On commodity derivatives and the Norwegian initiatives
to create a fish derivatives market.
Article Type:
Company overview
Commodities industry
(Contracts)
Derivatives (Financial instruments)
(Prices and rates)
Gronvik, Gunnvald
04/01/2008
Publication:
Name:&Economic&Bulletin Publisher:&Norges&Bank Audience:&Academic Format:&Magazine/Journal Subject:&B&Business,&&Economics Copyright:&COPYRIGHT&2008&Norges&Bank ISSN:&
Date:&April, 2008 Source Volume:&79 Source Issue:&1
Event&Code:&490 Contracts & 610 Contracts & 740 Commodity & service prices Computer&Subject:&C Company pricing policy
SIC&Code:&6221 Commodity contracts brokers, 6280 Security and Commodity Services
Statute:&Germany. Securities Trading Act
Accession Number:
Full Text:
Hedging against future price movements can be important both for
those producing goods and for those buying them. Commodity derivatives
may be employed as a hedge against price risk, and this is one of the
reasons behind several initiatives to establish fish derivatives markets
in Norway. This article discusses the general terms for establishing
commodity derivatives markets. There is seldom more than one derivatives
market for a commodity. The success of a Norwegian fish derivatives
market will depend on global competition between such marketplaces, and
this competition will determine whether and what type of initiative that
will succeed.Norwegian (and European) legislation for commodity derivatives
appears to be adequate. The markets are well organised and Norwegian
legislation ensures that transactions involving standardised products
are settled in a clearing house and that netting rules apply. This
contributes to ensuring financial security in the commodity derivatives
markets. The market positions held by financial institutions are
otherwise too small to threaten general financial stability.1. IntroductionDuring the past decade, power and freight derivatives markets have
developed in Norway and efforts are currently underway to establish a
salmon derivatives market. All of these markets are based on the
participation of buyers and sellers in many countries. Authorities
worldwide are increasingly focusing attention on commodity derivatives
markets. In the 1997 Tokyo Communique, supervisory bodies from 18
countries recommended standards for the regulation and supervision of
commodity derivatives markets. The Markets in Financial Instruments
Directive (1) provided the EEA countries with a common standard for
regulating these markets (which is in accordance with the Tokyo
Communique). In Norway, the Directive was implemented through a new Act
on securities trading which came into effect in the latter part of 2007.
As a basis for discussing such markets, it may be useful to explain how
these markets function.A derivative is a contract to buy and/or sell an asset at a
predetermined date at a price determined at the contract date. The asset
to be delivered is called the under(ring asset for the derivative or
simply the underlying. Goods and services are the assets underlying
commodity derivatives, whereas other financial instruments or foreign
currency are the assets underlying financial derivatives. In principle,
the derivative's underlying asset should be delivered, but most
derivatives markets today only involve a financial settlement. In cases
where physical settlement of the underlying asset is required, the
market usually provides a delivery facility so that purely financial
investors can also participate in the market for the purpose of hedging
price risk or speculation.In derivatives markets, the most common types of forward contracts
are futures and forwards. The most important difference between futures
and forwards is how the contracts are settled. Both contracts involve a
future purchase where the price, quantity and quality of goods and the
time and place of delivery are predetermined. The value of a futures
contract is set daily at market value and buyers and sellers are
credited or debited daily in relation to the changes in value. In a
forward contract, the entire settlement takes place when the contract
matures.We also differentiate between derivatives that are traded directly
in an organised market (exchange traded) and over-the-counter (OTC)
derivatives. When derivatives are traded in organised markets, the
product is fully specified. The contracts traded are the same size, the
maturity date is the same, and counterparty risk is eliminated since all
transactions go through a clearing house which is the central
counterparty, etc. This may be compared to the purchase of off-the-shelf
items in a supermarket (e.g. 1 kg of sugar). With an OTC transaction,
the product can be specially adapted just as the grocer can customise a
product to our wishes when we go to the cheese counter and ask for a
centre-cut, medium-sized piece of Gouda. The market participants
offering OTC contracts are usually brokers, and trading directly in the
organised market where they can reduce the risk of their OTC
transactions is often an element of their risk management. Therefore,
successful marketplaces for commodity derivatives often live in
symbiosis with brokers dealing in OTC contracts.When a clearing house participates in a transaction as central
counterparty, it acts as an intermediary between the buyer and seller.
