’s striking to me is that, while risk management and derivatives are a much more global business than equities, there is still limited global standardization in regulation than I would have expected by now. With clearing gaining regulatory tailwinds post-crisis, ideally we need to provide global clearing solutions to provide capital efficiencies for our clients. The world has become very small.
It’s been a volatile year for FX markets, particularly the Euro and British Pound. Do you see that slowing down, or is this the year of volatility in FX?
I can’t predict what volatility will do, but of course volatile markets means people have to hedge risks and that drives trading activity.
In terms of FX volumes, Europe has around 65 percent of this huge $5 trillion a day global FX market, but even with the current regulatory push, only a small fraction is exchange traded and cleared. So there’s huge room for growth.
CME Europe has stepped up its offerings in energy with new natural gas contracts, and electricity contracts on the way. What were the changes that told you that now is the right time for new derivatives contracts in these areas?
Other than oil, which is traded as a “global brand,” the business cycle in energy and power in Europe is still at an early stage: much is bilateral and only gradually shifting to cleared and exchange-traded. A great deal of the market is still in national silos, both in terms of physical energy market infrastructure and financial energy trading. As continent-wide physical markets develop and growing renewables influences supply/demand, we expect to see rapid evolution in energy derivatives usage. There’ll a broadening range of users, concerned above all about first-rate clearing technology, efficient cross-margining and, of course, competitive fees.
In terms of the evolving structure of derivatives trading in Europe in energy, customers will see more choice, but given the fragmented nature of existing markets, we also see scope for collaboration models in this area – and potentially other similar asset classes.
How much will geopolitics – whether the Russia/Ukraine conflict or Middle East tensions – affect these markets in Europe?
I can’t foresee the next flash point, but most of our clients assume that there will continue to be volatility spikes based on a variety of geopolitical issues, driven by underlying tensions from growth and resource imbalances across regions.
This type of macro volatility could also influence continuing development in metals trading: as with oil we already have “global brands” being traded, but the need for maximum capital efficiency as participants manage risks across in different regions should spur further innovation in clearing.
There are still a lot of economic challenges for Europe, and new regulation continues to play out. What are the biggest needs you see arising for futures markets participants in Europe over the next year?
It’s important to remember that derivatives markets – and indeed capital markets generally – are hardly developed in Europe compared to the U.S. Europe has been intermediary – i.e. bank – dominated. Now in the post-crisis regulated world, the banks can’t do everything as they used to do, a lot of activities have become too expensive and the risks are too high. That’s why capital efficient mechanisms like listed derivatives will move more and more centre-stage.
The regulatory regime is now finally getting much clearer. Undoubtedly, EU securities regulation does reflect an equities mindset, and it’s no surprise that many players and industry groups have been seeking to ensure we get the right balance for what are very different asset classes and
What about Europe’s own macro risks?
Certainly investors are following Grexit closely, but it is 2 percent of the Eurozone and exposures are very much reduced. And naturally everyone is getting themselves fully informed at the U.K./EU situation and there’s been much sensible analysis in recent weeks. My personal feeling is that both sides will do a very great deal to prevent the U.K. leaving.
The biggest risk I see is that as some growth returns to the Eurozone, the pressure for structural reforms in some of the core countries will ease and important decisions get postponed, leading in worst case to a Japan scenario. But in fact the preconditions are there for rapid development of Europe’s securities and derivatives markets, taking on a bigger role in Europe’s financial markets, and thus fuelling stronger growth across the continent.