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COMPANIES & FINANCE UK: The meaning of Liffe, the futures, the universe, et cetera: London's biggest derivatives exchange is to launch a product that will put it at the cutting edge of the futures market - though investor appetite remains unclear

Financial Times Jan 20, 2001

There is often an important psychological turning point in sport when a team that has been defending for much of the match suddenly attacks. Something like this will happen on Monday week at Liffe, Britain's biggest derivatives exchange, as it launches a potentially important product with all the razzmatazz it can muster.

For much of the past three years Liffe - the London International Financial Futures and Options Exchange - has had its back to the wall as rivals tried to snatch business and it has negotiated a tricky transition from old-fashioned floor trading to a modern screen-based system.

At one point, its very survival was in doubt. Now, thanks in great measure to the leadership of Brian Williamson, chairman, it is on the offensive again.

The change will be underscored by the start of trading in so-called Universal Stock Futures on January 29. These allow investors to take out futures contracts on single stocks - initially, 25 of the largest companies in the US and Europe, such as Cisco Systems, Vodafone and Deutsche Bank.

Liffe is the first with a single market for blue chips from around the world. It also offers the simplicity of a single set of rules and one central counterparty.

The equity futures market has been dominated by products based on the collective constituents of indices, such as the FTSE 100, that allow investors to hedge their risks in broadly-based portfolios. Single stock futures are similar: an easy, financially efficient and low-cost way of taking a position in an individual company while avoiding the hassle of buying the underlying shares. They are a simpler, purer way of hedging than the existing market in individual company options and do not attract their contract premiums.

It seems an obvious idea, so why has it not taken off before? One reason is that it has been banned in the US, that cradle of financial innovation, though this is changing. Another is that it is not well suited to floor-based trading.

Computers, however, can handle the number-crunching and Liffe should have an advantage since its new Connect platform - now better behaved after some embarrassing glitches - allows screen-based trading worldwide. Eurex, the only rival with a global reach, seems unenthusiastic about single stock futures.

There is also a question-mark over the market's enthusiasm for the product. Some suspect it will get a lukewarm reception, with conservative fund managers reluctant to place big bets on single companies. Certainly, turnover in other pioneering markets has not been exciting.

Liffe itself reports such good feedback that it has upped its original list of 15 stocks to 25. And it is hardly alone in its enthusiasm. The Chicago Board Options Exchange is keen to get into stock futures when the law permits. Indeed, a worry for Liffe must be that the record of protective US regulators suggests they may prevent it offering its products there until domestic competition is ready. That is one reason I suspect the contracts will take time to gain decent volume. But provided Liffe executes well, its contracts ought to be winners.

Richard Sandor, a leading figure in the Chicago industry (and recent addition to the Liffe board), points out that interest rate derivatives dominated the past two decades of the 20th century because of concern about debt and inflation.

The surge in equity values during the long US bull market has led to the market capitalisation of just two companies - Cisco and Microsoft - being greater than the US government's entire long bond issuance in the 1990s. "The planet's debt-to-equity ratio has changed," he says, and the need to hedge individual stocks will leap dramatically.