Download PDF, Issue 26 - Swiss Futures and Options Association

SWISS 

DERIVATIVES 

ISSUE 26 – NOVEMBER 2004 

Review 

Focus 

Regulation 

Event 

Review 25 th 

Bürgenstock Meeting 

SWISS 

FUTURES 

AND 

OPTIONS 

ASSOCIATION 

Official publication of the Swiss Futures and Options Association, SFOA.

ssw 

Like it small, fast and flexible? 

Futures and options on Exchange Traded Funds are just what you need to get ahead. These innovative 

products give you the speed and flexibility to master the investment challenges of today and 

tomorrow. Our ETF derivatives are based on the most liquid ETFs. And they provide investors access 

to the major national and international benchmark blue chip indexes in the Eurozone and across 

Europe. In short, they represent another trendsetting idea from Eurex. www.eurexchange.com 

what can we do for you?

Contents 

Contents 

SWISS 

FUTURES 

AND 

OPTIONS 

ASSOCIATION 

SFOA – Swiss Futures and Options 

Association 

Ms. Carol Gregoir, Secretary General 

18b, rue du Gothard, P.O. Box 325 

CH-1225 Chêne-Bourg, Switzerland 

Phone +41 22 860 21 03 

Fax +41 22 860 21 15 

AFM – Association of Futures Markets 

Ms. Krisztina Kasza, Head of Secretariat 

Robert Karoly krt. 61–65 

Budapest 1134, Hungary 

Phone +36 30 34 35 370 

Fax +36 1 477 0455 

kkasza@axelero.hu, www.afm-org.hu 

ACI SUISSE – The Financial Markets 

Association 

Mr. Otto Amberg, Secretary General 

c/o Schroders & Co. Bank AG 

P.O. Box 

CH-8021 Zürich, Switzerland 

secretariat@acisuisse.ch 

www.acisuisse.ch 

IFRI Foundation – International Financial 

Risk Institute 

Mr. Peter Guidolin, 

Executive Manager 

2, cours de Rive 

CH-1204 Geneva, Switzerland 

Phone +41 22 312 56 78 

Fax +41 22 312 56 77 

info@riskinstitute.ch 

www.riskinstitute.ch 

SAMT – Swiss Association of Market 

Technicians 

c/o ISFB, attn: Ms. Brigitte Wicht-Ricci 

7, route de Drize 

CH-1227 Carouge, Switzerland 

Fax +41 22 827 23 15 

SAMT@ifta.org, www.ifta.org/SAMT 

Editorial 

Paul Meier, Chairman SFOA 5 

Focus 

The Birth of the CFTC 6 

William T. Bagley, First Chairman, CFTC 

Regulatory Innovation in a Changing Global Environment 8 

Sharon Brown-Hruska, Acting Chairman, CFTC 

European Regulation – Quo Vadis? 12 

Anthony Belchambers, CEO, FOA 

Kick off for China’s Risk Regime 14 

Nick Sawyer, Editor, Asia Risk Magazine 

Special 

The Metals Markets Are Still Roaring Along 20 

James E. Newsome, President, NYMEX 

Leveraging Precious Metals Experience 22 

Interview with Bernard W. Dan, President & CEO, CBOT 

Interview 

Oil Prices: Hostages of Baghdad or a Sign of Long-term Shortage? 24 

Amory B. Lovins, CEO, Rocky Mountain Institute 

Event 

Review of the 25 th Bürgenstock Meeting 26 

Legal & Compliance 

The Taxation of Specific Hybrid Instruments 32 

Thierry De Mitri, Partner, Piaget & Associés 

Hedge Funds 

Risk in Alternative Investments 34 

Luca Celati, co-Founder, Abraxas Capital Management 

Education 

Commodities: Bubble or Emerging Secular Uptrend? 40 

Bruno Estier, President, SAMT 

Emerging Markets 

The Emerging Markets Forum on Bürgenstock 44 

A Perspective on Eastern European Exchanges 46 

Liliana Paraipan, Director Marketing & PR, RCE 

Book Review 

The Dark Side of Risk Management 47 

Profile 

IFRI – The International Financial Risk Institute 48 

Urs Schneider, IFRI 

3 

SWISS DERIVATIVES REVIEW 26 – NOVEMBER 2004

INTEREST 

RATES 

AGRICULTURAL 

EQUITIES 

METALS 

MARKET 

DATA 

STRENGTH. INNOVATION. TRANSPARENCY. 

Upgrade 

Your Trade 

CBOT ® Gold & Silver Futures Contracts 

Step Up to 100% 

Electronic Performance 

Liquid Markets 

Global Access 

Full-sized Contracts 

Mini-sized Contracts 

For more information visit www.cbot.com/metals 

Driving Futures for Over 155 Years 

The information herein is taken from sources believed to be reliable. However, it is intended 

for purposes of information and education only and is not guaranteed by the Chicago Board 

of Trade as to accuracy, completeness, nor any trading result, and does not constitute 

trading advice or constitute a solicitation of the purchase or sale of any futures or options. 

The Rules and Regulations of the Chicago Board of Trade should be consulted as the 

authoritative source on all current contract specifications and regulations. 

©2004 Board of Trade of the City of Chicago, Inc. 

All Rights Reserved 

www.cbot.com

Dear Members 

and Friends of SFOA 

Editorial 

This year’s Bürgenstock conference, our 25 th anniversary event, has received very 

good feedback and I believe it can be considered to have been very successful! We had 

record attendance, fine weather, interesting panels, good food and excellent entertainment 

– all leading to high spirits and – combined with the exceptional surroundings 

of Bürgenstock – made for a most enjoyable experience for all. 

5 

Of course, business took an important part – remarkable panels and a fascinating 

presentation by the balloonist Bertrand Piccard were sandwiched between a most 

interesting opening keynote presentation by Ken Griffin and closing crossfire featuring 

four top industry leaders discussing the way forward with Patrick Young. Enjoy 

the articles summarizing this year’s meeting and mark the diary for next year’s conference: 

September 7–11, 2005. 

Regulation and Precious Metals are two key themes of this Swiss Derivatives Review. 

Given the fact that the US is the birthplace of regulation we chose to have two contributions 

from that area – one from the first chairman of the CFTC on its history 

and another one by the current acting chairman on its outlook. Precious metals are 

gaining interest. On the one hand the product itself is becoming fashionable again in 

a larger investor’s circle and on the other hand, the competition among exchanges for 

the same product is heating up in this field. 

This year has brought us some interesting developments: New products and markets, 

more competition among markets, exploding volumes – in short, the derivatives markets 

are more important than ever – and that development will no doubt continue. 

For our Association it was an important year as well – 25 years you celebrate only 

once! That is why we decided to publish a special book including look-backs and 

anecdotes as well as crystal-ball gazing and it makes for very interesting reading. 

I realize it is early for New Year’s wishes – but the next SDR will hit your desks in 

the New Year only. Therefore let me wish you all the best for the New Year. May it 

bring you lots of joy and happiness, success and satisfaction and above all – good 

health. Happy 2005! 

Sincerely yours, 

Paul Meier 

Chairman SFOA 


The Birth of the CFTC 

Focus 

William T. Bagley, the First Chairman of the CFTC, and Godfather to the SFOA, has collected reminiscences on 

the birth of the CFTC and the SFOA. 

6 

The United States Commodity Futures 

Trading Commission, CFTC (1975), and 

the original Swiss Commodities Association, 

SCA (1979), which today is the 

Swiss Futures and Options Association, 

SFOA, were both inspired in the same 

decade and they grew up together. I like 

to say the SCA actually may have been 

sired by the CFTC. Let me explain that 

last remark. 

It was 1979 and I was serving as the 

First Chairman of the CFTC. Then-U.S. 

Ambassador to Switzerland invited me 

to speak at the Bern Residence. About 

75 to 100 professionals gathered at the 

Ambassador’s residence for a luncheon. 

We had follow-up meetings and dinners, 

including meetings in Zurich. Swiss professionals 

complained that they could 

not follow all of the new processes and 

regulations emanating from the new 

CFTC. Somehow we were mailing our 

publications by slow boat 

rather than by air mail! 

Ferdinand “Bob” Prizi told 

me that. Swiss leaders, I am 

sure, had the same idea but I 

did say, “You should start an 

Association so that we can 

communicate with each 

other.” So it seems that the Ambassador 

and those Swiss Commodity leaders 

spawned the Association in 1979. I like 

to think of myself as perhaps a 

Godfather but certainly a catalyst who 

was lucky enough to be on the scene 

25 years ago. 

Incidentally, while I flew from 

Washington, D.C. to Geneva, my bags 

flew to Boston – I met and spoke in my 

shabby traveling clothes. Also, after 

gathering my baggage, I flew to Hong 

Kong and Japan to pay a visit to the 

Japanese Community Federation – they 

were just opening themselves to World 

Commodity Trading. Yes, 19 hours on a 

coach-class flight – and I was criticized in 

Washington, D.C. for “flying around the 

world at government expense”! 

More important is the story of the 

growth and, if you will, the legitimization, 

of the Commodity Futures Industry. 

I fully believe that the CFTC was the 

genesis of this worldwide growth and 

acceptance, and the original Swiss 

Commodities Association launched that 

acceptance by helping professionalize the 

industry. 

The U.S. Congress passed the CFTC 

Act in October 1974 to replace a tiny 

bureau within the U.S, Department of 

Agriculture, the Commodity Exchange 

Authority. The CEA “regulated” trading 

only in agricultural commodities actually 

named by U.S. statutes, i.e. soy beans 

and sow bellies and other named farm 

products. The CEA had been orphaned 

in the basement of the United States 

Department of Agriculture building in 

Washington, D.C. It had only about 20 

staff members in D.C. and intercom 

“Futures have become the 

biggest insurance market 

in the world.” 

communication was by a 1920’s buzzer 

system. In Chicago, the CEA office was 

in the basement of the Board of Trade. 

The tenant was trying to regulate the 

landlord. 

The “Old Guard”, mostly from the 

Chicago Board of Trade, were opposed 

to what they thought would be more regulation, 

but masterful leadership from 

Leo Melamed of the Chicago Mercantile 

Exchange encouraged Congress – led by 

its Agricultural Committees – to craft the 

Act. The omnibus all-inclusive definition 

of a Commodity was adopted: “Any item 

of goods or service that is traded on an 

exchange”. The Act also preempted the 

various state regulatory bodies, which 

led to abuses in so-called “London 

Options”. The CFTC simply was not 

constituted and did not have staff to 

chase these abusive off-Exchange cold 

call telephonic naked option sellers. 

Those first days of a new regulatory 

commission were, indeed, hectic. The 

Act, passed in October 1974, provided 

that it go into effect six months later – on 

Monday, April 21, 1975. Because of 

delays, the President Ford-appointed 

Commission was not sworn-in and could 

not operate until Wednesday, April 16. 

We had two days to promulgate the first 

Commission Order – to “license” existing 

exchanges and trading. This initial 

regulatory order was delivered to the 

Federal Register at 1:50 p.m. Friday, 

April 18 (by two SEC lawyers whom we 

had recruited) to be printed in the 

Monday Federal Register. Had we 

missed the 2 p.m. print deadline, the 

Markets would have not been able to 

open on the following Monday! 

Those first days and 

months were also made difficult 

because we were new to 

the legal world. There was no 

body of court case law. We 

had to establish Appellate 

Court precedent before we 

could obtain injunctions 

against the illegal “London Option” 

operators and others. The Exchanges, 

however, were most cooperative. We 

issued a series of market-place rules and 

regulations – extant today – and the 

market professionals complied. Contrary 

to some earlier beliefs, we established a 

market-friendly Commission. And did 

the markets grow! 

Massive exponential volume growth 

followed our authorization of new markets, 

including those in interest rates, 

currencies, and in basic financial futures. 

The first U.S. venture into financial 

futures, led by Melamed, began at the 

CME’s International Money Market 

about two years prior to the birth of 

the CFTC. Next came T-bill futures, 

approved by the CFTC and the U.S. 


Focus 

Treasury. Then came Ginnie Mae mortgage 

futures at the CBOT. Earlier, the 

U.S. Securities and Exchange Commission 

shunted aside Futures overtures 

to assume jurisdiction. But when the 

CFTC approved mortgage futures, 

we were immediately challenged 

by the Securities and 

Exchange Commission staff, they 

claiming this was their turf (I had 

to find and talk to Rod Hills, SEC 

Chairman, to stop a threatened 

suit: SEC vs. CFTC). The rest is 

history. Again, the CFTC led the way for 

a major new institutionalized Financial 

Futures market. Again, industry leaders 

in our Exchanges (notably the Chicago 

Mercantile Exchange) were ready to 

implement progress in the market place. 

Incidentally, and as an aside, the Ginnie 

Mae contract never worked out and was 

delisted. However, the CBOT tried U.S. 

30-year bond futures, which worked 

famously well. 

Still, there were some who would try 

to defy the most basic market limit regulations, 

epitomized by the Hunt 

Brothers’ families. Acknowledging the 

established three million bushel soybean 

limit, the brothers simply and very simplistically 

had nine family members each 

take a three million bushel position – and 

this at the end of the harvest season with 

storage at its capacity. Even after the 

CFTC-enforced soybean compliance, the 

Hunts continued their exploits, effectively 

cornering silver futures – at least for a 

short time. 

“Markets and trade have 

been building blocks for 

world cooperation.” 

Happily and quite logically, all of this 

has now settled down. In a cooperative 

mode, a 1979 CFTC action chartered the 

National Futures Association to create a 

separate, omnibus industry self-regulatory 

body. The N.F.A. has performed 

admirably ever since as the front line of 

regulation backed up by a strong CFTC 

when necessary. The markets have 

matured. They are accepted and respected 

in the United States and in most of our 

trading world where collectively they 

perform a needed ongoing economic 

function. In one sense, Futures have 

become the biggest insurance market in 

the world. 

Again we, the CFTC and the original 

Swiss Commodities Association, were 

fortunate to be there in the beginning – 

in the 1970’s. 

Markets and trade have been the basis 

not just for early trade route commerce 

but as building blocks for world cooperation. 

Now, as we 

enter this new century 

of instant global communication, 

perhaps – 

just perhaps – fair and 

accessible global markets 

will become the basis of 

global understanding, 

global civility, and – maybe – a lasting 

peace around the world. That day will 

come. 

As a postscript, I should add that 

prior to April 1975, I had no knowledge 

of or affinity with Commodity Futures. 

President Ford’s staff – actually, my 

friend, then-Chief of Staff Don Rumsfeld 

– recommended me because I was in no 

way connected to the industry. 

William T. Bagley is a senior partner in the statewide law 

firm of Nossaman, Guthner, Knox & Elliott, LLP, based 

in the San Francisco office. Mr. Bagley served as a member 

or Chairman of numerous Boards, Associations and 

public Commissions as well as in the Legislature. He also 

served in Washington, D.C., appointed by President Ford, 

as the first Chairman of the Commodity Futures Trading 

Commission (1975–79). 

7 


Regulatory Innovation in a 

Changing Global Environment 

Focus 

Sharon Brown-Hruska, acting Chairman of the U.S. Commodity Futures Trading Commission, advanced the concept 

of regulatory innovation. In this article, she comments on the organization’s move away from a rule-based 

approach to the adoption of a core principles-based approach and speaks about her own personal goals and 

convictions as the top-most derivatives regulator. 

8 

Probably more than at any other time in history, derivatives 

markets are thriving. Domestically and globally, we are experiencing 

a tremendous surge in innovation and change in the 

derivatives industry, with a proliferation of products and trading 

systems and concomitant increases in the use of derivatives 

by a broader spectrum of customers. In order to keep pace with 

the changing market environment and continue to perform the 

mission of customer protection and market integrity, regulatory 

authorities must innovate, too. At the Commodity Futures 

Trading Commission (“Commission” or “CFTC”), moving 

away from prescriptive rules and constraints to the adoption of 

a core principles-based approach has enabled us to promote the 

growth and innovation in the global markets while ensuring 

that financial and market integrity are preserved. 

As Acting Chairman of the Commission, my colleague and 

I, Commissioner Walt Lukken, bring a diverse, but highly 

complementary, set of skills to the task of regulating the 

markets under our purview. Commissioner Lukken came to the 

Commission with experience in the legislative arena, working 

on the professional staff of the Senate Agriculture Committee 

and contributing to the crafting of a regulatory model that has 

enabled great progress in the derivatives markets. As a college 

professor and economist, I 

have spent most of my career 

studying, writing, and teaching 

about derivatives 

markets, and have a pretty 

good understanding of the 

markets and the way regulation 

interfaces with them. 

“We strive to eliminate 

regulatory barriers to 

entry.” 

While we have had some recent attrition at the Commission 

level (the Commission normally consists of five Presidential 

appointees), our respective backgrounds and the depth of talent 

and experience at the staff level will allow us to perform our 

duties effectively until new commissioners can be brought on 

board. 

Although we may have different backgrounds, Walt and 

I have sought to accommodate innovation in products and 

markets by focusing on regulatory innovation. Regulatory 

innovation is actually the toughest kind, since there are many 

forces against change in the regulatory arena, often including 

regulators themselves. Achieving regulatory innovation 

requires proactive participation not only by regulators, but legislators, 

the administration, foreign policy-makers, and industry 

interests like traders, firms and exchanges. This kind of 

innovation requires a full court press. But the payoff is huge, 

with markets that are more efficient and agile, igniting innovation 

in products and services that can lower risks and increase 

wealth for individuals, business, and the economy. 

The CFTC, which was created in 1974 and given exclusive 

jurisdiction over futures markets, has had the unique challenge 

of regulating derivatives, perhaps the most innovative markets 

of our time. As such, the derivatives industry has seen tremendous 

change and concomitant uncertainty. Part of the uncertainty 

derived from ambiguity over what kind of regulation 

was appropriate for these products, as well as which regulatory 

agency had jurisdiction over the variety of derivatives that 

were being developed. 

Since its inception, the CFTC has been at the center of a 

jurisdictional storm, because derivatives, by definition, are contracts 

whose value is based on prices and rates associated with 

commodities and assets that are also regulated by various other 

agencies within the US federal government, as well as by state 

and foreign regulators. This regulatory environment created 

significant legal uncertainty for the developers and users of 

derivative products. Indeed, legal uncertainty was so acute in 

the territory of derivatives on equities, it took an act of 

Congress to help resolve the jurisdictional impasse between the 

CFTC and the Securities and Exchange Commission to finally 

allow the introduction of security futures products. 

That act was the Commodity Futures Modernization Act 

(Modernization Act) of 2000, 

which not only sought to 

resolve the legal uncertainty 

experienced by users of 

financial derivatives, but it 

also laid out a blueprint 

for regulatory innovation. 

Following the guidance of the 

President’s Working Group on Financial Markets outlined in 

the report on Over the Counter Derivatives Markets and the 

Commodity Exchange Act, the Modernization Act codified 

changes that were necessary to allow the CFTC to cope with 

innovation, including that of the rapidly expanding over-thecounter 

markets and the increasingly electronic and global 

marketplace. 

The Modernization Act was the culmination of an ongoing 

effort to recognize that banks and other financial institutions 

that market over-the-counter transactions were often already 

under the purview of other regulatory agencies. Further, given 

that OTC transactions were typically customized transactions 

done on a principal to principal basis between professional 

market participants and sophisticated counterparties, it was 

recognized that the prescriptive regulatory approach and invasive 

disclosure requirements typical of exchange-style regulation 

were not meaningful nor practicable. 

Replacing the model of day-to-day review and approval is a 

mechanism that allows markets to self-certify new rules and 


“This approach moves us in 

the direction of a risk-based 

model of compliance.” 

Focus 

rule changes, proposed contracts, or operational changes that 

are consistent with core principles. The core principles are 

complemented by a system that no longer relies on checking the 

figures on financial statements or checking off boxes in our 

audit and compliance function, but instead moves us in the 

direction of a risk-based model of compliance. This is a road 

that many of our markets and firms have been paving for the 

last 20 years, using techniques like Monte Carlo simulation 

and variance at risk (VAR) type models to determine everything 

from prudent margin levels to minimum capital requirements. 

