London Calling
Just months after setting up in Dublin, Nymex is preparing to move its open-outcry floor to London. In its continuing battle with the IPE, technology holds the key.
The battle has been joined and traders are feeling the heat. In February, Greenpeace protesters stormed the floor of the International Petroleum Exchange (IPE) in London, where witnesses reported a donnybrook between protesters and the energy traders. While the event highlighted the problems with security on an open-outcry floor versus an electronic exchange, the security threat was quickly forgotten when, just weeks later, the IPE dropped a bombshell that has had traders up in arms. Starting April 7, all Brent and gas oil futures trading on the IPE will be electronic.
The announcement comes just weeks after the New York Mercantile Exchange (Nymex) announced plans to uproot its nearly new Dublin trading floor and set up an open-outcry floor in London later this year. At the time of the announcement, the paint inside the Dublin floor was just dry. The Nymex open-outcry pit was set up in record time—just three weeks—and since Nov. 1, traders have been trading Brent oil futures in Ireland’s capital. Nymex will continue trading in Dublin until the establishment of its London floor, planned for late summer or early fall pending regulatory approval.
Traders are understandably put off by the idea of electronic trading. If a tractor can do a farm laborer’s job at less cost, the business-savvy farmer will move to machines. Such basic economic laws are no different in the world of financial services. If the IPE manages to hold onto liquidity in the transition to electronic trading, there will be a lot of bright, colored jackets to be seen in London’s job center over the next few weeks. The IPE declined to comment on the Nymex move to London.
The impetus behind Nymex’s move to Dublin was the announcement that starting Nov. 1, the morning session for trading Brent crude futures at the IPE would be for electronic trading only. Nymex hoped to gain customers or repeat business from traders disgruntled by the IPE’s decision. At the time, Nymex president Jim Newsome was clear about the reasons for the move. "Both our oil industry customers and the London oil-trading community have been adamant about maintaining open-outcry energy trading. We feel it is incumbent on us to fill the void that is opening up," he says.
With the IPE’s move to full e-trading in gas oil as well as Brent futures, one source from a firm that employs traders on the IPE says that traders are angry that the exchange has closed its open-outcry floor so quickly. "It’s pretty dramatic," he says. "There’s clearly no regard for people’s jobs. The IPE is just playing to Nymex’s tune."
Sam Gaer, CIO of Nymex in New York, is also the interim CEO of Nymex Europe, where he oversees the establishment of the London floor. Nymex Europe is moving aggressively to set up its floor, he says. "We will set up a technologically advanced venue, following a similar model to Dublin," Gaer says. Dublin operated as a remote pit on the New York floor’s system, but Gaer emphasizes that despite the advanced systems behind the London floor, the venue for execution will be the open-outcry pits.
Broken Promise
The battle for the hearts and minds of London energy traders worried about the use of technology at the IPE began in earnest last year. The IPE sent a letter to its members that, in the words of a source close to the situation, "promised that as long as the electronic and open-outcry formats achieved a minimum of 30,000 lots each per day by 2006, then the IPE would maintain support for both channels." The source explains that the averages to date since the morning Brent session at the IPE went electronic is 26,000 lots, and 70,000 for open outcry. "The IPE has reneged on its promise, and that’s seen as a reaction to Nymex setting up in London," he says.
Nymex has been quick to respond to the IPE’s decision, inviting traders to trade on its floor in Dublin until the London floor is open. "The decision didn’t really surprise anybody," Gaer says. With the IPE committed to going electronic, and Nymex’s competitive drive based on its commitment to open-outcry trading, technology is at the center of a battle that will continue for months to come.
A Quick History Lesson
Moving from an open-outcry environment to electronic trading isn’t a matter of merely flipping a switch. Paul Pickup, an expert in exchange technology with London-based consultancy Trading Technology, explains that moving to electronic trading can have profound changes. "Liffe famously lost nearly all of its business to Eurex in its German Bund futures in 1998. Liffe was an open-outcry market at the time, whereas Eurex was electronic," he says. "After this, Liffe about-turned its strategy on IT and developed Liffe Connect."
Pickup believes that Nymex has an uphill struggle ahead of them, given the history of efficient electronic exchanges trumping open-outcry floors. Despite these challenges, commodities exchanges seem to prefer floor-based markets, he says. "Commodities traders say that as they are dealing large quantities and spreads selling one future against an older expiry, this requires a person rather than a computer to execute," he says.
But Pickup says he doubts Nymex will succeed in London. He references a report that on one Tuesday in February, 414 contracts were traded on the Nymex floor in Dublin—compared with more than 121,000 on the IPE. Dublin is a flop, says Pickup. Gaer responds by pointing out that contracts on the Dublin floor have peaked at 16,000 contracts. "I think that to establish a new contract and reach such a level of interest in just four months counts as a success," he says.
In November, Nymex’s Dublin location put it at a disadvantage, with traders unenthusiastic about moving over to Ireland from the IPE in London. But it proved to be a shrewd strategic move. The IPE’s announcement has leveled the battlefield. Once Nymex Europe gains regulatory approval, it can emphasize open-outcry trading as the key differentiating factor between it and the IPE. When location is no longer an issue and Nymex is established in London, the position and use of technology will truly be at the center of the battle for liquidity.
"The question then," says Pickup, "will be whether the liquidity will move with the traders."
Red Faces at the IPE
The IPE is happy to go electronic, but it seems that its staff need a little more practice with the word processor. One of the features of Microsoft Word is "tracked changes," where any changes made to a document are noted in the margin. The IPE sent a circular letter to its members as a Word document, explaining the decision to go fully electronic—but forgot to turn off the change-tracking feature used in the file.
According to one source, the letter stated that "the competition has now changed significantly, and this, paired with the increasing acceptance of electronic trading, has set the backdrop for the Board’s decision to complete the transition to a fully electronic model." However, deleted from the paragraph—but included in the file sent to members—was the sentence: "We are fully committed to continuing to assist our members in making this important transition."
"They’ve actually shown people that they made a conscious decision to take that sentence out," the source says. Whoever drafted that e-mail will have some explaining to do, the source says. The IPE refused to comment on this matter.
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