Both parties sign contracts with the central counterparty rather than
with each other. In this way, all market participants only have
counterparty risk in relation to the clearing house. The clearing house
performs this service for a small fee but also demands collateral for
its activities either in the form of a daily margin payment in
accordance with the contract's daily price movements or a guarantee
which covers the maximum loss on the portfolio of contracts held by the
market participant.Central banks focus most heavily on financial derivatives and in
particular exchange rate and interest rate derivatives. These are
clearly the largest derivatives markets and are also the markets that
can have the most substantial impact on central bank activities in the
areas of monetary policy and financial stability. Nevertheless, there is
also considerable activity in the area of equity derivatives and credit
derivatives. The standard of good practice for central counterparties
involved in securities trading, which has been developed by central
banks, the Basel Committee on Banking Supervision and supervisory
authorities, also applies to clearing houses involved in commodity
derivatives trading, cf. CPSS (2004).Internationally, there is a large group of derivatives whose
underlying assets are commodity prices. Contracts similar to
today's commodity derivatives contracts were first traded in the
1100s. The first organised derivatives markets where the underlying
assets were agricultural products appeared around 1850. The market
participants included farmers and their sales cooperatives (future
sellers) and the food and canning industry (future buyers). For both
parties, security surrounding future prices had an independent value -
the farmers increased the security of payment for seed grain and
fertilizer while the canning industry increased the security of its
pricing strategy and sales efforts. Commodity derivatives markets
provide a hedge against unfavourable price movements and this has an
independent value for both parties. Consequently, the transaction is
more than a zero-sum game. The value of this hedge depends on the extent
of the commodity's price fluctuations.
Markets have developed in pace with demand, and at present there
are global commodity derivatives markets with a range of underlying
commodities. One large group of underlying commodities is agricultural
products (grain, coffee, beef, food oil, orange juice, etc). Another
group is metal and semi-finished goods (aluminium, copper, rubber,
etc,). The group of underlying that receives most attention in Norway is
energy products (crude oil, electricity). A number of indices (credit
risk, equity indices, freight indices in shipping) are also used as the
underlying. Some of these index products are naturally classified
together with financial derivatives.2. On the development of new commodity derivatives marketsIn addition to the traditional commodity derivatives markets, new
markets are also being developed. There was little knowledge of
commodity derivatives markets in Norway before the liberalisation of the
electricity markets through a new Energy Act. In 1995, Nord Pool
established a financial market for derivatives based on wholesale
electricity prices. The market for hedging energy price risk (2) is now
well established and is regulated by changes made in the Securities
Trading Act in 2001. (3) A Norwegian marketplace for shipping freight
derivatives, Imarex, was established in 2000.Both of these markets have experienced dramatic events.* There was a dramatic increase in electricity forward contracts,
considerable need for hedging and particularly extensive trading on Nord
Pool at the end of April 1999. Because price movements were abnormally
volatile, Nord Pool increased margin requirements and accepted wider
deviations between the market makers' bid and offer prices.
Nevertheless, one of the market makers reneged on his obligations. The
others continued their activity and thus the market continued to
function so that it was still possible to hedge price risk. (4)* A Greek market participant with substantial positions on Imarex
went bankrupt and could not meet his obligations to NOS Clearing in
June/July 2004. The loss amounted to nearly NOK 60 million and led to a
critical situation for NOS. The Financial Supervisory Authority of
Norway (hereafter FSA Norway) demanded the introduction of measures to
improve financial strength. The owners also recognised the need to
improve the company's capital backing. Early in 2005, a new share
issue raised nearly NOK 65 million. Subsequently, the activities of
Imarex and NOS Clearing ASA could continue. (5)It appears now that both Nord Pool's power derivatives market
and Imarex's shipping freight derivatives market are securely
established.At present, there are several initiatives to establish a fish
derivatives market. The need to hedge the risk of fluctuations in salmon
prices is the primary reason for establishing a new market.
