Derivative market head banking on the euro

Date: 13/03/1997

By Tim Jones

RUMOURS may be spreading that the start date for the single currency will be postponed, but the president of the world's seventh largest futures and options exchange cannot afford to listen to the tittle-tattle on his trading-room floor.

In MATIF - le marché à terme international de France - Gérard Pfauwadel heads an enterprise which has already gambled a pile of cash on the certainty that the French franc will be replaced by the euro on 1 January 1999.

“Because we have no doubt that the franc will be converted into euro, we have already decided that all our existing products will be paid and delivered in euro after 1999,” he says. “We are completely dedicated to this strategy.”

MATIF, like other financial derivatives markets from Chicago to Tokyo, specialises in the trading of futures and options contracts. These allow investors to cover themselves against heavy losses in stock, bond and commodity markets or bet on future events.

Pfauwadel and his market have already placed their bets. If EMU kicks off on time, the gains for MATIF could be enormous, allowing the Paris exchange to become the market-place for contracts in euro ranging from three-month interest rates all the way to ten-year bonds - the so-called 'euro yield-curve'.

With its eye on the prize as the details of the transition to the single currency began to take shape last year, MATIF established a specialist panel to plan a strategy for its own change-over.

The exchange always had one aim in mind: to give itself a competitive edge over the London International Financial Futures Exchange (LIFFE), its much bigger rival.

Two weeks ago, another prong to its strategy emerged with the news that MATIF had formed an operational alliance with the Chicago Mercantile Exchange and the New York Mercantile Exchange.

“From 1 January 1999, all the French financial markets, tools, products and machinery will convert to euro,” says Pfauwadel. “This will definitely not be the case for London for political reasons and, even in Frankfurt, they have not decided whether they will convert all instruments to euro from day one.”

But MATIF decided to take the plunge and staked its reputation on that of its country's politicians.

“LIFFE is much bigger at least in part because we are based in the French capital markets, which are much smaller,” explains Pfauwadel. “But, in monetary union, we would have a huge capital market and could become the leader right along the euro yield-curve.”

Already, MATIF is offering to settle its three-month French franc interest rate contract, known as Pibor, in euro from March 1999.

Although LIFFE is doing the same for its three-month deutschemark interest rate contract, MATIF claims to have gone one step further.

Even before the single currency appears - in just nine months' time to be exact - the exchange will open a new alternative contract to the three-month Pibor which will be paid and settled in euro. This originally named Euribor will offer investors a choice.

“We will leave it open to customers whether they wish to move their open interest existing in the Pibor into the new maturity of the Euribor,” says Pfauwadel.

For those taking an interest in the French government's longer-term debt, MATIF will offer the same choice. From next year, instead of simply buying the contract to deliver a specified amount of ten-year bonds, investors will be able to choose between this and a euro option.

“This means that we are already positioned for the two main possibilities that the markets will offer next year,” says MATIF's president.

If the markets decide that EMU is definitely going ahead, they will buy French bonds and sell German ones so that the gap between the interest rates on the two will narrow.

If their growing scepticism turns out to be justified, they will do the opposite and choose to buy the French franc bonds rather than the euro issue.

“Whatever happens, we have the two instruments and the market will decide to take either one or the other,” says Pfauwadel.

He does not want to think about the possibility that EMU will not go ahead on time, but he knows that, regardless of events, the financial exchanges themselves can never be losers.

“If there is an additional year, the volatility of the markets would ensure that what we lost on wasted investment would be compensated by beautiful markets.”