Our regulatory model recognizes that not all markets are 

created equal. The statutory framework adopted in the Act 

allows different levels of regulatory involvement depending on 

the type of market one is operating and the sophistication of 

the market participants using them. For example, institutional 

market participants not needing the same protections as retail 

market participants are subject to a less intrusive regulatory 

framework than traditional markets like exchanges, which are 

increasingly available to retail customers. 

Many critics have chimed that this model leaves holes in our 

regulatory coverage. However, even in exempt markets, we 

retain and have exercised our authority to police against fraud 

and manipulation. In the OTC energy markets, for example, 

we have vigorously pursued those who engaged in false price 

reporting and manipulation. In the retail foreign exchange 

markets, we have been equally effective in prosecuting fraudulent 

activity that takes place outside the confines of our contract 

markets. Rather than limiting our authority or our juris- 

9 


Focus 

“It took an act of Congress 

to resolve the impasse 

between the CFTC and 

the SEC.” 

10 

dictional reach, the tiered oversight model has increased our 

strength and effectiveness as a regulatory agency. 

In my view, the most important feature of the core principles-based 

orientation is a movement away from regulatory 

micromanagement of business decision-making. For my part, 

I have long been critical of actions by regulators to dictate specific 

terms or conditions related to contract design and market 

structure. In these areas, I believe that the economic incentives 

of those who operate exchanges and firms who enter this market 

are aligned such that they will make the choices that are not 

inconsistent with our regulatory goals. 

Economic incentives are a driving force not only to market 

operation, but also to effective market self-regulation. 

Regardless of their organizational structure, self regulatory 

organizations (SROs) dedicate substantial investment to ensuring 

that individual misdeeds and isolated implosions cannot 

and will not jeopardize the integrity of the whole market. The 

incentives of industry to build reputational capital to attract 

investors make self-regulation work. 

Marshalling the expertise of the industry, drawing on its 

self-knowledge of costs and benefits, allows the CFTC to more 

efficiently use our resources to police and maintain the credibility 

of the markets, while also allowing us to reduce costs for 

market participants, consumers, and the taxpayers who pay 

our salaries. Concerns that there may be embedded conflicts in 

the self-regulatory model are worthy of consideration, and the 

CFTC will address that potential in our forthcoming review of 

SROs. 

Certainly, there will be challenges as we seek to fulfill the 

congressional mandate of the Modernization Act. First, many 

will resist regulatory innovation for fear it may change their 

competitive position. Others will resist because a different 

approach, regardless of its potential improvement, is not the 

way they have always done things. But as much as we might 

like to remain static, the marketplace is evolving and the industry 

is growing, and we must strive to keep pace with that 

change. To do so, we must be flexible in our approach, but 

inflexible with regard to the principles we uphold to ensure 

financial and economic integrity. 

On this score, I would note that regulatory flexibility 

applies with equal force to incumbent entities and new entities, 

whether they are domestic or foreign. We are no 

more willing to throw out the rulebook for new entrants than 

we are to use that rulebook as a weapon to keep them out. As 

regulators, we will do what we believe is the right thing to 

protect customers and ensure market integrity regardless of 

who we are dealing with. We also strive to eliminate regulatory 

barriers to entry, whether they are in the form of outdated 

rules or practices, or new prescriptions that impose uncalled 

Sharon Brown-Hruska was designated 

by President Bush as Acting 

Chairman of the Commodity 

Futures Trading Commission 

(CFTC), the federal agency that 

regulates commodity futures and 

options trading in the United 

States, on July 26, 2004. Prior to 

her nomination to the CFTC in 2002, Dr. Brown-Hruska 

was an Assistant Professor of Finance. Author of numerous 

scholarly and applied papers based on her research in 

the areas of derivatives and market microstructure, Dr. 

Brown-Hruska is a member of the President’s Working 

Group on Financial Markets and she was awarded the 

Key Women in Energy’s Global Leadership Award. 

for burdens on those who would seek to compete on the open 

and competitive market. 

The tendency of regulatory agencies to financially engineer 

markets to perfect them through prescriptive approaches is not 

our model. Business decisions regarding contract design or 

market structure belong with those who bear the cost and 

enjoy the benefits of making those choices. As long as those 

decisions are non-discriminatory and do not violate our core 

principles, firms should be able to manage their accounts as 

they think best serves their customers and exchanges should be 

able to determine what kinds of trades they allow or how they 

organize their marketplace. 

As we approach Congressional reauthorization for the 

Commission in 2005, we are committed to upholding the goals 

and principles espoused in the Modernization Act and moving 

forward with rule modernizations that better conform to the 

changing technologies and more global nature of the marketplace. 

As the one responsible for leading the CFTC through this 

challenging process, I will adhere to my own principles and 

seek above all else to be judicious and fair. While I have a substantial 

knowledge of the derivatives industry and good understanding 

of the workings of the agency, I admit that I do not 

intend to go it alone. In addition to the good counsel of my 

colleague Walt Lukken, I will be looking to the experts, the 

firms, the exchanges, and international regulators and policymakers 

for guidance and support. Given the strong foundation 

I have just outlined, I believe the future is bright and I look forward 

to continued positive change in the global derivatives 

industry. 


WHEN YOUR FIRST NAME IS “NEW,” 

YOU’VE GOT TO KEEP SURPRISING PEOPLE. 

As the world’s largest physical 

commodity futures exchange with more than 

130 years of experience, the New York Mercantile 

Exchange can always pull a rabbit out of its hat 

to meet all of your energy and metals trading 

and risk management needs. 

With innovative markets, ground-breaking services, and cutting-edge technology 

such as the NYMEX ClearPort sm trading and clearing platform, there’s always something 

new to address your business transformations. We provide an ever-expanding array of 

the tools you need to trade in a volatile market, along with continuous liquidity, price 

transparency, efficiency, and an AA+ guarantee. So whether things are taking 

a turn for the better or the worse, traders are turning to us. 

What’s the trick to enjoying such a long, successful history of combining 

innovation and stability? A good magician never tells. 

2 1 2 .2 9 9. 2 0 0 0 www.nymex.com

European Regulation – 

Quo Vadis? 

Focus 

Anthony Belchambers, CEO of the Futures and Options Associations, reviews the agenda of European Union 

(EU) regulation and summarises current trends and topics. 

12 

Regulatory Pause 

In terms of regulatory change, there are 

those who would argue strongly for a 

period of regulatory stability, particularly 

since there has been and is already 

an ongoing resource-intensive and highcost 

series of changes being generated by 

the Markets in Financial Instruments 

Directive (MIFID) and the proposal for 

the new Capital Requirements Directive 

(CRD), not to mention the proposal for 

a clearing and settlement directive and a 

number of directives touching on corporate 

governance and company law. 

Others argue that delays in regulatory 

reviews also have cost implications, particularly 

where there are continuing 

obstacles to the exercise of rights of market 

access within the EU. Clearly, if there 

are opportunities for streamlining the 

regulatory process which will not require 

extensive changes in legislation, and if 

this results in the deletion of unnecessary 

rules, regulatory duplication or conflict, 

or improves cross-border market access 

rights, then there should be no delay. 

If, on the other hand, it results in the 

introduction of swathes of new rules, 

then, unless they are capable of being 

fully justified not just in terms of content, 

but also of urgency, then the argument 

goes to those who would want a 

“regulatory pause”. Either way, greater 

regulatory coherence and cost-efficiency 

should be an ongoing priority. 

A European SEC 

In the hunt for a more efficient framework 

of regulation, the issue of whether 

or not to establish an EU SEC remains 

on the agenda. Clearly, the evolution of 

the informal Forum of European 

Securities Commission (FESCO) into 

the Committee of European Securities 

Regulators (CESR) with its Charter, 

more formalised processes and higher 

profile within a multi-tier EU legislative 

structure was an inevitable step forward. 

Few would disagree, but is it the first in 

a series of steps towards establishing a 

European SEC? 

Some would argue that the evolution 

of a pan-EU regulatory framework for 

financial services will lead inevitably to 

the bundling of the bulk of Europe’s regulators 

into a single body. It does have a 

certain superficial attraction. After all, 

growth in cross-border business, the 

blurring of product/service boundaries, 

European Union Initiatives 

convergence in markets, the potential for 

avoiding regulatory duplication/conflict 

and the promise of economies of scale all 

make for a convincing case. It could even 

be argued that the unification of regulation 

in the UK (and increasingly in other 

jurisdictions) provides a workable blueprint. 

However, the significant continuing 

divisions that exist across the European 

The European Commission’s programme for post-FSAP (Financial Services: 

Action Plan) actions in the context of financial services includes: 

– improving and establishing a common standard for member state implementation 

and enforcement of FSAP measures (which, in some cases, 

may, because of their protectionist nature, be obstructing the development 

of a meaningful single market); 

– developing and streamlining regulatory relationships with third (i.e. non- 

EU) countries, particularly the USA (through the regulatory process of 

mutual recognition for rules’ convergence and, where necessary, observance 

of host-state “top-up” rules); 

– monitoring and reviewing pan-EU regulation in order to ensure that it is 

efficient, coherent, cost-effective (singling out examples of over-regulation, 

unnecessary duplication and conflict between different directives) and 

applying cost-benefit analysis; 

– reviewing the FSAP for the purpose of ensuring that it is delivering and 

continues to deliver on its key objectives, such as liberalising market access, 

delivering pan-EU effective and appropriate standards of investor protection, 

enhancing consumer choice and reducing the cost of raising capital, 

trading and investment; 

– accelerating the integration of retail markets which is snagging on the wide 

differentiation in member state laws governing contracts, consumer protection, 

tax, etc and the instinctive preference on the part of retail consumers 

for national products/services; 

– reviewing the feasibility of affording better cross-border access for consumers 

to key regulatory protections such as compensation and Ombudsmen 

schemes. 


Focus 

Union’s regulators in terms of regulatory 

culture, attitudes, powers, practice and 

procedure suggest that that 

would simply not be the case. The 

establishment of an EU SEC – at 

this stage – would merely serve to 

internalise these differences and 

generate the creation of a 

Leviathan regulator mired in the 

process of political consensusbuilding 

across 25 member states 

and by bureaucratic processes 

which would snag innovation 

and market development. 

Levelling the Regulatory Playing 

Field 

If the preferred goal is to establish effective 

coordination and commonality 

across the rules and procedures of individual 

member state competent authorities 

and deliver a practical and effective 

level of regulatory harmonisation (tempered 

by the need for differentiation to 

accommodate diverse markets and niche 

financial service institutions), then structural 

convergence is not an essential 

pre-requisite. Indeed, the continuance of 

individual authorities working to common 

standards and principles would not 

only preserve an important element of 

“The establishment of 

an EU SEC would merely 

serve to internalise current 

differences among European 

regulators. ” 

competitiveness in the development of 

EU regulatory policy, but would ensure 

the preservation of those regulatory 

authorities which do have an open consensus-building 

approach to regulation. 

If we really want to achieve an effective 

and efficient single market in financial 

services, then it is vital that EU legislators 

and regulators take into full 

account the priorities of market operators 

and financial service providers, particularly 

in the context of their need for 

their activities to be reasonably profitable, 

innovative and competitive; and 

the parallel needs of investors and consumers 

to be able to conduct their trading 

activities at reasonable cost with 

all the benefits of open 

rights of access to markets, 

providers and products. 

We ignore these 

business priorities and 

the need for market efficiency 

at our peril. 

Anthony Belchambers, CEO, FOA 

The Futures and Options Association 

(FOA) is the European industry association 

for some 160 firms and institutions 

which engage in the carrying on 

of derivatives business, particularly 

in relation to exchange-traded transactions, 

and whose membership 

includes banks, brokerage houses 

and other financial institutions, commodity 

trade houses, power and energy 

companies, exchanges and clearing 

houses, fund managers and firms 

involved in supplying services into the 

futures and options sector. 

13 


Kick off for China’s Risk 

Regime 

Focus 

China’s new derivatives regulations come into full force on December 1 after a nine-month transition period. 

But the regulations, in the early stages at least, are unlikely to lead to a dramatic shift in the way licensed 

banks do business. Nick Sawyer reports. 

14 

It’s been more than six months since 

China’s new derivatives regulations came 

into force in March. Since then, the 

country’s banking regulator, the China 

Banking Regulatory Commission 

(CBRC), has been inundated with licence 

applications from domestic financial 

institutions and foreign banks with 

branches onshore, all keen to get derivatives 

licences in place before the end of 

a nine-month transition period on 

November 31. 

Banks have spent the early part of the 

year getting to grips with the licensing 

procedure, clarifying any ambiguities 

within the new regulations, and working 

out their business models. The licences 

are now filtering through, with ABN 

Amro, Bank of Tokyo-Mitsubishi, Citigroup, 

Credit Suisse First 

Boston (CSFB), Deutsche 

Bank, HSBC, ING, Mizuho 

Bank and Standard Chartered 

among those to receive 

approval from the CBRC. 

But with the transition period 

now coming to an end, the 

new regulations will be tested in practice 

as the regime comes into full force as of 

December 1. From that date, only 

licensed financial institutions will be able 

to offer derivatives products onshore in 

China. 

The regulations, which were published 

in February after two years of 

consultations between the CBRC, foreign 

and domestic banks, and the International 

Swaps and Derivatives Association 

(ISDA), offer a broad definition of the 

term ‘derivative’, allowing licensed institutions 

to trade a wide scope of derivatives 

products without needing caseby-case 

approval from the regulator. The 

rules also specify which financial institutions 

can trade derivatives, set out the 

licensing procedure and outline risk 

management requirements for dealers. 

Under the regulations, approved 

financial institutions – defined as domestic 

banks, onshore branches of foreign 

banks, trust and investment companies, 

finance companies, financial leasing 

firms and auto financing companies – 

will be able to offer derivatives products 

directly to customers, including domestic 

corporates, as a dealer or market maker, 

as well as trade derivatives on their own 

account as an end-user. 

Targeting Chinese corporates 

For foreign banks, the regulations create 

something approaching a level playing 

field. Previously, offshore banks could 

trade foreign currency-denominated 

derivatives with Chinese financial institutions 

that had the appropriate foreign 

exchange licences, but were prohibited 

from tapping the corporate sector. Now, 

“Licensed foreign banks will 

be able to target Chinese 

corporates directly.” 

onshore branches of foreign banks with 

a derivatives licence will be able to target 

Chinese corporates directly, opening the 

way for a potentially dramatic increase 

in the universe of onshore counterparties. 

Nonetheless, in the near term at least, 

there’s unlikely to be a sea change in the 

way banks do business in China. Few 

foreign banks have the credit appetite to 

deal with the vast majority of small to 

medium sized corporates, while the 

absence of available credit data is likely 

to hamper attempts to put credit lines in 

place. Chinese banks, on the other hand, 

already have existing relationship with 

domestic corporates. “The market will 

be more competitive with the involvement 

of foreign banks,” says the head of 

derivatives trading at one of the major 

Chinese banks in Beijing, which has been 

granted a derivatives licence by the 

CBRC. “But there are still many advantages 

for Chinese banks to trade derivatives 

with Chinese corporates. One is the 

long business relationship between the 

banks and corporates, while some 

Chinese corporates have an internal rule 

whereby they can only deal with Chinese 

banks. Also, Chinese banks would generally 

price the credit charge for the corporate 

lower than foreign banks.” 

Foreign banks are, for the most part, 

likely to focus on the larger Chinese corporates 

and the Sino-foreign joint venture 

companies, many of which are subsidiaries 

of multi-national companies 

that already have credit lines in place 

with the foreign banks overseas. “Our 

focus will be on the larger corporates, for 

example, those we know already or have 

credit lines with,” says Shen 

Yan, managing director and 

head of fixed-income sales, 

non-Japan Asia, at CSFB in 

Hong Kong. “The first batch 

of customers we will be targeting 

are the multi-national 

corporations and the Chinese 

companies that have large international 

operations. With smaller companies, it 

will take time for us to get to know them 

better.” 

Several foreign banks are already beefing 

up their credit risk management departments 

with an eye to setting up credit 

lines with a wider range of corporate 

counterparties in China. However, it 

seems likely that the majority of foreign 

banks’ business will continue to be with 

domestic financial institutions, many of 

Shen Yan, CSFB, 

Hong Kong 


“There’s no rule saying 

banks can’t offer 

structured products.” 

Focus 

which hedge the derivatives transactions 

they conduct with corporate customers 

by trading back-to-back with foreign 

bank counterparties. “I’d say even a year 

after we have the derivatives licence, Chinese 

financial institutions will still make 

up 95% of the total notional of swaps we 

do onshore,” says one derivatives head, 

at a global bank in Hong Kong. 

Derivatives as tools for profit 

However, in another significant change 

to the regulatory regime, financial institutions 

will be able to use derivatives as 

end-users to generate profit. Under the 

previous regime, derivatives could only 

be used for hedging and not speculative 

purposes, a rule imposed by the country’s 

central bank, the People’s Bank of China 

(PBOC), in 1995. What’s more, if a 

transaction was judged to be speculative, 

the validity of the contract could be 

called into question. That’s what happened 

following the collapse China’s 

Guangdong International Trust and 

Investment Corporation (Gitic) in 1999, 

when a Chinese court ruled that several 

swaps transactions with foreign banks 

were speculative. The contracts were 

deemed invalid as a result, prompting 

some foreign banks to stop doing business 

with Chinese counterparties. 

The new regulations do not specifically 

repeal the 1995 PBOC Notice, and 

several banks and law firms have queried 

this point with the CBRC over the last 

few months. “That’s been one of the 

questions the banks have been asking the 

CBRC: can you state the PBOC 1995 

Notice is no longer valid,” says one 

Hong Kong-based banker. “The official 

answer is that the CBRC cannot change 

the rules that other people make, but the 

regulations do say that where there is 

any discrepancy between the new rules 

and previous regulations, the new rules 

shall prevail. So that has given us some 

comfort.” 

However, while many of the uncertainties 

in the regulations have been clarified, 

there are still some aspects of the 

new regulations that are causing some 

confusion. For instance, while it’s clear 

that financial institutions are allowed to 

use derivatives for generating profit, does 

the ‘hedging only’ requirement still apply 

to Chinese corporates? The CBRC only 

regulates financial institutions, so makes 

no reference to whether corporates can 

use derivatives as a means to enhance 

yields on excess cash through the use of 

structured investment products. 

“It’s not dealt with in the rules. The 

rules only apply to financial institutions,” 

says Chin-Chong Liew, partner in 

the derivatives practice at law firm Allen 

& Overy, in Hong Kong. “There’s no 

single law that makes it clear, but looking 

at other laws and requirements and 

understanding the regulatory framework, 

you come to that conclusion [that 

they can only use derivatives for hedging].” 

Self-regulation to fill the gap? 

Others, however, argue that there is some 

scope for the selling of structured products 

to corporates in deposit or note 

form, so long as banks are careful in 

their due diligence procedures, ensure the 

product is suitable for the firm and 

appropriate authorisation is obtained 

from board members. “At least as far as 

the [derivatives] regulations are concerned, 

there’s no rules saying banks 

can’t [offer structured products to corporates],” 

comments another Hong Kong 

banker. “But we would look to do principal 

protected products, we would also 

look as to how big a percentage of the 

corporate’s capital is at risk, and we 

would look at whether the corporate had 

proper authorisation from senior management 

or even the board of directors. 

We would probably look on this to be 

self-regulatory as it is in Hong Kong or 

the US, rather than rely on a set of rules 

emerging.” 

The regulations themselves do set out 

a list of due diligence requirements for 

financial institutions conducting derivatives 

in China. Dealers must assess the 

suitability of their counterparties and 

determine whether they understand the 

risks and whether the transaction meets 

their business objective. The regulations 

state that dealers can to some extent rely 

on written documents provided by the 

counterparty in “good faith”. When it 

comes to corporates, the bank must disclose 

the risks and outline various scenarios 

that could lead to losses. They 

also need to obtain a letter of confirmation 

from clients stating that they are 

aware of the risks involved in the transaction. 

