Analysis: Common commodities, varied philosophies for ICE, Liffe

By Rene Pastor

NEW YORK (Reuters) – On the surface, it seems a good match: the world’s two biggest markets for trading coffee, cocoa and sugar join forces, lowering margin costs, fostering spread trade and aiding liquidity.

But there are deep, philosophical differences between IntercontinentalExchange (ICE.N: Quote, Profile, Research) and London’s Liffe, which it would buy as part of a joint $11.3 billion bid for NYSE Euronext (NYX.N: Quote, Profile, Research). And the union would come at a time when both exchanges are under heavy fire.

In New York, several bouts of “flash crash”-like volatility in sugar and cocoa futures have provoked outrage among traditional traders such as sugar merchants and millers who claim ICE is wrecking the market by drawing in liquidity from high-frequency and algorithmic traders.

In London, it’s a different story: traders say some of the biggest players in the physical markets are exerting undue influence, distorting prices in the absence of more rigorous regulation or intervention by the exchange.

“It raises an awful lot of questions, such as potential difference in regulations between the markets,” said Jonathan Parkman, joint head of agriculture for London-based Marex Financial Ltd, an independent, specialist brokerage whose clients include hedge funds and commodity producers.

“It’s something that we’ve got to keep an eye on, something that could have a big effect, the way the market philosophies are run, but it’s too early at the moment to make any considered reaction,” he told Reuters at a cocoa conference in the Bahamas.

With news on Friday that ICE and Nasdaq OMX (NDAQ.O: Quote, Profile, Research) will seek to trump Deutsche Boerse’s bid to buy NYSE Euronext, which owns Liffe, commodity traders are being forced to ponder the implications of a single venue.

Whether that would provoke interest from the U.S. Commodity Futures Trading Commission remains to be seen, although ICE already has feet in different domiciles: ICE Futures’ soft commodity contracts and lookalike U.S. crude futures are regulated by the CFTC, but its UK Brent and gasoil contracts remain under the jurisdiction of lighter-touch Britain.

“I don’t think it’s good to have all soft commodities owned by one entity,” said Nick Gentile, head of trading operations for Atlantic Capital Advisors, a fund specializing in soft commodities. “You are creating a monopoly.”


While the two exchanges host similar commodities, there are important distinctions between the contracts: ICE trades raw sugar, while Liffe’s contract is for whites, or processed; ICE’s Arabica coffee is the benchmark for high-quality beans from Central America, while Liffe’s Robusta is lower-quality, the type produced largely in Vietnam.

From a financial perspective, traders who want to bet on the spread between the differing grades could do so much more easily — and with lower costs — on a united platform. The same principle has helped ICE’s U.S. WTI crude oil futures contract gain ground on the NYMEX over the years.

“It opens the possibility of cross-margining between commodities that are listed on both exchanges,” said James Kirkup, head of sugar brokerage at ABN Amro (Markets) UK Ltd.

For London traders, being run under new ownership is something to which they have grown accustomed.

The soft commodity contracts originally traded on the London Commodity Exchange, before it merged with the London International Financial Futures Exchange (Liffe) in 1996. Liffe was then acquired by Paris-based Euronext in 2002, which in turn the NYSE Group bought in 2007.

While common control over similar contracts could potentially increase the pricing power of the exchange, many in the industry are looking on the bright side, particularly since the commodities in question are not fungible.

“If you are long of raw sugar and short of whites, it would be treated as a spread,” said Jonathan Kingsman, managing director of Lausanne-based sugar and ethanol consultancy Kingsman SA. “It might make (trading) a little easier.”


U.S. traders who have accused ICE of failing to listen to the trading community are more alarmed, fearing the deal could export what they see as a bad attitude. Many have been out of sorts since ICE bought the New York Board of Trade four years ago and shut its open-outcry trading floor a year later.

After several months of mounting frustration among many traders, however, there are signs ICE is taking note.

ICE officials said this week that they may apply a “circuit breaker” in the cocoa market to reduce unwarranted volatility [ID:nN31292921] and have reinstituted an implied matching engine for spread orders in sugar.

ICE says about 10 percent of its soft commodity volume is from high-frequency traders; Liffe this week estimated its share at well below 5 percent.

But U.S. traders are equally discomfited by the prospect of facing the kind of market distortions that have rocked Liffe over the past year.

Last year, major European cocoa buyers complained bitterly when the spot contract surged to a huge premium against the second position in what dealers said was a trading play that resulted in the biggest expiry delivery in nearly 14 years.

Liffe too has been listening. In February it began collecting data on all major positions and expects to begin publishing the aggregate figures — similar to the CFTC’s weekly report — in the second or third quarter.

And now a surge in the prompt May Robusta coffee contract versus July has prompted a new round of speculation about a market squeeze.

“There was no shortage of robusta coffee,” Gentile said. The takeover “just opens the door for more manipulation”.

(Additional reporting by Marcy Nicholson in the Bahamas, Nigel Hunt and David Brough in London; Editing by Dale Hudson)

Analysis: Common commodities, varied philosophies for ICE, Liffe