International sales of various kinds of frozen white fish (blocks) are
also considerable and a derivatives market for frozen white fish is also
conceivable.Another possibility is timber which is also important in Norway and
the Nordic countries. One of the reasons that there is no derivatives
market for timber, may be that Norwegian forest owners used to own the
processing industry. Thus, the security that a derivatives market can
provide existed internally in the value chain. However, around 1990, the
direct ownership of the processing industry ceased as the industry
became more international. A market for futures contracts in wood pulp
already exists in Chicago where the standard unit is 20 (metric) tonnes
of wood pulp and the price is based on a European price index. Whether
this market covers all relevant hedging needs is uncertain.Demand for this kind of hedging requires that price fluctuations
are so extensive that there is a genuine need for protection. Certainty
about future prices thus has an independent value. Development of a
commodity derivatives market requires a clearly defined price against
which the derivative can be settled. This will be explained in the next
paragraph. The hedging product supplied by the market must be
inexpensive and the counterparty risk must be low. The contracts must be
standardised so that the market can become liquid. Achieving this
requires organised trading, formulation of contracts and a settlement
system.The final settlement price is usually standardised against a spot
market for the underlying commodity. The size and quality of the lot to
be secured must be clearly defined. For example, there are a number of
derivatives for various kinds and qualities of grain. Prices from the
grain exchange for the physical delivery of the grain are used as the
underlying for the derivatives. The expiry date of the derivatives
contract (once a month or the like) must be specified. To guarantee
execution of the contracts, the exchange requires collateral or
completion of the contracts through a clearing house which requires a
margin payment as collateral. In CPSS (2004), recommendation no. 4 is
that margins shall cover losses in all normal market situations, and
that the parameters used to calculate margin requirements should be
based on risk and reassessed regularly.Some commodity derivatives are not based on an underlying commodity
that is traded in a market. The price against which the derivatives
contract is settled is an index that has been established in such a way
as to provide enough security that market participants are willing to
purchase hedging products against the index. This is the case, for
example, for freight indices which are traded on Imarex. Imarex uses the
Baltic Exchange (6), among others, to establish settlement prices.Specifications of the underlying commodity, a standard contract
including collateral requirements for settlement, are available on the
marketplaces' websites. Table 1 shows the prices for forward
freight agreements on Imarex's website.The marketplace must establish a product that is clearly defined
and suited for trade. It must also ensure sufficient activity to
generate enough liquidity that prices are so clearly established (7)
that the portfolio may be rebalanced without huge expense. Efforts to
acquire liquidity are particularly important in the start-up phase
because this determines whether the market is attractive enough to be
profitable. In marketplaces where all interest is focused on one
product, the life expectancies of the market and the product are the
same. In some of the major marketplaces for commodity derivatives
(London, New York and Chicago), several products are traded. Products
are listed and de-listed on the basis of interest and profitability for
the marketplace. As a result of global financial integration, the
liquidity of a product has largely been gathered in one or a few global
marketplaces. If a market survives the first hurdle, one can assume that
it will attract business from everyone globally who needs to hedge the
specific price risk traded on that market. When seemingly similar
products are traded, they are often in reality different. The difference
may lie in the geographic area of delivery or in the quality of the
commodity. This is the case, for example, with various oil derivatives
and grain derivatives.To establish the initial activity, the initiators have close
contact with those who are assumed to be natural users. They will be
large manufacturers or large consumers of the commodity. Like stock
markets, commodity derivatives markets have members who receive
information from the market and have access to trade in the market.
Unlike stock market members, many members of commodity derivatives
markets are often end users. The system of having a fixed group of
members also contributed to settlement security at one time. Today,
international recommendations on the use of a clearing house are usually
followed. This reduces risk and allows markets to be accessible to more
participants. Among these participants are speculators who take
positions on the basis of their assessments of future prices. Such
speculation increases liquidity and has a positive effect on the
establishment of deep, liquid markets. Contracts that oblige particular
market participants to quote bid and offer prices for a certain minimum
volume on a continuous basis, is one important way of securing
liquidity. Markets that have such market-makers are by definition
liquid. In commodity derivatives markets, it is the marketplace that
must take the initiative to find market participants who are willing to
take on these obligations. In financial derivatives markets, also the
issuer of the underlying may take the initiative as they also have an
interest in deep and liquid markets for their security.3. Regulating commodity derivatives marketsIn Norway (and the Nordic countries), commodity derivatives have
been defined as financial instruments for a number of years. With the
MiFID, which by now is implemented throughout the entire EEA, this is
the European standard. Therefore, in most European countries, the same
supervisory authority that supervises the securities markets also
supervises the commodity derivatives markets and their activities. (8)
Commodity derivatives markets are also strictly regulated in the US,
Canada and Japan. In these countries, there are special organisations
that supervise these activities. These countries and the European
regulations follow the standards that were established in the Tokyo
Communique.The first Norwegian regulation came in 2001 and was based on a
proposal from the commodity derivatives committee (NOU 1999:29). This
committee based its proposal on the fact that the need for an organised
and well-functioning market which had the confidence of the general
public indicated that the activity must be regulated by legislation. The
