Derivatives exchange targets growing band of Irish investors

Once the preserve of traders in bright blazers, these days the LIFFE derivatives exchange is keen to attract the private investors it once treated with caution.

The London International Financial Futures and Options Exchange (LIFFE) was in Dublin last week to meet existing users and to drum up new business.

But as well as targeting its traditional client base of banks, investment houses and hedge funds, with products like its new euro swap note, Europe's largest derivatives exchange has its eye on the high-net-worth investors that have emerged in increasing numbers in the Republic in recent years.

"We have a lot of interest in the retail investor," managing director Mr Simon Raybould told The Irish Times, noting LIFFE had recently introduced a programme to bring such investors onto the exchange, particularly for equity products.

The exchange, which replaced its 'open outcry' system - where traders in multi-coloured blazers stood in a pit shouting the prices at which they were willing to buy and sell - with an electronic platform in 1998, is the first to admit that derivatives have a bad name with the general public.

Scandals such as those involving Nick Leeson and Barings Bank, and the spectacular 1998 collapse of US hedge fund Long Term Capital Management have not helped.

Throw in the esoteric terms associated with futures and options - hedging strategies like butterfly spreads, risk reversal and short straddles don't mean a lot to the man in the street - and it is easy to understand why the retail investor has steered clear.

But LIFFE, in the news of late because of a takeover approach from the London Stock Exchange, is quick to point out that derivative instruments are a vital element in the modern financial world and people depend on them without even realising it.

Mortgage holders, for instance, have the option of choosing a fixed-rate loan because their lending institution can use derivative products like interest rate swaps to hedge it.

The exchange claims its products offer the professional private investor possibilities far beyond the simple "buy at a given price, then hold or sell" type of investment.

However, Mr Raybould admits that "some products are appropriate to the professional investor and some products are not".

Cocoa futures or three-month euro-yen interest rate options are generally not suitable even for the clued-in professional retail investor, but LIFFE says it is now offering equity products that are.

The exchange currently trades 65 universal stock futures (USFs) and plans to introduce a further 30 by the end of this month.

The USFs are futures contracts on the shares of individual companies; they are based on blue-chip stocks across a range of sectors and include the likes of Microsoft, ABN AMRO, BP and GlaxoSmithKline.

LIFFE says they offer easy, cheap and efficient access to global share price movements. Investors have only one point of access, rather than having to deal through a number of stock exchanges, and face no currency exchange costs, stamp duty or other costs associated with transferring ownership of shares.

Like other derivative products, they have low margin requirements as investors can trade without having to put the full amount of money up front.

In addition, such products allow investors to respond quickly to market fluctuations, the exchange says.

"They allow the institutional and individual investor to do what hedge funds have been able to do for a long time and this is go short," Mr Raybould said.

Short-selling involves selling shares that are not held in anticipation of a fall in prices.

If the price does fall, the shares are bought back at the lower level, a process known as short-covering, and are then sold at the pre-agreed higher price to realise a profit.

The exchange has designated seven brokers who will work closely with it to improve access to these products for private investors. While it has no Irish broker yet, it would like to see some come forward.

Investors interested in how the system works can get information and take part in simulated trading exercises by accessing the exchange's website at LIFFEinvestor.com.

But they would do well to remember that trading futures and options can be a potentially high-risk strategy.

LIFFE advises that private investors can lessen the risks of trading by ensuring they have a high degree of product knowledge, they always invest within their means and they deal with a broker who is experienced in the futures and options industry.

jmosullivan@irish-times.ie