Since CME Group closed its last trading pits in 2015, large trades in agricultural contracts have not been easy to execute. Traders say that what had been a fast and efficient negotiation on the floor now tends to be tricky to fullfill on CME's electronic trading system without disclosing market-moving information.
The exchange's new block trade policy is intended to change that. Since January, CME has permitted traders to negotiate large deals off-exchange in any of its agricultural futures and options. While CME had already offered block trading on most of its other products, the new block trade rule is a big change for its agricultural markets, which historically have required all trades to be executed through the central market.
In the past, many futures exchanges prohibited block trades out of concern that they would hurt the price discovery process and drive business away. But Tim Andriesen, CME's managing director of agricultural products, said he believes block trading will actually add volume, liquidity, and transparency. “A lot of this business is going to the OTC market, and if you move this through the OTC market, it is never seen—there is no obligation to report,” he noted.
Light Trading So Far
At CME, all block trades in agricultural futures and options must be reported to the exchange within a short period of time after they have been negotiated, he said. That time period is limited to 15 minutes for less liquid contracts such as lumber, palm oil and oats, and only 5 minutes for all other contracts. After they have been reported, the block trades become visible to the market via CME Direct’s live block trade window or the block trading page at cmegroup.com.
The number of block trades executed since the launch in January has been relatively light so far, but Andriesen said he expects that to change as market participants become more familiar with the functionality and realize the benefits for certain types of trades. “We’re seeing more and more people coming into the market,” he said.
"Block trade facilities are particularly useful when traders want to avoid 'legging risk' in complex trades."
Aaron Pauker
RBC Capital Markets
CME data shows that in the first month of trading, agricultural options attracted the most block trades. Out of the 28,066 contracts executed through block trades from Jan. 8 to Jan. 31, more than half were in options on corn, soybean and wheat futures.
CME also has begun permitting cross trades in all of its agricultural futures and options. In this type of trade, two sides to a trade can have a private discussion on the size and pricing. The trade is then entered into CME's Globex platform via a special protocol for cross trades. Cross trades are used in all of CME's other asset classes and have been permitted for certain agricultural options, but under the new rules, this type of trading can be used across the entire agricultural complex.
Judging by past experience in other contracts, these new trading functionalities are likely to be particularly useful further out on the curve, where it is difficult to find sufficient liquidity quoted in the order book, or for complex trades such as a “crush option.” This is a trade based on the pricing differences at different points of the soybean processing chain. One leg is based on the price of soybeans, the other on the combined value of the soybean meal and soybean oil. In effect, this type of trade measures the profit margin for processing companies.
According to CME data, blocks and crosses proved to be a popular method of execution for options on soybeans, soybean meal and soybean oil. As of the end of January, more than 25,000 soybean meal options were traded through crosses, roughly a third of total cross volume in the agricultural complex.
Late in February, CME pulled back on one detail of the new rules. The exchange withdrew the permission to use block trades with soybean crush spread options, without providing an explanation.
Another benefit of the new trading functionalities is that they have the potential to bring in new customers from the financial world. Aaron Pauker, vice president at RBC Capital Markets, oversees execution of commodity futures and options for the firm's customers. He commented that block trading will add more liquidity to the market by giving financial investors access to liquidity that they have not had since the trading floors closed.
“In the electronic trading environment, people use algos and iceberg functionality to conceal the true size of their orders,” Pauker said. “That reduces the depth of the market visible on the screens and makes it harder to source liquidity down the curve for a spread trade.”
He added that he does not see the introduction of blocks and crosses as a threat to the liquidity of the market. The front month contracts are so liquid that traders and hedgers do not need to use these facilities to get their trades done and have no incentive to pay the extra fees for that type of trade.
Euronext Joins the Trend
In changing its view on block trading CME follows other exchanges that already offer block trades for agricultural futures and options, such as ICE's futures markets in New York and London. On Jan. 30, Euronext joined the trend.
The Paris-based exchange announced plans to allow block trading in all of its commodity futures and extend its “large-in-scale” trade facility to its two flagship commodity products—milling wheat futures and rapeseed futures. The new facility, which went live on Feb. 28, will help support block trading in these contracts “by improving liquidity and allowing participants to signal trading interest to selected counterparty groups,” the exchange said.
These new block trading options may expand arbitrage possibilities, suggested Pauker. In the sugar market, people use block trades for the spread between raw sugar traded on ICE's market in London and refined sugar traded on ICE's market in New York. Once Euronext makes this type of trading available, he predicted more trading activity in inter-exchange spreads such as Chicago’s soft red wheat contract versus Euronext's milling wheat contract, or soybeans versus rapeseed. Block trade facilities are particularly useful, he said, when traders want to avoid “legging risk,” i.e., the risk that the market moves before one of the components can be executed.