committee chose a general regulation rather than a specific regulation
for power derivatives, where the need for regulation was most
pronounced, because they could not dismiss the possibility that other
commodity derivatives would be developed. The possibility of salmon
derivatives contracts was mentioned in particular.In accordance with the proposal from the committee, commodities
derivatives were defined as financial instruments in the Securities
Trading Act. Initially, only some of the provisions in the Act were in
force. These included the netting rules, which contributed to keeping
the bilateral positions of market participants at a low level. It was
also decided that the use of a clearing house would be required for all
investment firms trading in regulated marketplaces. This reduced
financial risk. The commodity derivatives committee stated that
commodity derivatives activity cannot in itself have an impact on
financial stability.Commodity derivatives are also defined as financial instruments in
the new Securities Trading Act. This means that the rules in the new
Stock Exchange Act also apply. (9) Thus, firms operating a regulated
marketplace lot commodity derivatives must be licensed as a regulated
market or stock exchange and only investment firms can operate as an
organised intermediary. (10) The ordinary rules of behaviour in the
Securities Trading Act, the requirement of good business practice and
the rules on supervision and sanctions also apply for commodity
derivatives trading.Rules prohibiting insider trading were among those that were not
put into force in connection with the initial legislation. The rules
were not adopted in part because the definition of inside information at
that time did not suit commodity derivatives.The difficulty of defining inside information for a commodity
derivative may, for example, be illustrated by a plan for extensive
maintenance of hydro-electric power stations. In general, one must
assume that such a plan may have an impact on the market for electricity
and power derivatives. Knowledge of these plans would qualify as inside
information and employees at the power company would be privy to this
information. However, if there is perfect competition in the energy
market, other energy producers will change their production schedule in
order to realise the gain that results from higher prices in the spot
market. Consequently, the equilibrium price will remain unchanged. This
means that there will be no net effect on the spot price or on forward
prices against which the derivatives market is designed to provide a
hedge. Information that can affect prices in the commodities market is
not necessarily information that is relevant to prices in the commodity
derivatives market. Knowledge of the maintenance plan may therefore be
called inside information in the underlying commodities market, but this
market is not regulated by the Securities Trading Act. This knowledge
will only be inside information for prices in the financial forward
market if the market for the underlying commodity does not function
perfectly.Nevertheless, there may be other information with limited
distribution that can provide an unreasonable information advantage. One
example might be knowledge of planned changes in the regulation in force
(due to climate changes or the like). It is not the distributor or
producer of the underlying commodity but the employees at the regulatory
authorities who may have access to such information before it becomes
public information. It is important to prevent misuse of such
information. Clarification of the rules (11) indicates that FSA Norway
would categorise trading in financial instruments by individuals with
this type of information as insider trading. With regard to salmon
prices that are listed in Norway, knowledge of changes both in the
Norwegian regulations and in the trade regime for salmon (maximum prices
to the EU, ban on sales to Russia or opening up for trade with the US)
qualifies as inside information. This indicates that the public
authorities should also have strict rules to ensure that market-relevant
information reaches the market in an appropriate manner. In this area,
the Norwegian authorities must also cooperate with the authorities in
other countries.In 2005, a specific definition of inside information for commodity
derivatives was given and the rule prohibiting insider trading was
applied. This was an adaptation to Directive 2003/6/EC of the European
Parliament and of the Council of 28 January 2003 on insider dealing and
market manipulation (market abuse) and the rule has been implemented in
the new act. (12) Whether the new rules solve the actual difficulties of
defining inside information for commodity derivatives is not clear.Investment firms' transactions in financial instruments
(including commodity derivatives) in a regulated marketplace must be
settled in a clearing house (Section 10-8 of the new Securities Trading
Act). The same requirement does not apply to other market participants
but companies that are not subject to an authorisation requirement (cf.
note 10) will not have substantial activity aimed at the general public.
The clearing house will be the central counterparty in derivative
settlements and they will calculate and charge the necessary margins.
The legislation on netting still applies. The settlement requirements,
which are in accordance with international recommendations, contribute
to opening up markets for a larger number of participants. Since the
netting roles apply, the clearing houses can operate with very limited
risk, and this will also make it easier to make arrangements with
market-makers.The two Norwegian initiatives to establish a salmon derivatives
market received authorisation for their activities under the old Stock
Exchange Act with the status of authorised marketplaces. The
authorisations were converted to apply to regulated markets under the
new Stock Exchange Act. When the word "stock exchange" is not
used, the regulation regime is simpler. One important difference is that
there is no ban on ownership exceeding 10 per cent of the share capital
for regulated markets as there is for stock exchanges. In regulated
markets, advance notice to FSA Norway concerning such acquisitions is
required. FSA Norway can stop the acquisition if the buyer is considered
to be fit and proper.4. New Norwegian initiatives to establish a marketplace for seafood
derivativesFor some time, there has been interest in establishing a salmon
derivatives market in Norway. The commodity derivatives committee
explained the potential to the Ministry of Fisheries and Coastal Affairs
(see NOU 1999:29, p 10). Subsequently, the matter was followed up by
Oiulfstad (2004), among others. The newspapers have reported on
initiatives to establish such market places in three Norwegian cities.
