Business Times (Malaysia) August 4, 2003, Monday SECTION: PortfolioMarket trek; Pg. 7 LENGTH: 865 words HEADLINE: Boosting mart with mini contracts BYLINE: By Fred Tam BODY: FOR the past century, the US has led the world in innovations in futures trading, beginning with the trading of commodity futures like corn, oats, wheat, eggs, butter, cotton and soyabeans in the Chicago Board of Trade in the early 1900s, financial products in the 1970s like stock indices, T- bills, T-bonds, currencies, electricity futures in the 1990s and single stock futures in 2002. These products, though controversial, survived principally because they provided two vital economic functions - that of risk transfer and price discovery. But coming up with a product to trade death, through what the US calls "terrorism futures" is dead wacky. Does the Pentagon, which mooted this absurd programme, hopes to use terror futures to prevent terrorist attacks or is there a more sinister reason for introducing it? As we understand it, futures trading are derivative products. Derivatives, by definition, are instruments whose value depends on (or is derived from) the value of an underlying asset or security. In the case of terror futures, what would be the underlying instrument? The leader with the likelihood to be assassinated of course. Had this grotesque idea not been shot down by US senators, the world would be witnessing the macabre trading of Saddam futures, or Arafat futures, or Jordan's King Adbullah II futures by October this year. From what we know about futures contracts, the delivery unit must be standardised in terms of quantity, quality, delivery time, place and mode. Take for example our crude palm oil futures contract. The underlying instrument is crude palm oil; delivery unit is 25 tonnes plus or minus not more than 2 per cent; the oil must be of good merchantable quality, in bulk, unbleached, in Port Tank Installations located at the option of the seller at Port Klang, Butterworth and Pasir Gudang. Free fatty acids must not exceed 4 per cent and moisture and impurities shall not exceed 0.25 per cent. Assuming Darpa, the unit in the Pentagon who came out with this morbid idea, had introduced Kim Jong II futures. We wonder how they would standardise the underlying instrument to be delivered? Must Kim Jong II be caught alive, or doesn't it matter? Must all his limbs be intact upon delivery, or can we give or take not more than two or three limbs severed from the body? Which are the points of delivery? Pyongyang or New York? Isn't this absurd? What finally stopped the US from going ahead with this programme, which the Bush Administration has sought US$8 million (US$1 = RM3.80) to fund, is not so much the difficulties of drafting the contract specifications as they can easily "unstandardise" it, but their worry that the very countries that are targets of terror futures may well set up betting parlours and, in the words of Byron Dorgan of North Dakota, "bet on the assassination of an American political figure or the overthrow of this institution or that institution". To be fair, not all that the US innovates is nonsensical though. Derivatives have been and are still great instruments to hedge against price risks as well as for price discovery. Derivatives have been around in some form for centuries, but their growth has accelerated rapidly in the last ten years. Total worldwide turnover in futures and options on securities reached a record 4.32 billion contracts in the first nine months of 2002, up 40 per cent on the same period in 2001. The Malaysian Derivative Exchange Bhd's (MDEX) performance between 1992 and 2002 also mirrored the world's upward trend in volume in percentage terms, growing by 497 per cent during the period while the world's top 20 exchanges grew by 817 per cent (see Table 2). This incredible growth in the use of derivatives underscores its importance as an instrument for risk shifting as well as for price discovery, yet in absolute terms, MDEX's performance is far behind when compared to recently-introduced derivatives in Asian exchanges like the Korean Stock Exchange, National Stock Exchange of India, Shanghai Futures Exchange and Taiwan Futures Exchange. Except for the crude palm oil futures contract, performances from the others have been lacklustre. The Kuala Lumpur Stock Exchange Composite Index (KLCI) stock index futures contract is one of them. An active contract before 1998, its volumes have dwindled to a daily average of 958 lots for year 2002. Our research shows that one of the reasons for its unattractiveness is its large contract size. This size is just too huge for the retail investor, which accounts for the bulk of the contract's daily turnover. The global trend is towards mini contracts, which have proven to be a hit wherever it is launched. For examples, the Kospi 200 options contract, the E-Mini S & P 500 and the E-Mini Nasdaq 100, all have been successful. Reducing the multiplier of the KLCI stock index futures contract from RM100 to RM50 is the way to go, and we agree with MDEX's recent proposal to downsize it. The earlier this is implemented, the better it will be for all parties. The writer is a full member of the Society of Technical Analysts, UK GRAPHIC: Graphics (Statistics) - Weekly % gain/loss. Graphics (Statistics) - Comparison between top 20 global futures and MDEXvolume.