Dairy futures market support growing

Milk powder futures are a financial instrument derived from an asset. Rather than trade the asset itself, derivative traders make an agreement to exchange the underlying value of the asset at a future date.

The new dairy futures market planned by stock exchange operator NZX is getting a warm reception.

Over the next three weeks, NZX will receive and consider submissions to newly released consultation papers about the regulation and operation of the derivatives market, which will be launched with wholemilk powder trading and expand over time into other commodities.

NZX head of traded products Fiona MacKenzie said the bourse had conducted a thorough pre-consultative programme with the Securities Commission, potential participants and derivative market specialists and expected a thoughtful, rather than a quick, response.

The futures market launch date has yet to be announced. NZX will only say equity options, index futures and dairy commodity derivative products will be offered in phases over the coming year.

Meanwhile, an upgrade of NZX's clearing and settlement system to improve the risk profile of its markets and broaden the product offering is scheduled for a November 20 launch.

Craigs Investment Partners investment adviser Martin Allison said the introduction of a derivatives market after five years of discussions was a big step with "no downsides I can see".

Few mature investment markets did not have a futures market, which tended to increase liquidity, attract more players and "in an abstract way" eventually increased the size of the market.

"Very amateur" investors likened derivatives trading to going to the races, but an institutional investor used the market as an asset protector or insurance against adverse market movements, Allison said.

"It also attracts major institutions, particularly global managers offshore, which may not look at the New Zealand market [otherwise]."

Institutional investors such as bankers and stockbrokers would use futures markets and know how they worked. But education would be needed for retail investors.

He did not recommend this type of investment for "mums and dads".

AMP Capital Investors head of investment strategy Jason Wong welcomed the market as being "very useful for our job in managing money".

"The New Zealand market is so illiquid. If we want to buy $20 million of stock it would be hard as we [would be] pushing share prices around.

"With the [prospect of] index futures, rather than buy 30 individual stocks and push share prices around, if you had a liquid market in index futures we'd be able to buy the index on the futures market," he said. "Maybe it is quite liquid and we know it is not going to have an impact on the price of that product, so we can readily trade in and out of New Zealand equities."

Wong said his company represented "mum and dad" investors and that he did not think retail investors would shy from the new market.

"Exporters like to hedge against currency movements - it's just the same. You just treat it like another share really."

A corporate New Zealand farmer whose dairying empire extends to several countries and who trades in US corn and milk futures market warned Kiwi farmers to be careful about trading in futures.

The farmer, who wished to remain anonymous, said: "It is a valuable tool, no doubt about it. But you enter it at your peril and remember when you buy a full [future trading] contract it's not a win-win, it's a win-lose."

DEFINING A DERIVATIVE

* A financial instrument derived from an asset. Rather than trade the asset itself, derivative traders make an agreement to exchange the underlying value of the asset at a future date.

* Derivatives are used for hedging - a mechanism to eliminate or reduce risk (similar to a Kiwi firm hedging against movement in US currency in which it globally trades).

* The NZX deadline for considering submissions to consultation paper on new rules for futures trading is October 30.


See the NZX consultation documents here.