CASE – what to look for when setting up an exchange



Discussion Paper

Setting up a Derivatives Exchange

What to look for and points to consider

Paul Meier

Chairman

Swiss Futures and Options Association

Background

This paper is based on an actual request for support in setting up a derivatives exchange. Because the issues are rather generic than market specific this paper is drawn up without reference to the country involved. This way it can also be used in other situations.

It is to be pointed out that this is a very superficial discussion paper and cannot be used as a blue-print for establishing an exchange (and a clearing house). Obviously such a complex market as the derivatives has a lot of different facets and details to cover that would be beyond the reach of such a paper! This paper is merely meant to outline and briefly discuss the issues facing someone setting up a new exchange.

As mentioned also in the conclusion: building up a successful exchange requires time and pulling together by a lot of different organisations. It also involves a lot of education and demand a level playing field for all participants. Trading should not start before all facets of the market needs are covered.

Contents

1 Short History of Derivatives

2 Needs for a successful derivatives market

2.1. Market/Set-up

1. Underlying Market

2. Ownership Structure

1. General

2. Profit-making venture or not?

3. Combined or separate ownership?

1. Market environment (incl tax situation)

2. Regulatory Environment

1. General Comment

2. Market Surveillance

3. Position Limits

2.3.4. Client Documentation

3. Clearing House

1. Horizontal or Vertical Approach?

2. Clearing Safeguards

3. Exchange and Clearing House Fees

4. Margining

1. Variation Margins

2. Initial Margins

1. General Comment

2. Long Options

3. Covered short options

4. Naked short options

3. Margin rates

4. Acceptable margins/collateral

5. Choice of Products

1. General

2. Financial Products

1. Stocks

2. Indices

6. Some Contract Specs

1. Size of Contracts

2. Cash settlement or delivery?

2.7.4. Final settlement procedure on cash settled markets

5. Settlement procedure on physically settled markets

6. European or American Style

7. Contract Months (Expiry cycles)

1. Futures

2. Stock Options

3. Options on Futures

7. Target Clientele

1. General

2. Hedger or Investor?

8. Technology

1. Choice of Trading System

9. Market Organisation

1. Order-Driven or Market Making?

2. Give-ups

3. Price Dissemination

4. Static Data

5. Press Relations

10. Education

1. General Comment

2. Traders

3. Investors/Speculators

4. Backoffices

5. Regulators, Politicians

6. Media

2. Conclusion

1) Short History of Derivatives

Exchange Traded Financial Derivatives are rather young – around 30 years old. The idea of derivatives is very old, however – already Aristotle described the use of derivatives in his book Thales. Intermittent activities with derivative fever took place on and off, but it was not until 1848 that a concentrated effort started to standardise these products with the establishment of the Chicago Board of Trade.

For a very long time derivatives markets were concentrated in a few cities (Chicago, New York, and London had internationally accepted markets; some countries also knew rather local markets) and were limited to commodities. This changed in the early seventies for two reasons:

- the quiet markets of the sixties made it very hard on the commodity exchanges to survive. Therefore they went on the hunt for new products and in the early 70’s came up with standardised options on stocks as well as futures on interest rates. CBoT founded their daughter Chicago Board Options Exchange (CBOE) for two reasons: regulatory (futures are regulated by the CFTC and stock options by the SEC) and to make sure to immunize their members as far as possible from a possible failure of CBOE.

- when President Nixon abolished the gold standard August 15, 1971 hedging currencies became a big issue and it did not take long before currency futures (and options thereon) where offered by the IMM (which is a daughter company of the CME; again set up as a daughter to immunize their members from possible losses)

Once interest futures got established in 1975 (interestingly on GNMA’s rather than T-Bonds) the activities on exchange traded derivatives started to pick up steam quickly. The European Options Exchange was established in Amsterdam in 1978, followed by Liffe and other exchanges on the continent as well as Asia. With the start of index futures in 1981 the dam broke completely and today most countries with some kind of underlying market are offering derivatives. Very often, unfortunately, these ventures are started without proper pre-conditions and quickly fail (1995, e.g. 75 exchanges existed in China, none have survived).