However, there has been some 

question over the level of detail required, 

what format the confirmation should 

take, and whether this information will 

be sufficient to prove customers were 

aware of the risks in a Chinese court. 

“I don’t think the regulators themselves 

have so far established what the 

criteria really mean, and ultimately it will 

be for a court to decide,” says Paget Dare 

Bryan, partner at law firm Clifford 

Chance, in Hong Kong. “Therefore playing 

it safe is going to be the best advice 

you can give to a client. Banks need to 

consider the risk warnings very seriously 

and apply them to the deal they are actually 

looking at, rather than the generic 

wording that they might be more used to 

using in interbank trades.” 

Questions also remain on the products 

banks are allowed to structure 

under the new regulations. While the 

rules themselves are very broad in their 

definition of derivatives, the CBRC states 

that a financial institution engaging in 

derivatives involving foreign exchange, 

stocks, commodities or exchange-traded 

derivatives must comply with other 

applicable regulations. As it stands, 

banks are barred from conducting equity 

and commodity transactions, both regulated 

by the China Securities Regulatory 

15 


Focus 

“Further liberalisation 

is required before RMB 

derivatives emerge.” 

16 

Commission (CSRC). So under current 

rules, it would seem unlikely that banks 

would be able to structure any product 

with an equity or commodity derivative 

component, at least without separate 

approval from the CSRC. The problem is 

that no approval process exists to allow 

the CSRC to give banks a waiver. In fact, 

there are currently no rules governing 

equity derivatives in China, and it’s 

unclear as to whether the regulator 

would be able to give banks the go-ahead 

to structure products with an equity 

derivatives component even if there 

were. 

However, if a bank structured a note 

with returns linked to the performance of 

a fund of hedge funds, and some of 

those underlying hedge funds 

invest in equity in offshore 

markets as a part of their 

strategy, would that fall 

under the remit of the 

CSRC? Questions like this 

will probably have to be 

worked out in practice, say 

lawyers. “The regulations are about getting 

a financial institution a licence to 

trade derivatives. It’s not about the derivatives 

products financial institutions can 

do,” says Dare Bryan at Clifford Chance. 

“There are still lots of issues, and I think 

the questions that will follow from banks 

will be about bringing in structured 

notes or swaps, and working out how to 

use these rules to make money or service 

their clients.” 

Philip Tsao, UBS, 

Hong Kong 

Foreign currency vs. Renminbi 

The regulations themselves do not differentiate 

between foreign currency and 

renminbi-denominated derivatives, and 

the CBRC has indicated that a bank with 

a derivatives licence (and, in the case of a 

foreign bank, a renminbi licence) will not 

need to get a separate licence to deal in 

renminbi (RMB) derivatives. 

However, the caveat that banks have 

to rely on existing rules for foreign 

exchange, equities and commodities, 

including those on foreign exchange 

administration, regulated by the State 

Administration of Foreign Exchange 

(Safe), means that banks will most likely 

focus on foreign currency-denominated 

derivatives in the near-term. Currently, 

“In 2003, China received 

$53 billion foreign direct 

investment.” 

the only local currency derivatives product 

available to onshore firms is a 

12-month RMB forwards contract, 

offered on a trial basis by the four largest 

Chinese banks – Agricultural Bank of 

China, Bank of China, China Construction 

Bank and the Industrial and 

Commercial Bank of China. The contract 

is designed for short-term traderelated 

purposes, and the size of the 

trade is limited to the value of the 

imported or exported goods. However, 

the renminbi is currently non-convertible 

on the capital account, meaning that 

RMB cross-currency swaps are a nonstarter. 

“There isn’t really a renminbi derivatives 

market at the moment other than 

renminbi forwards of not more than one 

year, which can only be dealt with by the 

big four banks,” says Liew at Allen & 

Overy. “The regulations state that Safe 

has its rules on foreign exchange, and 

you have to comply with those rules. I 

think people have read a bit too much 

into it and talked about doing renminbi 

derivatives straight away.” 

There’s potentially more flexibility on 

the development of RMB interest rate 

swaps. However, the PBOC has tight 

control of interest rates, both for loans 

and deposits, meaning there’s no efficient, 

market-driven floating rate index. 

“The only thing I am really interested in 

is the establishment of an acceptable 

floating rate index in China,” says a 

Hong Kong-based derivatives trader. 

“How can you have an interbank market 

with a government fixed rate? The rates 

are managed, and as a result, you can’t 

write swaps on them.” 

Most bankers agree that 

further liberalisation, or at 

least some sign from the 

PBOC, CBRC or Safe, is 

required before RMB derivatives 

emerge. “The regulations 

do not explicitly specify 

the currency covered. I think 

the intention of the regulations is to 

make it broad enough so that the CBRC 

doesn’t need to keep amending the rules 

as time goes by,” says Ivan Wong, head 

of risk management advisory, Asia- 

Pacific, at HSBC, in Hong Kong. “We 

expect the RMB derivatives market to 

grow strongly once interest rates are 

liberalised and the RMB itself becomes 

freely convertible on the capital 

account.” 

Certainly, bankers are eagerly awaiting 

the emergence of a renminbi derivatives 

market. “[The foreign currencydenominated 

derivatives market] will be 

a profitable business in its own right, 

bearing in mind it’s not just access to the 

corporate sector, but also potentially an 

increasing amount of structured investment 

products to retail and wealth management 

customers,” comments Mike 

Bass, head of rates and foreign exchange, 

at Standard Chartered, in Singapore. 


The rush of endless opportunity. 

Liquidity powers trading. The GLOBEX ® platform from CME connects 

you to that power. From Eurodollars on GLOBEX to E-mini TM S&P 500 ® , 

E-mini NASDAQ-100 ® and E-mini Russell 2000 ® futures to electronic 

Foreign Exchange, GLOBEX delivers speed and open access to electronic 

trading of global markets anytime – day or night. 

Discover for yourself how lightning-fast trading can change your world. 

CALL US IN LONDON FOR MORE INFORMATION. 44 (0) 207 623 6174. 

cme.com/international 

CME, Chicago Mercantile Exchange, Globe logo, GLOBEX, GLOBEX logo and E-mini are trademarks of Chicago Mercantile 

Exchange Inc. S&P 500 ® is a registered trademark of Standard & Poor's (S&P), a division of The McGraw-Hill Companies, Inc. 

used under license. NASDAQ-100 ® is a trademark of The NASDAQ Stock Market, Inc. used under license. Russell 2000 ® is a 

trademark and service mark of the Frank Russell Company, used under license.

Focus 

“After the RMB products 

open, the revenue will just 

double or triple every year.” 

18 

“But in time, once there is a relaxation in 

the currency regime and interest rate 

regime, the big driver for us is going to 

be the development of the local currency 

market.” 

A huge market 

The potential size of the market is enormous, 

say bankers. China had around 

$202 billion of foreign debt as of the end 

of March and foreign exchange reserves 

of around $440 billion at the end of 

May. What’s more, China overtook the 

US as the biggest recipient of foreign 

direct investment last year, with 

$53 billion flowing into the country in 

2003, according to the OECD. “After 

the renminbi products open, the revenue 

will just double or triple every year,” says 

Philip Tsao, managing director, joint 

head of debt capital markets group and 

head of risk management, Asia, at UBS, 

in Hong Kong. “The hedging needs are 

so huge, while the products – long-dated 

cross-currency swaps and interest rate 

swaps – are just not there.” 

But further liberalisation is on the 

horizon. As part of its commitments to 

the World Trade Organisation, China is 

committed to opening up its currency by 

the end of 2006. Once that happens, 

dealers anticipate the beginnings of an 

RMB cross-currency swap market. “The 

renminbi should open up in two years’ 

time with the WTO timetable, which 

means that the government and the regulators 

may allow for certain renminbi 

derivatives instruments to be developed,” 

says Dennis Wan, managing 

director and head of sales, credit and 

rates markets, at JP Morgan Chase, in 

Hong Kong. “And once they are developed, 

then we will have a much bigger 

population of end-users in China.” 

Nick Sawyer is the Editor of Asia Risk magazine, the 

leading risk management and derivatives publication in 

the Asia-Pacific region. 

This article was first published in the September 2004 

edition of Asia Risk magazine (www.asiarisk. com.hk). 

Contact: nsawyer@riskwaters.com 

More clarity for close-out netting needed 

Now that a regulatory framework for derivatives is in place in China, bankers and lawyers are turning their attention to outstanding legal 

and documentation issues. In particular, bankers are looking for greater clarity on close-out netting and the use of collateral. 

“Close-out netting and set-off has been one of the major concerns for the banks,” says Dennis Wan, managing director and head of 

sales, credit and rates markets, at JP Morgan Chase, in Hong Kong. “If banks want to do more business and if set-off is perfected in 

the bankruptcy law, then they can offer more credit lines to counterparties.” 

Close-out netting provisions exist in the International Swaps and Derivatives Association’s (ISDA) master agreement, and are aimed 

at reducing credit risk and freeing up credit lines by enabling banks to calculate derivatives exposures on a net, rather than gross, basis. 

However, while the China Banking Regulatory Commission (CBRC) seems to be encouraging the use of internationally accepted documents 

such as the ISDA master agreement, there is some question over whether some of the clauses in the document – and specifically 

those relating to netting – would be enforceable in China in the event of a bankruptcy. 

Close-out netting is not a legally recognised term in China, although set-off – a similar concept that allows a counterparty to offset 

debt owed to it by a company against the debts it owes that company – is recognised under Chinese law. However, there are several 

uncertainties on the interpretation of the set-off laws, particularly on whether set-off is allowed after liquidation proceedings have begun. 

“The next stage is for the law to change in China to create a netting law to assist the financial institutions in using ISDA documentation. 

The CBRC wants banks to use these types of documentation, but banks could find that some of the clauses in the master agreement 

don’t actually work in the situations you need them,” says Paget Dare Bryan, partner at law firm Clifford Chance, in Hong Kong. 

“The more ISDA master agreements are signed up, the more these issues will become apparent to the organisations.” 

Bankers hope that these uncertainties will be addressed in China’s new bankruptcy law, a draft of which is currently before the 

China’s National People’s Congress for review. However, the latest draft is not believed to make any significant changes to the set-off 

provisions. Nonetheless, it certainly won’t stop banks targeting the China derivatives market. 

“These are the things that any institution in China needs to manage,” says Ivan Wong, head of risk management advisory, Asia- 

Pacific, at HSBC, in Hong Kong. “[Close-out netting] is important, but I think the institutions that are serious about this huge marketplace 

probably need to come up with the appropriate policies to manage that.” 


Further your future: team up with a global leader in exchange-traded derivatives. 

If managing your fund or business involves options and futures, you’ll profit from our premier global execution and 

clearing services for all exchange-traded derivatives. As a member of the major financial exchange worldwide, we provide 

liquidity and distribution to a wide range of clients, including hedge funds, banks, corporations and asset managers. 

We’ve developed innovative technology – SwisKey – to make your back office account balancing as efficient as possible, 

and our committed advisors ensure its operational effectiveness from installation through daily troubleshooting. Enjoy 

the best of both worlds – human know-how and technological superiority – in the global derivatives market. You and us.

The Metals Markets 

Are Still Roaring Along 

Special 

Metals trading volume on the New York Mercantile Exchange, Inc., appears to be heading towards its second 

consecutive record year, reminiscent of the bull markets of the early 1980s, writes James E. Newsome, 

President of the Exchange. 

20 

COMEX merger anniversary 

Coincidentally, the Exchange this year 

marked the 10 th anniversary of its merger 

with the Commodity Exchange, Inc. 

(COMEX), a union that created the 

largest physical commodity futures 

exchange, a trading forum exclusively 

for strategic commodities – precious and 

base metals and energy. 

The 2004 metals markets are among 

the strongest that have been seen since 

the venerable COMEX gold, silver, and 

copper futures and options contracts 

joined the Exchange energy, platinum, 

and palladium contracts under the auspices 

of a single exchange on August 3, 

1994. Aluminum futures and options 

were added to the COMEX Division 

slate in 1999. Trading activity is up in 

nearly every category. 

Metals futures volume through the 

third quarter of 2004 was running 20% 

ahead of the first three quarters 

of 2003, a year that shattered 

long-standing records, 

and options volume was up 

25% for the same period. 

During 2003, for example, 

total COMEX Division volume 

broke the record that 

had stood since 1987. Gold futures 

volume, running 22% above last year 

through the third quarter, set a volume 

record in 2003 that surpassed the mark 

set in 1982. Through the third quarter of 

2004, nearly every other contract in the 

metals complex also showed strong performance 

over the year-ago period. 

Welcome to the bull market 

Prices are strong this year, too, and bullish 

prices tend to attract investors. 

During the first quarter, prices had 

increased to levels that had not been seen 

since the 1980s for platinum and silver, 

and reached seven and eight year highs 

for copper and gold. 

There are a number of fundamental 

factors that have led to the resurgence in 

metals market activity, but the most significant 

reason metals industry market 

participants and customers turn to our 

exchange as the premier source of risk 

management, market efficiency, and 

price transparency is the unique liquidity 

offered through open outcry trading. 

This trading activity accounts for 

approximately 95% of overall Exchange 

volume, providing the base to expand 

electronically and internationally. The 

Exchange is committed to maintaining 

the strength of this forum, as well as continuing 

to expand its efficiency through 

the on-going development of technology 

that reinforces and strengthens the level 

of service to its customers. 

New technology 

At the beginning of October, for example, 

the Exchange introduced the New 

York Mercantile Exchange Electronic 

“Metals markets tend 

to be less correlated to 

the financial markets.” 

Order Network (NEON) in the gold and 

silver futures rings. NEON was developed 

internally to provide a gateway for 

firms and traders to electronically route 

orders right to the trading rings. The network 

uses an open application program 

interface that conforms to financial 

industry standard message formats 

which enables market participants to 

communicate on-line with the Exchange 

no matter what applications they use. 

NEON also allows firms to view order 

data including status and fill details 

through an internet-based program. 

The introduction of these services 

could not be more timely, with increased 

metals market strength stemming from 

expanding worldwide demand for metal, 

particularly from China which has been 

a voracious consumer of a broad variety 

of commodities. Investors also want a 

hedge against the U.S. dollar which has 

been relatively weak against the Euro – 

the hedging role is traditionally played 

by gold. 

The weaker dollar also added strength 

to prices by boosting those dollardenominated 

commodities, which fed 

into the trends that attracted investors. 

Hedge funds have poured billions of dollars 

into the commodities markets this 

year. 

Low correlations 

It was not just the strong commodity 

prices that attracted investors. 

Commodity markets, as a general rule, 

and the metals markets in particular, 

tend to be less correlated to the financial 

markets. The low (less than 0.5) or negative 

correlations shown on the accompanying 

table implies that 

metals prices are counter 

cyclical to the prices for 

equities and bonds, and 

often energy, although energy 

prices have recently experienced 

a bullish trend that has 

seen new market highs nearly 

day-by-day. The data indicate that the 

metals, particularly gold, perform well 

during periods of financial stress. 

Investor interest in gold was rekindled 

after September 11, 2001, and in the 

more than three years since that atrocity, 

prices have not revisited the $271.60 settlement 

price of September 10, 2001. 

There was no settlement price for 

September 11 because trading on the 

Exchange, which was across the street 

from the World Trade Center, was 

abruptly halted after only about an hour, 

and the next spot price settlement was 

$290.20 per ounce on September 14, 

2001. 

The immediate run up of gold prices 

was not solely due to the attacks of 

September 11. Most bull markets are 


“Investor interest in gold was 

rekindled after September 11.” 

Correlation of monthly average prices, October 1999 to September 2004 

S&P Treasury Bonds Crude Oil Natural Gas Gasoline 

Gold –0.195 0.189 0.223 0.177 0.05 

Silver –0.057 –0.091 0.107 –0.049 0.106 

Platinum 0.059 –0.051 0.35 0.207 0.295 

Copper –0.009 –0.197 0.112 0.117 0.13 

driven by a confluence of circumstances, 

and the foundations of a return of 

investors to gold had been present for 

some time, such as the steep declines in 

the equity markets. The attacks were 

the catalyst that tied all of the various 

market factors together, which 

have also sustained the market’s 

strength. 

International investors 

The metals futures and options 

contracts are used by a wide 

range of industry and commercial 

market participants, and their renewed 

emphasis in diversified investment portfolios 

represent a variety of strategies 

and opinions on the market outlook 

which still has a significant untapped 

potential for the metals futures and 

options markets. 

Asia is a potentially fruitful area for 

the Exchange to expand its business. 

This year, the Exchange concluded agreements 

with other exchanges and market 

regulators in the region that have 

brought Asian market participants 

directly into the Exchange and COMEX 

Division markets through the NYMEX 

ACCESS ® electronic trading system. 

The internet-based system is the afterhours 

electronic extension of the trading 

floor that permits trading in the metals 

and energy futures markets for an additional 

17 hours after the open outcry 

session ends in the afternoon in New 

York, allowing trading during the business 

day in Asia. 

Through an alliance with the Tokyo 

Commodity Exchange, the Exchange 

metals and energy futures contracts have 

been available since July for direct trading 

during the business hours in Tokyo. 

Regulatory authorities in Hong Kong 

and Singapore also this year approved 

direct internet-based trading in the 

Exchange’s metals and energy markets 

from those cities. Market participants in 

Asia wasted little time in taking advantage 

of their new opportunities. In July, 

approximately 2,300 energy and metals 

“This could include a 

future listing of Exchange 

contracts in China.” 

contracts traded on NYMEX ACCESS ® 

from the region, and for August, the 

monthly volume increased to almost 

8,000 contracts. Asian volume nearly 

tripled during September; in addition, 

market participants began trading from 

Switzerland this year, as well. There has 

also been significant after-hours trading 

from London via NYMEX ACCESS ® for 

a decade. 

In June, the Exchange signed a memorandum 

of understanding with the 

Shanghai Futures Exchange to explore 

areas of mutual interest and cooperation. 

In the future, this could include a possible 

listing of Exchange contracts in 

China and the ability of market participants 

to trade the Shanghai Futures 

Exchange products from New York. 

Market confidence 

The vitality of the Exchange’s metals 

markets and its ability to conclude agreements 

in market centers far from the 

United States is due in no small part to 

the confidence that market participants 

have in the trading forum. The matter of 

counterparty credit risk is no longer 

regarded as casually as it once was. The 

Exchange’s financial controls and market 

surveillance functions are designed to 

assure that market participants do not 

become overextended to the point that 

they could endanger the broader market. 

During 2003, the well-regarded clearing 

organization of the Exchange was 

strengthened further by combining the 

Exchange Division and COMEX 

Division guarantee funds into a single 

pool totaling approximately $150 million. 

The fund is also backstopped by a 

$100 million default insurance policy 

that could be drawn on in the unlikely 

event that the guarantee fund is depleted 

by the failure of a clearing member. 

The Exchange metals futures and 

options markets are the keys to vital 

dynamic market activity that provides a 

wide universe of commercial 

hedgers and 

investors with a safe, 

liquid, and transparent 

market forum, serving 

as market benchmarks 

for market participants 

worldwide. 

James E. Newsome at the 25 th 

Bürgenstock Meeting in Switzerland, 

September 10, 2004. 

James E. Newsome, Ph.D., President, 

New York Mercantile 

Exchange, Inc., www. nymex.com. 

Former Chairman and Commissioner 

of the CFTC. 

Special 

21 


Leveraging Precious 

Metals Experience 

Special 

Successfully trading precious metals futures contracts for over 34 years, the Chicago Board of Trade is 

currently expanding its product range. The Swiss Derivatives Review met the Board of Trade’s President and 

CEO, Bernard W. Dan at the 25 th International Derivatives Conference on Bürgenstock. 

22 

Swiss Derivatives Review: Mr. Dan, the 

CBOT has a long history in precious 

metals trading. What are the parameters 

of the current product expansion? 

