* Hedge funds reluctant to be early movers
* Arbitrage players too small to kickstart liquidity
* Compulsory migration seen as more effective
By Claire Milhench and Emma Farge
LONDON/GENEVA, Nov 19 Investors say they have no
plans to switch to the new Brent NX contract which was unveiled
over a year ago, leaving futures exchange ICE with tough choices
to make in 2013 over how to terminate the existing benchmark.
The majority of fund managers care little about the
technicalities of cargo delivery dates, the reason why ICE
introduced the new contract, and some are barely aware it is on
the board. The equivalent of just 0.1 percent of total Brent
volumes has switched.
Many are reluctant to move to ICE's Brent New Expiry (NX)
contract before it has built up enough open interest, creating a
catch-22 situation in which users cling to the old contract.
Brent is used to price at least two-thirds of the
world's oil, with an average daily open interest of $22 billion
based on current prices at near $110 a barrel.
"The market is going to stay on the old contract until they
are forced to (move)," said Olivier Jakob, an energy analyst at
Petromatrix in Switzerland. "ICE will have to give a closing
date for the old one in order for liquidity to shift."
"The problem with introducing any new futures contract is
that of the chicken and the egg. As long as there is a viable
alternative the market will stick with that," an energy broker
The new NX contract is being introduced to reflect a
broader change in the underlying physical crude oil market by
price assessment agency Platts, which aims to make a larger
number of cargoes count in the process of setting Brent prices.
Platts is using a longer window to work out the price of
dated Brent, assessing cargoes loading in a 10-25 day period,
rather than 10-21 days.
IntercontinentalExchange Inc expected open positions
in the old contract for December 2012 and beyond to migrate over
the course of 2012 but progress has been slow. The December
Brent NX contract expired on Nov. 5 with zero exchanges for
Open interest, or the total amount of outstanding contracts,
has gradually increased on NX monthly futures from an average of
37 contracts or 37,000 barrels in January to 1,406 contracts or
1,406,000 barrels in October. Still, this represents only 0.1
percent of the total volume on Brent.
Hedge fund managers said they were reluctant to make the
first move, with some saying it was not even on their radar.
Brent's nearest rival as a global benchmark is the Chicago
Mercantile Exchange's U.S. light sweet crude futures contract,
"Brent NX doesn't have much trading volume at the moment -
there is not much open interest, and we don't want to be more
than 15 percent of the open interest in any contract," said
Yu-Dee Chang, portfolio manager at Ace Investment Stategies.
"Liquidity is very much a concern."
A trader added that some small arbitrage players were arbing
the difference between the two contracts but this was not enough
to kickstart liquidity. "It's difficult to move the crowd from
what they know," he said.
Chang said the migration of open interest had to happen in
2013 or it would not happen at all, and called for ICE to offer
incentives to persuade people to shift: "I see the migration
process being very slow unless ICE makes a big push to get
people to move."
The exchange currently offers an "exchange for related
market" option, allowing users to close a position in the old
contract and open a position in Brent NX.
There is also no charge for switching between old and new
Brent in the same month, but some market participants were
unimpressed, saying it wasn't much of an incentive.
David Peniket, president of ICE Futures Europe, acknowledged
ICE would need to take more steps to encourage the migration of
liquidity but said the new contract needed to move through one
or two expiries first.
"We want to monitor the initial expiries of the NX contract,
and market participants will want to look at that to confirm the
price judgements that they may have made in the past in terms of
the relationship between the two," he told Reuters.
"But there are additional steps that the exchange will need
to consider taking in order to encourage the migration."
Market participants expect the exchange to adopt compulsory
migration in the end. "It's more effective to say, as of this
date, the contract ceases to exist," said one. "But ICE seems
reluctant to go down that path."
Peniket declined to comment on what additional steps would
be considered to encourage people to switch but said it needed
to happen in the least disruptive way possible.
One aspect that concerns the market is the possibility of
split liquidity, where a sizeable chunk of money has rolled into
Brent NX but the rest is still in the old contract. But Peniket
did not think such a situation would last very long.
"A number of participants want to see a baseline level of
liquidity," he said. "If you got to a stage where you started to
see significant liquidity in the Brent NX contract and NX
liquidity growing rapidly, the period where you have significant
liquidity in both would be relatively limited."