The Nordic derivatives market is not the biggest, but it is one of the most interesting. And just at the moment, the market is living through particularly interesting times – something that, as the Chinese curse suggests, is not always pleasant.

In keeping with Nordic countries’ leadership in information technology – the internet was adopted very early in Scandinavia; Nokia is Finnish and Ericsson Swedish – the Nordic markets have been at the forefront of electronic innovation in derivatives.

The entire structure of the futures and options markets in the Nordic countries has been shaped by this fact, and by one company in particular.

OM, started in 1984 by Olof Stenhammar, was a Swedish options exchange – the name stands for Optionsmäklarna.

The electronic trading systems built by this company were so far ahead of their time that they have been adopted far beyond Scandinavia, by some 50 exchanges, in countries from Jamaica to Papua New Guinea.

This technology, as well as the end of the Cold War, also allowed this small company to buy or merge with all the national stock exchanges in the Nordic region, except for Oslo Børs; all those in the Baltic states; plus, in 2007, Armenia’s.

Along the way, OMX attracted the attention of Nasdaq, the technological powerhouse of the US stock exchange scene. After some complicated manoeuvres, the two were united in February 2008 as Nasdaq OMX.

This group’s global ambitions are only too evident – but the Nordic market remains an important base. Only in March this year, Nasdaq OMX bought another chunk of the Nord Pool group, which it has been devouring bit by bit since October 2008. Nord Pool entities operate a variety of services, centred around the Scandinavian electricity markets.

Cooperation as marriage

As well as all these acquisitions, OMX has also made alliances over the years – and those have not always ended so happily. In fact, the present state of relations among the Nordic derivatives exchanges is like a large extended family riven by a painful divorce.

Most acrimonious is the relationship between Nasdaq OMX and EDX London, now the derivatives arm of the London Stock Exchange, but originally the OM London Exchange.

The rivalry between OM and the LSE goes back more than a decade, and even led to OM making a hostile bid to buy the LSE in 2000.

In 2002 they thought they had fallen in love. The LSE, led by former Liffe board member Clara Furse, paid £18m to set up a derivatives exchange, EDX, as a joint venture with OM. The Swedish company got 24% of the equity and contributed its technology and its own London outpost, the OM London Exchange. That had been established in 1989 as a conduit for remote trading in Scandinavian derivatives.

Not wanting to attack Liffe head on, the new EDX remained a kind of gateway to the Nordic markets, offering similar or identical products to those at OMX and Oslo Børs. In 2006, it struck into a new area with derivatives on the many depositary receipts of Russian companies traded on the London Stock Exchange.

But EDX’s offering of Nordic products created that rare thing in listed derivatives: a choice of exchanges on which to trade a particular risk – even if those exchanges were closely linked together. Even Oslo Børs is not independent of OMX, as the US-Swedish company owns 10% of it.

The Nordic markets thus offer a small and incomplete experiment in competition between exchanges. Competition can lead either to a stable and open competitive market – or to an endgame in which one player drives out the others.

EDX, Nasdaq OMX and Oslo Børs are now in the middle game – it could go either way. But the feeling given by Nasdaq OMX employees and by the company’s record is that it is playing to win.

A range of risks

At present, in terms of the number of contracts traded, Nasdaq OMX leads the pack with 109.6m contracts traded during 2009. That was a 30% decline from 2008’s volume – unaccustomed for an exchange whose volume has grown pretty well every year since it started.

EDX’s total volume, including its growing Russian derivatives business, was 126m contracts, 12% down on the previous year.

The smaller Oslo Børs hosted trading of 13.5m contracts in 2009, 15% fewer than in 2008.

The leading contracts reflect the economies of the region. Most important are Nasdaq OMX’s OMXS 30 index, offering investors exposure to Sweden’s 30 most actively traded blue chip stocks, and Oslo Børs’s OBX Index contract, which tracks the 25 most liquid stocks at the exchange.

