Securities Board of India Guest Lecture Convergence of Derivative and Cash Markets Andrew Sheng Chairman Securities and Futures Commission Hong Kong 26 May 2005
Table of Contents 1. Global Trend in Derivative Markets 2. Derivative Markets in Asia and Hong Kong 3. Convergence of Derivative and Cash Markets 4. Regulatory Implications 5. Conclusions 2
Global Derivative Markets growing faster than Cash Markets • BIS data on global derivative transactions: Notional Amount (billion U.S. dollars) End June 2001 End June 2004 Growth Rate for Total OTC Exchange Total OTC Exchange Total Traded Traded Foreign 20,435 (99.7%) 66 (0.3%) 20,501 31,510 (99.7%) 98 (0.3%) 31,608 54% Exchange Interest 75,813 (81.2%) 17,515 (18.8%) 93,328 177,457 (78.2%) 49,385 (21.8%) 226,842 143% Rates Equity- 2,039 (51.6%) 1,912 (48.4%) 3,951 5,094 (60.6%) 3,318 (39.4%) 8,412 113% linked Total 98,287 19,493 117,780 214,061 52,801 266,862 127% World Federation of Exchange (including 49 stock • exchanges) data: Stock Market (billion U.S. dollars) End June 2001 End June 2004 Growth 3,476 3,354 -3.5% Market Turnover 28,827 32,280 12.0% Market Cap 3
Performance of the Global Derivative Markets • Most derivative transactions in foreign exchange and interest rate products take place in OTC markets, but 40% of equity-linked derivatives are transacted in regulated exchange markets. • Growth of derivative markets outstripped that of the stock markets (equity-linked derivative markets grew 113% from Jun 2001 to Jun 2004, but market cap only increased by 12%) • In Hong Kong (no commodities exchange), growth in derivative markets mostly in equity-related derivatives. 4
International and Regional Trading of Stock Index Futures Contracts • Asian region experienced the highest growth rate (15%) in 2004, compared to Americas: 12% and EU: 1%. • HK trading of stock index futures increased by 46% in 2004. Number of Contracts traded 350,000,000 300,000,000 250,000,000 2004 2003 200,000,000 Hong Kong is ranked 150,000,000 11 th internationally and 6 th regionally 100,000,000 50,000,000 0 Chicago Eurex Korea Euronext National Stock Chicago Board OMX Singapore TAIF EX Osaka SE Hong Kong Toky o SE Mercantile Exchange Exchange of Trade Stockholm SE Exchange Exchanges Exchange India (CBOT) and Clearing 5 (CME) Source: World Federation of Exchanges
International and Regional Trading of Stock Options Contracts • Growth rate in Asia (20%) in 2004 similar to EU (19%), but lower than Americas (33%). • HK trading of stock options increased by 33% in 2004. Number of Contracts traded 350,000,000 300,000,000 2004 2003 250,000,000 200,000,000 Hong Kong is ranked 16 th internationally 150,000,000 and 2 nd regionally 100,000,000 50,000,000 0 International E uronex t S ao P aulo Chicago E urex A merican S E P hiladelphia B uenos A ires P acific S E OMX A ustralian B orsa B ourse de B ME JS E S outh Hong K ong National RTS S E S ecurities S E B oard S E S E S tock holm S E Italiana Montreal S panish A frica E x changes S tock E x change Options S E E x changes and Clearing E x change (IS E ) E x change India (CB OE ) 6 Source: World Federation of Exchanges
Ranking of Stock Markets by Market Cap (end Mar 2005, US$ billion) • Hong Kong’s stock market is ranked 9 th, ,complementing trading of derivatives NYSE Tokyo Nasdaq London Euronext @* Toronto** Deutsche Börse Spanish Exchanges (BME)*** Hong Kong**** Switzerland 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 Remarks: * Comprises Euronext Amsterdam, Euronext Brussels, Euronext Lisbon and Euronext Paris ** Includes also TSX Venture *** Comprises Bolsa de Barcelona, Bolsa de Bilbao, Bolsa de Madrid and Bolsa de Valencia 7 **** Includes GEM Sources : WFE and HKEx
Hong Kong Derivative Markets • Types of derivative products – 4 types of Futures – 2 types of Options • 4 types of Futures include : – Index Futures (HSI Futures, Mini HSI Futures, H-shares Index Futures, MSCI China Free Index Futures*, Dow Jones Industrial Average Futures) – 11,805,613 contracts in 2004 – Stock Futures – 17,274 contracts in 2004 – HIBOR Futures (1-Month HIBOR and 3-Month HIBOR) – 59,040 contracts in 2004 – 3-Year Exchange Fund Note Futures – 2,225 contracts in 2004 • 2 types of Options include : – Index Options (HSI Options, Mini HSI Options, H-shares Index Options**) – 2,133,708 contracts in 2004 – Stock Options – 5,611,832 contracts in 2004 8 Remarks: *Trading in MSCI China Free Index Futures was suspended with effect from 29 March 2004. **Trading in H-shares Index Options commenced on 14 June 2004.
