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M. Isi Eromosele
The derivatives market is highly competitive. Generally, there
are two indications for competition in a market: new market entries and
customer choice. The derivatives market scores high on both. New players
regularly enter the market and customers can choose between many substitute products across both its segments.
Market entries
The derivatives market can be characterized as highly
dynamic with plenty of market entries. There are no legal, regulatory or
structural barriers to entering the derivatives market. Almost all derivatives exchanges
across the world have been created during the last three decades only.
The United States
was home to the first wave of equity options exchange foundations in the 1970s in
the wake of academic breakthroughs in options valuation and the introduction of
computer systems. The CBOE was founded in 1973, the American Stock Exchange, Montreal Exchange and Philadelphia Stock Exchange
started options trading in 1975 while the Pacific Exchange commenced options
trading in 1976.
A second wave of new derivatives exchanges occurred in the 1980s
and early 1990s in Europe . During that time, a financial
derivatives exchange was established in almost every major Western European financial
market - the most important ones being London with
Liffe in 1982, Paris with Matif in 1986,
and Frankfurt with DTB in 1990. Most of these organizations formed their own clearing houses.
In recent years, new derivatives exchanges have started to
compete with existing derivatives marketplaces. In such a dynamic market, the
already large number of derivatives exchanges is likely to continue growing.
Away from the developed markets, related activities in emerging
markets were also intensive. Three derivatives operations have commenced
trading in the Middle East since 2005: Dubai
Gold and Commodities Exchange , Kuwait Qatar .
Banks are also constantly entering new product segments: Goldman
Sachs, for example, has invested heavily into the commodity derivatives segment
in recent years. BNP Paribas has
successfully developed the OTC equity derivatives segment. There are numerous successful market entries into the OTC segment such
as ICAP or GFI, which provide trading services via electronic platforms, or of
clearing service providers such as Liffe’s Bclear.
Varied Choices
This dynamic market offers users choice falling into three
categories: (a) choice between different OTC dealers within the OTC segment, (b)
choice between the OTC and on-exchange segments for many contract types, and (c)
choice between different derivatives exchanges.
To deliver maximum benefits to its users and to the economy, the
derivatives market must meet three prerequisites: derivatives trading and
clearing must be safe, the market must be innovative and it must be efficient.
There are wanted and unwanted risks in the derivatives
market. Both the OTC and exchange segments have arrangements in place to
mitigate unwanted risks, although these are inherently more effective in the
exchange segment.
The main reason for using derivatives is to gain exposure to
a wanted risk. This usually is a market risk that either could compensate for
an opposite risk (hedging) or that an investor wants to benefit from for
investment purposes - via the positive evolution of market prices.
However, as with other financial instruments, there are also
unwanted risks associated with derivatives trading that investors seek to avoid.
These unwanted risks are counterparty, operational, legal and liquidity risks.
Risk Mitigation In The Derivatives Market
To fulfill its role of protecting against risks and providing
the means for investing, the derivatives market itself must be safe and
mitigate unwanted risks effectively.
The derivatives market has arrangements in place to mitigate
unwanted risks that arise from conducting derivatives transactions. From a
practical point of view, these arrangements have proven successful - the
unwanted risks in the derivatives market have been reduced to a tolerable level. Even when failures of
market participants have occurred, they have not seriously affected other
market participants.
M. Isi Eromosele is
the President | Chief Executive Officer | Executive Creative Director of Oseme
Group - Oseme Creative | Oseme Consulting | Oseme Finance
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2012 Oseme Group
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