Currency exchange finds new life as futures market
After losing the balk of its profitable currency trading business, the 10‑year old Ukrainian Interbank Currency Exchange is reinventing itself and may soon emerge from near‑dormancy as the nation’s first commodities futures exchange.
From its founding by a group of banks in 1992 until the 1998 Russian financial crisis, the UICE did brisk business in the foreign exchange market, accounting for most of the foreign‑currency exchange transactions conducted in the country.
After the crisis, the National Bank of Ukraine designated the UICE the exclusive currency exchange for the nation’s banks. The exchange’s business boomed until 1999, when World Bank criticism of UICE’s lack of transparency caused the central bank to order currency trading at the exchange halted. Today, banks trade currencies directly under the NBU’s supervision.
Deprived of its major activity, the exchange all but skidded to a halt. Managers began to look for ways to revive the marketplace, which occupies a large two‑story building on Kontraktova Square in Podil.
A future in commodities
Even before the 1998 crisis, some limited trading in corporate stocks and commodities had been done at the UICE. Both, however, were relatively minor activities and took a back seat to currency trading.
A decision made by the UICE last month will change that, and the exchange’s managers hope that entering the commodities trading arena will breathe new life into the UICE.
“We are working on starting to trade in futures, which we believe is a very promising business for Ukraine,” said Oleh Andronov, chairman of the board at UICE. “While there might be limited demand for futures at present, this industry has the potential to flourish in a number of years, and we aim to establish ourselves in this market.”
He said that the market would initially trade in agricultural commodities, and perhaps oil and electricity futures.
Andronov said that although futures trading will be a novelty at first, Ukrainian traders and agricultural producers would likely create a demand in time.
Commodities exchanges trade futures contracts, so named because they represent a legally binding agreement to buy or sell a commodity, like sunflower seeds or wheat, at a specific date in the future at a price agreed to by the buyer and seller. The contracts are standardized according to the quality, quantity, delivery time and location for each commodity.
Commodities contracts allow farmers and agricultural producers to hedge risks and reduce uncertainty by locking in the prices a crop will bring often even before it is planted.
Speculators also trade on commodities exchanges, buying contracts with the hope that prices will rise and they can be sold at a profit.
“A futures market will appeal to Ukrainian producers, since they will be able to hedge their risks and reduce financial uncertainty,” Andronov said. “Futures are used all over the world for this purpose.”
The UICE is working with the State Committee for Securities and the Stock Market and the Economy Ministry to establish the rules that will govern the new market and to develop standardized futures contracts. The exchange is initially developing eight standard contracts for agricultural commodities and one for oil. Andronov said that Economy Ministry approval is expected within a few weeks, and that the exchange would open its trading floor by January 2003.
UICE has created a subsidiary, Universal Commodity Exchange Kontraktovy Dom, to handle the commodities trading business.
Once trading commences, Andronov said, the exchange will move slowly at first to allow traders and staff to become accustomed to the new securities and fine‑tune trading rules. At the same time, Andronov said that he expects demand for the contracts to begin to grow.
“Since futures are a new and complex financial instrument, it is unrealistic to expect a boom in this market in the near future,” said Andronov. “First of all, both traders and clients will have to learn this industry, and we will take some time to do so. As customers and traders realize the benefits of futures, however, demand will increase.”
Currency potential
Commodities trading is not entirely alien to the UICE. Between 1997 and 1998, the exchange traded foreign‑currency futures. Demand for the instruments grew until currency trading was suspended by the central bank, Andronov said.
“This [trading in currency futures] was a fast‑growing market with good potential. If not for the crisis, we believe it would have developed well,” Andronov said.
Andronov said that foreign currency futures continue to have good potential. He wants the NBU to eventually lift its ban, allowing UICE to offer trading in currency futures.
“We are appealing to the NBU to allow us to renew trading in currency futures,” Andronov said. “Although it is unclear when we will be able to do so, we hope we will start trading in these instruments by the end of the year as well.”
Some disagree that Ukraine is ready for futures trading. HVB Ukraine Treasurer Oleh Chury said that currency futures are unlikely to generate strong demand.
“I doubt there will be strong demand for currency futures,” Chury said. “These instruments had only limited demand before the financial crisis, and it is unreasonable to expect that demand would change drastically now. Furthermore, it is unlikely to expect the NBU to revise its currency trading policy and lift its ban in the next couple of years.”
In addition to futures, the exchange is also trying to maintain its presence on the capital market for stock and bond trading and privatization auctions, as well as for commodities. The UICE presently holds monthly auctions for Ukrainian oil products.
These auctions, Andronov said, are the exchange’s major revenue source today. The exchange earns a commission equal to half a percent of each transaction’s value. Other trading activities also generate commissions for the UICE. It collects half a percent of the value of privatization auctions conducted by the State Property Fund, a fee equal to 0.001 percent for the sale of government bonds, and 0.1 percent for non‑government securities.
Developing markets
With the nation’s stock and bond markets still undeveloped, some feel that developing a trading platform for the relatively sophisticated financial derivatives market is premature.
Andronov sees the markets for stocks and commodities developing more or less concurrently. When Ukraine’s capital market fully develops, he said, the commodities futures market will be ready as well.
“The capital market is not active now. Privatized enterprises will have to develop before trading in corporate securities will pick up,” said Andronov.
Andronov said that strategic investors are concentrating on acquiring controlling interests in Ukrainian companies. Once they do that, modernize the companies and make them more marketable, they will be able to sell all or part of their stakes to portfolio investors.
“That should happen on a massive scale, we expect, in two to three years,” Andronov said. “Then, stock trading will grow.”
Andronov said that non‑state pension funds and insurance companies, both typical customers for corporate stocks and bonds, need to develop in order for the capital market to grow.
Ukraine’s capital markets and trading sector in general are undeveloped, limiting the business available for intermediaries like the UICE.
“There is no doubt that the financial sector, along with intermediaries and other market specialists, still lags behind other Central and Eastern European countries and Russia,” said Andry Mikhnev, the World Bank’s project officer for private sector and information and communications technology development in Ukraine.
“The sector suffers from legislative gaps, such as the lack of a law on corporations and the limitations of the current law on financial instruments,” Mikhnev said. Mikhnev said that problems with transparency, corruption and government bureaucracy limit the flow of foreign direct investment into the country and constrain the development of the financial sector.
“This explains the relatively undeveloped state of intermediaries in Ukraine,” Mikhnev said.
Despite constraints, both Mikhnev and Andronov are optimistic about long‑term prospects.
“Despite problems and the slow pace of economic development, it is safe to say that Ukraine’s markets, along with its infrastructure and intermediaries, are developing and will become more mature and active in the future,” Mikhnev said.
“We are optimistic about the future, and although activity may be limited now, trading is certain to grow in a couple of years in all sectors,” Andronov said.