The status is as follows:* Oslo: European Fish Exchange has given up its attempts to
establish a market.* Tromso: On 2 March 2007, FishEx ASA was licensed to operate an
authorised marketplace for trading of salmon derivatives. At the same
time, Nord Pool Clearing ASA's authorisation was broadened to
include clearing of salmon derivatives.* Bergen: On 11 May 2007, Fish Pool ASA was licensed to operate an
authorised marketplace for trading of salmon and seafood derivatives. On
19 April 2007, a press release announced that Fish Pool ASA had entered
into an agreement with NOS Clearing ASA to handle settlements.In other words, there are two companies with settlement agreements
in two different clearing houses that have been authorised to operate
regulated marketplaces. (13) They each have contact with their clearing
houses which have been granted broader authorisations to cover netting
and settlement of such derivatives. The one firm has been engaged in OTC
trading for more than a year and the other firm started organised
electronic trading of standardised products in autumn 2007. Based on
information from and direct contact with the company (14), the following
picture emerges:FishEx in Tromso has been established primarily to create more
predictable conditions for the fish farming industry by offering
products that hedge the risk of fluctuations in salmon prices. The
company received authorisation as an "authorised marketplace for
commodity derivatives based on fish and seafood as the underlying
commodity". FSA Norway demanded an increase in the capital base
before the company could start up operations, and a capital increase was
completed recently. Following this capital increase, the ownership
structure is as follows: Sparebank 1 Nord-Norge Invest 22 %, KapNord
Fond (owned by banks and the business sector in Northern Norway) 19 %,
Marinvest (i.e. Rafisklaget), 16% Troms Kraft Invest 16%, Oslo Bets 9%,
SR Investering (i.e. Sparebank 1 Rogaland) 9%, Sildinvest (i.e.
Sildesalgslaget) 8%.FishEx began its trading activities during the last week of October
2007 when they decided that they had the necessary minimum of paying
members, and additional members have joined since the marketplace
opened. Members pay an annual fee of 750 euros and participation in the
market also requires a clearing agreement with a guarantee of 20 000
euros. The Norwegian members are producers or buyers who purchase for
further distribution, whereas the foreign members represent the salmon
processing industry. Nearly all members have a solid foundation in the
underlying salmon market, but recently an ordinary securities firm has
become a member. Some of the members have previously hedged price risk
in the OTC market through FishPool or Direct Hedge, a Danish-Swiss
company that was the first to offer OTC trading in salmon derivatives.
Since the market opened, trading and settlement have according to their
own statements, run smoothly.The product traded in this marketplace is a forward contract at an
average price per week. The contact covers the price of one metric ton
of salmon delivered in a week referred to here as D (for delivery week).
FishEx believes that week contracts provide the most satisfactory hedge
against volatile prices. For example, in December the price fluctuations
between the weeks before Christmas and the period between Christmas and
New Year dominate, and month contracts would not capture this
fundamental uncertainty. The price in the settlement will be based on
price figures from Statistics Norway's export statistics. Thus,
domestic sales of fish will not be part of the basis for the index. From
the beginning, FishEx listed forward contracts for salmon prices every
week for a period of six to seven months ahead. At all times, there will
be forward contracts for individual weeks covering the next four to
seven-week period. Weeks further ahead will be collected in blocks of
four weeks. Thus, as many as twelve forward contracts will be listed,
and all trading on FishEx will be in these standardised products. The
trades are executed anonymously which means that the clearing house acts
as central counterparty for both parties involved in the transaction.The contracts refer to the average price for trading in week D. It
is possible to enter into contracts at this price until Friday of week
D-1 and the price is announced when Statistics Norway publishes its
statistics on Wednesday of week D+1. The settlement will go to the
settlement bank on Thursday of week D+1 and since the transaction was in
forward contracts, the entire settlement will be concluded at once. The
contracts will be listed in euros and the clearing house, Nord Pool
Clearing, will use the same settlement system for both electricity and
fish derivatives. (15) The exchange rate will be the average rate at
2:15pm during the week of delivery.Turnover on FishEx during the first weeks is not known and so far
the market can hardly be referred to as liquid. Establishing an open,
liquid market requires a larger number of participants. At the very
least, commodity brokers and/or investment firms must be members and the
general public must be informed about prices and turnover in the market.The company has not explained whether or how they will publish
market information. Due to competition, they have been cautious about
public announcements. The market participants receive information on the
volume of various contracts, offer price and highest bid and offer
price. Two companies, both of which are in the industry, are market
makers and quote bid and offer prices with a small spread. The binding
volume underlying the prices is generally low. FishEx has an agreement
with the market makers for all listed contracts. It is likely that
interest will be highest for three- to six-month forward contracts.
