London International Financial Futures Exchange Yearbook

In September 1982 a new market opened in London-The London International Financial Futures Exchange LIFFE. The market occupies the Royal Exchange building in the City of London adjacent to the Bank of England. The Exchange provides facilities for dealing in futures contracts including short term interest rates, government bonds, stock indices and foreign currencies. The Exchange also offers traded options on financial instruments and currencies. The ability to deal in these financial futures and options contracts is an integral part of the range of services which the City offers.

In the past year the London International Financial Futures Exchange has played an essential role in the new financial market structures that have developed after ‘Big Bang’. In the particular case of gilts, it is difficult to imagine how the marketmakers would have been able to operate effectively without the hedging facilities offered by the long gilt contract. Before looking at individual contracts and their roles, however, it will be useful to consider the overall development of the exchange over the last couple of years.

LIFFE opened in the Royal Exchange building in the City of London in September 1982, to provide a market in the European time zone offering financial futures and, since 1985, financial options, to dealers and investors. From the outset Building Societies have worked with the Exchange to evaluate the ways in which Societies might use financial futures and to persuade the Government to grant the necessary enabling powers.

Although the London International Financial Futures Exchange (liffe) has firmly established itself as an institutional rather than a retail market, many institutional fund managers have continued to fight shy of it. At first this could easily be attributed to ignorance of its uses but an intensive education programme over the five years has still not yielded the results that might have been hoped.

Since the opening of the London International Financial Futures Exchange in 1982, the taxation treatment of financial futures and options has undergone considerable change as new law has been introduced. Initially, the Inland Revenue attempted to treat matters under existing statute and case law. This approach centred on distinguishing between traders and investors. In 1984 legislation was introduced to exempt pension funds from taxation when dealing in financial futures and in the following year capital gains tax was substituted for Schedule D Case VI in non-trading situations.

The primary objective of any accounting policy should be to ensure that the financial accounts properly reflect the economic consequences of a particular transaction. It is therefore important to appreciate the economic risks and rewards inherent in a futures or options contract and its underlying commercial rationale when developing accounting principles for these contracts.

The following article describes a number of instruments actively traded in the interbank market including financial innovations which have come to the fore during the 1980s, and examines their relationship to contracts traded on LIFFE.

The world-wide collapse in share prices of October, 1987, has caused commentators to claim that share markets and other financial markets are not efficient, and that the existence of financial futures and options markets tends to destabilise prices of shares and other financial assets. Both ideas are wrong. The first reflects a misunderstanding about market efficiency. Market efficiency means that price equals value. Value depends on the expectation of investors about the future. If investors change their expectations, values of shares or other assets change, and prices must change too. Major shifts in assessment of the economic situation will lead to major changes in asset prices. Market efficiency requires that prices should change, but it does not imply that they will change in a steady, still less a predictable, way. Occasionally, a panic can happen, as it did in this case, but the evidence favours the view that financial markets are normally efficient. The idea that futures and options markets tend to destabilise cash market prices is also wrong.

The development of a wholly new financial market in the City of London is a rare event and the launch of the London International Financial Futures Exchange in the converted main hall of the Royal Exchange on the last day of September 1982 has few parallels. Whilst new products have been launched on existing markets, such as traded options on the Stock Exchange in 1978, and even new markets for futures like the International Petroleum Exchange in 1981, the start of liffe was much more significant. From the very beginning liffe was seen as a complete new exchange trading a variety of futures contracts and providing a European equivalent of the great Chicago exchanges, the Chicago Board of Trade and the Chicago Mercantile Exchange.

The first year of the ‘Big Bang’ arrangements in cash sterling securities markets saw a substantial expansion in activity in liffe sterling-based futures and options contracts. This largely reflected the impetus to trading given by the market reforms themselves. However, the unsettled economic and financial background to the sterling markets also probably contributed significantly to market participants’ need for hedging instruments.

Currently, liffe lists seven option contracts; five on futures (Long Gilt, us Treasury Bond, Short Sterling, Eurodollar and FTSE-100), and two on physical currency (Dollar-Sterling and Dollar-Mark). liffe operates as unique system for margining its option contracts. The system is operated for it by the International Commodities Clearing House. It uses the most desirable features of the various existing systems used on other exchanges, but contains an original element not found elsewhere.

In 1987 LIFFE embarked upon an ambitious project to develop and introduce a new Trade Registration System to support the current and predicted volume growth and provide additional facilities and efficiencies to both the exchange and its members. The first implementation phase of the Trade Registration System (TRS) occurred on September 3rd 1987 when the system was brought into operation, processing all the option contracts. On February 18th 1988 the first group of futures contracts, JGB and Currencies, were introduced to TRS.

The International Commodities Clearing House (icch) has been providing futures markets in London with clearing and guaranteeing services since its formulation as the London Produce Clearing House Limited in 1888. Sugar and coffee were the first two commodities to use the Company’s clearing services after 1888, and the Cocoa trade followed in 1928, with the opening of the London Market.

To preserve the link between market membership and ICCH membership it is necessary to be a Member of LIFFE to be eligible to clear liffe trades. As Clearing Members will be aware, the net worth requirement for ICCH Clearing Membership on liffe is £500,000 and if a Clearing Member intends to act as a General Clearing Member the net worth requirement is £1,000,000 for the reasons set out in paragraph 1.2 below.

1.01 Save as otherwise specified herein, words and phrases defined in the Rules shall have the same meanings in these terms and in the Administrative Procedures.

1.01 Save as otherwise specified herein, words and phrases defined in the Rules shall have the same meanings in these terms and in the Administrative Procedures.

1.01 Save as otherwise specified herein, words and phrases defined in the Rules shall have the same meanings in these terms and in the Administrative Procedures.

1.01 Save as otherwise specified herein, words and phrases defined in the Rules shall have the same meanings in these terms.

1.01 Save as otherwise specified herein, words and phrases defined in the Rules shall have the same meanings in these terms.

Expressions referring to writing shall, unless the contrary intention appears, be construed as including references to printing, lithography, photography, and other modes of representing or reproducing words in a visible form.

The object of the market shall be to provide facilities for members and their clients to hedge against future changes in interest rates, foreign currency rates of exchange and the price of equity stocks, in particular to protect themselves against the possible adverse consequences for them or their businesses of such changes. It shall be the responsibility of each member to ensure so far as practicable that the facilities are used for purposes which are consistent with this object. The Board shall have power to regulate the market so as to ensure, inter alia, that the facilities are not used for purposes which are inconsistent with the object of the market.

The object of the market is to provide facilities for members and their clients to hedge against future changes in interest rates, foreign currency rates of exchange and the price of equity stocks, in particular to protect themselves against the possible adverse consequences for them or their businesses of such changes. It shall be the responsibility of each member to ensure so far as practicable that the facilities are used for purposes which are consistent with this object. The Directors and the Exchange shall have power to regulate the market so as to ensure, inter alia, that the facilities are not used for purposes which are inconsistent with the object of the market.

1.1. The Trading Procedures are promulgated under the authority of various enabling clauses included within section 4.15 of the Rules of the Exchange and have the same status with regard to enforceability as the Rules of the Exchange.