SHUAA CAPITAL – Dubai gets its own futures market

SHUAA Capital – Dubai gets its own futures market
By Magdi Shannon, Head of Trading

Every genuinely advanced economy needs to be sufficiently supported by sophisticated, well-functioning financial markets. For emerging markets such as the UAE, a futures market is the natural next step along the development lifecycle.

Futures have historically proven highly successful and highly beneficial in markets where they have been traded, to the extent that futures trading volumes often exceed those of cash equities. South Africa, Turkey and India are all live case studies of major emerging markets where futures trading had boosted their overall financial market performance; driving their corresponding cash equity markets through exponential volume growth, over an average of 5 to 7 years after their introduction. Today, out of the top 15 global futures markets by traded volume, 9 are from emerging markets. Given the UAE’s ascension into the Emerging Markets bracket by MSCI, stakeholders are working hard to ensure the UAE financial ecosystem experiences similar success stories – and rightfully so.

Futures fundamentally help balance out financial markets. Firstly, they are inexpensive to trade as compared to shares, incentivizing greater market participation, which contributes to greater market sophistication. Secondly, they require less capital to trade than shares, which means high gearing levels. This is far more advantageous than trading cash equity on margin.  Thirdly, they allow investors to profti in both rising and falling markets. Finally, the ability to hedge portfolios will appeal to investors holding UAE portfolios.

For a futures market to function efficiently, market makers are required. Market makers are unique players in a market ecosystem and their role is often perceived as vague. Their fundamental role is to maintain an orderly and liquid market, so as to ultimately catalyse market efficiency. In any given market, such as the Nasdaq Dubai Futures Market, a buyer/seller of a contract will find a seller/buyer counterparty and a trade will take place. However, when the market experiences a lack of liquidity, the market maker will quote a two-way market (bid/offer) to incentivize the trade, thereby creating liquidity.

Liquidity is an important element of sound market performance. A conventional measure of liquidity is the bid-ask spread. The smaller the spread the more liquid the market, and vice versa. The tighter the spread, the cheaper the cost to the trader, therefore driving more volume. Consistently high volumes and liquidity are signs of a sophisticated market.

To further appreciate market making, it is important to dispel some common myths. The most common misconception is that market makers exist to increase volume by trading their own book and profiting from capital gains using additional information they have. This is false. Firstly, their presence is only to ensure a competitive bid and offer always exists.  Secondly, a market maker is not privy to any more information than anyone else on the trading floor. Thirdly, their gains are strictly from bid-offer price spread and greater trading flow. Another misconception is that market makers manipulate prices. The truth is market makers ensure an efficient and orderly market by smoothing out any mispricing.

When Nasdaq Dubai approached us at SHUAA, to become market makers for the newly established futures market, we seized the opportunity. Our pre-existing role as market makers dating back to 2007, coupled with our long standing knowledge of capital markets and state of the art trading system, certainly position us well to drive such an initiative forward. Following the initial launch phase, the next step will be to expand our product depth within the UAE, initiate index futures and explore the feasibility of expanding the product reach across the region.

These initiatives will not only increase the breadth of our services, in the greater scheme of things, they will allow us to contribute to the development of the UAE’s financial ecosystem, once again putting this great country on the forefront of innovation. A successful outcome will encourage our regional neighbours to follow suit, leading to larger regional capital inflows, increased market sophistication and a shining path to advanced economy status.