Derivatives have arrived. Today they are no longer viewed as the ultimate speculation tool but they are accepted as risk management tools, be it to hedge positions, to replicate positions generically, to assure deliveries in the futures or to simply facilitate portfolio management.

2) Needs for a successful derivatives market

2.1. Market Set-up

2.1.1. Underlying Market

Before the launch of a derivatives market it is important that there is a functioning underlying market. This means both proper liquidity, market structures, legal and compliance surroundings as well as customer acceptance.

The Derivatives are a natural evolution of the cash markets: first you trade the cash products, then a forward market develops (either as a non-standardised forward market or as a standardised futures market). Once that market works one can add an option market, again either non-standardised (over-the-counter) or standardised.

Very important, of course, is that the need to list and trade derivatives is accepted by the market place. Only with a well-functioning interplay between the various market segments will the derivatives market flourish. At the same time, the underlying market will become more efficient, liquid and successful!

2.1.2. Ownership

2.1.2.1. General

An important question is who should own the Derivatives Exchange and its Clearing House and how should that ownership be structured. Should it be part of the Underlying market or a separate entity? Also, should it be a for-profit enterprise or a “utility”, providing a service to the investing community?

2.1.2.2. Profit-making venture or not?

The trend today is clearly towards profit-making exchanges and clearing houses. This may be in contrast to the original idea of a market place to function as a public utility whose main purpose is to serve as a centre for price-finding, trading and subsequent price-dissemination, but obviously an exchange or a clearinghouse is subject to constant changes that need to be financed to stay attractive.

2.1.2.3. Combined or separate ownership?

One big advantage of a combined ownership could be that the same infrastructure can be used, producing savings in the process. Also for margining purposes there might be advantages, especially if clearing house for derivatives is at the same time also settlement system for stocks and bonds.

Being independent would facilitate choice of products and possible co-operations with other exchanges/clearing houses. It would also facilitate outsourcing of activities to other exchanges/ clearing houses which could bring considerable cost-savings and leave the door open for expansion late on.

2.2. Market Environment (incl Tax Situation)

It is very important that the legal framework for the Derivates is set before any trading begins. This involves both the rights and obligations of the market participants as well as the organisation of the markets.

Some of the things to be considered (this list is of course in no way complete, but serves rather to illustrate some of the items to be considered; it would be necessary to work together with specialists on this):

- In many countries e.g. there are no specific laws on how derivatives should be treated and as a result often are considered to be part of the gambling laws. This, of course, makes it almost impossible for the market to become successful as contracts are not enforceable

- Tax treatment of Derivatives need to be clear and must not create inequities between the different market participants resp products (e.g. different tax treatment for stocks, bonds and/or deriviatives)

- Short Sales of underlying products must be possible (otherwise there is no possibility for proper market making)

2.3. Regulatory Environment

2.3.1. General Comment

The regulatory framework is very important – both to keep the market proper as well as to assure the acceptance by the investors, both home and abroad.

Ideally the Regulators cover both the underlying as well as the derivative markets. This should apply whether the markets concentrate on financials or commodities or both!

The regulation should be set-up by the state as well as the supervision of the exchange and the clearing house. The regulation of the market participants, however, can be either handled by the Regulatory Body, or that body can delegate this to the exchange or an organisation supported by it or the market place could set-up a self-regulatory organisation which would control the market participants according to the rules set forth by the Regulator.

There is no clear favorite for this. Switzerland has faired well with its solution – clear regulation by the Banking Commission and choice to market participants to be supervised by an SRO respectively by the BC.

No matter what the solution will be it will require enough lead-time to establish the necessary know-how.

2.3.2. Market Surveillance

It might be advisable to set up a market surveillance program to make sure a fair market exists at all times.