Market makers pay a lower transaction fee, but otherwise have no
advantages in relation to the other members.The company's first priority now is to attract more members
and increase the liquidity of already existing products. Later, the
company will focus on adapting salmon derivatives to market demands. It
may be attractive to list seasons that consist of three blocks making it
possible to hedge prices up to one and a half years ahead. Subsequently,
the company may consider expanding their product range to include
derivatives based on other types of fish. Forward contracts on herring,
mackerel and other white fish may be of interest.FishEx is convinced that there will be no problem of inside
information about salmon prices at regulators. If the company begins
trading in contracts based on white fish or other fishing products,
knowledge of quotas and quota allocations may lead to problems relating
to regulators with inside information.Fish Pool in Bergen aims at creating a global marketplace for
hedging the risk of price fluctuations for fish and seafood products.
The company was initially established by important participants in the
business sector, including the financial industry in Bergen. In February
2007, Imarex NOS ASA purchased 34.3% in a share offering and at the same
time secured the right to increase their shareholding to 50.1%. Their
website also lists the following shareholders: Bergen Energi AS (20.4
%), GC Rieber AS (11.7 %), Sparebanken Vest (5.8 %), DnB NOR Bank ASA
(5.3 %), Nordea Bank Norge ASA (5.3 %), Fana Sparebank (5.2 %), Holberg
Fondene (3.8 %), Sparebanken Sogn og Fjordane (2.5 %).Fish Pool started trading in April 2006. Since then, Imarex NOS has
provided capital and can provide experience in the area of electronic
trading and settlement solutions. Fish Pool publishes daily reference
prices for contracts. Fish Pool reports a steady flow of new members
since start-up. The first member joined shortly after the marketplace
opened, and at present Fish Pool has more than 130 members. They include
fish farming companies, fish processing companies and financial brokers.
There is no membership lee, but companies must provide a credit rating
or a special settlement guarantee. The membership list is not public
information due to competition.Fish Pool trades futures contracts for the average monthly price in
NOK. In many respects, Fish Pool may be described as an intermediary,
and in autumn 2007 contracts and interest in contracts until summer 2009
were mapped out. Interest is highest in the shortest contracts, i.e. a
half year ahead. Interest in hedging against price fluctuations further
ahead has fallen. In October 2007, Fish Pool announced that a number of
contracts expiring at the end of 2007 and year contracts for 2008 had
been traded. They had not executed any trades in futures contracts with
expiration dates in 2009. Prices for these contracts are partly based on
registered interest lot these contracts and partly on Fish Pool's
own estimates. The reference price used in the settlement of these
contracts has been calculated on the basis of a detailed specification
which ensures that the quality of the underlying product does not
change. A special committee supervises the calculation of this price.A one-month contract may be entered into until the last day of the
month of expiry. At that time, the basis for the price is generally
known so there is limited trading towards the end of the month. The
reference price is stipulated on the 15th of the month following the
expiration of the contract. Fish Pool currently offers trades that are
netted through a clearing house and trades that are settled directly
between the buyer and seller. Since the trades that are settled through
the clearing house are futures contracts, margins are paid in on a daily
basis. Therefore, the final settlement of the contracts often involves
only a small sum and is executed on the 16th of the month. For contracts
that do not go through a clearing house, Fish Pool sends out a letter
with the reference price and the settlement amount. This letter will
serve as a voucher in the private billing of such contracts.Fish Pool does not publicise sales figures due to competition. On
their webpage in March 2008, however, Fish Pool announced record
turnover in February, with contracts for more than 1200 metric tons of
salmon. They stated that the contract value of the month passed NOK 1
trillion. Compared with the news-letters released a few months ago, it
appears that activity has increased considerably.Fish Pool uses the same electronic trading system that is used by
Imarex. This system is also used by commodity derivatives markets in
other countries. Due to limited activity and know-how about the system,
many members place their orders by phone, fax or e-mail and Fish
Pool's employees place the orders into the electronic trading
system. Whether parts of the market can today be called liquid is a
matter of opinion. The majority of trades involve futures contracts with
expiry dates in the next twelve months. In efforts to establish a liquid
market, the marketplace has close contact with market participants to
map out hedging needs and price assessments.One way to strengthen liquidity would be to establish a market
maker system. Fish Pool would like to have such a function connected to
the marketplace. So far, however, they have been unable to find anyone
willing to take on the risk of continuously quoting two-way prices with
a minimal spread between bid and offer prices. Regulatory uncertainty is
considered to have little impact on price movements. Price movements are
driven by fundamental changes in supply and demand.In those cases where a clearing house does not execute the
settlement, the parties must approve each other. Settlement of the trade
is based on mutual credit limits which may, for example, be based on
bank guarantees. When the clearing house (NOS Clearing) is involved,
they will make daily calculations and require regular margin payments.
