Presented by
Léon Bitton, VP R&D
Montreal Exchange
Winnipeg, March 14th, 2003
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• Bourse Trades all $CDN Interest
Rate Derivatives
• Bourse Trades all Canadian Equity
Derivatives
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$ Traded / Notional value 2002
Interest Rate Derivatives : 5 $ trillion
Equity Derivatives : 143 $ billion
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60 000
50 000
40 000
30 000
20 000
10 000
2002
2001
02 / 01
+9%
+24%
Interest-rate futures
*Open Interest: +31%
Equity
Index
Futures
+20%
Equity options
+15%
Total
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MX
TSE Vancouver Alberta
Derivatives
Senior equities
CDNX
CDCC 100%
TSX
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• Demutualization
• First North American Traditional
Derivative exchange to be fully electronic
• Creation of an on-line Training Institute
• Remote Access USA / UK
• BOX – New US option Exchange
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MONTRÉAL
VANCOUVER
WINNIPEG
CALGARY
LONDON
TORONTO
NEW YORK CHICAGO
Broker
Dealer FCMs,
Proprietary
Firms
Authorized
Persons
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An open electronic trading platform using the following main components:
• NSC trading system used by several exchanges around the world
• Open architecture allowing firms to connect using their own proprietary front end solutions or one developed by an Independent Software
Vendor (ISV)
• Internet based connection – Under review
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Participants
Access Trading
SAM
Post trading
Data
Dissemination
And Clearing
Order &
Quote
Market Data
(HSVF protocol)
• Independant
Service Vendor
(ISV) using
MMTP protocol
(SLE screen)
• ISV using FIX protocol
• ISV and Order
Flow Provider
(OFP) using
STAMP protocol
Communication
(HUB)
Gateways
Trade information
Trading
Engine
(NSC)
Mind Trade
Management
Database
Data
Dissemination
Surveillance
Tools
Market
Data
Data Vendors
Participants & ISVs
(SLC Screen)
Montreal Exchange
Internet Site
Canadian Press
Trade confirmation
Automated Trade
Reporting to
Participants (ATR)
Trade
Market Data for underlying
C D C C
T S X
Trade &
Allocation information
Participants
Back Office
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• Price transparency
• Fairness
• Expanded access
• Rapid order execution
• Straight through processing for execution
• Flexibility of trading hours
• Enhanced liquidity
• Security
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Clearing House carries out three main functions:
• Registers and manages commitments resulting from market transactions
(back-office function)
• Provides protection against counterparty credit risk (netting function)
• Ensures the financial integrity of the market
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CDCC
• Manages a nominal risk of approximately 600 billion $
• “AA” rating from Standard &
Poor’s
Members
• 33 members
• Major financial institutions
• Contribution to Clearing fund and margin: 1,9 billion $
Client Client
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Two kinds of hedging instruments
•
Price fixing Instruments
– Futures
– Forwards
– Swaps
•
Price Limiting Instruments
– Options
Two distinct markets for execution
Exchange based Off Exchange
– bilateral OTC
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Total Worldwide Exchange
Derivatives volume by Asset Class *
Interest
13%
Metals
2%
Gov Debt
15%
Currency
1%
Individual
Stock
27%
* Source: IOMA 2001
Equity Index
35%
Energy
4%
AG
3%
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Dimension of Derivatives Market
Global notional outstanding in
OTC derivatives markets
Forex
20,5%
-
End June 2001: $99.7 trillion
Commodities
0,7%
Equities
2,0%
Credit-linked
0,7%
Interest rate
76,1%
* Source : BIS
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The Global Cash and Derivative Market/Equity
$17.28
$4.93
(in $Trillions)
$28.03
$39.75
Cash Exchange-Traded Index Futures
Exchange-Traded Index Options Exchange-Traded Stock Options
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• Standardization facilitates market liquidity


Futures are price transparent, ensuring fair prices
Anonymity
•
Clearing corporations reduce counterparty risk


Margin
S&P rating
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•Customized •Standardized as to size and maturity
•A structured market
(exchanges are regulated)
•Limited risk of default –
Clearing House
•Marked to market daily
•Margin is mandatory
•Traded in OTC markets
•Subject to counterparty risk
•Generally settled at maturity
•No margin requirements
(or optional)
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Prerequisite for an efficient Market –
Diversity of users and concentration of liquidity
• Hedger is managing risk, either through a price fixing process (futures) or by taking out insurance (options).
