LIFFE – Ready for EMU


Richard Pratt*


Economic and Monetary Union (EMU) is the biggest challenge facing LIFFE since it opened in 1982. LIFFE has substantial strengths on which to build and is basing its strategy for EMU on a detailed analysis of market needs. Only by meeting those needs can any exchange prosper.

As we move towards EMU, LIFFE continues to grow. During 1997, LIFFE has, for the first time in its history, overtaken the Chicago Mercantile Exchange (CME) to become the second largest futures and options exchange in the world after the Chicago Board of Trade (CBOT). During September 1997, LIFFE traded a record 20,105,184 futures and options contracts, its busiest month ever (43% up on September 1996) and more than any other exchange in the world for that month. This continuing growth, not only reflects the market’s confidence in LIFFE as an exchange, but also shows continuing demand by its membership and end-users for its products and its trading platform – both open outcry and electronic.

LIFFE has always looked ahead and in 1996 it announced a strategy to prepare for EMU, the first exchange to do so. This strategy focuses on extending and adapting its product range; developing its trading platforms and enhancing its regulatory standards.

As early as March 1996, LIFFE changed the legal provisions of its contracts for the March 1999 delivery month of its Three Month Euromark and its Three Month Short Sterling futures contracts. Two additional delivery months in its Three Month Eurolira futures contract, including the March 1999 delivery month, were listed in March 1997. These provisions, to three of Europe’s most heavily-traded short term interest rate contracts, allow for settlement against euro interest rates for each currency that participates fully in EMU. If EMU is delayed, or if a particular country is not a full participant, the relevant contracts will settle as originally deemed, giving LIFFE’s members, and end users, the best of both worlds in terms of contract flexibility.

In Europe, there may be only one Euro deposit market, except in circumstances where reserve requirements would be introduced within the EMU area. As a consequence, it is likely there will be only one three month interest rate futures and options contract. Depending on which countries join EMU, only some (perhaps one) of the existing contracts will survive. LIFFE has a wider range of European short term interest rate futures than any other exchange, and holds over 80% of the market share of trading in these contracts. For delivery months after January 1999, this rises to 90%. While all of these products currently settle against the appropriate BBA LIBOR, LIFFE has already made the necessary provisions so that they can all settle against the BBA Euro LIBOR if, and as long as, the respective currencies participate in EMU.

At present, for currencies expected to participate in EMU, total volumes in short term interest rate derivatives are only about half of that for their equivalent in US dollars. As EMU approaches, volumes will increase, reflecting increased use of money market futures, for example, for hedging credit instruments. LIFFE’s strength, as outlined above, is in the short term end of the market.

LIFFE also listed the March 1999 delivery month for its Three Month Ecu contract on 18 March 1997, which will convert automatically into euros with a simple 1:1 conversion, if EMU goes ahead. In effect, the first ever euro futures contract now trades on LIFFE. When EMU occurs, it is likely that the euro will rank alongside the dollar and yen as a major internationally traded currency.

Whilst LIFFE expects there to be one generic short term interest rate futures contract, bond contracts are more complicated as there are likely to be credit spread differentials and liquidity differences between the bonds issued by individual countries. The potential impact of EMU on LIFFE’s European government bond contracts is therefore being researched. LIFFE has held consultations on the Long Gilt, BTP and Bund contracts, which have involved market participants as well as the relevant central banks. Research and discussions centre around the expectations and eventual outcome of the "euro" bond market as well as designing a successor futures contract. LIFFE’s March 1999 delivery months for the Bond contract will be listed in June 1998 and the Exchange has already begun a study of different scenarios and their implications on relevant bond contract specifications.

As well as adapting existing products, LIFFE is introducing new ones designed to consolidate its position as the dominant exchange in deutschmark products. On September 18 1997, in response to strong member demand, it launched its own version of the five year German Government Bond future - the Bobl. The launch has opened up a range of more complex trading opportunities at LIFFE, for example spreads between five and ten year instruments - where LIFFE’s open outcry trading floor has an unquestionable lead. There has been guaranteed liquidity from day one through a unique market maker scheme, thus reinforcing the strength of LIFFE’s broad range of products in the run-up to EMU. In addition, LIFFE has introduced a fee holiday on all Bund and Bobl contracts and the spread between them from 18 September 1997, which will assist investors in taking full advantage of the trading opportunities available at LIFFE. LIFFE also announced that trading hours would be extended so that Deutschmark products now trade from 7.00 am from 18 September 1997. LIFFE’s Bobl futures and options contracts have demonstrated an excellent start to trading, with LIFFE already holding 14% of the market share.

As LIFFE consolidates its position as the leading exchange in Europe, so it has had to look for new premises to ensure that trading is not physically constrained in the run up to EMU. LIFFE is an "open outcry" exchange, modelled on the futures and options exchanges in Chicago, but has the best of both worlds in that it also has a successful automated futures’ trading system (APT). LIFFE still believes that for high volume contracts, open outcry trading remains the fairest and most efficient way of executing business on the Exchange during the main trading day. Open outcry markets tend to be more liquid than electronic ones, particularly in times of volatility and stress when they don’t freeze or slow down; LIFFE has a high proportion of "locals" (independent traders), who are important providers of liquidity. Studies have also shown that there is immediate, transparent translation of news into an open outcry market whereas it is much slower in an electronic one. They are also more transparent and flexible.