Bernard Dan: We have offered futures 

contracts in gold and silver for more 

than three decades. Our current metals 

products are hugely successful among 

investors. For instance, year-to-date volume 

in our mini-sized Gold and Silver 

contracts have seen organic growth of 

over 260 percent in mini-sized Gold and 

over 650 percent in mini-sized Silver. 

Yet, market participants increasingly 

asked for CBOT full-sized contracts. So 

in reality, the current product launch is 

not about a new product. We are leveraging 

our experience in precious metals 

futures to launch full-sized futures. 

we have all the prerequisites in place to 

offer investors the best trading environment 

available in metals futures. 

SDR: What are the specifics of this offering? 

Bernard Dan: Our value proposition 

includes fast execution, high transparency, 

global reach and enhanced liquidity. 

These are four key factors we perceive as 

clear competitive advantages vis-à-vis 

other markets. 

All CBOT futures contracts in Gold 

and Silver will trade on our high performance 

electronic trading platform, 

which provides straight through processing. 

This greatly improves transparency 

and speed while accommodating all 

market participants, including retail and 

institutional investors. 

Further, our electronic distribution 

model allows for 21 hours trading, 

achieving open access for participants 

around the world. 

SDR: What about liquidity? 

Bernard Dan: We launched the full-sized 

contracts with a broader distribution in 

mind. This is why we have committed 

market makers to provide liquidity in the 

new contracts. Up to six market makers 

will compete with each other to ensure 

tight spreads and efficient, deep markets. 

SDR: So your customers are predominantly 

commercial metals traders? 

Bernard Dan: These contracts and the 

superior electronic trading platform 

likely will appeal to all hedge and speculative 

traders, including: retail, institutional, 

commercial, proprietary trading 

operations, trading arcades, commodity 

trading advisors, floor traders, hedge 

fund advisors, commodity funds and 

exchange members (CBOT and others). 

By offering both full- and mini-sized 

metals contracts, the CBOT is responding 

to the entire range of customers’ 

needs for metals products. 

SDR: In the light of the broader geopolitical 

picture, the timing seems to be pretty 

good. 

Bernard Dan: It is true that when political 

uncertainty is rising, precious metals 

gain the interest of market participants. 

However, there has been demand for 

these full-sized products for some time, 

independent of world politics. 

With our superior electronic platform 

exceeding even the highest expectations, 

Launched on October 6, CBOT fullsized 

Gold futures (100 ounce), 

and CBOT full-sized Silver futures 

(5,000 ounce), will complement 

the exchange’s existing mini-sized 

metals contracts. CBOT mini-sized 

Gold futures (33.2 ounce), and 

CBOT mini-sized Silver futures 

(1,000 ounce) also trade exclusively 

on the exchange’s electronic trading 

platform. 


A new standard 

in the derivatives industry 

GL STREAM TM 

Client 

Connectivity 

Order 

Management 

Trading 

Market 

Connectivity 

Post Trade 

Management 

GL TRADE sets a new standard in the derivatives 

industry with the GL STREAM TM Front to Back 

Solution, a unique technology managing both client 

and market orders for any type of instrument across 

the entire order life cycle. 

The GL STREAM TM Front to Back Solution covers the 

five steps of the order flow relevant to your business: 

■ Client Connectivity: Fix compatibility for client 

order flow capture 

■ Order Management: client & market central 

orderbook, electronic ticket and STP efficiency 

with the back-office 

■ Trading: specialized tools for derivatives trading 

i.e. options trading, pre-programmed tactics... 

■ Market Connectivity: access to 45 derivatives 

markets 

■ Post Trade Management: automated allocation, 

matching & clearing tools with back-office 

real-time integration & client reporting 

For order routing, join the GL NET network 

community of over 180 institutions with dedicated 

expertise on the derivatives markets. 

For further information, contact 

GL TRADE SCHWEIZ AG 

Mühlegasse 29 

8001 Zürich 

Tel. 41.1.254.3880 

info@gltrade.ch 

www.gltrade.com

Oil Prices: Hostages of Baghdad 

or a Sign of Long-term Shortage? 

Interview 

Swiss Derivatives Review asked physicist Amory B. Lovins about the background and implications of today’s 

high oil prices. Rather than being concerned about depletion, the author of the study Winning the Oil Endgame 

believes that oil will become uncompetitive before it becomes unavailable. In fact his study shows that it is 

cheaper to save and substitute for oil than to continue buying it. 

24 

Swiss Derivatives Review: In 2004, we witness record prices for 

oil on world markets. How do these prices relate in a historic 

long-term perspective? 

Amory B. Lovins: Real prices were much higher around 1981 

than in 2004. See Figure. 

Figure 3: World oil consumption and real price, 1970–1Q2004 103 

Demand grew quickly at low prices until the 1973 “first oil shock,” 

then slowly at high prices, until 1979’s worse “second oil shock” sent demand 

into decline, softening price until demand began to rise again. 

Prices spiked in the 1991 Gulf War. In 2003, the Iraq War and OPEC discipline 

returned prices to 1974–79 levels, and in 2004, they rose further. 

crude oil price 

(1 Jan. Saudi 34º API light, 2000 $/bbl FOB) 

60 

50 

40 

30 

20 

10 

0 

1970 

45 

50 

1974 

55 

1983 

1973 

1985 

60 

SDR: Yet prices are higher than during most of the 1990. From 

your point of view, are these high prices a sign of a long-term 

shortage or rather a reflection of the current (mid-term) political 

situation in the Middle 

East, or of increased consumption 

in China? 

ABL: Oil prices have fluctuated 

randomly for more than 

115 years. In 2004, tight supply-demand 

balance (due 

largely to ineffectual US energy policy, secondarily to 

China/India demand growth) has made prices high and 

volatile, and the market has added a ~$5–15/bbl risk premium 

for Middle East insecurity. (In particular, two-thirds of Saudi 

output – critical to market liquidity – comes through one processing 

plant and two terminals.) Opinions differ on how far 

the risk premium is despite or because of the presence of US 

troops in Iraq. Those US forces’ peacetime readiness costs are 

about two to three times the typical direct cost of 

US oil imports from the Persian Gulf. 

65 

70 

2003 1Q2004 

2000 (preliminary, 

30 Apr 04 

price) 

75 

80 

world oil consumption, annual average (Mbbl/d) 

Source: RMI analysis from EIA: March 2004 International Petroleum Monthly, “U.S. Petroleum Prices” 2004. 

1981 

1987 

1980 

1979 

1989 

1991 

Source: Winning the Oil Endgame, p. 15. 

1997 

1998 

1999 

2002 

85 

SDR: What implications does your conclusion suggest? 

“Oil will probably become 

uncompetitive even at low 

prices.” 

ABL: High and volatile oil prices are difficult for all importers, 

especially low-income countries, and are likely, if nothing 

changes, to persist until economies soften. There is little room 

to relax the supply/demand tension on the supply side – least of 

all in the US, which burns 26%, extracts 9%, and owns only 

2–3% of world reserves. The most valuable relief would be a 

clear signal to the markets that the US is moving to adopt the 

sort of demand-halving approach outlined in our Pentagon cofunded 

study “Winning the Oil Endgame” (20 Sept. 2004). This 

independent, peer-reviewed analysis shows in detail how to 

eliminate US oil use over the next few decades, and revitalize the 

US rural and industrial economies, led by business for profit. 

Half the projected 2025 oil use can be saved through proven 

end-use efficiency techniques costing $12/bbl (2000 $), and the 

other half can be cost-effectively displaced by advanced biofuels 

and saved natural gas. The study is built around competitivestrategy 

business cases for the car, truck, plane, and oil industries, 

and those sectors’ initial reactions have been positive. 

SDR: Current estimates of confirmed oil reserves tend to oscillate 

between 30 and 60 years. Are these realistic? 

ABL: Nobody knows. About 94% of world oil reserves are 

held by governments; their reserve details are official secrets, 

about which they have strong incentives to lie. What does seem 

certain is that peak output would be seen only in the rear-view 

mirror (too late to respond gracefully), partly because OPEC’s 

cartel action inverts the market by causing the costliest oil to be 

depleted first, it prevents the smooth run-up of prices normally 

predicted by economic theory. 

I am not personally very concerned 

about oil depletion, 

but know that the slow 

turnover of vehicle stocks 

needs decades for a smooth 

transition beyond oil. It 

would therefore seem prudent to get started. Fortunately, as 

Winning the Oil Endgame shows, it’s cheaper to save and substitute 

for oil than to buy it at the US government’s forecast 

price ($26/bbl in 2025 at 2000 $). The only consequence, 

therefore, of displacing oil earlier than necessary is to earn the 

displacement profits (approx. $70bn/y net) earlier – which is a 

good thing. 

SDR: Do you think that current oil prices adequately reflect the 

finiteness of oil reserves? 


“The Stone Age didn’t end 

because the world ran out 

of stones, and the Oil Age 

won’t end because the 

world runs out of oil.” 

Sheikh Yamani 

Interview 

ABL: No. Nor do prices reflect price volatility (which in spring 

2004 the market was valuing at ~$4/bbl), the full measure of 

insecurity, military costs in the Middle East, climate change and 

other environmental impacts, etc. However, Winning the Oil 

Endgame conservatively assumes that all these externalities are 

worth zero – and still shows that it’s cheaper to get off oil altogether 

than to keep on buying it. 

SDR: Will the oil price continue to rise due to the finiteness of 

this resource? 

ABL: It’s equally plausible that long-run real oil prices could 

continue, for a considerable time, to trend flat or even downwards 

like other commodities, if (as many in the field expect) 

the technology of finding and lifting oil continues to outpace 

depletion. However, technologies for saving and displacing oil 

are getting bigger and cheaper 

even faster than the stunning 

progress in technologies for 

extracting oil – and have more 

scope for continuing to do so. I 

would therefore bet not on higher 

oil prices (though they may 

occur, especially if the Middle 

East and other key producing 

regions continue their political 

instability), but rather that oil will probably become uncompetitive 

even at low prices before it becomes unavailable even 

at high prices. As Sheikh Yamani and others have famously 

said, “The Stone Age didn’t end because the world ran out of 

stones, and the Oil Age won’t end because the world runs out 

of oil.” 

SDR: What influence, if any, has the outcome of the US elections 

on the oil price? 

ABL: Sophisticated investors might be concerned that if the 

re-elected Bush Administration reintroduces its twice-failed 

energy legislation in the hope of getting enough Senate votes to 

pass it, matters will become worse because even if passed 

(which remains uncertain), the legislation’s central projects will 

be largely unfinanceable in the private capital market and in 

any case will do little to address the problem. The Bush 

Administration is now in an excellent position for a fundamental 

reappraisal of the content and process of energy policy, but 

it’s too early to tell if that important opportunity will prevail 

over older reflexes. 

SDR: What influence, if any, will oil prices have on the price of 

other fuel and forms of energy (gas, electricity etc)? How 

important are such correlations? Are they due to increase? 

ABL: US and world-market gas prices tend to follow oil prices 

for burner-tip parity. Even spot coal prices do the same. Most 

countries, including the US, now have electricity supplies 

almost independent of oil, but the link via gas prices can be 

important. Fortunately, Winning the Oil Endgame shows how 

to save half of US gas (two-thirds of it by saving electricity, 

chiefly on-peak) at a cost below $1/EJ – at least six times below 

today’s market price for gas. 

SDR: Are there any marketable substitutes to oil? 

“The study Winning the 

Oil Endgame shows how 

to eliminate US oil use led 

by business for profit.” 

ABL: Yes. As described in Winning the Oil Endgame, demandand 

supply-substitutes for oil can completely displace it in the 

US, and probably elsewhere, 

at lower cost 

than the [rather low] 

US government forecast 

of oil price in the coming 

decades. The oil problem 

is therefore one we 

needn’t have, and it’s 

cheaper not to. 

Winning the Oil Endgame can be downloaded free or ordered 

as a hard copy for US$40 at www.oilendgame.com 

Amory B. Lovins 

Physicist Amory Lovins is 

cofounder and CEO of Rocky 

Mountain Institute (www.rmi.org) 

and Chairman of Hypercar, Inc. 

(www.hypercar.com). Published in 

29 books and hundreds of papers, 

his work has been recognized by 

the “Alternative Nobel,” Onassis, Nissan, Shingo, and 

Mitchell Prizes, a MacArthur Fellowship, the Happold 

Medal, nine honorary doctorates, and the Heinz, 

Lindbergh, World Technology, and “Hero for the Planet” 

Awards. Newsweek has called him “one of the Western 

world’s most influential energy thinkers”; Car, the 22 nd 

most powerful person in the global automotive industry; 

and The Wall Street Journal, one of the 39 people in the 

world most likely to change the course of business in the 

1990s. 

25 


Event 

Review of the 25 th 


26 

Summary of the 5 th Special Emerging Markets Forum 

Thursday, September 9, 2004 @ 25 th Anniversary 


Jointly organized by the Association of Futures Markets, AFM, 

and the Swiss Futures and Options Association, SFOA, the 

5 th Annual Special Emerging Markets Forum preceded the main 

Bürgenstock program on Thursday, September 9, 2004. 

In his opening remarks, SFOA Chairman Paul Meier highlighted 

the importance of sound derivatives markets for 

economic development particularly in emerging markets. 

Exchanges in such markets need solid foundations, including 

well functioning underlying markets. 

Roundtable 1 – Market Needs 

The first roundtable discussion was smoothly moderated by 

Rod Gravelet-Blondin, General Manager of the Johannesburg 

Securities Exchange’s Agricultural Products Division. He 

launched the topic of market needs in terms of product development 

and market making by asking the panelists to discuss 

who and what determines market needs. Panelist Peter Koster, 

CEO of the European Climate Exchange stated that he believes 

the market is always right and espoused free markets in general. 

But, is the market always right? Peter Shepherd, Director of 

Marketing at Euronext LIFFE believes that all participants 

have needs and wants, and can be counted on to act out of selfinterest. 

Dr. Foo-shiung Ho, President of the Taiwan Futures 

Exchange pointed out that the two types of markets, professional 

and retail, have different needs and uneven levels of 

influence on the market. Ireneusz Lazor, Vice President of the 

Paul-André Jacot, Ferdinand Prisi and Paul Meier – 

3 Chairmen in 25 years SFOA 

Polish Power Exchange described how the move towards a free 

electricity market in Poland sees end-users driving the 

push for transparent and competitive prices, making this 

market force a positive driver of change. When asked how his 

exchange is dealing with the market trend towards globalization, 

Csaba Bugar, CEO of the Budapest Commodity Exchange 

said that Hungary, as a new member of the EU, is focusing on 

developing innovative products to meet the demands of their 

new European market situation. He sees opportunity in regionalization. 

Roundtable attendee Chitra Ramkrishna eloquently 

rounded off the discussion by stating that while different elements 

of the market have various and often competing market 

needs and wants, the market acts as an intermediary to make 

products that are interesting to buyers and sellers alike. She 

thereby won the audience participation prize. 

Roundtable 2 – Market Structure and Ownership 

György Dudás, CEO of Keler Ltd. in Budapest, moderated the 

second roundtable discussion. He asked each of the panelists 

to describe the unique situation of his or her home market. 

Xiaoqiang Wu, Vice Chairman of the Shanghai Futures 

Exchange, speaking through his able interpreter, offered a fascinating 

and detailed history of the development of the derivatives 

market in China, beginning with the relaxing of central 

economic planning around 1980. He described the roller-coaster 

ride this vibrant, yet volatile emerging market has taken, 

along the way assuming such massive dimensions and offering 

such vast potential. Representing the gestating Turkish 

Derivatives Exchange, with just two derivative contracts trading, 

CEO Hamdi Bagci foresees for his country a single market 

for all derivative products. Offering a contrasting scenario, 

John Tierney, Managing Director of the Options Industry 

Council, is active in the US market in which there is competition 

for every order. He sees competition’s powerful impact on 

the evolution of markets, keeping prices tight and greatly 

enhancing liquidity. Liliana Paraipan, Director of Marketing & 

Public Relations at the Romanian Commodities Exchange sees 

a big shift approaching this emerging market. A move towards 

privatization and consolidation in which the stock exchange 

will also be permitted to trade derivatives will essentially 

change the shape of things to come. All the panelists agreed 

that education is a vital requirement for success in emerging 

markets, whether it is education of regulators as in China or 

broad brush education for the retail market as in India. 

Roundtable 3 – Technology 

Patrick Catania, CEO of the Asia West Group in Chicago, 

expertly steered the discussion about technology from an 

emerging market’s point of view in the 3 rd roundtable. He told 


A blazing sponsor for Friday night 

Event 

the story of how the CBOT “awakened” to technology back in 

1989 in the wake of an ill-fated trading situation involving 

human fallibility, which left the exchange scrambling for the 

perceived integrity of technology, a search which can be argued 

to have ultimately lead to the birth of electronic trading. Chitra 

Ramkrishna, Deputy Managing Director of the National Stock 

Exchange of India, stated that her exchange would not exist 

without technology. She cautioned, however, that while technology 

has become inevitable, it should be more than a mere 

facilitator, but should be able to respond to competition in 

terms of time and cost. The focus in India is on affordable computing 

which is responsive and scaleable. Mr. Pasi Miettinen, 

Vice President of OnExchange, intriguingly pointed out that 

some emerging markets seem to be more technologically 

advanced and sophisticated than relatively more mature markets. 

He sees three trends arising in emerging markets: the 

converging of markets, improved return on investment and 

the drive to capture the local trading market. Allan Thomson, 

Director of Equity and Derivatives Trading of the Johannesburg 

Securities Exchange said that if an exchange is not 

100% up-to-date in terms of technology, then it is not even on 

the playing field. The question for him is, where to source technology. 

Joakim Lange, Vice President of OM Technology illustrated 

how the demands and requirements on technology in a 

high-cost country such as Sweden can be a hindrance to development. 

He sees a combination of buy and build as the ultimate 

solution. Nick Garrow, Sales Director of Patsystems in 

London is a provider of trading systems to emerging markets. 

He underlined the need for a clear business plan that determines 

the functionalities needed, as an essential ingredient for 

successful technological development. The old topic of technology, 

though often discussed, still seems to have found an echo 

in this emerging markets roundtable. 

Summary of the 25 th Anniversary Bürgenstock Meeting 

Thursday, September 9, 2004 

Crossfire – Old Pros View the New Game 

Corks flew as Paul Meier, Chairman of the SFOA, warmly welcomed 

the conference participants with a champagne toast to 

the Bürgenstock meeting’s 25 th anniversary. He then introduced 

a stellar panel of distinguished contributors to the phenomenal 

growth of derivatives markets over the past 25 years, all well 

known throughout the community. 

As Crossfire moderator Hal Hansen put it, “we were the 

guys who took the old game and gave it a new twist”. He outlined 

the movement of exchanges from mutual organizations to 

for-profit companies and wondered if it truly benefits the market. 

Sir Michael Jenkins, Chairman of E-Crossnet, pointed out 

that while today’s for-profit exchanges may be more innovative, 

he is not sure if this is due to their for-profit status or to 

rampant advances in technology. Olof Stenhammar, Chairman 

of OM Hex AB, an early pioneer of and driving force behind 

electronic trading, believes that demutualization has improved 

everything, enabling greater flexibility and faster reaction 

times. Ivers Riley, Chairman of the International Securities 

Exchange, stated that today’s competitive environment makes 

these the “good old days”. He sees integrity and self-regulation 

as the answer to conflicts of interest. Robert K. Wilmouth of 

the National Futures Association warned that self-regulation 

taken too far can potentially thwart competition. The conversation 

moved into the area of the eventual demise of floor trading. 

Hal Hansen wondered if there might not be nuances in 

floor trading which cannot be replaced by electronic trading. 

Dr. Jörg Franke, Chairman of the Supervisory Board of RTS 

Realtime Systems, sees the inevitable represented by the emerging 

markets which typically are starting up exclusively electronic 

and have no reason to go “back” to open outcry. The 

panel ended on a lighter note as the panel of Bürgenstock veterans 

traded their favorite stories of conferences past. 

