Ottawa Discourages Trading of Canadian Bond Futures in Chicago

STARTING today, Canadian bond futures will be traded in the pits of the Chicago Board of Trade alongside pork bellies, corn, and soybeans. It is a development the Canadian government is not pleased about.

A Canadian bond future is a contract to deliver a Canadian government bond at a set price at a set future date. Futures belong to a family of financial instruments called ``derivatives'' because they derive their value from an underlying equity, bond, mortgage, or other instrument.

Until now, trading in Canadian bond futures has been the exclusive province of the Montreal Exchange. The Chicago Board of Trade (CBOT) is opening its own trading because it senses that the developing market for such futures is ripe.

But if Canada's federal Department of Finance has anything to say about it - and it does - trading in Canadian bond futures will once again be the sole responsibility of the Montreal Exchange.

Yet retaking control means winning what many describe as a fast, brutal contest between Montreal and the CBOT that could last anywhere from a few weeks to six months. ``Experience shows that two markets trading in the same product, at the same time of day, will not continue to exist together,'' says John Ballard, vice president of derivatives at the Montreal Exchange. ``We want to make sure that it will be our market that remains.''

So does the Canadian government. In recent meetings with Canadian brokers, Department of Finance officials outlined a strategy to help Montreal. In at least one such meeting last week, department officials communicated to Canadian brokerage firms the government's desire that they not do any deals involving the CBOT's Canadian bond futures, brokers who were at the meeting told the Monitor.

``Point blank, the Department [of Finance] is doing everything in its power to discourage Canadian brokers from trading in the Chicago contract,'' says Curt Hussey, a futures trader with the Toronto Dominion Bank. ``At this point, there is a verbal understanding [between brokers and government] not to participate. But when push comes to shove, [the government] could put more serious measures in place.''

In a phone interview, a Finance official denied that the government had asked or pressured firms not to trade in Chicago. But the official did indicate government concern over the fact that futures contracts often set the price for cash trading in government bonds. ``No sovereign government has an interest in seeing major price leadership in its domestic securities coming from offshore,'' the official said.

Traders say the Canadian firms will honor the government's well-understood mandate to abstain from trading with Chicago, at least initially. If, however, the number of trades and dollar volume - known as ``liquidity'' - build rapidly in Chicago while declining in Montreal, several traders said their firms will be forced to begin trading in Chicago too.

``It's not a total surprise that [the Canadian government] is trying to rally support,'' says Susan Batina, product manager for the CBOT. ``Of course, we would like to see Canadian dealers trading here. But we're not relying on them to make our market.''

A similar battle is being fought over German bond futures between the London International Financial Futures Market (LIFFE) and the German futures market. The Bundesbank, Germany's central bank, has ordered German banks to support the German market. But LIFFE still holds the bulk of the market.

Canadian bond futures are a somewhat new financial instrument in Canada - just over four years old. Trading on the Montreal Exchange has only begun to pick up strongly in the last six months after a slow start. The Montreal Exchange recently moved up to trading levels in which more than 5,000 contracts and about $500 million (Canadian; US$360 million) in futures are traded daily. But at such levels, it can still be tough to find a buyer for a big $50 million contract, for example.

Some analysts think trading Canadian futures on the huge CBOT will solve this sort of liquidity problem. The CBOT tried and failed some years ago to introduce a yen bond futures market. But CBOT officials are hopeful, saying that more than one market can survive. ``We are not launching this contract to stop trading in Montreal,'' Ms. Batina says. ``We may just see a greater market overall.''

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