2.3.3. Position limits

There are position limits for investors in certain markets. Again the situation is a bit different between securities and commodities markets.

In securities there need to be limits on derivatives in order to avoid possible manipulation of the underlying. These limits should reflect the size of the underlying product respectively the number of shares available for trading. Thus a larger company will have bigger position limits than smaller companies.

An important consideration in setting position limits is to make sure that possible reporting limit in the underlying stock cannot be circumvented (e.g. in the case of 5% ownership a reporting is necessary) respectively that a reporting will also have to be done if the shares are owned via option holdings.

Also necessary may be a requirement that a position limit applys per trader, not per account he holds (i.o.w. if a trader has filled his position limit with one broker he should not be allowed to open additional positions with another broker).

Separate rules may have to apply in the case of market makers (since here the derivatives positions are usually offset by opposite positions in the underlying)

In Commodities a similar problem exists: Hedgers should be exempt. To prevent abuse they should have a requirement to be ready to prove that their positions are the result of hedges. (if e.g. a wheat producer has a long position in wheat futures he would have to prove that he has sales against that position, otherwise he can be forced to reduce his position to speculative levels). This requirement should be covered by a separate agreement to be signed by the hedger.

2.3.4. Client Documentation

It will have to be assured that all clients are properly documented as derivatives do offer a lot of special issues. Especially important is to include a passage where the clients confirm that they understand the risks associated with trading derivatives. It might be advisable to prepare a sample document to be used.

2.4. Clearing House

2.4.1. Horizontal or Vertical Approach?

As mentioned earlier the Clearing House can either be owned and run by the exchange (for practical purposes a separate legal entity would make sense to immunize the exchange from any possible problem) or as an entirely different organisation.

In London e.g. the London Clearing House (LCH/Clearnet) clears the business of various exchanges (both in the underlying market as well as derivatives) as does the Options Clearing Corporation in Chicago, which clears all US options business handled by the six exchanges. The advantage of this approach is the flexibility for the clearing house to run its business and also to clear business from other exchanges. The draw back (for the exchanges) is that it is a separate profit-making entity and its profits do not accrue to the exchange. This is called the horizontal approach.

The vertical approach (silo) has same ownership for both trading and clearing (such as Eurex). The advantage here is closer control of the clearing activities by the exchange, control of the pricing and income to the exchange. One big advantage of course is the fact that the end-to-end process is not interrupted. Systems-ownership has no interfaces to contend with.

2.4.2. Clearing safeguards

Clearing is basically a straightforward process. Important, however, is the control of the clearing members, setting up proper rules and regulations as well as safeguards such as organising a guaranty fund (a fund that can be tapped to pay debt left by a defaulting member).

It also has to be assured that members have they up-to-date positions every morning before trading so that they can check them with their clients. So technology and connectivities to clearing members are very important

2.4.3. Exchange and Clearing House Fees

There has been a tendency in the past to start with rather high fees because in the context of the overall value they appear low. In today’s competitive environment, it could well be the wrong strategy. Many exchange never really got off the ground or are just scraping by due to this reason!

2.5. Margining

2.5.1. Variation Margins

Clearing of the business is one thing, the daily maintenance of the positions is just as important. After all the clearing house guarantees all the trades and it is necessary to assure smooth and prompt settling of accounts every day before trading begins. This means in the cases of futures that the daily p&l is collected from those on the losing side and then passed on to those on the winning side. These transfers must be done by automatic settlement via standing instructions between clearing house and clearing member. In the case of options it must be assured that the margining needed for the positions is on deposit by the clearing members.

To assure that an efficient, automated way needs to be established to calculate closing or settlement prices for futures and options as well as a valuations of the various underlying products to be able to calculate the necessary margins due.

