Last week, we took a look at the somewhat unique situation of WTI Crude Futures being in Contango while their near identical twin, Brent Crude Futures were in backwardation; and now a recent article from the Wall Street Journal (you can see the full text here) highlighted an interesting consequence of these pricing anomalies – the rise of ICE.
The futures exchange is where trades are made, and it wasn’t that long ago that they hosted bustling trading pits replete with screaming, gesticulating traders scrambling to get the best deal possible. But now, most of these trades are placed electronically. You’ll frequently hear us make reference to the CME, or Chicago Mercantile Exchange, on this blog. The CME is easily the largest futures exchange in the U.S., and one of the dominant exchanges in the world. However, ruling the oil trade since 1983 has been the New York Mercantile Exchange, and the clearing fees associated with that contract alone are enough to make it venerable… which is probably why the CME bought them out in 2008. Still, ICE, or the Inter Continental Exchange, where Brent Crude is traded, is quickly becoming a contender in the battle of the exchanges, beating out NYMEX’s WTI trade in volume for the first time in four years in the month of June.
Does it really matter who the belle of the exchange ball is? To a managed futures investor – no. We don’t really care what exchange a manager is executing his or her trades on; we really just care about the trade result. To the CTAs (Commodity Trading Advisors) themselves, it matters slightly, in so far as they may need to eventually add ICE Crude to their portfolio in place of Nymex Crude (if they haven’t already done so), and all of the data collection and setup tasks which go along with that.
Beyond that, competition among exchanges can theoretically provide many of the same benefits to traders that competition among retail stores gives to average consumers- pricing. But in practice this has rarely worked. There have been several tries by exchanges to break into the CME’s interest rate futures monopoly via severely discounted clearing costs. But as these competing exchanges have found out, cost is but one consideration when deciding which markets to trade, and far below liquidity and volume at that.
What ICE seems to have figured out (or lucked into), is to compete not directly with futures on the same deliverable, but instead, indirectly, via a market 95% the same. Perhaps we’ll see the same at some point in the future with Russian Wheat, Brazilian Sugar, and so on. With the managed futures industry showing no signs of slowing down any time soon, it isn’t too much of a stretch to imagine exchanges creating these sorts of one off markets to lure CTAs to add the markets to their portfolios.