By Tom Vulcan

Early in June, just after the Dubai Gold & Commodities Exchange [DCGX] launched its new crude oil contracts, HardAssetsInvestor.com reporter Tom Vulcan had the opportunity to talk with the CEO of DGCX, Malcolm Wall Morris, both about the exchange and its new futures contracts.

Tom Vulcan (Vulcan): Why can the Middle East aspire to become a global hub for commodities derivatives?

Malcolm Wall Morris (Wall Morris): Well, that's a very interesting question.

In various parts of the world, you tend to have producing regions, and you have consuming regions. And you have, of course, the financial centers in London, New York, Chicago, Tokyo, Singapore, etc., where you have a mixture of the two within a robust banking and regulatory environment.

Dubai is a trading center - a physical commodities trading center for the Middle East. Dubai was the very first free port in the region. It's known as the gateway to India. There's a large flow of physical goods that passes through Dubai, and always has passed through Dubai.

So, taking that next step on: If you've got a flow of physical commodity goods coming through Dubai, it would seem a very logical, and also an essential step, to be able to provide risk management and investment products, or tools or services to facilitate that.

That is, if you like, how DGCX came about. We're here to provide the framework to encourage the flow of physical goods through Dubai, and therefore we should provide not only, for example, the warehousing, the transfer of goods systems, but also an exchange on which you can manage price volatility.

If you look at the growth of this particular region - the liquidity that exists here, whether that be from the GCC [Gulf Cooperation Council] countries and other Gulf states, the Indian subcontinent, etc. - there are funds that are very happy to flow into Dubai and flow into this region which potentially aren't so happy (for myriad of reasons, whether they be geophysical, whatever), to be in the London markets or, indeed, the Japanese markets or the U.S. markets.

The fact is that the globalization phenomenon that's taking place and the centricity that's been going on in London, New York, Chicago and the other financial centers, are now looking at the Middle East actually as a huge pool of liquidity, and are therefore able to service and better provide markets and the products that the liquidity would like to trade. It makes perfect sense, therefore, to have a financial center here.

Vulcan: What advantages are there to investing in commodity futures in the Middle East itself?

Wall Morris: Well, I think for that one you need to look at the existing client base at DGCX. DGCX currently has 217 members. If we look at this client base, and at the proportion of business that transacts every single day - to give you an idea of that, we trade every day between four and five times the volume of any other commodity derivatives exchange within the MENA [Middle East and North Africa] region - we are the region's largest commodities derivatives exchange.

Approximately 35% of our business originates from within the UAE - companies that are based in the UAE. A similar amount of business actually comes out of the U.S. And, then, a further 20% of the business comes out of Western Europe, mainly the UK. The balance is coming out of the Far East, Australasia, etc. We have a very interesting spread of international businesses who transact with the liquidity that exists through the Middle East.

If you ask our local clients (who account for 35% of the business that takes place today), they transact business here on our market potentially for two reasons.

The first is that they have funds within the UAE, or funds within the region, and they're able to access prices, management and investment products on our exchange without having to incur the costly, and sometimes cumbersome, effects of having to transfer funds into the international markets. They can maintain funds under the guidance of ESCA, the Emirates Securities and Commodities Authority, which is the federal regulator of our market in the UAE, a full member of].

And then you have, for example, a second group of customers, who potentially don't have the in-depth knowledge of derivatives instruments, but, however, do have an exposure, say, to the gold price, or the oil price, and who now prefer to transact at source in the region where they conduct their day-to-day business, and to have access to these products - again, without having to deal both with international regulators and the complexities and the cost, time and efficiency of transferring money.

So those are the clients within the region. For the clients outside the region, for whom the figure I gave you is quite considerable, it is the possibility of transacting with that new liquidity (that new volume that's taking place), and the possibility of looking at other international markets and actually being able to make prices and actually transact with that liquidity. So, if you like, the markets are becoming bigger because of it.

Vulcan: How can sophisticated investors from both the Middle East and elsewhere gain commodities exposure in the local market in Dubai?

Wall Morris: Only two weeks ago we launched both the NYMEX West Texas Intermediate Light Sweet Crude [DWTI] oil contract and the ICE Brent Crude Oil [DBRC] contract here on the DGCX. So what we've actually done is bring the two global crude oil price benchmarks to the region - to the world's largest producer of crude oil. We've actually brought those products here, which means they can transact those markets from this region. Now the way that works is that the markets open, and they trade, every single day, but at the end of every single day we settle the markets at the closing price or at the settlement price of the NYMEX and ICE markets. So it's as if you have transacted volume on the parent contracts, because your overnight price exposure is exactly the same as on those markets.

Vulcan: Who are your competitors? I don't think DGCX has any, does it?