Growth of the Hong Kong Derivative Markets 25 Total Turnover Volume of Futures and Options (million contracts) 19.6 20 Trading of derivatives in Hong Kong has recovered from Asian Financial Crisis 14.5 15 11.0 10.5 10.1 9.7 10 9.3 8.5 7.2 5.6 4.8 5 2.7 1.1 0.5 0.2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 9 Source: HKEx
HK’s Distribution of Derivative Trading by Participant Types (12 months ending Jun 2004, %) A healthy development of derivative trading requires a balanced mix of retail and institutional participants. Overseas institutional Proprietary trading Overseas retail investors 9% Registered traders/ investors 22% market makers 2% 28% Local institutional investors Local retail investors 10% 29% 10 Source: HKEx DTMS 2003/04
Convergence of Derivative and Cash Markets in 2 Aspects 1. Products/Market Participants • Derivative warrants • Equity-linked structured products • Decline of volatility • Impact of hedge funds • Issues to consider 2. Exchanges • Demutualization facilitates convergence Product lines, capital flows (participants), Cash Derivative service providers Market Market (exchanges) 11
1. Convergence in Products/Market Participants • Traditionally, products offered by stock exchanges and derivative exchanges are quite distinct • In recent years, new hybrid products like derivative warrants and equity-linked structured products have become very popular in Hong Kong and some of the major European markets (e.g. Germany, Switzerland, Italy, France) • Institutional players like hedge funds and investment firms are looking for opportunities of mis-pricings between related products in different markets. 12
What are Derivative Warrants? • Warrants on blue chip stocks issued by third party investment/commercial banks • Listed on a stock exchange and traded like stocks (no margining) • Investors face the credit risk of issuers (no guarantee by central clearing house) • Popular among investors : – Allow leveraged play on the underlying stocks – Required investment is small – Easy to understand and trade – Market information is transparent – Marketing efforts by issuers • Most investors like call warrants 13
Hong Kong’s Derivative Warrant Market • Hong Kong was ranked first in terms of market turnover in 2004, followed by Germany • Total trading value in 2004 was about US$67 billion (average daily turnover US$ 272 million, representing 13% of total daily market turnover) • Total issue size in 2004 was about US$ 18 billion, and accounted for about 27% of total funds raised in 2004 • Newly listed derivative warrants was 1,259 in 2004 (issued by 14 issuers) 14
Hong Kong’s derivative warrant market was the most active in the world in 2004 80,000 Turnover of Derivative Warrants by Major Markets (US$ mn ) 70,000 2001 2002 2003 2004 60,000 50,000 40,000 30,000 20,000 10,000 0 Hong Kong Germany^ Euronext* Switzerland Italy Remarks: * Figures for Euronext are the aggregate figures from the exchanges of Amsterdam, Brussels, Lisbon and Paris. ^ Figures for Germany are the aggregate figures from all German Exchanges (Deustche Borse). 15 Source: WFE Monthly Statistics, December 2004
Trading Activities of Derivative Warrants 600 15% Total Trade Value (HKD bn) % of Total Market Turnover 13% 500 11% % to Total Market Turnover 400 Trade Valule (HK$ bn) 9% 300 7% 5% 200 3% 100 1% 0 -1% 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001* 2002 2003 2004 16 * : There was no new issuance of derivative warrants during the second half of 2001, pending the amendments of listing rules. Sources: Fact Books of HKEx, HKEx Securities and Derivatives Markets Quarterly Report
Issuing Activities of Derivative Warrants 160 1400 Total Issue Size Number of Newly Issued Derivative Warrants 140 1200 Number of Newly Issued Derivative Warrants 120 1000 Total Issue Size (HK$ bn) 100 800 80 600 60 400 40 200 20 0 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001* 2002 2003 2004 17 * : There was no new issuance of derivative warrants during the second half of 2001, pending the amendments of listing rules. Sources: Fact Books of HKEx, HKEx Securities and Derivatives Markets Quarterly Report
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