Tocom sets targets high

With competition between global commodity exchanges fierce, the Tokyo Commodity Exchange has big plans to bolster its market position this year, Tocom's chairman and chief executive, Masaaki Nangaku, tells Stella Farrington

This year is set to be a key one for the Tokyo Commodity Exchange (Tocom), as it develops a new trading platform, pushes ahead with plans for 24-hour opening and continues to explore demutualisation. With global competition among exchanges heating up, Tocom's chairman and chief executive, Masaaki Nangaku, is determined the exchange will become more competitive in order to benefit from the increased interest in commodities in Asia.

Tocom membership is growing, with UK investment bank Barclays Capital, Newedge Japan (formerly Fimat Japan) and South Africa's Standard Bank becoming members last year, joining Credit Suisse, Goldman Sachs, Lehman Brothers and Morgan Stanley.

While volumes for commodity trading in Japan have fallen since 2004, the exchange expects volume growth this year in its leading product offerings of gold, gasoline, platinum and rubber. Other products offered are silver, palladium, rubber, crude oil, kerosene and aluminum.

Commodities have traditionally been considered one of the riskier asset classes, and Asia one of the riskier regions - has this been a challenge for Tocom in the past? Is this changing now?

Masaaki Nangaku: In the past, commodities were maybe a minor part of an investor's assets, but recently commodity trading represents an important share of an investment portfolio and is no longer considered a 'riskier asset class'. Due to the general lack of infrastructure in Asia, the region may have been considered risky, but this isn't true for Japan, which is regarded as one of the world's sophisticated markets, with a long history in trading futures. With this in mind, these particular points were not an issue at Tocom.

What progress has been made since the 2005 China Aviation Oil scandal to bolster confidence in Asia derivatives trading?

This incident in the Singapore over-the-counter (OTC) derivatives market had little impact on the Japanese commodity futures markets. As far as the markets in Asia are concerned, the demand for products that eliminate counterparty risk has been increasing, partly because of this incident. We are seeing other exchanges - for example, the Singapore Exchange and the New York Mercantile Exchange (Nymex) - offering OTC clearing services.

Interest in commodity trading globally has soared from around 2003 onwards. Do you think the markets are totally saturated now?

In sharp contrast with the record volumes at exchanges overseas, the Japanese commodity futures markets have been on the decline since 2004. As a result, Tocom has been focusing on reforming its market structure, and global players are showing more and more interest in our market. I believe that this is a sign of the healthy growth we can expect in the future.

Do you think Asia could see greater growth in volumes in the next couple of years than elsewhere in the world?

The growth in volume in China and India has only just begun and is not yet mature. We may see some corrections in their growth evolution, but in the long run we can expect high growth in these two countries, which, coupled with the anticipated recovery of the Japanese commodity markets, could lead to tremendous growth for the Asian region as a whole.

A major trend has been the increase in number of financial market participants, such as hedge funds, entering commodity markets. How long do you see them staying in these markets?

Although we are still at an early stage, we are seeing such participants enter our market. As I mentioned before, commodity futures are now an important component of an investment portfolio and, accordingly, as long as this is the case, these players will likely stay in our market.

Do you think commodity trading in Asia is held back by the fact that exchanges in China and India don't allow foreign companies to trade on them? Does Tocom benefit or suffer from this?

If foreigners had free access to exchanges in China and India, as they do to exchanges in Japan, it is conceivable that their already high volume growth would be even higher.

One of the benefits for Tocom is the time we have to reform our market to be more competitive to the outside world before China can complete the deregulation of its markets.

There are also cases where a win/win relationship can be established between exchanges. Arbitrage trading, for example, can benefit several markets at the same time and, from this standpoint, it is unfortunate that currently market participants cannot implement such trading strategies between China or India and Japan.

What are the greatest challenges facing commodity exchanges in Asia today? Are there any Japan-specific challenges?

One of the issues facing the Asian region is that regulations, market participants and the level of development in terms of market maturity vary dramatically from one country to the other, so that market participants have to adapt to many different market environments.

There are also Japan-specific challenges we are facing, such as the transformation of the business model from retail-strong markets to markets orientated towards institutional investors.

How is electronic trading changing commodity markets in Asia?

The increase in share in electronic trading has accelerated the globalisation of markets, made trading environments more efficient and improved transparency. Easier access to exchanges and reduced trading fees have created more trading opportunities for market participants, and exchanges, facing intense competition for the same customer base, are forced to continuously improve their systems and organisation, which will have a positive effect on the development of futures markets.

What effect do you expect the global credit crunch to have on gold trading?

A short-term influence could be described using the subprime loan crisis as an example. Last August, the subprime loan crisis may have affected our gold market, where the price limit down was reached on one day, followed by a sharp rally on the next trading day. The free flow of funds across borders, shifting abruptly from financial to commodity markets and vice versa may have played a role in this incident.

