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Hedging risks with NYSE Liffe futures contractKiev, 30 November 2011Lionel Porte, Product Manager, Commodity Derivatives NYSE Liffe

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Effective Hedging tool: Ingredients for success

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NYSE Liffe Commodities - A “Price Benchmark”

NYSE Liffe has a well established portfolio of Commodity futures contracts that act as “price benchmarks” for their respective underlying physical markets:• Global Price Benchmarks

– Cocoa, Robusta Coffee, White Sugar

• European Price Benchmarks– Milling Wheat, Rapeseed, Corn, Malting Barley

• UK Price Benchmark– Feed Wheat

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Contract basis & price convergence

• The delivery mechanism should reflect the practice of the underlying physical market – and preferably be based on a current physical contract

• The amount available for delivery against the contract should reflect commonly traded qualities

• If the contract is underpinned by an index or other reference price, the market should have confidence that this is a true reflection of physical market values

• N.B All current major agricultural commodity futures contracts are underpinned by standardised physical delivery terms

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Free market conditions

• Government intervention– Should be minimised but if it exists the market should be fully aware of

the conditions under which intervention will be made – Quotas, embargo, taxes for exports… all kind of sudden political actions

can alter their role.

• Price volatility – Price volatility (combined with free market conditions) is key to the

successful development of commodity futures markets

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Ingredients of Volatility

Demand • Tight supply

• Energy and food need• InelasticDemand

• Uncertainty of needs

Production• Variables Stocks• Climate changes • New Producers

Price Volatility

Market Organizations• WTO agreements,

• Free trade agreements• CAP reforms

• Role of the public authorities

Trading flows • Currencies

• Information flows• Freight

Financial Sphere• Financial investors

• Hedge funds• Index funds

A fragile balance, fierce competition, phasing out of safety nets

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Market structure and access

• An active chain of producers, traders, processors and manufacturers

• Supported by a pro-active broking community (with access to finance)

• Global access for trading

• Secure and established central counterparty (CCP)

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Examples of failure and success Contract (launch year) Active or Inactive Rationale for success/failure

Amsterdam Potato Futures (1995)

Inactive (-) Index not considered true reflection of spot market values

Robusta Coffee Futures (2008)

Active (+) Replaced previous Contract by extending deliverable base and increasing Contract size

Rapeseed Oil Futures (2006)

Inactive (-) Government subsidies created abundance of cheap commodity

Weather Futures (2001) Inactive (-) Limited number of market participants and limited knowledge

London Potato Futures (1991)

Inactive (-) Delivery convergence issues

Corn Futures (2007) Active (+) Replaced previous Contract by extending deliverable base but still has scope for development

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The future price is a function of the underlying and the basis (hence the notion of derivatives). The relationship between the spot and future price can widen or narrow – but (everything else being equal) the gap (known as ‘basis’) should narrow towards expiry of the future (cost of carry diminishes over time). At moment of expiry the gap is zero

Futures price

Spot price

Basis

3 months before exp

Price

2 months before exp

1 months before exp

Expiration

Futures Markets versus spot Markets

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How it works: Futures Pricing

• What is the notion of fair value of prices in the market• Factors impacting the future price is the cost of carry • What’s in it ? The financing Interest rates and storage costs• Futures prices= Spot Price + basis ( cost of carry +quality)• Contango & Backwardation

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Futures versus spot Market

Price

Time

Physical

Quality premium

Freight

Financial feesStorage

Dec April May

MAY

March

Spot Dec

Basis March

Basis May

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Physical Markets correlation vs Futures

• Pricing a similar product to keep the correlation Quality• Currency hedging Euro/Dollar• Grain Export area North Africa, Middle East• competitors• Liquidity of the futures market benchmark• Importance of keeping a stable basis in the time

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Source : Plantureux

Ukrainian Markets correlation vs Wheat Futures

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Ukrainian Markets correlation vs Rapeseed Futures

Source : Plantureux

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Source : Plantureux

Ukrainian Markets correlation vs Maize Futures

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NYL Commodities: a secure, regulated market

CLEARING RULESLCH Clearnet SA for Paris

NYSE Liffe Clearing for LondonInitial margins

Daily Margin callsAutomatic position settlement

FINANCIAL SECURITY Members’ equity capital requirements Clearing house’s capital requirements

MARKET SAFETY RULES

Delivery Limits (Paris contracts)NYSE Liffe Market Surveillance

AMF and FSA RegulationIndividual Risk exposure

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Challenges & Conclusion• NYSE Liffe is a long-established and well-respected provider of Commodity

futures and options Contracts.

• Education – many operators know the mechanism but others are new to the futures markets

• Education is key and the exchange will be working alongside its partners to develop understanding of futures as a pricing, trading and hedging mechanism

• Liquidity – it takes time to build market open interest and liquidity and all players must remain committed to the market if it is to grow and succeed

• A sound physical delivery basis – the Exchange and its customers must ensure that the futures markets reflect physical market practice and that there is a credible and supportive arbitration service behind the Contracts

• Free market conditions – futures markets thrive in free market conditions that are absent from artificial price intervention

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Access to the markets

• Exchange Fees

• Agricultural Paris NYSE Liffe Commodities (Malting Barley, Milling Wheat, Rapeseed and Corn)

NYSE Liffe Exchange Fee: € 0.25 per lotClearing House Fee: € 0.75 per lotTotal: € 1 per lot

• Margin Requirements

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Outright Margin Intermonth Spread

Malting Barley Futures (EOB)

€ 1800 per lot -

Milling Wheat Futures (EBM)

€ 950 per lot € 150

Rapeseed Futures (ECO) € 1200 per lot € 313

Corn Futures (EMA)

Skimmed Milk Powder

€ 750 per lot

€ 3600 per lot

€ 138

-

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ISV & QV Codes for grains products

QV CodesRapeseed Futures IJA<CMDTY>CT<GO> PM 0#COM:

Milling Wheat Futures CAA<CMDTY>CT<GO> PV 0#BL2:

Corn Futures EPA<CMDTY>CT<GO> PZ 0#EMA:

Malting Barley futures BRLA<CMDTY>CT<GO> EOB 0#EOB:

Rapeseed Options IJA<CMDTY>OMON<GO> PM 0#COM+

Corn Options CAA<CMDTY>OMON<GO> OBM 0#BL2+

Milling Wheat Options EPA<CMDTY>OMON<GO> N/A 0#EMA+

Malting Barley Options BRLA<CMDTY>OMON<GO> OOB 0#EOB+

Exchange Product Product Symbol

NYSE Liffe Paris Malting Barley Futures yEOB

NYSE Liffe Paris Milling Wheat Futures yEBM

NYSE Liffe Paris Rapeseed Futures yECO

NYSE Liffe Paris Corn Futures yEMA

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NYSE Liffe – Questions & Further Information • Your contacts In Paris: • Lionel Porte, Product Development• lporte@nyx.com • +33 1 49 27 19 29

• Email:commodities@nyx.com• Web and 15 mn delayed prices:www.nyx.com/commodities