A New Approach For Exchanges
Sometimes, exchanges like the London Metal Exchange and the CME Group will identify a commodity that they believe will have a large enough interest to launch a futures market, allowing companies to mitigate the price risks on their physical contracts. However, in recent years the success of launching a new product on an exchange has been limited, and often offerings have been pulled due to a lack of interest.
As we approach 2025 and more companies are looking to reduce exposures to the increasing volatility we are seeing, I believe there is a real opportunity for exchanges to increase their product offering. But, having had several conversations directly with the exchanges and having sat on a committee or two in the past, I believe they are going about these launches the wrong way.
Obviously the most important thing for a new product on an exchange is volume. If there is a lack of interest in trading the product, it will face a very difficult time getting off the ground. Historically, the participants most willing to try out new products are traders and brokers, who have the teams in place and the experience to navigate these markets. And so these are often the prime targets of exchanges to try and drum up interest. They might also focus on the minutia surrounding the deliverable specs of a contract: shape or grade of material for example. However, in my opinion this is an incorrect approach.
Instead of focusing on traders, exchanges should be focusing on producers. If they could convince/incentivize producers to utilize their exchange price for their physical contracts, it would force the hand of the traders and end consumers that buy from them. A trader or a consumer that hedges their price risk would be forced to utilize the same exchange to execute futures on that the producer was using to define the price of their physical contract. By convincing the producer to utilize the exchange, they are creating 3 times the potential volume of traded contracts. The producer will have its initial short position that they will close out when they sell physical to the trader. The trader will create a short position when it buys from the producer, closed out when it sells to the end consumer. And the consumer will have a short position when it buys from the trader or producer, and close out that position when it sells the finished product.
Convincing producers to try something new can be difficult, but with companies more focused on risk, there is a real opportunity for exchanges to step up and deliver access to companies that are looking to reduce exposures.