2.5.2. Initial Margins

2.5.2.1. General Comment

The following describes the various possibilities of margins. It is not uncommon to have different set of rules between a clearing house and the clearing member and between the clearing member and its client. The former can be a bit more relaxed due to the fact that the clearing house should have power to automatically collect from the correspondence bank any margin due, whereby the time lag may be a bit bigger between the clearing member and its client. It is important that the rules are clearly spelled out in the rule book to be published by the clearing house!

2.5.2.2. Long options

For long options no margin is necessary unless the options are future styled (in the case of futures styled options the premium is only due at expiry, before that they are margined just like a future). For the sake of simplicity futures styled options should not be offered!

2.5.2.3. covered short options

In most markets investors that sell options against stocks in their portfolios can pledge their stock position as security. This is a very good solution for the client, should, however, only be offered if an escrow system is in place like in the US (instead of delivering stock to the clearing house, the custodian delivers an escrow receipt with which the clearing house can obtain the stock in case of exercise).

If such a system is not available it is advisable to allow naked shorts only and to demand cash or general collateral margins (see 2.5.2.4)

2.5.2.4. Naked shorts

In the case of naked shorts of options as well as futures in general an “original margin” (also known as initial marging) is due. There are two approaches that can be used: the portfolio-based system or a case-by-case system.

The portfolio-based system measures the risk of the entire portfolio, i.o.w. certain longs may off-set the risk of certain shorts, even if they are not in the same product. Market volatilities and various other risk measurements are included in the calculation as well. Professionals may ask for that but my suggestion would be not to use this (at least initially) for the simple reason that it is very difficult to explain this to clients.

In a case by case system the margin is applied to individual positions (after elimination of clear spreads reducing risk, i.o.w. a Sept long in a stock index and a Dec short in in the same index will have a smaller margin than an outright position). The advantage of this system is its simplicity both in its use as well as explainability. Obviously it is not as flexible towards changing market conditions, but daily changes are possible and this should be enough flexibility.

2.5.3. Margin rates

Usually small investors (very often even institutional investors) have to put up higher margins than hedgers (the reason behind it is that the hedgers will pay the margins same day but investors may be a day behind). For simplicity reasons I would suggest to leave it up to the clearing member to set the margins to be collected (sole demand would have to be that it be at least the margin to be deposited with the clearing house).

In some markets the maintenance margin is known. This means that the extra margin that the investor has to submit (in the sample just mentioned the 25%) will be used to pay variation margins and in the case it is used up the investor has to put up the full 25% again. The advantage of this is it reduces the money transfers necessary between the clearing bank and its clients. It is not advisable, however, to use this system between clearing house and clearing member.

2.5.4. Acceptable margins

It is suggested that only cash and Government paper is accepted as collateral. Whether this is restricted to Government paper of the country where the exchange is located or should include G7 paper (US, UK, Canada, Japan and EUR) depends on local rules. It may well be advisable to allow both to make it on international clients easier to margin their positions.

Obviously cash is the preferred way. To make it interesting for clearing members to deposit cash the clearing house may decide to either pay interest on cash margins or to offer members a money market fund scheme.

2.6. Choice of products

2.6.1. General

Important for the success of an exchange is, of course, the choice of the proper contracts. As mentioned initially it will be crucial that the investors, hedgers and investors accept the product and will also trade it.

As a stock exchange it would appear to be natural to concentrate on financials first: Stocks and Indices. The choices are wide, but I would make sure to limit the choice to those markets that have a good chance, both by acceptance by clients and readiness of the underlying market (both technically and in liquidity).

Then again, of course, there well could be some commodities available which are trading regularly and where standardisation is already done or would be possible. This could give an exchange an additional service to offer to the national economy.

2.6.2. Financial Products

2.6.2.1. Stocks

Both futures and options are possible to be listed for individual stocks.

Options would be the traditional choice and certainly must be included.

Futures on stocks have a rocky history – they are not really active in mature markets, but there are various exchanges that have a successful listing of stock futures. Especially in markets where deliveries are difficult (or at least not yet automated) it may well be attractive for different market participants to invest in stocks via futures, as they can avoid those problems.