• Speculator is taking risk - using investment decision as primary source of income
• Arbitrageur is special - exploiting variations in market conditions
– credit, tax treatments, liquidity
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An illustration of emission allowances and futures trading
 At the beginning of 2003, a coal-fired power plant receives allowances matching its carbon dioxide (CO2) emissions cap, say 20,000 emission allowances
(hypothesis: 1 emission allowance equals 1 ton of CO2 emissions):
0 5,000 10,000 15,000 20,000 emission allowances
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First situation: surplus of emission allowances ‣ ‣ ‣ Selling futures.
 In December, the CO2 emissions of the plant equal only 15,000 tons thanks to the implementation of new CO2 filters:
Surplu s
0 5,000 10,000 15,000 20,000 emission allowances
 Alternative 1:
If the treasurer of the plant knows that the implementation of new
CO2 filters will lower its C02 emissions below 20,000 and if he plans to sell the surplus, selling a Dec 03 futures contract on 5,000 allowances @12 will place a floor to the December 2003 market price.
 Alternative 2:
The plant may keep the surplus for use against its target in future years or sell it to a trader at the market price.
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Second situation: shortage of emission allowances ‣ ‣ ‣ Buying futures
 In December, the CO2 emissions of the plant reach 25,000 tons, it is a shortage of 5,000 allowances.
Shortag e
0 5,000 10,000 15,000 20,000 25,000 emission allowances
 Alternative 1:
If the treasurer of the plant anticipates an increase in the
C02 emissions, buying a Dec 03 futures contract on
5,000 allowances @12 will cap the December 2003 price.
 Alternative 2:
The treasurer of the plant will buy 5,000 allowances at the market price to fill up the shortage in allowances.
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Benefits of the futures market
• The futures market improves risk transfer by enhancing the ability of investors to hedge or assume risk.
• The futures market contributes to the overall efficiency and liquidity of the cash market.
• The futures market improves the transparency of the market.
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Prerequisites for an Efficient
Emissions Trading Market
• Liquidity
Need:
• Sizeable market volume and sufficiently high number of market players
• One-stop shopping for spot and derivatives contracts
• Economic efficiency/minimized infrastructure cost
• Diversity of market players
Need:
• Different market participants with different background and different targets (power generators/industries/traders/financial institutions)
• Cross-border activity
• Standardization
Need:
• Standardised underlyings because they reduce market fragmentation, facilitate risk management and reduce transaction costs
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Prerequisites for an Efficient
Emissions Trading Market
(con’t)
• Risk management tools / Certainty
Need:
• Improved risk management through Derivatives Market.
• Sound Exchange and Clearing House
Need:
• A centralised market place through which buyers and sellers trade carbon emissions and futures with reduced credit risk exposure.
• An Exchange with a market - Neutral position and good reputation for fairness and transparency in the conduct of trading
• Trade facilitation: electronic access and transparent model.
• Legal Framework
Need:
• Establishment of the framework and rules governing the market.
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Investors
(Outright, arbitrageur)
Companies involved in the carbon market
Undertakes emission-reduction projects
Environment
Canada
Emissions trading registry
Independent Compliance and Monitoring
• Self-governing structure
• Provides confidence to the market
• Must meet minimum requirements to be an Approved participant or a clearing member
Registry,Trading,
Clearing & Settlement
• Centralised price discovery
• Market liquidity
• Market Anonymity
• Reduced transaction costs
• Central counterparty risk
Distribution &
Market Access
• Canada
• U.S.A.
• U. K.
• Etc.
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• To provide a one stop shopping for spot and derivative contracts on Canadian environment products.
• Early launch to enable Canadian business to gain practical experience of emissions trading ahead of the implementation of the Kyoto Protocol (2008-2012).
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• Trading emission allowances is no different from trading any other commodity. Anyone who holds an account in a central registry will be able to buy and sell allowances.
• An electronic emission trading system will provide industry, governments and other organizations in Canada with the opportunity to buy and sell emission reductions at a reduced overall cost.
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MX Value proposition: An integrated spot and derivatives cost-effective solution
Central credit
Counterparty
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• Bourse de Montréal
• www.m-x.ca
• Derivatives Institute
• www.derivatives-institute.com
• Léon Bitton
• lbitton@m-x.ca
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