But, historically, gold has been a safe haven for investors in times of uncertainty. Gold offers investors access to constant opportunities to hedge their portfolios, because they are widely traded in different markets in the world, enabling around-the-clock trading in very liquid markets. Accordingly, a crisis in the financial community, such as the one you are referring to, should help promote a shift of funds from the financial markets to the commodity markets, including gold trading.

What is your outlook for volumes at Tocom?

We expect Tocom volumes on most contracts to recover. Recently, our gold, gasoline, platinum and rubber contracts have been performing well and should continue to do so.

Why do people choose to trade precious metals and oil on Tocom rather than the larger US and European exchanges?

Tocom's gold, platinum, gasoline and rubber markets rank either first or second in trading volume in the world, and such levels of liquidity attract investors. Japanese players may also be attracted to contracts denominated in yen and based on the metric system. Some other players, including those already taking part in other markets, may choose to trade on Tocom to take advantage of arbitrage opportunities between our market and other markets listing similar products with maybe different contract specifications and in different time zones.

Tocom is planning to unveil a new trading system in fiscal year 2008. Is that still on schedule? What is the exchange hoping to achieve with it?

The new trading system - provided by OMX, with NTT Data as the system integrator - is on course to be operational by the end of fiscal year 2008 (March 31, 2009), as originally scheduled. As competition among exchanges has recently intensified, the performance of the trading system has become an important factor in gaining a competitive edge. Our goal is to introduce this world-class trading system in line with international standards to attract prop traders and also increase algorithmic trading.

How are plans progressing for 24-hour trading?

The exchange has already extended trading hours by two hours, with the afternoon session closing at 17:30 instead of 15:30 since January 7. We will extend the closing time to 23:00 once we've introduced our new trading system. Our goal is to implement 24-hour trading no more than a year after the introduction of the new system.

What is the latest on possible plans for demutualisation in 2008, and why is this deemed necessary?

We have set up a committee to deliberate on the demutualisation process, then the exchange will issue its policy on the subject. At present, Tocom carries out its exchange business as a membership organisation under the Commodity Exchange Act. However, to prevail in this intensified competition among exchanges, we recognise we should further increase our operational efficiency and the speed of our decision-making, while we must also address the funding requirements for the introduction of a new trading system and, therefore, we believe demutualisation of the exchange is necessary.

Do you expect participation in Tocom from foreign firms to continue increasing?

From January to August 2007, global firms represented over 8.3% of Tocom's overall trading volume, up from 1.1% in 2005. In 2007, three foreign firms obtained Tocom membership - Barclays Capital, Newedge Japan and Standard Bank - and, since more are enquiring about our membership procedure, we expect this trend to continue.

After an encouraging start, volumes dropped off on your mini-gold contract before picking up again. What are your expectations now for that contract?

Following a slight slow down in monthly trading volumes in August (57,456 lots), our gold-mini contract has been experiencing a sharp rise in volume to reach 114,301 lots in October. So far, the trading volume of our gold-mini contract has more than met our expectations. It is still a little early to say, but we are confident that as more of our broker members make the necessary adjustments to offer the gold mini to their customers, this contract will prove to be yet another success story for Tocom.

Which contract are you expecting to put in the best performance over the next 12 months?

We expect our lead contracts - gold, gasoline, platinum and rubber - to continue to perform well in terms of traded volumes this year.

Are there any new contracts are in the pipeline?

Tocom is conducting feasibility studies on the launch of an index futures contract based on the Tocom index and other futures contracts, such as LPG and fuel oil, and mini contracts on other futures.

What do you think about the worldwide trend of consolidation among exchanges globally? Has Tocom been approached by any exchanges wishing to buy it? Would you consider offers? Or has Tocom got any plans to merge or buy other smaller exchanges?

Being faced with a highly competitive global environment, it has become difficult for a single exchange to offer a wide array of listed products and develop a user-friendly and efficient trading platform to attract the flow of global funds, and therefore exchanges worldwide are consolidating.

In Japan, the exchange landscape has also experienced dramatic changes - partly due to the fact that some exchanges could no longer cover their operational costs because of sluggish trading volumes - with four commodity exchanges left in 2007, down from seven in 2006.

Rather than focusing on this issue, Tocom has decided to devote its full attention to the measures I've outlined earlier - the introduction of our new trading system, the extension of our trading hours, the demutualisation of the exchange and the launch of new products - to reform its market, as we respond swiftly and effectively to the ever more sophisticated and diverse needs of market participants, to firmly establish ourselves as the primary market in Asia.

Tocom has signed memorandums of understanding (MoUs) with several overseas exchanges. What do these agreements achieve?

Tocom has been able to expand internationally thanks to MoUs signed with overseas exchanges. For example, our MoU with Nymex made it possible for our members to have direct access to this market; the Dubai Gold & Commodities Exchange and Tocom signed an MoU to create an overlap of their trading hours to create arbitrage opportunities between the two markets; and the MoU signed with the Multi Commodity Exchange of India (MCX) paved the way for a licence agreement that permits MCX to use Tocom's crude oil settlement price to settle its own crude oil contract.