2.6.2.2. Indices

If an index product is to be launched it would be good to have a future and then an option on a well established reference index. If none exists, it would be important to first launch and establish such an index to get it known and popular. If an index product is launched it is to be assured that market making is easily do-able (buy/sell of basket of stocks should be possible) to assure fair prices. The more difficult it is to hedge positions the more prices will tend to be “unfair” and keep clients away.

2.7. Some Contract Specs

2.7.1. Size of contracts

The choice of the size of the contracts is very important! It would have to reflect the usual practice in the underlying market. This is especially important in commodities, where the derivatives markets play a very important role – if they fit the value chain. If contract sizes were to differ from the usual market practices futures and options could not be used properly and would not be of interest to the commercial users.

2.7.2. Cash settlement or delivery?

There is no clear answer on this for most products. Obviously index products should be cash-settled (either directly or via futures that can be received if the option is an option on a future, which themselves are cash settled again).

For all other products I would tend to favour physical delivery, although many will say cash settlement is better, especially in the case of commodities, to avoid investors having to take or make delivery.

Most markets have physical settlement of derivatives if a product or – in the case of an option - a future is the underlying. The main reason for this is the fact that this makes it much easier for the trade to pass on the underlying if necessary. Using an example: a cotton dealer is long cotton and hedged with futures. The future comes to its expiry and he decides to make delivery because the actual cotton is unsold. If delivery is possible it is easy to make the tender, get the cotton paid for and out of his system. In the case of a cash-settled future he would have the price settled at expiry, but still own the product and facing the decision to find a cash buyer or to re-sell another future to stay hedged.

Some people favor a cash-settled future to avoid manipulation of a market. This, however, is no solution as the index used to settle can be manipulated as well (and most likely much easier than the cash product itself).

2.7.3. Final Settlement procedure on cash settled markets

Settlement procedure on cash settled products is simple – a clear cut-of time needs to be specified. In the case of index products it usually is the average price of the opening or the closing of the market. If stock options are to be listed as well it might well be better to use the opening price and settle the stock options at the end of the day to avoid having all the closing transactions by the market makers at the same time.

2.7.4. Final Settlement Procedure on physically settled markets

There are two ways to finally settle contract months on products that have delivery: trade until day x and make delivery on all open contracts on day y, or allow shorts to chose the actual day of delivery during the delivery months.

Latter is the standard system in most traditional commodity contracts as well as in some of the financial futures. In newer contracts, however, it has become rather standard to have an expiry day and delivery a set of days thereafter. For a new launch I would chose latter system (unless there is strong demand from the trade side)

One thing should be assured: options on futures should have an expiry about one week earlier than the underlying future. This to give clients that have been exercised a chance to get out of the futures positions before it gets settled – this is especially important in physically settled futures (in the case of cash-settled futures it does not make sense because the future would be settled at the same time)

2.7.5. European or American style?

Options can be exercisable two ways –anytime (american style) or only at expiration (european style).

Traditionally options on individual stocks are American style to allow market makers (or holders of options in general) to exercise them ahead of a dividend or a capital event. It is strongly suggested that this is chosen for stock options as it facilitates marker making.

For index and commodity options, however, European style makes sense for two reasons: it facilitates spread trading (in the case of American style options there is always a risk that the short side is exercised, making spreads risky, especially those where both legs are in-the-money) and it can also act as a protection for clients (it usually does not make sense to exercise an option early).

2.7.6. Contract Months (expiry cycles)

2.7.6.1. Futures

In the case of financial futures it is suggested to follow the developing international standard of listing quarterly futures in the March cycle (i.o.w. March/June/Sept and Dec listings). In the case of most financial futures is suffices to list the next three, at most four months, since most trading will anyway take place in the spot months (the other months usually have only little liquidity and their prices are a function of carrying charges anyway).

In the case of futures on short-term interest rates more months should be added because each and everyone will have a different price based on expectations.