Jesper von Zweigbergk, senior vice-president of derivatives at Oslo Børs, says this offers market participants access to Norway’s energy-led economy. However, that energy bias is not manifested in high volumes of commodity derivatives.

Scandinavia also claims to have the world’s largest power derivatives exchange, Nord Pool ASA, which was set up by the electricity grids of Norway and Sweden but was bought by Nasdaq OMX in March. The exchange group had already bought Nord Pool Clearing and Nord Pool Consulting from Nord Pool in October 2008.

The acquisition does not include Nord Pool Spot, operator of the spot market, which is still owned by the two grids as well as those of Finland and Denmark.

Lively markets

Nordic exchange volumes are never going to exceed those in any of the world’s leading trading centres.

Ingrid Sandersjoo, senior partner in equity derivatives at Vantage Capital Markets, a trading firm in London and member of both EDX and Nasdaq OMX, describes the market as “a lot smaller, with less liquidity and without the depth”.

However, relative to the region’s size, these markets are distinctly lively – and it is notable that Nasdaq OMX boasts one of the world’s few active markets in non-government bond futures. Contracts trade briskly on the two and five year bonds of three mortgage banks – Spintab, Nordbanken Hypotek and Stadshypotek.

Leaving aside the slump year of 2009, volumes have also grown strongly at all three of the financial derivatives exchanges.

Antero Hellemaa, head of derivatives sales at Pohjola Bank in Finland, says the region’s history may explain why it has such a well established derivatives sector.

“It has a totally advanced culture of saving and investing, not only for institutions such as mutual funds and pension funds, but also for individual investors,” Hellemaa says.

Retail eclipsed

Nils-Robert Persson, executive chairman of software vendor Cinnober, has had plenty of time to observe this culture in action. He was CEO of OM Stockholm and deputy CEO of the OM group.

He says the market has changed dramatically since the days when he oversaw the exchange’s early steps into the market.

“In 1995, the Swedish market, together with the Dutch market, was the most retail-focused market in the world,” says Persson. “At OM, there were over 100,000 private investor accounts and the market was driven by the retail sector.”

He attributes this to the exchange’s concerted efforts to educate retail customers in using derivatives.

But that retail flavour has faded. A managing director at a global futures commission merchant (FCM) in Stockholm says the Swedish market today is much more “normalised”, like those of the UK or Germany, in that trading is dominated by institutional investors.

Retail investors have not abandoned the Swedish derivatives market, he says, but have embraced other instruments such as contracts for difference, which now make up a large proportion of trading in the country.

This change has coincided, according to the FCM official, with decreased efforts by the Sweden-based exchanges to prioritise retail customers.

Persson describes this shift as the exchanges trying to entice previously over-the-counter (OTC) trades on to the organised market, at the expense of the retail sector.

A wealth of tech firms

The region, especially Sweden, is rich in derivatives technology companies, such as Orc Software, Neonet, TriOptima and Cinnober. They have various specialisms ranging from building architecture for the exchanges to helping trading firms connect to bourses worldwide, perform risk management and other tasks.

As Persson explains, this wealth owes itself partly to the market’s history. “When the OM went live in 1985, it did so as an electronic exchange, which was something no other exchange had done before,” he says. “I would say that all the independent software vendors based out of Sweden have some offspring from OM’s fully electronic exchange, when nobody else had any IT solutions for derivatives trading, so it was necessary to start a number of projects at that time.”

Cooperation goes cold

For a time, the tripartite structure of the Nordic financial futures and options market seemed settled. Oslo had Norwegian single stocks and the OBX index; Nasdaq OMX had the same for Sweden and Denmark, plus Swedish long and short term interest rate contracts.

Through arrangements with those exchanges, EDX offered a different venue at which to trade most of those risks. Mutual links also existed between Oslo and Stockholm.

However, over the past two years the marriage has broken down.

Martin Granlund, head of Nordic derivatives at Nasdaq OMX in Stockholm, explains that his exchange’s decision to go it alone was born out of frustration with the partnership.