Fish Pool provides daily closing prices for this market settlement. (16)
The information concerning price and trading volume distributed by Fish
Pool to all market participants is based on all trades regardless of
whether they have been netted through the clearing house or not.5. Conclusions and future perspectivesCommodity derivatives markets provide a means of hedging against
the risk of unfavourable fluctuations in prices for a particular
commodity. For some commodities, this protection has in practice proved
to be important for the development of the value chain from production
to final sale to end users. Since this is a private, organised market
that provides hedging products, the government budgets are not affected.
The public authorities make their contribution by establishing an
adequate regulatory framework which ensures that markets are
well-organised and that the threat of collapse is reduced. The
application of netting rules and adequate financial soundness and
supervision of the clearing houses connected with derivatives trading
are particularly important for financial stability.In Norway, the marketplaces for power and freight derivatives have
been in operation for twelve and seven years respectively. After
experiencing dramatic episodes, both marketplaces have established their
activities as a useful means of hedging price risk. It is important for
international users of the marketplaces that regulation and supervision
of these activities in Norway are in line with good international
standards. As a result of the legislative decisions in 2001 and
implementation of the MiFID, the legal framework--both in Norway and the
EEA--is now in place. FSA Norway has six years' experience as a
supervisory body and is thus well qualified to ensure that such markets
develop in Norway without destructive scandals or dramatic events.With regard to the development of fish derivatives markets in
Norway, the activity surrounding the two initiatives appears to indicate
a need for products that hedge the price of salmon. Competition between
the two marketplaces has not been clarified, but a great deal will
probably be in place soon.The authorities need not be concerned about the outcome of this
competition. The existence of a market-based system to hedge price risk
may be an advantage since it would probably reduce the need for other
measures initiated by the authorities. The authorities should have a
relaxed attitude about the creation or loss of investor values as long
as the regulatory framework or supervision is not responsible for
creating or destroying assets. One area where some public agencies may
require training is information processing. If financial markets for
additional commodity derivatives are developed, equal access to relevant
information will be a critical factor. With new underlying commodities,
new public agencies may come into the "line of fire". Since
well-functioning procedures already exist in parts of government
administration, the necessary skills development should not pose any
particular problems.Those with interest in the initiatives to establish a market for
fish and seafood derivatives, can on a day-to-day basis monitor the
success of their initiative (and assess their possibility for a
financial loss). Observers outside the industry can at the same time
follow the future of the two initiatives and the potential market. If a
lasting market is established it will be proof that the possibility for
a price hedge for salmon is a useful contribution to the industry.ReferencesCPSS (2004): Recommendations for Central Counterparties. Third
report by Task force on Securities Settlement Systems. Bank for
International Settlements & International Organisation of Securities
Commissions, November 2004NOU 1999:29 Varederivater (Commodity Derivatives) Report from an
advisory group with mission and appointment from the Ministry of Finance
7th of July and 25th of September 1998. Final report to the Ministry 8th
of September 1999. Statens forvaltingstenesteTokyo Commique (1997): Tokyo Communique on Supervision of Commodity
Futures Markets. Annex 1, pp 118-133 in NOU 1999:29Oiulfstad, Bjorn O. (2004): "Etablering av markedsplass for
oppdrettslaks" (Establishing a marketplace for farmed salmon), pp
89-93 in Arbok , Law firm Steenstrup Stordrange DA(1) The Markets in Financial Instruments Directive (Directive
2004/39/EF) was published in the Official Journal on 30 April 2004. It
was incorporated in the EEA agreement on 29 April 2005 by resolution
65/2005.(2) After the Energy Act was liberalised in 1991. Nord Pool was
established as a marketplace for electricity in 1994 and financial
futures were introduced in 1995. The joint Norwegian-Swedish electricity
market was established in 1996 and financial forward contracts with
clearing were introduced in 1997. Finland joined the Nordic energy
market in 1998 and Denmark in 2000.(3) Deliberations on the proposal from the Commodity Derivatives
Committee NOU (1999:29) were completed and amendments based on the
proposal entered into force 1 July 2001. cf. Proposition to the
Odelsting no. 53 () and Recommendation O. no. 104 (),(4) This episode is discussed in paragraph 4.8 of NOU 1999:29.(5) Refer to NOS' annual report for 2004:
http://www.nos.no/section.asp?section id=556&intArticle[D=801(6) The Baltic Exchange is a London-based marketplace for freight
rates. They gather information daily on completed contracts and maintain
a code of conduct for market behaviour. For additional information,
refer to their website:
/default.asp?action=article&ID=1(7) Prices are clearly established when there is little difference
between purchase price and sales price.(8) The EU committees ESC (European Securities Committee) and CESR
(Committee of European Securities Regulators) deal with commodity
derivatives issues.(9) The laws are the Securities Trading Act and Act on regulated
markets (Stock Exchange Act) respectively. Both acts were adopted on 29
June 2007 and came into force on I January 2008.(10) Providing investment services such as buying and selling
commodity derivatives for the general public requires authorisation.