The temptation is great to list every available month. Experience has shown, however, that this is not a good solution and shies away investors. For short-term investors this might be interesting, for all those investors, however, that use the futures to replicate their underlying positions and keep them over a longer time this is a bad solution as it means they have to roll-over the position every month. Having the quarterly expiries also improves liquidity in the traded month as it does not split up the trading.

2.7.6.2. Stock Options

A varied approach is suggested here. As a basic start quarterly options, again in the March cycle. In addition, it would make sense to add monthly series to make sure that say for the first three months option series can be traded (i.o.w. early Jan one could trade Jan, Feb and Mar and once the Januaries have expired add April and so on). In addition would add half-yearly or even yearly strike months two years and beyond.

Reasoning: with the short-term options a lot of investors might find interest and sellers often prefer to sell options short-term. Investors buying options as replacement for stocks prefer long-term options, however.

2.7.6.3. Options on Futures

Clearly options on Futures should follow the underlying contracts, but easily can have longer maturities than are listed for futures. Since they should be European style there is no danger of an exercise of something that does not trade yet.

Again, the addition of serial months early on could/should be considered. This, of course, brings with it the fact that options would be listed with no congruous underlying (Bund futures, e.g. have a quarterly cycle. As a consequence there would be no January future on a January option. This problem is solved in that the option is an option on the next underlying futures market, in other words in the above case the holder of a January option would receive a March futures upon exercise).

2.8. Target Clientele

2.8.1. General

Before this can be answered a survey of market needs must be done. Why is the derivative created? In the case of financial products it would have to determined whether products on individual stocks are preferred or rather index products. A lot will depend on the state of the underlying market, especially also in the case of Bonds or currencies. A strong market needs to exist! In the case of commodities the first question must be – will it help the local industry? Will she support it? Does is cover a regional need (if say two or three countries have a similar product with active trading across borders)? Or is it launched to facilitate international investment in that country? Is there a demand for it by the trade? A lot of questions to be researched, before a decision can be made on products to list.

2.8.2. Hedger or Investor?

Often derivative markets have been launched to satisfy a speculative demand. But to me very clearly, as mentioned earlier, the driving force for any market must be the hedger. A market that does not cover the needs of the hedger (or, even if it does, the hedger does not use it) will never have a chance. At the end of the contract there has to be congruence of price of future and under-lying and if that does not work then the hedger will make or take delivery. In the absence of the people trading the underlying products that will never function.

Of course it is important to attract the investor – the more there are the easier it is for the trade to hedge their needs!

2.9. Technology

2.9.1. Choice of Trading System

Electronic vs open-outcry is a long discussion in the established markets and clearly the electronic version has now established itself in the financial markets. In commodities it will take a bit longer as the requirements for the system are different (financials are usually straight forward buy/sell markets in the nearby months, while commodities have much more trading in the various months which leads to a big spreading activity which is difficult to replicate electronically).

It could well be that – especially if the underlying market is currently still trading open-outcry – open outcry is the proper system selection. It is not to be forgotten, however, that also this system will need electronic support to avoid a complete manual system which would have a hard time absorbing strong volumes. In many instances the open outcry market delivers excellent result and – in some cases – probably even superior results than the electronic market.

Obviously currently most exchanges that are started up are electronic. The big advantage is the fact that a lot of manual interfaces, which all require special control steps, can be avoided. Also it might be easier to add volumes and to hook up to other markets/systems. Further a lot of these systems are available and can be had for reasonable price.

Without knowing the local circumstances no recommendation can be given as to system to be used.

2.10. Market Organisation

2.10.1. Order driven – Market making

This will be a very important decision to assure the viability of the new market.

To start out a new market the temptation may be there to choose an order driven market because there is no need to have devoted market makers. For futures, where usually just the spot months is trading, this may work. But in options market, this system will make for a lot of (very) wide spreads and maybe even no quotes at all.