“In March 2008, Nasdaq OMX decided to terminate the cooperation with EDX,” Granlund says. “We believe there is untapped potential for growth in the London region and we decided that we wanted to be in control of the customer relationship.”

In August that year, the LSE bought out Nasdaq’s 24.9% stake in EDX. Then EDX found a new technology provider – the Canadian TMX Group, which licensed its Sola trading platform to EDX.

LSE has clearly not been put off joint ventures altogether – as part of the deal TMX Group, which owns the Toronto and Montreal exchanges and 54% of Boston Options Exchange, took a 19.9% stake in EDX.

TMX’s chief executive Tom Kloet told FOW last summer: “I don’t view TMX as a technology vendor, but if we have an opportunity to use technology as an asset, we would invest in the party we are dealing with.

“So we talked to our friends at the LSE and decided that we would take some of the cash proceeds and reinvest that for ownership rights. We will help participate in the development of the exchange, not just through technology.”

Oslo has to choose

Meanwhile, Oslo Børs was caught a little like a child in the middle of a messy divorce. In 2007 Nasdaq OMX had tried to buy the Norwegian exchange, completing its clean sweep of Nordic markets, but talks broke down.

Despite the 10% shareholding Nasdaq OMX had acquired in 2006, Oslo Børs has ended up staying closer to EDX, and latterly the relationship with Nasdaq OMX has become distant.

The Norwegian exchange’s von Zweigbergk explains that EDX still fulfils the role of facilitating interest in Norwegian derivatives from London clients.

“Oslo Børs members clear at Oslo Clearing and EDX members clear at LCH.Clearnet,” he says. “EDX are listing and offering products being exact duplicates of the ones we’ve got and vice versa, and we have one common order book.

“So an EDX member trading and clearing in London can be matched by an Oslo Børs member trading and clearing in Oslo – the liquidity is common. This also means the clearing houses LCH and Oslo Clearing are connected.”

Therefore, Oslo Børs has also switched from Nasdaq OMX’s technology to Sola.

In March 2009 Nasdaq OMX began trading Norwegian equities, and in September it launched a suite of products designed to compete with Oslo Børs’s main derivatives.

It has 15 Norwegian single stock futures and options, none of which has traded yet, and a new index of Oslo-listed shares, the OMXO 20, which traded 15 times in each of January and February.

In December last year, Oslo Børs withdrew the right for the two exchanges’ members to access each other’s contracts.

The split, and the aftermath

It was also in December that Nasdaq OMX and EDX finally parted company. The new Sola platform was switched on and EDX lost the right to offer futures and options on the OMXS 30 index, and on Nasdaq OMX’s suite of Swedish single stock contracts.

EDX has tried to fill the gap with a new family of copycat FTSE indices – the FTSE Sweden 30, FTSE Denmark 20 and FTSE Finland 25. Its website shows a graph to demonstrate that the FTSE Sweden 30 correlates with the OMXS 30 to an accuracy of 99.9%.

But its volumes have been hit very hard. EDX is not over-keen to disclose how badly trading has suffered, and was reluctant to discuss the recent events with FOW in detail.

However, figures seem to suggest that the exchange’s total equity options volume fell from 6.195m in November to 2.85m in December, while Swedish single stock futures went from 560,000 to 165,000.

This year options volumes have recovered to 3.15m in January and 3.37m in February – it is likely that this is now mainly Russian volume.

No volume is recorded for any of the new Scandinavian FTSE index contracts, and Swedish futures had dwindled to 95,000 contracts in February.

The LSE admitted in a trading update on March 25 that “trading of Scandinavian derivatives” had been “falling away since December”, but did not give figures.

The exchange told FOW: “Trading on EDX offers the possibility to trade a range of derivatives on Nordic countries with significant advantages. For example, our single stock option products are identical in construct to the local market and offer choice to customers.

“These options clear through LCH.Clearnet and a new competitive pricing tariff with fee caps has recently been introduced in combination with attractive market making schemes.”

It is early days yet, and new derivative contracts often take time to gather momentum and liquidity.