LIFFE will improve the cost effectiveness of open outcry and reduce the cost to members of using that trading platform. The exchange has agreed to embark upon an extensive renewal of electronic systems, such as price reporting, post trade processing management, clearing and membership administration. In addition, LIFFE will provide the basic infrastructure and as much additional support as possible to allow Member firms and third party suppliers to develop new order management systems and electronic hand held trader cards in a way which is compatible with LIFFE’s own system. LIFFE will develop a new generation, electronic trading platform for its financial futures and options contracts. The Exchange concluded that there was demand, particularly from the world’s major financial institutions, for screen based systems – particularly for trading after hours.

In late December 1996, LIFFE announced that it had concluded an agreement to buy what is, in effect, an option on a site at Spitalfields, enabling LIFFE, if it so chooses, to develop a new open outcry trading floor and offices. The new larger site will enable LIFFE to develop a trading floor of up to 100,000 square feet and additionally to house all of its administration and management functions under one roof. As an interim measure, LIFFE is also converting the old trading floor at the London Stock Exchange to give it the flexibility of moving some of LIFFE’s products from their current location at Cannon Bridge. These contracts, (Long Gilt, Short Sterling, Euroyen, FT-SE and all Commodity products) will be relocated in phases from May 1998 onwards. LIFFE does not want to be physically constrained in the run-up to EMU and thus of all LIFFE’s contracts, it is the European ones that are likely to develop the most, therefore they should be located where there is the greatest space for expansion. Having analysed the various split market alternatives, and consulted members, it is clear that the greatest space for expansion of European contracts will be at Cannon Bridge after the domestic contracts have been relocated to the Stock Exchange.

LIFFE is also underpinning its position as a well regulated exchange with high standards. It is a Recognised Investment Exchange under the UK Financial Services Act 1986, accountable to the UK Securities and Investment Board (SIB), which is being reformed. The start of the reform has been the submission by the SIB to the Chancellor, of its statement on "NewRo’s" aims (NewRo being the "Super-SIB" in which all the functions carried out by the current "SRO"s (Self-Regulating Organisations) will be combined with the supervisory responsibilities of the Bank of England and insurance regulators. LIFFE was particularly pleased to see that the vital role of the exchanges as front-line regulators was fully recognised and that NewRo will respect three key principles which we believe are vital in maintaining effective regulation, while at the same time providing enough flexibility to allow innovation by firms and exchanges. The three principles are that:

First, flexibility is crucial. We are pleased that NewRo is committed to responding quickly to market developments and to adopting a flexible approach to regulation.

secondly, that NewRo will welcome practitioner input

and, lastly, that NewRo will ensure appropriate distinctions are made between the regulation of retail business, reflecting the varying expertise of investors and their relative need for protection.

LIFFE is reinforcing its own regulatory standards by achieving better surveillance through upgraded video logging and has undertaken an extensive Rules Review to increase efficiency and reduce the time taken to complete disciplinary proceedings.

LIFFE’s strategy and preparations for Economic and Monetary Union, as described above, are reinforced by substantial existing strengths. Its position as one of the City of London’s two main financial markets is highly beneficial as LIFFE believes that London will remain Europe’s leading financial centre post-EMU (London employs more people involved in the financial centre than the entire population of Frankfurt). London’s foreign exchange market is the largest in the world : greater than Tokyo and New York combined. Every trade executed on LIFFE is cleared through the London Clearing House (LCH), which provides a secure and efficient clearing service to LIFFE members, protecting the integrity of London-based domestic and international markets and the interest of their participants.

LIFFE provides the best opportunities for profit for members and their customers by offering the widest, most liquid range of products among derivatives exchanges in the world, i.e. futures and options in money market, bond, equity indices, individual equities, agricultural and soft commodities, denominated in seven major different currencies, and also offers other trading facilities, such as spread trading and strategy trades. Europe’s most heavily traded government bond future (the German Government Bond "Bund" contract ) is traded at LIFFE and its aggregate market share for Deutschmark interest rate products (the DM curve being likely to transform into the benchmark euro curve) is currently 54%. It offers the most secure environment for investors through its high regulatory standards, its transparent market and its reliability in times of high volume.

The London International Financial Futures and Options Exchange (LIFFE) is determined to anticipate and meet market needs. The advent of EMU is seen as the greatest challenge to face the Exchange in its history and is viewed both as a challenge and an opportunity. By developing the strategy and strengths set out in this statement, we believe it can be successful in its bid to consolidate its position as the leading derivatives exchange in the world.


* Director of External Affairs LIFFE .Cannon Bridge - London EC4R 3XX