Book with a Golden Cover 

Patrick Young, Chairman of erivatives.com unveiled the SFOA 

25 th Anniversary Book, “An Intangible Commodity”, in the 

creation of which he was a driving force. The quality of the 

book speaks for itself. The special conference edition with the 

golden cover is available to all attending participants. 

Hats Off to SFOA 

In his welcoming address, Rudolf Ferscha, CEO of Eurex, congratulated 

the SFOA, both for its 25-year anniversary and the 

record attendance at this year’s conference. He noted that with 

the everincreasing presence, interest and influence of emerging 

markets, the SFOA in Geneva seemed poised to become the 

“United Nations” of the derivatives industry. He went to introduce 

this year’s keynote speaker Ken Griffin, President and 

CEO of Citadel Investment Group. 

Keynote Visions 

In a riveting address, remarkable both in content and delivery, 

Ken Griffin outlined in broad strokes how the forces of innovation 

are reshaping our industry. He believes that electronic 

exchanges are creating better market places that encourage the 

growth of trading and contribute to a better world. Corrosive 

market structures and internalization impede market growth 

and ultimately lower market value. The future is here now and 

27 


Event 

28 

floor-based markets will become a thing of the past. As competition 

increases, new opportunities will arise. Ken stated that 

we are moving past the mindset in which markets should not 

compete among themselves. He anticipates the rising of global 

investors but not necessarily of a monolithic global market. 

Regional, cultural and national interests will continue to bear 

their influences. 

Opening Panel – One Global Market Place: 

Utopia or Reality Soon? 

Moderated by FOA Chairman Roy Leighton, the opening 

panel covered a range of topics with a distinct accent on 

Switzerland. The white cross on red was borne admirably by 

Ambassador Alexis P. Lautenberg as he praised the strides this 

country has taken in regulatory matters in recent years. 

Chairman of the Swiss Bankers’ Association, Pierre Mirabaud, 

commented that as a global market place becomes more 

and more of a reality, with no real natural resources to speak 

of, the proper place for Switzerland is at the forefront of that 

globalization. He also views his county’s improved regulatory 

environment positively, but warns of the hampering effect of 

over-regulation. Rudolf Ferscha made a plea for greater transparency 

and competition in world markets, stating that competition 

pushes the whole system in the right direction, ultimately 

leading to end-user benefit. When asked what advice he 

would have for Switzerland, Ken Griffin replied that he saw 

this country as the ultimate safe haven with regulation that 

helps decrease uncertainty of the kind affecting US markets. 

While other subjects were discussed, Switzerland came through 

this panel discussion looking about as handsome as the view 

over the lake from the terrace outside the conference room 

window. 

The Board celebrating 25 years SFOA 


Friday, September 10, 2004 

Four interesting and well-attended panel discussions were 

held on Friday, 10 September 2004, the second day of the 

25 th Anniversary SFOA Bürgenstock Meeting. 

Panel 1 – New Environment 

The first panel discussion addressed the topic of new rules for 

hedge funds and the issue of regulation in general. The panel 

was moderated by Nick Durlacher, CBE, Chairman of ELEX- 

ON. Achim Pütz, Senior Partner of SJ Berwin and Council 

Member of the AIMA in London lent his expertise as he 

unwound the tangled web of European hedge fund regulation, 

or at least attempted something of the sort. Martin 

Schweikhart, Regional Team Leader at Man Investments, representing 

the market-making side, feels that regulations in 

Germany and elsewhere are still too tight to move hedge fund 

products on-shore. The downside to this is that certain countries 

and institutions still retain a sense of the negative connotations 

historically associated with off-shore-based funds. 

However, there does seem to be some ponderous movement 

towards hedge fund-friendly regulation throughout the 

Continent. Carlos Gonzales Vilbazo, Head of Product 

Management at Credit Suisse, provided a buy-side perspective 

and believes that hedge funds are transitioning from a professional-oriented 

investment instrument to a retail product with 

easier access. He views taxation as the primary impediment to 

bringing hedge funds on-shore in Europe. Roseanne Kelly, 

Head of Investment Fund Listing at the Irish Stock Exchange 

wisely added that no form of regulation can make an honest 

man out of a dishonest one. She pointed out the London model 

in which investment managers dealing with hedge funds are 

registered and regulated, but products are not, as a potential 

alternative to hodgepodge national regulation. Nick Durlacher 

attempted to stimulate the early morning audience by asking 

for a show of hands of all those who favored pan-European 

regulation of hedge funds. However, it was unclear whether the 

3 or 4 raised hands indicated a genuine distaste for such regulation 

or the late hour of the previous night’s social activities. 

Panel 2 – Providing and Handling Liquidity 

The second panel discussion addressed the topic of providing 

and handling liquidity. Moderating the panel was Edward Tilly, 

Vice Chairman of the Chicago Board of Options Exchange. He 

set the discussion in motion by asking the panelists to discuss 

their views of what the future holds. John Foyle, Deputy Chief 

Executive of Euronext LIFFE, stated that with his company’s 

wide palette of products and market models, the prime issue 


CNBC Europe reporting live from Bürgenstock 

Event 

concerning their customers is the degree of market liquidity. We 

are living in a much more competitive time and need to offer 

greater flexibility to market makers. Bernard Dan, President 

and CEO of the Chicago Board of Trade pointed out that his 

exchange has focused on global distribution, access and speed, 

all of which attract liquidity, and incidentally, record volumes 

on the CBOT this year. He also mentioned that particularly 

complex trades can be facilitated by the CBOT’s open outcry 

platform, which indeed has been made fully automated, and 

augmented by other platforms. CBOT today provides 22-hour 

a day accessibility. Luc Bertrand, President and CEO of the 

Montreal Exchange and Vice Chairman of the Boston Options 

Exchange, noted that his exchange keeps barriers of market 

entry as low as possible in order to provide equal access to 

market makers. Michael Barmettler, a trader at Timberhill 

filled in at the last moment for Rudolf Ferscha. He called for a 

central order book to lower barriers for market makers, to foster 

transparency and to promote high on-screen spreads. While 

he strongly favors electronic trading, Bernard Dan pointed out 

that proprietary trading platforms can adapt to all deployed 

algorithms. For him, transparency is the reason markets exist 

and he believes that consolidation to a few giants will not 

foster industry growth. While the topics of liquidity, internalization 

and bandwidth were also discussed by the panel, the 

discussion largely tended to revolve around the issues of consolidation 

and competition. 

Panel 3 – New Frontiers in Commodities 

The third panel lit up with a discussion of the future of energy 

products. Moderator John V. Rainbolt, Attorney with Rainbolt 

Law Practice, paraphrased an 18-months old Wall Street 

Journal article, which described energy trading as just the latest 

of a long series of boom and bust industries. The other 

panel members, all representing the industry, begged to differ 

and went on to present the very real plans, solid basis and 

progress of their various endeavors. First off was Mr. 

Takamichi Hamada; President of the Tokyo Commodity 

Exchange, who presented an in-depth look at his company’s 

activities in the energy sector and also traced the dramatic rise 

of oil prices in recent months. TOCOM is now the second 

largest commodities market after NYMEX, with whom it has 

recently struck a cooperation agreement. And from NYMEX 

itself, Joseph Raia, Vice President of Marketing, outlined his 

132 year-old company’s leading position as the largest physical 

commodities exchange worldwide, one that uses both electronic 

and open outcry platforms. Leslie Hosking, Managing 

Director and CEO of NEMMCO in Australia made an interesting 

presentation of his country’s unique approach to outpacing 

the “bad boy” image of the electricity market in the wake 

of the Enron scandal. In contrast to many other countries, 

Australia is moving away from public ownership of the electricity 

industry to a privately held structure, which is nonetheless 

powerfully centralized, a veritable monopoly. He 

believes this will reduce the greatest risk in the electricity market, 

which he views as volatility. Giorgio Szegö, Chairman of 

Gestore del Mercato Ellectrico in Rome, presented the Italian 

energy market, launched in January 2004. There too, the aim 

is centralization of the national electricity market. A derivatives 

market based on a day-end energy product and adjustment 

product are also part of the process. He mentioned that regulatory 

issues, particularly concerning the EU, remain open. 

Philippe Lautard, Deputy General Manager of Gas and Power 

Trading for Total represented the top player in the UK market. 

He sees trading volumes in European electricity exchanges 

consistently increasing as well as promising developments in 

futures and OTC-traded products. John Rainbolt summed it all 

up by stating that perhaps the Wall Street Journal article ought 

not to be taken too seriously in view of electricity markets 

which are apparently alive and thriving. 

Panel 4 – Prospects for European Clearing 

The burning issue of the future of European clearing was 

handled with fireproof gloves, which seared nonetheless, in 

Friday’s final panel discussion. It was an interesting exchange 

among panelists with widely differing views. Of course, the 

main bone of contention were the Giovannini recommendations, 

issued by the EU commission charged with seeking ways 

to harmonize the settlement and clearing sector among its 

members. Moderator Bill Templer, Managing Director and 

Record attendance 

29 


Event 

Exchange of ideas and networking 

30 

European Head of ETD for UBS Investment Bank asked the 

panel participants to reflect on whether they believe the 

Giovannini recommendations were a clear road map to harmonization. 

Matthias Ganz, Member of the Board of Clearstream, 

emphatically stated ‘no’. He finds the recommendations too 

diffuse and not entirely practical in terms of implementation. 

They are certainly not the final answer. Daniel Gisler, Member 

of the Executive Board of Eurex Zürich AG, offered another 

view. While supporting the harmonization process in theory, he 

is unsure how national regulatory bodies will react to the commission’s 

recommendations. Symbolically representing the EU, 

Professor Mario Nava was under pressure to defend the 

Giovannini report as a good starting point and cautioned that 

the recommendations within it require cooperation between 

the private and public sectors. The ultimate aim is to remove 

national barriers. David Hardy, Chief Executive of LCH. 

Clearnet, mused that the balance between the public and private 

responses to any upcoming EU requirements will be interesting 

to watch. Daniel Gisler pointed out that there are not yet 

any concrete plans and all problems and barriers remain on the 

table to be discussed. Nevertheless, the concerned parties do 

seem to be anticipating the commission’s decisions and are in 

the process of pre-positioning themselves to prosper in the perceived 

harmonized market landscape. Bill Templer opined that 

this pre-positioning could be viewed as counterproductive to 

the harmonization process itself. Mario Nava made it clear that 

the commission is not proposing tighter regulation, but seeks to 

provide a level playing field in the settlement/clearing market 

and in no way seeks to impede competition. 

Presentation – Adventure, a State of Mind: 

the Metaphor of the Round-the-World Balloon Flight 

Conference attendees were thrilled to take things to a higher 

note on Friday afternoon when the ultimate high-flyer 

Dr. Bertrand Piccard rounded up Friday’s conference session 

with an inspiring keynote speech. Captain of the Breitling 

Orbiter 3 – the first non-stop around-the-world balloon flight 

– Dr. Piccard took the conference audience soaring on a 

metaphorical flight. When flying around the world in a balloon, 

he learned that we always have to deal with the wind, 

whether it is the jet stream or the winds of market change. 

Following old paradigms of struggle, we often try to fight and 

control those winds instead of going with them. On his lofty 

journey around the world, as well as through life, Dr. Piccard 

has learned that in a balloon you have no power, no choice but 

to go with the wind. The only parameter that can be influenced 

in ballooning is changing altitude. Yet this means you have to 

drop ballast. Figuratively speaking, this means dropping preconceived 

notions, paradigms and dogmas. In everyday life, it 

is crucial to realize, which factors can be changed – and put an 

effort there – and to let those be, which cannot be changed and 

will only create stress if tried. Dr. Piccard underlined that this 

ought not be confounded with fatalism, which means not to 

fight at all. 

Reflecting on the perception of his achievement, Dr. Piccard 

explained that adventure is not what you do – i.e. spectacular 

events – but how you do it – i.e. to look for the extraordinary, 

to leave the usual safety and to try the unknown. That is also 

how unknown capabilities are explored. Pioneering spirit 

means to accept failure. The Breitling team was confronted 

with failure many times and yet succeeded, because they 

accepted the unknown. Dr. Piccard found that releasing control 

leads to greater efficiency of flight. This may lead into a crisis, 

that is a combination of danger and opportunity, but it definitely 

leads to adventure, an experience each of us must say yes 

to in our own lives, whether those lives are spent drifting high 

above the clouds or sitting firmly behind a desk. Approaching 

life as such an adventure forces us to get in touch with ourselves, 

to rise above accustomed responses and to seek new 

solutions. While the adventurous and courageous Dr. Piccard 

traveled around the world in the Breitling Orbiter 3, it would 

seem he traveled even further on his own personal journey, 

inspiring us all to follow him. 


Saturday, September 11, 2004 

The spirit of Bürgenstock 

Saturday’s conference session began with a moving tribute to 

the victims of the 9/11 attacks by Joseph O’Neill, Senior Vice 

President, Strategic Planning of the New York Board of Trade. 

He reminded the conference attendees of the extraordinary 

sacrifice made by the financial community on that fateful day. 


A fascinating presentation by balloonist Bertrand Piccard 

Event 

The beautiful musical offering by Sara Terzano on harp and 

Giuseppe Tripodi on violin gave all those present time to 

reflect. 

After a short break, Alfred Meyer, “the most experienced 

SFOA member ever”, revived the convivial tone, which generally 

marked the SFOA conference this year with reminiscences 

of the raucous beginnings and early days of the SFOA and the 

Bürgenstock Conference. 

Crossfire: “What can be expected of the future?” 

The final Crossfire of the 25 th Anniversary Bürgenstock 

Conference was comprised of a star-studded panel of giants in 

the financial world. Wonderfully moderated, as always, by the 

capable Patrick Young, Chairman of erivatives.com, in his 

smooth and humorous style, the panel addressed the question: 

What can be expected of the future? Mr. Young ventured that 

the derivatives industry is at the edge of the greatest period of 

expansion ever, but wondered about the effects of the growing 

competition among exchanges. Richard Sandor, Chairman and 

CEO of Chicago Climate Exchange, Inc. opined that competition 

has been tremendously helpful by spurring development 

and the invention process, in a business, which “reinvents itself 

every 5 to 10 years like Madonna.” Offering his view of what 

the future holds, Peter Wuffli, President of the Group Executive 

Board of UBS AG, in his first SFOA appearance, anticipates 

an economic shift from West to East that will spur dramatic 

growth. He sees a European market stifled by national regulation. 

Michael Spencer, CEO of ICAP, sees a convergence 

between the OTC and exchange markets and feels that both 

have benefits to offer: The OTC market is traditionally more 

innovative, while exchanges work better with large volumes 

and many different players. When asked about areas of future 

expansion, James Newsome, formerly of the CFTC, now 

President of the New York Mercantile Exchange, indicated that 

his new company intends to take a horizontal approach, 

including OTC clearing and plans to take NYMEX global. 

Peter Wuffli sees the advent of unmanageable conflicts of interests 

hindering growth. However, Richard Sandor feels that in 

terms of competition, the question is: how is the customer best 

served? How are you going to get markets to be the best transaction 

vehicle? He pointed out that the history of this business 

sector has been one of innovation of products, in which 90% 

of current products did not exist 20 years ago. Exchanges are 

a for-profit utility model and will last as long as they serve their 

purpose. Peter Wuffli believes there are two requirements for 

successful for-profit utility management from a European perspective: 

clear separation from the regulatory function and the 

opening up national borders. 

There was also a lively discussion about the future number 

of European exchanges, with the number ranging from three to 

just one. No consensus about the exact figure could be found. 

In regard to the essential issues going forward, James 

Newsome feels that costs, while important, are not as vital as 

value to the customer. He also warns that we must be careful 

not to allow regulators to get involved in business decisions. 

Prescient words coming from a former regulator. Michael 

Spencer joined in the fray, which consistently marked this 

year’s conference, regarding electronic versus open-outcry trading, 

by envisioning a continued co-existence of both trading 

models. He does not feel that all contracts are suitable for electronic 

trading and sees a future in which the pie is sliced three 

ways, electronic, voice and a mixture of the two. Richard 

Sandor begged to differ by predicting that open-outcry trading 

will “diminish, diminish, diminish and then further diminish.” 

The issue of competition was brought up again when James 

Newsome stated that the number of exchanges will decrease, 

both in the US and in Europe. Richard Sandor pointed out that 

excess profits produce ruinous competition and that market is 

currently in that latter phase. Michael Spencer sees demutualization 

further driving competition and leading to an 

approaching wave of acquisitions and mergers, particularly in 

Europe. Peter Wuffli agreed with these views, but foresees a 

much slower timeframe for changes and mergers in Europe. 

The consensus seemed to be that competitive pressures will 

continue to drive innovative and change within the industry, 

leading to consolidation. Remaining open, however, were the 

questions of trading formats and the actual number of future 

exchanges that will survive. Undoubtedly, these questions as 

well as many others will become clearer at next year’s SFOA 

Bürgenstock Conference. 

The Saturday Crossfire, chaired by Patrick L Young, SFOA, 

gathered Richard L Sandor, CCX, Peter A Wuffli, UBS, 

Michael Spencer, ICAP, and James E Newsome, NYMEX 

31 



The Taxation of Specific 

Hybrid Instruments 

This paper focuses on the tax treatment of some specific hybrid financial instruments and summarizes the basic 

tax principles applicable. Swiss withholding tax aspects will not be analysed. 

32 

For a few years, private investors have 

had a large choice of hybrid instruments 

issued by banks and other financial intermediaries 

available to them. The taxation 

of income derived from this kind of 

investments is all but clear. It is, however, 

crucial for private investors to know 

the tax treatment that may apply to their 

investments. Depending on the applicable 

tax treatment, the performance of 

hybrid instruments can vary significantly. 

I. Basic tax principles 

Switzerland is a federal State with a 

direct tax system composed of three different 

levels of taxation: (1) federal, (2) 

cantonal and (3) communal. Swiss resident 

individuals are taxed on their 

worldwide net income (arising 

from domestic and foreign 

sources). Hence, federal 

as well as cantonal/communal 

tax laws foresee that any 

recurring or non-recurring 

income received by a taxpayer 

is subject to direct income 

tax. However, capital gains realised on 

private movable assets are exempt from 

federal and cantonal/communal income 

taxes. 

It should be noted that the abovementioned 

tax exemption is not applicable 

where the taxpayer is deemed a professional 

trader (because managing his 

movable private assets actively and with 

the same professionalism and intensity as 

a professional trader). In such a case, the 

private investor is deemed to conduct a 

business so that both investment income 

and capital gains are subject to income 

tax. Where the assets are viewed as a private 

investment, the distinction between 

investment income (which is taxable) 

and capital gains (which are tax exempt) 

is fundamental, in particular when considering 

the taxation of hybrid instruments. 

1. Interest from ordinary debt 

instruments 

As a rule, any income derived from a 

debt instrument (loan, bank account, 

bonds, etc.) is subject to income tax. 

From a tax point of view, interest is taxable 

provided that a payment (1) arises 

from the debtor in favour of the private 

investor (creditor) and (2) does not represent 

a reimbursement of the principal 

amount (i.e. exceeds the nominal value). 

Hence, where a private investor sells a 

bond, the part of the selling price that 

includes accrued interest is not considered 

as taxable income but as an exempt 

capital gain. This particular tax treatment 

can be explained by the fact that 

the payment is not made by the debtor 

“A private investor should 

avoid non-transparent 

reverse convertibles.” 

but by the new creditor. In other words, 

capital gains realised upon disposal of a 

bond prior to maturity are tax exempt. 

However, the reimbursement received at 

maturity of the ordinary bond is qualified 

as taxable interest: in such a case, 

the payment is made by the debtor to the 

private investor and exceeds the value of 

the principal. 

The above-mentioned rules are subject 

to an important exception in connection 

with original issue discount bond 

(hereinafter “OIDB”) or bonds with redemption 

premium (hereinafter “BRP”). 