Wall Morris: You've got to be frank. There are other exchanges within the whole MENA region, but we're the only commodity derivatives exchange in this region which operates a price discovery platform, a trading platform, and, this is the most important part, a clearing function within the region.

Vulcan: Would you say that it is correct that Dubai is already recognized globally?

Wall Morris: I would. From the last figures that were reported, all of the U.S.-based investment banks now have offices in Dubai.

The last figure I saw, there are something like over 400 other financial institutions that are reported to have representation in Dubai. DGCX regards itself as the gateway between the regional liquidity and international liquidity. We are the place where, if you transact business internationally or transact business regionally, you can come together on one exchange and do business.

I think very much that Dubai regards itself as the gateway to the Middle East and a place where international businesses can come and set up in the free-zone environment, with a very advantageous tax environment, in a very well-regulated regime, and actually transact business. And almost, if you like, become a financial club akin to the Singapore of the Middle East.

Vulcan: Looking at your range of future contracts, what's been successful so far, and where do you see the brightness of the future?

Wall Morris: Well, the range of products that we've got now, and had for the last few weeks, encompasses precious metals - gold and silver. It encompasses currencies, and also since two weeks ago, crude oil. We have the three key economic instruments on one exchange, i.e., gold, crude oil and currencies.

So to manage your exposure, particularly currency exposure, or to hedge against inflation or energy price risk (and gold tends to be regarded as a safe haven in times of economic uncertainty), DGCX provides those three key economic instruments.

Up until very recently, the largest contract we had was our gold contract, which at the end of last year, if we look at our portfolio of contracts, accounted for approximately 80% of the business that was transacted on the exchange. Gold was the very first contract that we listed.

What is interesting, however, is that, whereas the gold volumes continue to rise, as a proportion of that overall business, this year it's falling. For example, in May, last month, gold accounted for just under 50% of the volume, although the volume in gold is still rising. What it means is that the currency contracts' volumes are growing and the proportion of their business is growing, but also, more importantly, the crude oil contracts that we listed were the most successful product launches in the exchange's brief history. On day one, the crude oil contracts, mainly the WTI (the West Texas Intermediate contract), accounted for 40% of the exchange's volume.

For us, it's absolutely key that we list the products that are demanded by customers. Customers are saying: "It's fantastic! You've got precious metals, you've got currencies, but we are in the middle of the world's largest producer of crude oil and you've haven't got crude oil contracts. Can you list those?"

So, going forward, they have been very, very successful since launch, and what we're seeing is that the proportion of the gold business, despite its volume continuing to grow, is actually falling in relation to the other products we've got. Of course, we plan to launch further products, but it has to be absolutely in conjunction with the requirements of customers.

Vulcan: I wrote an article a couple of weeks ago on plastics futures, and I know that you've had some plastics futures in the pipeline. Do you see them in the pipeline for a wee bit longer, or should we...?

Wall Morris: That's a very good question. We've made no secret of our desire to launch plastics futures. It was very much an initiative which dovetails with the DMCC's [Dubai Multi Commodity Centre] desire to stimulate the flow of physical goods through Dubai, and Dubai as a commodities trading center. There is, however, a fundamental difference between the likes of, say, a crude oil contract launch and a plastics contracts launch. Namely crude oil is an extracted derivative product which is traded on many exchanges around the world. There are international price benchmarks. Plastics, although they have been listed on other exchanges, the volumes that have been listed to date are very, very slight - very, very slight indeed.

Vulcan: You recently listed a steel contract, didn't you? How's it doing?

Wall Morris: We listed a steel contract last October. The contract was, at the time, the very first contract of its type in the world.

The initial interest has been very strong, and in fact, with the exception of crude oil, it has probably been the contract about which I get the most inquiries from people who are interested. Up until very recently, when the LME listed a steel billet contract, it was the only steel derivative listed in the world. The volumes we had to begin with were very encouraging, but of course we are under no false impressions that these sorts of markets take time to develop and to grow. But of course, again, that was an initiative that we undertook in conjunction with the DMCC.

Vulcan: I presume that where you are in the time zone of the world is of enormous importance to you.

Wall Morris: Indeed! We're either three or four hours ahead of the UK - depending on time of year, of course. When our markets open at 8:30 in the morning, the Far East is open. But since our markets are open until 11:30 at night, they are open even when the U.S. is open. So we bridge all the time zones with our market hours.

Vulcan: Do you see India and China as potentially very large markets for your products?

Wall Morris: Yes, they are potentially huge markets. But until such time that they are able to open those markets up and allow exchanges like us to access their populations, that won't be the case. Saying that, though, the DGCX has entered into a Memorandum of Understanding with the Shanghai Futures Exchange in order to share information on product development, etc., and so we can better understand how our respective liquidity pools, if you like, operate, and in preparation, potentially, for such a thing happening.

Vulcan: Malcolm, thank you very much.