But market participants have little comfort for EDX. “All the Swedish trades take place now on Nasdaq OMX, EDX is not doing anything there now,” says Sandersjoo at Vantage. “The only exception is the Norwegian options tend to be traded on the EDX as Nasdaq OMX’s offering is slightly different.”

She says it boils down to the old maxim: liquidity breeds liquidity. “I really don’t think that EDX are going to get the Swedish business,” she says. “I know they tried, but all the big Swedish banks have taken up memberships at Nasdaq OMX.”

Sandersjoo is equally dismissive of Nasdaq OMX’s attempt on the Norwegian market. “All the big Norwegian trading houses are active on the Oslo Stock Exchange,” she says. “Nasdaq OMX’s contracts are not fungible with the Oslo Stock Exchange.

“Its a question of which exchange has the deeper liquidity,” she concludes.

The Stockholm-based FCM executive agrees, saying history suggests that, other things being equal, a successful contract usually stays successful at its first home.

Best foot forward

All the exchanges remain outwardly confident, however.

“By developing products and a market model in line with customer needs, we feel we can improve efficiencies, lower costs and offer a more accessible proposition,” says EDX. “In addition, our market place service desk is an efficient mechanism through which over the counter trades can be reported to the exchange and benefit from capped fees.”

So what’s the effect of the break-up? Granlund says the impact is difficult to count as the global financial crisis has depressed trading volumes, but he concludes: “Everyone who participated at Nasdaq OMX before the split is doing so afterwards.”

Granlund is bullish on the prospects for growth in the region. The drive for new members in previous years has yet to fully be felt in trading activities, he believes. Couple that with a gradual upturn in the global market as the world emerges from recession, and you have a recipe for expansion.

Key to Nasdaq OMX’s plans is rolling out a new trading system, which Granlund says will drastically reduce latency. He also vows to “monitor” product expansion, though he says it is too soon to reveal any products under discussion.

Von Zweigbergk, too, is optimistic for the future, though he says Oslo Børs is focusing on persuading companies to list on the Norwegian market, which in turn will create opportunities to offer derivatives linked to their shares.

Sandersjoo is more subdued in her outlook for the Nordic region. “I don’t believe it will develop into a main market to rival those of London, Frankfurt and Paris,” she says.

At Pohjola Bank, Hellemaa foresees growth, as market participants continue to embrace derivatives, but he questions whether the Nordic exchanges will profit from it. His view is that the bigger growth “will be outside the local markets”.

Competition – for better or worse

Both EDX and Nasdaq OMX publicly declare that: “We welcome competition in the market.”

Describing Nasdaq OMX’s product expansion, Granlund says it is “natural” for the bourse to want to offer the complete regional offering. He concludes that the rivalry with EDX “is healthy and keeps us on our toes. It helps us stay focused.”

For its part, EDX has shown its belief in open markets by hints that it may challenge Liffe’s dominance of UK equity derivatives with its own products.

Granlund even predicts that such struggles between exchanges will become more widespread. “What is happening in the Nordic region,” he says, “is at the forefront of what I believe is going to happen in the rest of Europe – competition.”

However, if competition means a fight to the death, then the logical end of competing successfully is that competition may cease.

Nasdaq OMX certainly does not seem to be holding back from the fight. Since its separation from EDX, it has for the first time established a London-based sales team, which has been successful in attracting 34 trading firms, most of them from London.

Granlund says this has allowed the exchange to develop a direct relationship with London-based market participants, who provide feedback the bourse would not get elsewhere.

In another move into EDX’s territory, Nasdaq OMX has listed some Russian single stock futures and options, denominated in dollars and physically settled. So far it has Gazprom, Rosneft, Lukoil, Surgutneftegaz and Norilsk Nickel in standardised form. An index of Russian blue chips is planned.

The past year in Nordic derivatives have definitely constituted “interesting times”. The next year is likely to be even more interesting. By the end, we should know whether competition in this market is going to support choice or kill it.