2. Interest from zero-coupon bonds, 

discount bonds and bonds with 

redemption premium 

It is usual for bonds to combine a below 

market periodic interest coupon with 

either OIDB or BRP (i.e. mixed bonds). 

The private investor thus receives a direct 

yield (periodic coupon yield) and an indirect 

yield corresponding to the premium 

received upon maturity (single interest 

payment). 

From a tax point of view, it is crucial 

to determine whether the periodic 

coupon or the single interest component 

is predominant. Where a bond qualifies 

as a bond with predominant single interest 

payment, the tax law provides that 

the capital gain realised by the private 

investor upon alienation or repayment of 

the bond is fully taxable. This tax treatment 

is applicable despite the fact that 

the “single interest component” is paid 

by the buyer of the bond and not by the 

debtor. According to the current practice 

of the Federal Tax Administration (hereinafter 

“FTA”) published in a recent circular, 

a bond has predominant 

single interest payment 

when less than 50% of the 

yield to maturity (combining 

direct and indirect yield) 

consists of periodic interest 

coupons. Such qualification 

is made at the time of 

issuance on the basis of a financial calculation. 

Price movements occurring after 

the issuance day of the bond do not modify 

the fiscal qualification. 

Mr. Arthur buys a zero-coupon bond 

at issuance. The bond features may 

be summarised as follows: 

• Issuance price: 78.35% 

• Principal amount: 100.00% 

• Term: 

5 years 

• Interest coupon: 0.00% 

After three years, Mr. Arthur sells 

the bond to Mr. Jones for 91.5%. 

Mr. Jones would like to keep the bond 

until redemption. 

From a tax perspective, this bond 

must be qualified as a bond with 

predominant single interest. As a 

consequence, Mr. Arthur is taxable 

on 13.15% (91.5–78.35) whereas 

Mr. Jones will be taxable on 8.5% 

(100–91.5). 


“Swiss taxation is very advantageous 

when it comes to transparent 

hybrid instruments.” 


Based on the above-mentioned rules, 

the zero-coupon bond is obviously a 

bond with predominant single interest as 

illustrated in the example. 

To sum up, the compensation paid by 

the issuer for a mixed bond with predominant 

single interest payment is subject 

to income tax at the time the bond 

matures. The same tax treatment applies 

in case of disposal prior to maturity. In 

the latter situation, the difference 

between the selling price and the acquisition 

price (or issuance price) is subject to 

income tax. 

II. Taxation of hybrid instruments 

As a rule, hybrid instruments combine a 

bond with a derivative product. It must 

be underlined that the tax treatment of 

each hybrid instrument has to be carefully 

analysed. 

1. Classical convertible bond and 

option bond 

When a private investor holds a classical 

convertible bond, he is entitled (but not 

obliged) to convert the underlying debt 

into shares of the issuing company or of 

another company during a limited period 

of time. With classical option bonds, the 

private investor has a separate option 

that may be exercised for shares in addition 

to the repayment of the bond. 

According to the above-mentioned 

circular of the FTA, some conditions 

have to be met in order for a bond to 

qualify as a classical convertible bond or 

as a classical option bond, notably: (i) 

the issuer of the bond has to be a Swiss 

company and (ii) the option or conversion 

right attached to the bond should 

entitle the private investor to acquire 

newly issued shares in the Swiss company 

issuing the bond or in a Swiss or foreign 

affiliated company. Provided these 

conditions are met, the tax treatment is 

very advantageous. Indeed, a sale or 

redemption of a classical option bond or 

of a convertible bond by a private 

investor will never trigger income tax. 

Only the periodically paid interest is considered 

as taxable income for the private 

investor. 

2. Other convertible bonds and option 

bonds 

Where convertible bonds and option 

bonds are not classical but “transparent” 

(i.e. the two components of the hybrid 

instrument can be clearly identified and 

valuated separately), one should further 

examine whether or not the bond qualifies 

as an OIDB or as a BRP with predominant 

single interest. In case the 

answer is positive, both the periodic 

interest coupon and the capital gain are 

subject to income tax. In case the answer 

is negative, the capital gain realised upon 

sale of the bond prior to maturity is tax 

exempt. In both cases, reimbursement 

proceeds are taxable. 

In case the hybrid instrument is neither 

classical nor transparent, the private 

investor shall be taxable on any received 

amount (periodic interest coupon, capital 

gain arising from the sale of the 

redemption of the bond). 

3. Reverse convertibles 

A reverse convertible may be characterized 

as a combination of a bond and of a 

put option on an underlying commodity 

(typically on a specific share). In broad 

terms, the private investor acquires a 

bond from the debtor and simultaneously 

sells him a put option in relation with 

the underlying asset. Depending whether 

the debtor exercises the put option or 

not, the private investor either receives a 

cash repayment or acquires the underlying 

commodity (instead of obtaining 

repayment of the cash invested). 

From a tax point of view, the treatment 

of reverse convertibles is similar to 

the one of non-classical convertible 

bonds and option bonds. Assuming the 

reverse convertible is “transparent” (i.e. 

the bond part of the product can be isolated 

from the option part), the option 

premium paid by the issuer to the private 

investor is exempt from income tax 

whereas interest related to the bond part 

of the product are taxable. Should the 

private investor hold “non-transparent” 

reverse convertibles, any amount paid by 

the issuer is fully taxable (irrespective of 

the existence of an option component). 

For this reason a private investor should 

avoid acquiring non-transparent reverse 

convertibles. 

III. Conclusion 

The rules summarised above are quite 

complex. The circular issued by the FTA 

explains the tax treatment of the main 

hybrid instruments in broad terms and 

clarifies various tax issues in relation 

with this kind of financial products. The 

taxation is very advantageous when it 

comes to transparent hybrid instruments. 

This qualification, however, requires an 

important administrative burden both 

from the issuer and from the bank in 

charge of the management of the private 

investors’ assets. 

Thierry De Mitri is a Partner of 

Piaget & Associés since 2001. The 

certified tax expert holds a law 

degree from the University of 

Geneva and a Certificate in 

Management Studies from HEC 

Lausanne. Mr. De Mitri teaches 

tax law at several high level banking 

and accounting schools. 

33 


Hedge Funds 

34 

Risk in Alternative 

Investments 

Management, Monitoring, Biases and other Myths 

In the earlier article published on the last issue of the Swiss Derivatives Review, a fictional CIO described how 

liquidity risk and diversification would be managed at his Fund of Funds. The article pointed out how liquidity 

is a poorly-understood but critical driver of performance in Alternative Investments. How could the CIO describe 

the approach to risk management and the opportunity of getting involved in Alternative Investments? 

“Alternative Investments exhibit limited 

or no correlation with traditional asset 

classes and as such present attractive 

diversification opportunities to institutional 

investors. We are keen on managers 

who present a track record of 

steady returns and robust Sharpe Ratios. 

Last, they must be able to meet our risk 

requirements, namely have an in-house 

risk manager and provide risk information 

through third-party providers”. 

Does all of this sound too good to be 

true? 

In order to answer this major question, 

one has to review some of these statements 

carefully. Semantics play an important 

role in marketing the Fund-of- 

Funds’ supposed risk acumen and in 

blurring the line between perception and 

reality. Let me challenge the mainstream 

arguments above as follows: 

1) Alternative Investments are far more 

strongly – and positively – correlated 

with traditional long-only paper 

assets than most are willing to 

acknowledge. One should then seriously 

question the whole diversification 

rationale for engaging in 

Alternative Investments. 

2) Stability is a psychologically attractive 

feature that is prone to misuses. The 

frequency of positive returns – the key 

crude test of stability – does not necessarily 

translate into strong performance. 

Ditto for oft-quoted indicators 

such as Sharpe Ratios. 

3) Historical volatility is by far the predominant 

method of risk-adjustment 

of returns but a very crude one to 

compare returns across strategies. 

4) Getting risk information and knowing 

how to use it are by no means synonymous. 

This difference though is what 

sets risk management apart from risk 

monitoring. 

The following sections address each 

point in turn. 

Chart 1: Correlation of Returns between Hedge Fund Indices, Equities and 

Bonds, 2002–2004. 

Correlations between Alternative 

Investment strategies and traditional 

asset classes 

Charts 1 and 2 plot the correlation of 

returns between some of the most popular 

Alternative Investment strategies – 

embodied in hedge fund indices – and 

traditional asset classes, typically stocks 

and bonds. Each strategy has two correlations, 

plotted respectively on the vertical 

axis for stocks and on the horizontal 

axis for bonds. The S&P 500 Index and 

the Bloomberg/ EFFAS 7+ Treasury 

Index were selected as proxies for equities 

and bonds, respectively. To add some 

international flavour, the charts include 

the popular MSCI World Index, too. 

Across these two dimensions, the correlation 

coefficients range of course 

between –1 and 1. So, one may label the 

top right quadrant as the one with the 

most favourable returns for the “paper 

assets”. The Goldilocks economy of the 

second half of the 1990’s would be an 

example of such a phase. If the correlation 

argument held, one should expect 

strategies to be well scattered across the 

chart. But are they? 

The clustering of Hedge Fund returns 

in the top-right quadrant of Chart 1 

above speaks for itself. The lesson is that 

there is some kind of pseudo-benchmarking 

relative to traditional “paper economy” 

asset classes – most notably when 

these display positive returns. CTAs and 

Short-Selling Strategies are the only 

notable outliers in the bottom right 

quadrant. 

You may object that there is nothing 

wrong with having positively-correlated 

returns with traditional asset classes 

during fair-weather phases. After all, you 

may add, positive absolute returns to 

investors are what matters. It may be 

that hedge fund managers display their 

smarts especially during bear markets. Is 

that true? 

Chart 2 plots the same correlations as 

above but over a 5-year period ending 

last May. If the diversification and lowcorrelation 

arguments applied, one 

should expect the points in the chart to 

be relatively scattered across the chart. 


“These results seriously 

question the diversification 

rationale for engaging 

in Alternative Investments.” 

Hedge Funds 

Chart 2: Correlation of Returns between Hedge Fund Indices, Equities and 

Bonds, 1999–2004. 

Comparing Strategies A and B, one 

would likely be tempted to infer that a 

probability of positive return of about 

50 bp., for instance, is higher for 

Strategy A than for Strategy B. Based on 

the frequency of returns, it is hard to dispute 

that point, since the returns on 

Strategy A have a mean of 48 bp. and a 

standard deviation of only 45 bp. The 

returns on Strategy B, on the other hand, 

display a standard deviation of 179 bp., 

or about 4 times greater. 

According to the transitive principle 

and taking this logic further, the probability 

of a positive return above +0.5%, 

say 2%, for Portfolio A should always 

exceed the corresponding probability for 

Portfolio B. 

35 

Again, the clustering of Hedge Fund 

returns in the top right quadrant does 

not differ much from the previous picture. 

Outliers are still the same as before. 

Similar plots emerge for returns during 

shorter periods between May 1999 and 

May 2004. 

What does this mean? For all the 

diversification benefits that hedge fund 

managers are supposed to bring to 

investors, it is simply too risky – and 

politically incorrect – to underperform 

traditional asset classes when these 

exhibit positive returns. Simply put, two 

different risk frames are at play to make 

investors’ perspective lop-sided in their 

Hedge Fund performance assessments: 

• during downturns, investors are biased 

to focus on the relative performance, 

i.e. they lose less than long-only strategies; 

any positive absolute return that 

they can produce is icing on the cake; 

• during uptrends, investors praise hedge 

funds’ lower risk relative to long-only 

strategies – which makes up for the 

underperformance bias of the former 

category vis-à-vis the latter. 

As risk-adjustment in Alternative 

Investments relies overwhelmingly on 

historical simulation alone (see the next 

point), there is no way to include in the 

process the significant correlations 

shown earlier. 

Frequency and probability of 

returns, 

Consider the following chart: 

P A(0.5%) > P B(0.5%) 

P A(2%) > P B(2%) 

and, in addition, 

P A(2%) 

This way of thinking assumes implicitly 

that underlying prices may follow a continuous 

function. Market prices, however, 

can and do experience discontinuities, 

Chart 3: Using Frequency in Drawing Probability Assessments for Trading 

Strategies. 


Hedge Funds 

36 

so that the transitive principle may not 

apply and 

P B(2%) > P A(0.5%) > P A(2%) 

The relative size of P B(0.5%) and P A(2%) 

is not known but does not matter for the 

purposes of this explanation. 

In the specific example, the Terminal 

Value of Strategy B is 112.7, or 47 bp. 

greater than Strategy A’s. Note from the 

example that the latter underperforms 

despite having experienced no catastrophic 

draw-down during the period 

(as one would sooner or later have to 

expect of positive carry-style strategies 

such as this one). 

Two important psychological 

biases are at work over here: 

• Extrapolation bias, whereby 

investors form their 

future projections by extrapolating 

from past experience. 

With this bias, 

investors fail to adjust their 

expectations for the regression 

to the mean. This bias is a subset of 

representativeness (Kahneman & Tversky, 

1974), a psychological tendency 

whereby individuals, when faced with 

samples A and B, tend to deem A as 

representative of B. This is embodied in 

the use of frequency, a measure from 

the past, to form expectations on probability, 

which concerns the future. The 

sequence of events in the past is assumed 

to be a good proxy for the series 

of future returns and their probability. 

• Hedonic framing (Thaler, 1985), the 

psychological bias whereby investors 

prefer savouring a series of little wins 

and lumping together losses. This bias 

is appealing on two counts: 

a) A series of positive returns is associated 

with the idea that one’s portfolio 

is growing steadily over time. 

As investors are rewarded in dollars, 

rather than in probabilityweighted 

dollars, this overlooks 

the fact that a portfolio’s value may 

be progressively eroded in probability-weighted 

terms. Credit portfolios, 

with their stream of creditspread 

income and occasional 

major draw-downs, are the classic 

case in point. 

b) It is far easier to dismiss the occasional 

major draw-down from selling 

risk insurance as an “aberration” 

or as an “exceptional” event than 

when a stream of tiny losses occur. 

Simply put, frequency may be used as a 

proxy for the probability of returns but 

has little to do with them, since the 

“Intelligent investors will 

be looking for some creative 

tension between risk and 

trading functions.” 

former is derived from the past and the 

latter refers to the future, respectively. 

Due to mental conditioning that includes 

“be right” attitudes that are taught since 

one’s early school days, investors keep 

associating the frequency of wins with 

strong performance. That is then reflected 

in managers’ evaluation and selection. 

Unfortunately, the 80–20 rule applies, in 

that 80% of trading profits usually come 

from less than 20% of one’s trades and 

over half result from just between 3% 

and 10% of the trades (Kiev, 2002). 

These statistics alone should make investors 

think twice about inferring 

stability in performance when presented 

with a series of positive returns. Counterintuitive 

as it may sound, no downside 

volatility is more worrisome than some. 

Short of clairvoyance, the lack of volatility 

betrays the selling of some insurance 

on some events that may look remote 

from a statistical point of view, or, worse, 

even some smoothing of P&L by accounting 

means. Thaler (1999) states: 

… we should expect to see that some of 

the discretion inherent in any accounting 

system will be used to avoid to experience 

losses. 

Risk adjustment based on historical 

volatility 

Hedge funds are not known for their 

eagerness to provide detailed position 

information. Accordingly, investors use 

what they have to draw conclusions, 

namely historical information. 

Using the standard deviation of 

returns to calculate volatility, 

the so-called Historical 

Simulation (HS) method – is 

indeed one of the earliest 

methodologies used to calculate 

market risk in banks and 

financial institutions. Advances 

in Risk Management 

theory and the impressive rise 

in computing power enabled 

the development of more advanced 

methodologies, such as the Variance- 

Covariance (VCV) Method or the 

Monte-Carlo Simulation. These have 

progressively replaced HS over time. 

While reasonable for market risk, the 

HS method can become dangerously 

inaccurate when credit risk is involved. 

Credit is involved directly with credit 

arbitrage or distressed strategies and 

indirectly with equity strategies. Unlike 

market risk, credit involves lumpy losses. 

Take the example of an investor who is 

presented with a pure market-risk strategy, 

typically a macro fund, and a credit 

strategy. If these have experienced the 

same return and the same historical 

volatility to date, the HS method may 

make their risk-adjusted performance 

look very close. Nevertheless, the credit 

fund’s performance is exposed to losses 

that are positively correlated with time 


D O W J O N E S I N D E X E S 

THE DOW : THE UNITED STATES :: 

A. DOW JONES TITANS : 18 GLOBAL SECTORS 

B. DOW JONES TITANS : 15 COUNTRIES 

C. DOW JONES TITANS : THE WORLD 

D. ALL OF THE ABOVE 

DOW JONES TITANS INDEXES. THINK OF THEM AS 

“THE DOW” FOR NEARLY ANY MARKET YOU CHOOSE. 

Looking for an index that tracks Italian stocks? The Financial Services sector? Asia? 

Dow Jones Titans indexes let you measure these markets and more. Like the Dow 

Jones Industrial Average, they are blue-chip indicators of the markets they represent. 

To learn more about how you can license the Dow Jones Industrial Average and the Dow Jones 

Titans indexes as the basis of investment products such as ETFs, futures and options, 

call us at (U.S.) +1.609.520.7799, (Europe) +1.49.69.9714.2890 or (Asia) +85.2.2831.2850. 

www.djindexes.com 

BLUE-CHIP INDEXES | BENCHMARK INDEXES | SPECIALTY INDEXES | CUSTOM INDEXES 

“Dow Jones”, “Dow Jones Indexes”, “Dow Jones Industrial Average”, “Dow Jones Titans” and “The Dow” 

are service marks of Dow Jones & Company, Inc. Dow Jones does not sell, nor does it sponsor, 

endorse, or make any recommendation regarding the purchase or sale of any security.

Hedge Funds 

38 

but the macro fund is not. This shows 

how much caution is necessary when 

making these performance assessments. 

The use of historical 

volatility for risk adjustment 

and the quest for stability 

is evident in the misuses of 

one of the most commonly 

used risk statistics in the 

Alternative Investment industry, 

the Sharpe Ratio 

(Sharpe, 1994). It is calculated 

as: 

Sharpe Ratio = 

Excess Return 

over Risk Free Rate 

Volatility 

Of Returns 

In layman’s terms, this is simply the 

excess return divided by the volatility of 

returns. Three major methodological 

issues loom large. While the cottage 

industry of information that feeds the 

information food chain surrounding 

Alternative Investments may not be very 

concerned about them, they nevertheless 

deserve attention: 

• As clearly indicated by William F. 

Sharpe himself, the ratio was designed 

for static portfolios, notably mutual 

funds. This is hardly the case with the 

intense portfolio rebalancing that is 

one of the hallmarks of hedge funds. 

Active portfolio management being the 

undisputable style feature of hedge 

funds, it is puzzling why investors use a 

risk indicator that is more reflective of 

passive portfolio management. 

• The ratio attributes equal weighting to 

up- and downside volatility, thereby 

penalizing hedge fund styles that aim 

for asymmetrical returns, typically 

with directional option strategies. 

• The incentive may be there for managers 

to construct portfolios that display 

a high Sharpe Ratio prior to mean 

reversion in returns, ie, the occasional 

large loss. Goetzmann et al. (2002) 

have explored the use of option-like 

strategies to devise high-Sharpe Ratio 

“It is dangerous to use 

the frequency of returns 

as a proxy for probability 

assessments.” 

portfolios irrespective of the manager’s 

skill. 

Few practices – irrespective of how widespread 

they are – are as dangerous as the 

use of the Sharpe Ratio as a mechanical 

pre-screening tool device for hedge fund 

managers. Given the crude volatility 

methodology illustrated above, there is a 

potential adverse selection and survivorship 

bias issue. This is because funds 

with high positive volatility would be as 

likely to get screened out as funds with 

high volatility resulting from drawdowns. 

Other measures, such as the 

Sortino Ratio have been devised in order 

to address the issue above. 