Nevertheless. both die old law (Section 7-1) and the new law (Section
9-2) allow for the participation of specialised commodity brokers in the
market. The new law does not require authorisation for firms where
"the main activity is own-account trading of commodities or
commodity derivatives assuming that the firm is not part of a group
where the main activity is providing other investment services or
banking services."(11) Refer to item 3.1.4 in FSA Norway's Circular no. 14/2005
"Securities Trading Act--some comments to Chapters 2 and 3".(12) Section 3-2 (4) of the new act states: "(4) Inside
information concerning commodity derivatives means precise information
that is not publicly available or generally known and which directly or
indirectly concerns one or more commodity derivatives and which
participants in the market where commodity derivatives arc traded will
expect to receive in accordance with that which FSA Norway considers to
be accepted market practice m the market concerned. Information which
participants will expect to receive means information that is normally
available for market participants or information that is to be announced
its a result of legislation, including private-law (civil) regulations
and practice in the commodity derivatives market involved or the
underlying commodity market. The Ministry may stipulate more detailed
rules on inside information in connection with commodity derivatives and
accepted market practice in regulations.(13) The name and terminology from the new act will be used here.(14) From http://www.fishex.no/and http://www.fishpool.eu
respectively.(15) For more information about the system of netting and
settlement, see Nord Pool's webite:
http://www.nordpool.no/nordpool/clearing/index.html.(16) More information about this clearing is available on NOS
Clearing's website: http://www.nos.no/frontpage.asp.Gunnvald Gronvik, special adviser, Norges Bank Financial Stability
** I would like to thank Trude Myklebust and colleagues at Norges
Bank for providing useful comments to this work. Any remaining errors
are the responsibility of the author. The views expressed are my own and
should not be interpreted as views held by Norges Bank.Table 1. Prices for forward freight agreements (FFA) from Saudi Arabia
to Japan on Imarex
Specifications
Clearing House
Underlying Index
Baltic Exchange Dirty Tanker Route 3-TD3
(260.000 metric tonnes of non heat crude
from Ras Tanura to Chiba)
Lot (contract) Size for
1,000 metric tonnes
trading and clearing
Minimum Price Fluctuation
0.25 WorldScale points
Minimum lots size for
0.1 lots = 100 metric tonnes
trading and clearing
Mark-to-market and
All contracts are marked-to-market using
daily settlements
the IMAREX forward curve which is set in
Oslo (GMT+1) at 18:30 CET. Mark-to-market
credits and debits are payable daily at
the latest by 15:00 CET the following
business day.
Trading Hrs
Electronic trading:
Market place service:
Oslo: 08:00-18:00
Singapore: 09:00-22:00
Houston: 07:00-16:00
Trading Hours on
Last Trading Day
Last Trading Day
Trading terminates at the close of
business on the 20th day of a given month,
the last day of the first month of a
quarter and the last day of the first
month of a calendar contract. If the last
trading day falls on a weekend or public
holiday, the last trading day will be the
nearest trading day prior to the last
trading day.
Margin requirements are determined by NOS.
Initial margins can be paid by cash or by
Letter of Credit (LoC), whilst variation
margins are settled in cash at the end of
each trading day.
Final Settlement
Financial only. All contracts settle on
the last day of the period using the
average value of all index days in the
period. For a list of non-index days
please refer to the IMAREX holiday
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