The Bourse de Montreal, Canada's oldest stock exchange, has taken yet another step toward consolidating its new mission as the national financial derivatives exchange. Its recently-launched Derivatives Institute will promote the derivative market and products by offering training to finance professionals and individual investors

In light of increased competition both at home and abroad, and the need for the various Canadian capital markets to achieve a critical mass of trading activities, an agreement was reached and finalized in 1999 to restructure Canadian capital markets along the lines of market specialization. The Vancouver Stock Exchange (VSE) and the Alberta Stock Exchange (ASE) merged to create the Canadian Venture Exchange (CDNX) in Vancouver, which trades only in junior securities. All senior equities are now traded at the Toronto Stock Exchange (TSE); and after 125 years in operation, the oldest stock exchange in Canada, the Montreal Exchange, has become the exclusive derivatives market in Canada.

Derivatives are generally not well understood by people who know little about finance. They have, for the most part, been used by institutional investors. "Derivative instruments are risk management or risk transfer tools. They are futures and option contracts that allow holders to set the price of an asset immediately or determine a future price. The same applies to options, except that for options, setting the price is optional," says Philippe Loumeau, the Bourse de

Montreal's senior executive vice-president, Business Development, Marketing and Strategy. A derivative instrument is therefore a financial tool, the value of which is derived from the value of an underlying asset. The underlying asset can be a commodity, such as wheat, or a financial asset, such as shares, bonds or indices.

The derivative instruments that are now traded on the floor of the Bourse de Montreal focus on interest rates, exchange indices and share products. Retail investors also use share options. Although this happens to a certain extent in Canada, it is far more common in other places, like Amsterdam.

"The success of the Amsterdam Option Market was driven by the use of share options by the retail clientele. Here in Canada, we have a long way to go to get investors -- both retail and institutional -- to understand and appreciate and hence, use derivative instruments," Loumeau says. He adds that this market is indeed addressed to the general public because share options accounted for 40% of Bourse de Montreal operations last year.

Strategy and development. The Bourse de Montreal is currently in the process of automating its trading system. "A year ago, the Montreal exchange was a live trading floor, manned by bustling traders. Today, 60% of our transactions are carried out on an electronic platform, and in September, all our products will have been incorporated into this automated trading system," says Loumeau. According to the senior executive vice-president, Montreal's automated system (SAM) will result in a more transparent, more efficient and less costly trading system that can be used by more brokers and therefore bring in more clients. He adds that automation and remote access are fundamental to market development.

Automation also represents a strong trend in the financial market industry overall. "We are extremely proud to be the first futures market in North America to be completely automated," says Loumeau. SAM constitutes one of the essential components of the Bourse de Montreal's strategy, in conjunction with the development of remote access and marketing efforts to reach other client pools and broaden its client base.

International focus. The Bourse de Montreal already works a great deal with other countries, since a major part of their open position is held by foreign investors. "We intend to continue developing our international focus because all the large futures markets have a local client base as well as large international traders who are very keen to deal with liquid futures markets worldwide," explains Loumeau. The goal is to attract intermediate and direct clients from North America, Europe and Asia.

Although Montreal is Canada's only financial derivatives exchange, there are several others in North America. Chicago has been considered for some time the Mecca of derivatives markets. The Chicago Board of Trade, the Chicago Mercantile Exchange, and the Chicago Board Option Exchange were, until very recently, the three largest futures markets in the world. However, Chicago lost its position as the capital of futures markets to a completely automated European market called Eurex. In terms of volume, the Bourse de Montreal ranks 30th worldwide, and it hopes to expand by increasing its trading activities.

The Derivatives Institute. It has been proven that to develop a market, you need to attract an initial core of liquidity and interest both locally and nationally. Loumeau says that in Canada, the use of derivative products overall is not as strong as in the other G7 countries. To help overcome this problem, the Derivatives Institute was launched to provide training and information on these products.

"The mission of the Derivatives Institute is to train and inform the public, and to demystify derivatives because many people consider them to be high-risk products. They can be risky, but they can also be secure products that actually allow you to transfer risk," adds Loumeau. Exchange-traded derivatives are distinct because the terms and conditions for delivery and pricing are standardized. They allow investors to benefit from the increase in the price of an asset at a fraction of the cost. Another advantage of derivatives is that the transactions are guaranteed by the clearing house, which ensures that both the buyer and the seller fulfill the terms of the contract.

In Canada, this is done by the Canadian Derivatives Clearing Corporation (CD CC). Options and futures can be used to protect a portfolio against a drop in the market, improve return on investment, plan the acquisition or disposal of investment securities, or take advantage of market fluctuations. These are just a few basic strategies for the use of derivatives.

The Institute also serves as a training and education centre designed to help individual, professional and institutional investors manage their portfolios. Training programs -- including courses, seminars and workshops -- are adapted to meet investors' needs and are available in classroom settings, by correspondence or online.

The Institute's Web site (www.derivativesinstitute.com), contains information on the Institute and derivatives, and, most importantly, its learning centre. In the coming year, about a dozen different courses will become available. These courses will look at the presentation and use of derivative products, as well as the transactions themselves and the way they are managed in the trading room, the back office (specifically the tax, accounting and regulatory aspects of derivatives), and in risk or portfolio management.

Training and information. Using the Internet, the Institute will eventually cross borders, attracting students from outside Canada. The first online course is already available in both English and French. It's an introductory course on derivative markets for anyone interested in financial markets, or owners of small or large portfolios who want to learn more about derivative products. It is also useful for anyone who wants to be able to "talk shop" with their brokers or trade these products directly themselves.

The Bourse de Montreal has been offering a classroom version of this course for some time, and it has been the most popular course among the general public. Given its popularity, it has been modified, with a few things added, to become the first course to be offered online. The Institute will also be offering courses on portfolio management strategies, the step-by-step implementation of these strategies and the operational support needed to implement appropriate controls. Loumeau points out that, "The Internet is an extremely useful vehicle for training because you can use various methods to deliver the educational content in a rich and diversified manner, and students can work through it at their own pace." He believes that e-learning is more accessible than reading a good textbook on the topic.

One of the thrusts of the Derivatives Institute's development involves collaborating with Canadian universities. Loumeau says that they would like to see university students become more familiar with derivative products, and that it's likely that some of the courses offered by the Institute will be included in certificates and diplomas at various universities.

As for the information component, the Bourse de Montreal is hoping to run symposiums and promotional events to market derivatives and the Institute. They also plan to establish partnerships with intermediaries and other institutes, such as the Institut de Finance Mathematique de Montreal (IFM2). Loumeau says that the IFM2 complements the Derivatives Institute, which works with practitioners, since the IFM2 focuses on the theoretical aspects of financial mathematics.

The Bourse de Montreal, with its Derivatives Institute, is looking confidently to the future, prepared to meet the challenges of the constantly changing financial environment.

Julie Demers (jdemers2000@hotmaiLcom) is the associate French editor of CMA Management magazine.