Risk Management 

Risk Management and Risk 

Monitoring 

The following table compares some of 

the key attributes that one 

may encounter in different 

risk operations. Some larger 

organizations may of course 

be more structured and feature 

specialists to cover both 

functions. This comparison is 

not intended to diminish the 

importance of getting reliable 

information, quite the contrary. 

Rather, it provides a quick acid test 

of how much independent risk thinking 

exists in a fund. 

Let’s face it, traders are not often 

quoted as examples of moderation in 

their egos. Not all of them have enough 

emotional intelligence or patience to 

select and hire independent thinkers! 

Conclusions 

What issues should top investors’ lists 

when talking about risk? 

1) “Carry” or “Arbitrage” strategies 

that produce frequent positive returns 

and event risk exposure are opposite 

sides of the same coin. If one gets paid 

Risk Monitoring 

Objective Use and interpretation Provision of information 

of information 

Time orientation Mostly forward-looking Mostly backward-looking 

Key question How/why may the portfolio How can the historical 

change in value? 

performance be attributed? 

Philosophy 80% decision-making-20% 80% productionproduction 

20% decision-making 

Ideal type of Direct Trading & Investment Product Control & 

previous experience Management experience Risk Monitoring 


“ ‘Carry’ strategies 

and event risk exposure 

are opposite sides of the 

same coin.” 

Hedge Funds 

on an ongoing basis for an extended 

period of time, there is always some 

fundamental bet underlying the strategy. 

On this basis, one should rather 

classify strategies as risk insurance 

buyers versus risk insurance sellers 

and understand the mix between these 

two categories in one’s portfolio. 

2) Bear in mind that hedonic framing 

pushes motivates investors towards 

more frequent positive returns and 

most insurance-buying strategies will 

experience losses most of the time and 

positive payoffs only occasionally. 

These factors will push investors to be 

systematically overweight in insurance-selling 

strategies. Rather than 

fooling themselves into illusions of 

stability of their returns and confusing 

luck with skill, investors would be 

well advised to manage that insurance 

mix more consciously. 

3) Having a computer and/or a person 

supply the figures regularly is a necessary 

but not sufficient condition to 

conclude that a Fund has a Risk 

Management function with teeth. 

Some “creative tension” between risk 

and trading functions inside a Fund is 

something that any intelligent investor 

should be actively looking for. 

4) If the Fund in which you are considering 

an investment leans more towards 

hiring “reporting” types, you should 

find out where is the added value of 

having a person provide what a good 

computer should fetch anyway. It 

may help reveal some unwillingness to 

invest in adequate computer/risk 

infrastructure and underscore other 

operational weaknesses. 

All the caveats raised in this article may 

not necessarily be what a short-term oriented 

marketer wants to hear. Calling a 

spade a spade, though, is at the heart of 

stronger quality control in the products 

offered to investors and in cementing 

longer-term relationships with them. 

Markets and probabilities eventually 

catch up with most short-term marketing 

shortcuts anyway. 

References 

Celati, L. (2004), Chapter 7, The Dark 

Side Of Risk Management, FT/Prentice 

Hall, London. 

Goetzmann, W., Ingersoll, J., Spiegel, M. 

& Welch, I. (2002), Sharpening Sharpe 

Ratios, Working Paper. 

Kahnemann, D., Tversky, A. (1974), 

Judgment under Uncertainty: Heuristics 

and Biases, Science 1974, 185, 1124– 

1131. 

Kiev (2002), The Psychology of Risk, 

Wiley, New York, p. 4. 

Sharpe W.F. (1994), The Sharpe Ratio, 

Journal of Portfolio Management. 

Thaler (1985), Mental Accounting and 

Consumer Choice. Journal of Economic 

Behaviour and Organization 1, 39–60. 

Thaler (1999), Mental Accounting 

Matters. Journal of Behavioural 

Decision-Making 12, 183–206. 

Hedge Fund indices and returns can 

be found on: www.hfr.com and www. 

edhec-risk.com 

Luca Celati is the co-Founder of Abraxas Capital 

Management, the London-based Investment Manager of 

Abraxas Fund, a Long-Gamma hedge fund. He can be 

reached at celati@abraxasfund.com 

The Author would like to thank Ms. Mara Airoldi for the 

kind support provided in the correlation study. 

39 


Education 

Commodities: Bubble or 

Emerging Secular Uptrend? 

Taboo before 2000, the word “bubble” shows up regularly since 2002 in the financial press and has become a 

mandatory fashionable item to attract readers whenever financial assets rise. A historical perspective allows 

us to have a fresh look at recent price evolution: let’s look at a few charts from a Technical Analyst’s perspective 

to see if we can gain some wisdom and insight into the cyclical forces at work within these markets. 

40 

Chart 1 – The Commodity Index 

First, we consider the following question: 

Has the CRB index started a secular 

uptrend around 1999 by failing to make 

a new low at the end of 2001? 

There are many measures of commodity 

indices. Although the CRB Index is 

seen as giving less weight to oil products 

than other commodity indices, we note 

that it has ended a secular downtrend in 

2002, after a rebound just above the 

1999 low. In Chart 1 below (courtesy of 

Tradermade International Ltd), the 

descending red line represents the downtrend 

that started from the area at about 

328 points in 1980–81. Most will recall 

that interest rates in the US were above 

12% at the time, since when interest 

rates have declined together with the 

CRB Index (which was capped by this 

red downtrend line until 2002). The 

duration of this downward move was 

about 20 years, which is a normal time 

span for a secular move. 

In Chart 1, it is worth noting that a 

continued rise of the CRB between the 

green line (support) and the blue line 

(resistance) would bring it back up to 

Chart 1 

the 1981 area of 330 by the end of 2006. 

That extrapolation might well be a bit 

too linear, but is not too far fetched, 

given the price behavior of the commodities 

composing that index. 

However, focusing on the more recent 

rise from early 2002 until its interruption 

by a black quarterly candle early in 

2003, we would expect that an equal rise 

of the second (current) leg could meet 

some heavy resistance near 291–292. 

Indeed a failure to maintain an advance 

above 292 for more than 2 weeks would 

call for a longer sideways consolidation, 

lasting possibly two or three quarters. 

This expected range would also need to 

hold well above the (now key) support of 

262 in order to maintain the longer-term 

target near 330. 

So far, apart from a slight slowdown 

in momentum (indicated by a potential 

bearish divergence in the “Slow 

Stochastic” – located below the price 

chart), the CRB index is giving no signs 

of reversal. Such divergence would be 

confirmed if the price fails to rise above 

292 during the last months of 2004. 

Chart 2 – The Oil Price 

If we consider the evolution of the oil 

price from a long-term perspective of 

more than 100 years on Chart 2 (courtesy 

of the Notley Information Service, 

Ridgefield CT, USA), we note on the 

upper part of this logarithmic price scale 

chart a black line displaying yearly 

prices, from 1868 updated until July 

2004 and on top of it a red line like a 

sinusoidal oscillating curve, which is a 

long-term smoothed rate of change of the 

yearly prices. That red line suggests that 

a major top occurred around 1984 and a 

major bottom of this momentum 

occurred around 1999. Such momentum 

would remain on an advancing path (and 

thus help maintain an advance of prices), 

providing the 2004 yearly close of the oil 

price remains above $21. This seems very 

likely under current circumstances. On 

the lower part of chart 2, the black line is 

a ratio of Oil by the S&P 500 displaying 

the Relative Strength (R/S) underperformance 

of oil for 18 years until 1999. The 

red curve is again a smoothed rate of 

change of the yearly prices. Hereby technical 

analysts assume that long-term 

momentum gives an indication on the 

long-term direction of prices or of 

Relative Strength. 

So by integrating this perspective of a 

major long-term bottom of price 

momentum of oil into the commodities 

picture, we feel that it is appropriate to 

speak of the high likelihood of a general 

secular bottom of commodities around 

the year 2000 and that it could coincide 

with an out performance of these assets 

versus US equities (since the CRB Index 

would display similar momentum behavior 

if data history was available for the 

CRB Index as it is here for the oil price). 

If we focus on prices from January 

1983 using a logarithmic price scale and 

quarterly price candles (Chart 3), it is 

difficult to envision an immediate top, 

since the quarterly “Slow Stochastic” 

lines have not yet crossed within the 


Education 

Chart 2 

Overbought zone (above 75%). The red 

line at $55 has been set as explained 

below. 

year, that futures contract was again testing 

its August 20 high, around $48 per 

barrel. 

Before jumping at any extreme price 

projections, we suggested a cautious 

approach, given that the oil price had 

already started a parabolic rise from $32 

to $48 per barrel in 2004. Even a weekly 

close above $49.25 would only indicate 

a modest potential rise towards the 

$53.45–$55.30 area. Thereafter, a likely 

stabilization is expected between $55 

and $40 per barrel. At the time, we indicated 

that immediate daily closes below 

$47 would indicate a termination of the 

parabolic rise, leading to an immediate 

consolidation between $50 and $37. On 

October 15, with price near $54, the rise 

has reached our $53.45–$55.30 target 

area. 

Though it is always difficult to predict 

the exact area of potential tops, especially 

with such a volatile commodity as oil, 

it is important to look for signs of a possible 

exhaustion of this parabolic rise – 

characterized by a significant daily price 

reversal (as seen in August 2004). A less 

common sign of a top in the oil price 

would be a transition to “price churning 

behavior”, specifically a flattening out of 

41 

Chart 3 – Oil Price Quarterly 

Looking at a weekly chart with a standard 

arithmetic price scale (Chart 4), the 

parabolic price acceleration could clearly 

be seen weeks ago, although (as mentioned 

in the comment of that chart on 

September 24, 2004) the view for 2004 

offered only modest upside potential 

from $48 to $55 at most. 

Chart 4 – Weekly NYMEX 

The history of the oil price is represented 

on this weekly NYMEX chart (Chart 4) 

by a continuation chart from September 

2000. A continuation chart is constructed 

by displaying the prices from the most 

liquid futures contracts, one after the 

other. The last weekly price bar shows 

the trading in the November 2004 

NYMEX futures contract for Light 

Sweet crude oil. On September 23 this 

Chart 3 


Education 

42 

Chart 4 

prices at these high levels. In any case, as 

mentioned three weeks ago, the ensuing 

consolidation between $55 and $40 is set 

to last for many weeks, possibly until the 

beginning of 2005. 

Let’s recap: A secular uptrend appears 

to have started around 2000 for commodities; 

the oil price behavior is probably 

only the tip of the iceberg. A parabolic 

rise in the oil price is developing. Is 

there any reason to panic? Well a surprise 

would be the expected consolidation 

in the oil price taking place as 

expected in the coming months. Indeed, 

a pause in a parabolic uptrend would 

calm down the expected fears of a fast 

return to excessive inflation and a slowdown 

in economic growth. 

Before jumping to the conclusion that 

the preceding charts are in fact raising 

the threat of a return to inflation, let’s 

consider another psychological proxy for 

the fear of inflation. 

terms of its history in relation to inflation: 

the Swiss franc for example. Here 

we would look at the gold price in Swiss 

francs (CHF) as a last resort measure of 

the ultimate value of money. A rise of 

gold in CHF above a long-term trading 

range, which has in fact lasted about 

10 years, may hint at a loss of value of 

paper money, in our example Swiss 

franc. This loss of value may result from 

increasing expectations about higher 

inflation or specific fears pushing the 

market to buy gold. 

Unlike the usual representation of 

gold in US dollars per ounce, on Chart 5 

it is represented in Swiss francs per ounce 

for the period from September 1986 to 

date. This allows us to analyze the gold 

price independently of the fluctuations of 

the US dollar against the Swiss franc. 

The major downtrend in the CHF 

gold price is illustrated by joining the 

highs of 1987, 1993 and 1997. After 

prices hit a low of CHF380 in 1999, this 

downtrend was broken during 2000. 

Since that time the price has moved 

broadly sideways, consolidating between 

a lower floor of CHF 432 per ounce and 

an upper area around 516. A breakthrough 

of the 516 ceiling during the 

second half of 2003 actually reached 

Chart 5 – Gold vs. Swiss Franc 

One approach to measure this impact is 

to look at the price of gold against a traditional 

safe currency; safe at least in 

Chart 5 


Bollinger Bands 

Let’s briefly review the concept of “Bollinger Bands”, made popular by the 

market analyst John Bollinger. The Bollinger Bands can be seen as two nonlinear 

lines (red and green) surrounding the weekly oil prices of Chart 4 and 

the monthly gold prices on Chart 5. 

To construct Bollinger Bands on a weekly chart, a central line (black) is 

needed, which is a simple moving average of 20 weekly closes. The number 

20 was optimized by John Bollinger. Further optimization is not forbidden, 

but it can be noted that the period 20 is used as default in most charting 

systems. Personally, I have selected 21 bars as my parameter value and used 

it for both weekly and monthly bars. The Bollinger Bands are the two lines 

either side of the central line on Chart 4, which create an envelope around 

that central moving average to capture most of the price action. The statistical 

concept of standard deviation (which measures the price dispersion 

around the central line) is used to compute the Bollinger Bands, which illustrate 

the historical price volatility of the last 21 weeks on a rolling basis. 

The expert eye of a statistician would immediately notice that these bands 

are removed from the central line by two times the standard deviation of 

21 weeks. 

It is important to note the different interpretation during a sideways price 

evolution or during a well-established trend (upward or downward). 

Chart 4 of the oil price allows us to differentiate nicely between these two 

cases. 

When prices are moving sideways, the upper Bollinger Band acts as a ceiling 

on the price (in technical jargon called “resistance”). In this case, the sellers 

in the market are stronger than the buyers, hence stopping the price from 

rising. Similarly, the lower Bollinger Band signals a floor (“support”), where 

buyers are stronger than sellers, leading to the end of a price decline. 

In Chart 4, during the first half of 2001 (between $26 and $31 per barrel – 

labeled 1, 2, 3), and from August to November 2003 (labeled 1, 2, 3, 4) 

with a ceiling established near $33, the three lines are about flat and both 

the upper and lower bands have had time to converge towards each other – 

this is a typical sign of lower volatility. 

On the contrary, as soon as a price trend emerges (as it is the case from 

January 2004 onwards – labeled A to H), the upper band rises faster than 

the central line, illustrating a typical increase in volatility. That upper band 

will only slow down the advance of prices towards new highs on a temporary 

basis. It is the central band that takes over from the lower band as a floor for 

prices, which acts as support as the price steps higher. The description would 

be symmetrically inverted in case of a declining price trend. 

540 in early 2004, but this breakout was 

not confirmed since the price pulled back 

to trade for three months below 516, further 

validating the neutral area below 

516. 

However, the recent test near 540 and 

the recent slow rise above 516 both need 

to be monitored. If the higher low in 

May 2004 (near 480) and the recent 

crossover of the two Slow Stochastic 

lines near 25% are viewed as a buy signal 

by the market, then there would be a 

case for a violent rise. A sustained price 

rise above 516–536 (staying for a while 

near 540) would open a potential upside 

target toward the key area of CHF 

589–600, which was a significant chart 

level from 1988 to 1994 (see the green 

line). That said, this upside target would 

be invalidated if we saw two monthly 

closings below CHF 455, which is the 

current level of the lower monthly 

Bollinger Band (see text box on Bollinger 

bands for further explanation). 

Since the gold price in CHF has not 

yet broken out above the top of this 

range, we interpret this as a calming 

influence on some of the extreme expectations 

fearing an imminent comeback of 

uncontrolled inflation. In short, no 

immediate panic warranted. 

Education 

43 

Bruno Estier is a global market analyst and founder of InvestorMade 

in Geneva. He is current President of the 

Swiss Association of Market Technicians, SAMT, and 

serves on the board of directors of the International 

Federation of Technical Analysts, IFTA, as Secretary and 

former Chairman. Before joining Geneva private bank 

Lombard, Odier & Cie, in 1994 as head Technical 

Analysis, advising until 2003 the Portfolio Investment 

Committee, Bruno had worked 12 years for JP Morgan in New York, Zurich 

and Paris in the field of Market Research and Technical Analysis. A graduate 

from the University of St Gallen and from the University of Chicago (GSB), he 

can be reached at bruno.estier@dplanet.ch. 



44 

The Emerging Markets 

Forum on Bürgenstock 

Since 2001, the Association of Futures Markets 

(AFM) is jointly organizing with the Swiss 

Futures and Options Association (SFOA) the 

Emerging Markets Forum, a special event just 

ahead of the SFOA Bürgenstock Meeting. The 

following article provided by AFM reviews the 

Forum’s history, which is closely linked to the 

AFM’s background and objectives. 

Background 

The rapid opening of economies in the East 

following the collapse of communist regimes, 

as well as economic globalization in the late 

80s and early 90s led to an increased demand 

for risk management tools. Also, a lot of 

people were looking for ways to speculate. As 

a result, many derivative exchanges were 

formed, especially in Eastern Europe, Asia 

and the Americas – unfortunately often too 

quickly and without proper organization, 

appropriate backing of the industry, support 

by politics and too much pushed by the speculative 

element. As a result many of them 

failed rather quickly. 

Foundation of AFM 

Several of the surviving exchanges realized 

that the problems and difficulties they faced 

were similar and often could be addressed by 

common approaches. They started to meet 

occasionally to discuss topics of common 

interest in 1996. Apart from meeting among 

themselves, many tried to participate in some 

of the regular gatherings of the established 

industry (Bürgenstock, Boca Raton and 

London), but had to realize that there mainly 

topics of more advanced nature were 

addressed. The need for a meeting place of the 

emerging exchanges and markets led to the 

official establishment of AFM in 1998 in 

Buenos Aires. 

Membership 

Any active exchange/clearing house for financial 

products or commodities can become 

member of AFM as well as users of and suppliers 

and vendors to the industry. 

Membership has been growing continuously 

and to date, AFM lists 15 members, mostly 

exchanges. The majority of members come 

from Europe, but AFM is reaching out to Asia 

and South America, hoping to become a truly 

global organization for the emerging markets. 

Objectives 

Know-how is key to the success of any enterprise, 

especially so in the case of a complex 

industry such as the derivatives business: 

construction of the product, connectivities, 

trading, clearing, margining, deliveries, compliance, 

regulation and legal implications as 

well as education – you name it. Each of these 

is a very important cog on the wheel to success. 

Therefore, the prime objective of the 

Association is to promote networking, communication 

and the exchange of information 

between member exchanges, clearing houses 

and market participants and with this to foster 

the development of sustainable marketplaces. 

The objectives are achieved through 

the annual conference of AFM, the Emerging 

Market Forum on Bürgenstock, through bilateral 

assistance programs between members 

and through participation in other international 

industry events. 

Apart from the Bürgenstock Forum, the 

major activity of AFM is the organization of 

its annual conference, which consists of informal 

roundtable discussions. 

History 

During the short history of AFM we witnessed 

many success stories and failures among the 

members and observers of the organization: 

emerging exchanges transforming to developed 

ones, mergers, buy-outs and closures. In 

the end this is the goal, of course, of any trade 

association: to learn from experiences and 

help avoid certain problems in the future, to 

network and get to know each other, in short 

– to raise the know-how standard of the 

industry represented. 

Therefore, following the foundation of 

AFM, annual conferences were held. In 2004, 

AFM organized its 7 th Annual Conference in 

Budapest with a record attendance of over 60 

from all over the world. Themes discussed 

included the state of affairs in the various 

regions as well as Regulation, Technology and 

Clearing with a specific view to emerging 

markets. 

Participation at the Bürgenstock Emerging 

Market Forum is open to all exchanges, regulators 

and clearing houses and has developed 

into a forum not to be missed. It is fair to 

say that these conferences have become a 

prestigious meeting point of emerging and 

developed exchanges of the world. Beyond the 

professional content of the roundtable discussions, 

the Bürgenstock Emerging Markets 

Forum has contributed to widen the international 

awareness of AFM within the industry. 

The Forum led to many new partnerships and 

to new membership applications. 

Outlook 

Risks are rising, as is awareness to them. 

