A new trading and clearing system is setting the stage for Japan?s premier commodity futures exchange to boost market liquidity.

Tokyo Commodity Exchange (TOCOM) was established in 1984 by a merger between three exchanges: Tokyo Textile Exchange, Tokyo Rubber Exchange and Tokyo Gold Exchange. Today TOCOM is the largest commodities exchange in Japan and the center of the commodity futures market in Asia. Its mission is to provide a fair benchmark price in each contract to speculators and physical commodity hedgers worldwide.

The exchange operates four markets: precious metals, aluminum, rubber and oil. The precious metals futures and options contracts include gold, silver, platinum and palladium. The oil futures contracts include gasoline, kerosene and crude oil.

Like all of Japan’s commodity exchanges, TOCOM has been confronting a major challenge. For years commodity futures contract volumes have been declining. In fiscal year 2003, 155.8 million futures contracts changed hands on all of Japan’s commodity exchanges. By the end of fiscal year 2008 the number had dropped 70% to 46.3 million contracts. The steep decline is largely attributed to the introduction of stricter rules against soliciting business from retail investors. Not surprisingly, the evaporation of liquidity has driven many brokerage firms out of business. In March 2004 the number of brokerage houses tood at 97; by the end of 2008 it had dropped to 53.

As if battling this trend was not difficult enough, TOCOM has had to face its own unique set of issues. Most significant was the exchange’s inability to offer easy access for market participants. The system the exchange had introduced in 2003 became outdated, and it became increasingly difficult to compete.

Clearly TOCOM had to take action. “Japan’s GDP is among the largest in the world, and our vision is to develop our exchange to the extent that it reflects the size of our economy,” says Tadashi Ezaki, President and CEO of TOCOM. “But we are concerned about declining volumes and our goal is to recover our market liquidity.”

Towards that end, NASDAQ OMX’s Advisory Services started working with TOCOM to help evaluate its business and trading system needs. In December 2008 TOCOM demutualized the exchange in order to streamline the decision-making process and raise funds to introduce a new trading system. TOCOM also aligned its rules with global standards, thus making it easier for participants to come to the market.

TOCOM introduced a new trading system from NASDAQ OMX in May 2009. The system performance is much improved. Latency has been reduced to less than 10 milliseconds, and TOCOM is aiming to achieve even faster speeds in the future. Faster speeds are especially attractive to algorithmic traders, who put through large volumes of orders.

“So far there is little algorithmic trading on TOCOM compared to overseas markets,” says Ezaki. “But judging from the number of inquiries from traders in the U.S. and Europe, there is growing interest in doing algorithmic trading on our exchange.”

New features, including combination orders for spread trading, have been introduced. The exchange now also offers circuit breakers. While TOCOM is not offering 24 hour trading yet, it has introduced a night trading session open until 11:00 p.m. Japan time.

NASDAQ OMX will continue to help TOCOM leverage future innovations to gain competitive advantage. “The relationship is mutually beneficial,” says Ezaki. “We can pass feedback from market participants on to NASDAQ OMX so they can build new functionality into their standard products.”

TOCOM’s future plans include:
• launching a market maker system in October 2009,
• working with the regulators to enable remote membership and direct market access, and
• improving the overall functionality of the Japan Commodity Clearinghouse (JCCH), the common clearinghouse for commodity exchanges in Japan.

TOCOM also plans to introduce trade at settlement (TAS) capability. TAS allows traders to enter an order to buy or sell an eligible futures contract month during the trading day at a price that will be equal to the settlement price for that contract month, or at a price that is up to a minimum price fluctuation above or below the settlement price.

Finally, TOCOM intends to increase the number of products listed on the exchange. By the end of fiscal year 2009 the exchange plans to list a Nikkei- TOCOM Commodity Index futures contract and reopen trading in its gas oil contract, which is currently suspended. In the future TOCOM would like to list futures contracts in non-ferrous metals such as copper, as well as coal, natural gas and emissions trading.

It is too early to cite any milestones or metrics because the system has been operational for just a few months. So far major market participants in Japan and abroad have responded positively to all the changes enabled by the technology. Most importantly, TOCOM is receiving more requests for information from potential customers worldwide.

TOCOM has a competitive edge because it is the largest commodity futures market in the Asian time zone.
Its platinum and rubber contracts are the largest by volume in the world. The exchange’s Middle East crude oil contract is used as a benchmark in Asian markets.

In addition, Japan’s well-organized financial infrastructure contributes to TOCOM’s strength. The government
recently revised the country’s Commodity Exchange Act so financial institutions can now participate in TOCOM’s market. These factors, combined with the new trading system, will likely attract more overseas participants and enable TOCOM to boost market liquidity and to differentiate itself from other exchanges. 

by Sherree DeCovny
photo Bruce Osborn