Clearly a market supported by active market makers is the desirable way to go. This way clients at all times will see a price at which they can trade, which makes the confidence in a market better. It might be difficult to organize market makers for all the products, especially in situations where the market-making know-how does not exist extensively. Therefore strong commitment would be necessary from banks and/or brokers to commit to market making. This may involve choosing only a small number of products to trade, at least to start. Also the market making needs may be restricted to near-by options only, leaving the further away strikes and trading months open and quotable on request only.

2.10.2. Give-ups

More and more clients have different brokers for clearing and execution. Some exchanges try to discourage this by either disallowing give-ups or making them very difficult. This should be avoided! If a client prefers to deal this way he should be able to! If he can’t, there is a good chance that he will not trade those products.

2.10.3. Price Dissemination

Make sure that major price providers will be on board to distribute prices not only locally but hopefully also internationally.

Providing prices is a lucrative business for many exchanges. But in my opinion this is short-sighted because many banks/brokers will not buy the service, meaning that the clients do not see prices. In that case most usually they will not trade the market. Therefore prices should be given away!

It could even be argued that this would be the proper way to go – after all the exchange fulfils a public need for price-finding and dissemination. I.o.w. it is a public monopoly that should function that way and not for profit of the exchange?!

2.10.4. Static Data

Price Dissemination is most important. Therefore it is important to assure that the static data (such as product codes) are done in a way where both data vendors and market users can apply them without much problem.

2.10.5. Press Relations

It will be important to build up a good relationship with the financial press. This does not just mean feeding them info but also educate them about derivatives, their use and applications. It is important that they know the interactions between the cash- and the derivatives markets, otherwise very quickly erroneous and negative press can spread, damaging the marketplace!

2.11. Education

2.11.1 General Comment

This may be the last item discussed in this paper, but actually might be the most important! Without properly educating market participants and people surrounding the market, including officials and regulators the long-term chances for success are not very good. Education is the solid foundation on which success will have to be built.

2.11.2. Traders

Obviously the users of the markets (market-makers, locals (people trading for themselves), banks and brokers) need to know about derivatives and their risk-managing aspects. It is important they really know how and when to use them. The better educated they are the better the market will function.

2.11.3. Investors

Obviously, a market will not survive from the trade alone. A broad array of participants are needed for a successful market, including Asset Managers, Institutional and private Investors, Pension Funds and so on. To assure that they really know what they are doing it is important that regular seminars are offered to them to assure proper handling of these products

2.11.4. Backoffices

Back-offices today are by far more than just order-processors. To understand what they are really doing it is important that they are educated. The derivatives business, with its open positions, daily valuations and marginings is different from any other business and therefore has different needs!

2.11.5. Regulators, Politicians

Before any exchange can get started the proper regulatory environment must to be set up. It is important that this be done by people that know the needs of the industry and maybe even be accompanied by some that can give proper support. Many established organisations do offer this.

2.11.6. Media/Relations with press

As mentioned above part of the education needs to go to the press!

3. Conclusions

Derivatives are an integral part of any well-established market. The needs of market participants are no longer restricted to buying and holding a product, but also the secure their forward needs, being able to buy protection, receiving additional income and of course to play the markets.

Setting up a derivatives exchange requires a lot of pre-work on the legal environment, proper regulatory set-up and supervision, education of all market participants, technical set-up, connectivities to market, information dissemination, market making just to name a few.

There well might be a push to get going quickly as these markets are the rage of time. This should not be done, however. Success of an exchange is just like reputation: it takes a long time to build it but only a short time to tear it down!

As mentioned at the beginning – this paper is but a short summary of items to be considered and should be considered a starting point and not a blue-print!

Good luck and lot’s of success!!

Paul Meier

Chairman

Swiss Futures and Options Association (SFOA)

18b Rue du Gothard,

PO Box 325

CH-1225 Chêne-Bourg

Switzerland

September 5, 2005/pm

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