Managing risks has become one of the most 

important issues – not just for the developed 

world. The derivatives industry is very young 

(if you consider the financial part only) and 

very old (if you consider that Thales used 

options to manipulate the olive crop and you 

find the first case of settlement risk in the 

Bible …). Obviously the last 25 years have 

brought tremendous change and incredible 

growth in the use of these products. Just think 

of stock markets without index futures or 

options. Or the energy markets without oil or 

gas futures. 

This touched both on the exchanges as 

well as the users. While the established 

markets are desperately searching for the next 

big hit, the emerging markets are trying to 

find the proper products to get (and more 

importantly keep) going. 

The average user of financial derivatives at 

inception had rather speculative objectives 

while the real growth in the recent years have 

come from a different direction – asset managers, 

mutual and/or pension funds – investors 

not exactly known for their speculative 

bent. Why? They have simply realized the 

many advantages derivatives can offer over 

holding the underlying asset. In this context 

the volumes have exploded and the products 

have been accepted – to the point where the 

price of the oil futures is quoted in the evening 

news. 

What does this all mean? A great challenge 

to the industry, both “established” and 

“emerging” – to keep innovating, to continue 

improving, to deliver products that the markets 

needs, at reasonable cost and properly 

regulated. No one can do this alone. Either the 

organizations will co-operate directly or learn 

from and with each other. In order to achieve 

this, trade organizations are more needed than 

ever! 

For more information on AFM, its 

members and its conferences, please 

contact Krisztina Kasza, Head of 

Secretariat of AFM at kkasza@ 

axelero.hu or visit the AFM website at 

http://www.afm-org.hu 



A Perspective on Eastern 

European Exchanges 

The commodity exchanges in Central Eastern Europe (CEE) are relatively new and their range of products is still limited. 

Key challenges include the European integration and global competition. This article describes these developments, taking 

as an example the Romanian Commodities Exchange. It further comments on whether a regional commodity exchange 

could be a successful solution for the CEE countries as well as whether alliances between exchanges could reduce costs 

and increase revenues so that they be competitive in terms of EU standards. 

46 

Commodity Exchanges in Romania 

More than thirteen years after the start of transition to free 

market economy, the development of the financial and commodity 

markets in transition economies is still limited. As compared 

to developed economies, securities and commodities 

markets are still in the early stages of development and many 

further steps will have to be taken before drawing level with 

mature markets. 

The transition to free market economy, globalization and 

the subsequent opening of commodity markets led to the 

demand for risk management tools. As a result, many commodity 

and derivative exchanges were formed in Eastern 

Europe. 

In Romania, up to 15 exchanges were created between 1992 

and 2002. The application of the Law 512/2002 governing the 

commodity exchange field was the starting point of a rapid 

consolidation process taking place during 2003. The beginning 

of 2004 found a strong commodity exchange operating all over 

Romania: The Romanian Commodities Exchange (RCE). 

Overview of the RCE 

RCE is the leader in the national market and has as prime 

objective: to become a regional leader. Being aware that a 

national exchange has no real chance of survival without international 

connections, RCE is one of the founders of the 

Association of Futures Markets (AFM). RCE is also on excellent 

terms with the world’s major exchanges and participates in 

international events. Since 2001, RCE through the AFM, 

became an important participant in the annual gathering of the 

international exchanges on Bürgenstock. 

The RCE was officially established on November 20, 1992, 

while the first trading session took place on December 10, 

1992. The RCE is a joint stock company, organized in accordance 

with the rules and regulations of the traditional 

exchanges in the world. The RCE ownership structure encompasses 

120 shareholders: commercial banks, investment companies, 

brokerage companies, as well as foreign trade companies. 

RCE develops cash markets for grains, oil and oil products, 

metals, scraps, etc. Also, since 1998, RCE develops a 

derivatives market for currencies and interest rate products. 

In 2003, the trading volume increased to approximately USD 

1.3 bn, meaning a 600% increase year-on-year. 

The RCE has five years’ experience on the futures market, 

with its electronic trading system implemented three years ago. 

This electronic system allows the quotations display on the 

RCE web-site in real time. In figures, the futures and options 

market as at December 31, 2003 boasts 45,940 traded 

contracts, a total exchange capitalisation of ROL 

1,050,027,785,808 and a total number of 2,463 transactions 

made through the electronic trading system. The most important 

contract on this market is the Futures contract “Dollar 

RCE”. 

Although the futures market volume doubled year-on-year, 

this trend is not representative for the Romanian market in 

general, where the main operators, such as commercial banks, 

lack a legal framework to operate on this market. In 2004, 

despite constraints in relation with the general economic environment, 

the RCE futures market matured and further developed 

its specific instruments and trading process. Notwithstanding 

the current legal premise, the launching of new 

underlying assets, such as indexes, T-Bills, and commodities, 

will bring a significant increase of the trading volume in 2004. 

As future projects, the RCE focuses its efforts on organising 

efficient regional cash markets for grains and petroleum products 

as a basis for a commodities futures market, expanding the 

terminals network throughout the country, trading commercial 

receivables, and consolidating the existing derivatives market. 

Future organization of CEE exchanges: 

how many options? 

What future is awaiting the commodity exchanges in the CEE 

countries given the fast EU integration process, which means 

that they will be part of a more developed European market? 

The global competition, the market internalization and the 

consolidation of trading systems in Europe could make it more 

difficult for the CEE exchanges to survive, especially for the 

small ones. Exchanges and policy makers are aware of these 

issues and are responding in a number of ways. The exchange 

of information and a closer cooperation in view of establishing 

different types of alliances are the main responses. Associations 

of emerging markets like the Association of Futures Markets 

(having the Secretariat in Budapest) are one example. Also, the 

alliances already in place among stock exchanges, such as the 

Warsaw Stock Exchange with Euronext, represent an alternative. 

We can see several options for the commodity exchanges: 

the integration in a regional commodity exchange, such as the 

RCE, individual alliances with a western exchanges, or a 

regional platform incorporated in a western exchange. Of 

course, each exchange should make a choice after assessing 

costs, benefits and risks associated with each of these options. 

Liliana Paraipan, Director Marketing & PR, Romanian 

Commodities Exchange, Bucharest. Tel: +40 21 2244742, 

Fax: +40 21 2242878, l.paraipan@brm.ro, www.brm.ro 


The Dark Side of Risk 

Management 

As many – if not most – practitioners in finance have heard of Behavioural Finance (BF), the notion that people 

are not the automatons depicted by conventional economics and efficient market hypothesis (EMH) may 

hardly strike as new. Nor is the topic of human error, which has been studied in several excellent publications 

on man-made disasters. The Dark Side of Risk Management, by Luca Celati (see also page 34), takes the challenge 

to a higher level by looking at the practical implications of Behavioural Finance findings. 

The book asks three basic questions: 

1) BF studies tend to look at the impact of their findings in 

markets. What happens inside organizations and how do the 

poorly-understood human biases affect risk decisions? 

2) Leaving aside the debates in academia, what should a trader, 

his boss and his risk manager be aware of in terms of 

each other’s psychological inclinations and their own? 

3) As the risk management industry has evolved in variety and 

depth of tools, what can be done to include these biases – 

and not just their effects, the losses that they may originate 

– into the standard risk manager’s toolkit? 

As any reader has to find his or her own answers on his own, 

the book is predominantly descriptive rather than prescriptive. 

It is organized in three sections: 

1) The Theory part shows how biases often start from the limitations 

in people’s information processing abilities. The 

overload resulting from the Information Age only compounds 

the problem. Thus, people use heuristics, a variety 

of shortcuts and rules-of-thumb that save time and simplify 

information. Sometimes they work and sometimes they do 

not. People do not have problems within themselves, they 

also have issues when others are involved in decision-making. 

A thorough review of groupthink and some hints of 

Game-theoretic models concludes the section. 

2) The Practice part shows a series of portfolio allocation and 

financial decision examples to illustrate how biases work in 

practice and how visual framing can often play a decisive 

role. A review follows with the behaviour of some of the key 

actors in the daily risk and trading drama. Thereafter, two 

chapters document the disastrous effects of biases in a series 

of risk disasters both in finance and in the real world. Aside 

from well-known trading mishaps, this section shows how 

flawed human assumptions and frames are at the root of 

other dramatic instances such as the 1987 Stock Market 

Crash, Chernobyl, the Space Shuttle and the Titanic. 

3) The Going Forward section outlines what a reader can do 

about the biases illustrated earlier in the book. This is where 

one understands the connection between standard BF and 

the need for introspection and meditation of which top 

traders and managers are aware. 

The Dark Side of Risk Management is hardly a book for beach 

readings, and indeed it is published as part of FT Professional 

Series. That is the price that the author pays for presenting the 

topic of psychological frames in risk management in such a 

comprehensive fashion. Accordingly, some may find the topic 

fairly complex in the theory part. The rest of the book, however, 

flows quite well and at the end the reader can feel that there 

is a framework in place to understand why his or her own 

organization and the top decision-makers follow certain patterns. 

The combination of humorous quotes, visual illusions, 

portfolio games and vivid description of risk problems make 

the book more engaging and enjoyable than most similar literature. 

As is the case with most BF-related literature, disbelievers 

and sceptics will have their objections and indeed the author 

has devoted an entire chapter to them. Rather then claiming to 

have found the absolute truth, the Dark Side of Risk 

Management is more about providing tools for self-understanding 

and for dismantling the many false truths that marketing 

has created in the risk management arena. While understandable 

from a marketing point of view, it is odd that most 

Operational Risk and empirical evidence in other fields (such 

as civil aviation) attribute about 70–80% of problems and losses 

to human error but then track mostly their effects, namely 

the losses that they determine. This book creates the opportunity 

to understand and measure the real nature of human biases 

in finance at their roots. That is where the book throws 

down the gauntlet by creating an extremely ambitious new 

angle in risk management. 

Book Review 

47 


Profile 

IFRI – The International Financial Risk Institute – 

20 Years in the Service of the Financial Industry 

from the Initiation to the Futures Markets to 

Strategic Risk Management 

On the occasion of the 25 th Bürgenstock meeting, SFOA chairman Paul Meier called IFCI SFOA’s elder daughter 

– this Institute offered a hearty Champaign toast to the celebrating SFOA and reports briefly about its own 

first twenty years below. 

48 

The space does not allow to thank all the institutions and more 

importantly all the personalities who created the institute and 

later had the courage and the necessary perseverance to assist 

it in its teaching innovations with the early PC’s and later the 

Web, but a longer version including the names can be found on 

the institute’s website on www.ifri.ch. 

The Institute marks its 20 th anniversary with three events: 

An informal barbecue bringing together several of its founders 

and most of its past employees at its original premises in 

Carouge on 1 September, the SFOA 25 th anniversary toast on 

Bürgenstock (courtesy Zurich Financial Services), and a luncheon 

presentation for its members and the members of the board 

of the Geneva Financial Center on the occasion of the 11 th 

Geneva Risk conference in December (courtesy The Geneva 

Financial Center). 

History and salient features 

IFCI was founded as a not-for-profit foundation in 1984 on the 

initiative of the SFOA and the major international Derivatives 

Exchanges, Commodity trading firms and other financial institutions 

with the objective to promote the understanding and to 

provide education, information and research in the area of 

Options and Futures markets. 

In 1986, SOFFEX selected IFCI’s Computer-based course on 

Options Trading as standard course. Other exchanges in their 

start-up phase, such as MATIF, MEFF, DTB later EUREX 

choose IFCI’s new CBT packages. IFCI produced a CBT module 

for TOCOM, translated into Japanese by NTT. 

From 1984 until 2004, IFCI and its partner institutions have 

trained thousands of traders and bankers on derivatives products 

and their proper use in seminars and computer-based 

training modules delivered in packages and including in some 

cases electronic examinations. Since the late nineties these 

packages are also partially on the Internet in English, French, 

German, Spanish, Italian, Japanese on five continents. Thanks 

to the early sponsorship by the American and European 

exchanges, the teaching packages could be further developed 

and with reasonable costs adapted to new developing markets 

in Eastern Europe, Asia (e.g. Malaysia), and Latin America 

(e.g. Brazil). 

From IFCI to IFRI – 1984–2004 

H 

I 

S 

T 

O 

R 

Y 

Training & Examination for 

stock exchanges and OTC 

Market regulators meeting 

in collaboration with SFOA 

Know-How transfer from 

USA to Europe 

Focus on Risks 

Training & examination for 

the derivatives exchanges 

O 

N 

G 

O 

I 

N 

G 

Institute for the CROs 

Annual Risk Management Round Table for CROs & 

research publications since 1995 

Web site since 1994 – www.ifri.ch 

Seminars and interactive PC-based packages in 6 languages and on 5 continents – later continued 

with partner institutions 

1984 

Création of the 

Fondation 

1994 2000 

2004 

IFRI 


Profile 

Transition from derivatives and commodities to risk 

Beginning with its foundation in 1984 but increasing in the 

1990s, the Institute was asked both by its members and academics 

not just to teach introduction and strategy seminars on 

derivative instruments with an objective to handle the challenge 

to enhance yields and to hedge portfolios professionally 

and more economically – but furthermore, to focus on the 

questions of financial risk and questions of professional risk 

measurement and risk transfer in the in industry. 

In the early nineties, several members of IFCI created a 

working group in order to study the questions of risk implied 

with the fast growth of the OTC market and threats caused 

by new “inexperienced participants” entering this industry. In 

1994, the first research paper entitled: ‘Benefits and Risks 

of Derivative Instruments’ was published for the Institute by 

professors R. Gibson, now university of Zürich, and H. 

Zimmermann, now university of Basel. 

The first annual Risk Management Round Table of IFCI 

took place in early March 1995 – just one week after the meltdown 

of Barings – and brought together many of the experts 

who had to handle the crisis and to answer to stakeholders. In 

retrospect, this event served as a catalyst for further activities. 

Subsequent discussions and workshops among these risk professionals 

resulted in a series of publications, a website on 

financial risk and the will to bring the high-level risk professionals 

regularly together in an appropriate forum. 

An advisory council of IFCI under the presidency of Bob 

Gumerlock, followed by Tim Shepeard-Walwyn and including 

key risk officers from both sides of the Atlantic prepared the 

transition from IFCI to IFRI. Thanks to the quality of the following 

annual Risk Round Tables and the cooptation of further 

members as well as the early cooperation with the market 

regulators from the Basel Committee, IOSCO and others, the 

Institute grew gradually into the role of the Institute for Chief 

Risk Officers (CROs). 

Today, in the fall of 2004, the Institute has a stabilized organizational 

membership of 35. The Annual Risk Round Tables 

provide an established platform and forum for a fruitful 

exchange of ideas among their CROs and senior risk officials 

along with a few selected other senior risk management specialists. 

Patrick de Saint-Aignan, speaking on Strategic Risk 

Management at the 10 th Round Table. 

Objectives of the Institute as of 2004 

The Mission of the International Financial Risk Institute (IFRI) 

is to provide opportunities to senior risk practitioners, especially 

the Chief Risk Officers of the world’s major financial institutions, 

to discuss and exchange ideas on both the principles 

and the practical application of financial risk management. The 

Institute thereby seeks to develop thought leadership and provide 

learning opportunities by and for senior risk professionals, 

with a view to enhance risk management best practice in the 

financial industry as a whole. 

To fulfill this Mission, the Institute has the following Four 

Objectives: 

1) To provide confidential discussion forums for the most senior 

risk representatives of its members to address topical, 

complex, risk management issues and to help shape the 

strategic agenda for, and evolution of, the risk management 

profession in the future. 

2) To provide an occasional exchange platform for IFRI members 

as well as the wider community of risk management 

industry bodies to leverage on the research and thought 

leadership work undertaken both by IFRI and others. 

3) To provide support to a selective network of the most senior 

risk professionals so that they can easily exchange and 

benchmark ideas and developments in risk management 

4) To produce and distribute occasional papers on topical risk 

management issues, aiming to link academic excellence with 

the practical requirements of workable solutions. These 

papers include academic research papers that have been vetted 

and enriched by discussion with risk practitioners, as 

well as shorter papers and articles for a wider distribution to 

the financial markets and regulators. (The Institute is not a 

lobby group to regulators, but will offer its public output to 

anyone who is interested in it.) 

10 th Risk Round Table 

In May 2004, the 10 th Annual Risk Management Round Table 

was held at Danesfield House, UK. Patrick de Saint-Aignan, 

Member of the Advisory Board of Morgan Stanley Dean 

Witter, summarized well the key topic, Strategic Risk 

Management (SRM): 

Over the past two decades, risk management has become an 

essential discipline at many organizations, including most 

financial services companies. It has proven effective in limiting 

the potential for dramatic losses from market movements, 

changes in creditworthiness and operational failures and has 

become an integral component of tactical and operational 

management. 

Yet most risk management, as practiced today, does not 

address some of the most important risks faced by a firm – the 

strategic risks that can significantly erode a firm’s value, ability 

to compete or even its outright viability. Successful manage- 

49 


Profile 

50 

Official Publication of the Swiss Futures and Options Association 

(SFOA) 

Issue 26 – November 2004 

Circulation and Print Run 7,750 

Total estimated readers >20,000 

Richard C. S. Evans, Chairman of IFRI and CRO, Deutsche 

Bank AG, London, leading one of the IFRI working groups 

at the 10 th Round Table. 

ment of these risks not only offers the possibility of eliminating 

damaging events, but can also contribute positively to performance 

by strengthening a firm’s relationships with customers, 

investors and regulators. 

Most strategic risks – diminished market share, impaired 

ability to raise funding, restrictive regulation or reputational 

damage, for example – are not as readily defined or measured 

as the tactical risks that dominate the day-to-day concerns of 

today’s risk managers. The probabilistic and control-oriented 

techniques of tactical risk management must be supplemented 

with tools drawn from corporate finance. This is because 

strategic risk management is an expansion of traditional risk 

management, not simply its extension to unorthodox risks. 

Distribution 

Mailed to subscribers in 

Switzerland 4,250 

Europe 2,500 

North America 500 

Asia and ROW 500 

Advertisement 

For rates of advertising, corporate profiles, inserts and other sales 

information, please contact: 

Carolyn Hicks, Advertisement Manager UK/Europe 

carolyn@spaceworks.ltd.uk 

Phone +44 20 8340 3273, Mobile +44 77 8573 7907 

68A Priory Road, London N8 7EX, United Kingdom 

Patrick Catania, Advertisement Manager USA 

pcat50@aol.com 

Phone +1 773 239 2633, Fax +1 773 238 2754 

Publisher 

Weber-Thedy, Corporate & Financial Communications 

Timo Kueng 

Zeltweg 25, P. O. Box, CH-8032 Zurich, Switzerland 

timo.kueng@weber-thedy.com 

Phone +41 1 266 15 80, Fax +41 1 266 15 81 

Production 

Schwabe AG, Farnsburgerstrasse 8, CH-4132 Muttenz 

Phone +41 61 467 85 85, Fax +41 61 467 85 86 

druckerei@schwabe.ch/www.schwabe.ch 

ISDN +41 61 463 04 91 

By Urs Schneider, IFCI-IFRI 1985–2004. For further information, 

please visit our web site on www.ifri.ch which also leads 

to other related risk web sites or contact Peter Guidolin or 

Bruno Estier at the IFRI Secretariat +41 22 312 56 78. 

All rights reserved. No portion of this magazine may be reproduced 

without written consent from the publisher. The views expressed are 

not necessarily those of the publisher or the Swiss Futures and 

Options Association (SFOA). Whilst every effort has been made to 

ensure that the information contained herein ist correct and up-todate, 

neither publisher nor the SFOA accept any responsibility for 

errors or omissions. No liability arising out of, or in connection with, 

the content of this magazine can be accepted. This magazine is 

provided for general information purposes only and does not constitute 

investment or other professional advice. 

Cover picture: PAMP S.A., Castel San Pietro, Switzerland, www.pamp.ch 


Subscription 

51

Download PDF, Issue 26 - Swiss Futures and Options Association

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?