Now Derivatives for Hollywood movies

U.S. regulators approved the first futures market based on movie box-office returns over the concern of lawmakers and Hollywood executives that the exchange may expose studios to speculative harm.

The Commodity Futures Trading Commission voted 5-0 today to let Veriana Networks Inc.’s Media Derivatives Inc. unit open a market for professional traders to make financial bets on how well a new movie will do in ticket sales. A plan by Cantor Fitzgerald LP to create a market that includes retail investors is pending before the commission.

Media Derivatives’ market, to be called Trend Exchange, “will help better manage economic uncertainty and financial volatility,” Rob Swagger, chief executive officer of the Scottsdale, Arizona-based company, said in an e-mailed statement today after the vote.

CFTC Commissioner Bart Chilton called it a “popcorn prediction market,” and Senate Judiciary Committee members warned CFTC Chairman Gary Gensler in a letter yesterday of the risk of “creating perverse incentives for movie failure that may undermine the integrity of the industry.”

Hollywood studios that participate by hedging their films’ prospects will doom ticket sales, said Peter Guber, chairman and CEO of independent production company Mandalay Pictures LLC.

“The word will get out in three seconds and the picture will be a complete catastrophe,” said Guber, who was chairman and CEO of Sony Pictures Entertainment in the early 1990s.

‘Serious Concerns’

The CFTC must still approve the type of contracts to be dealt before Trend Exchange can begin. The company has said its first product will center on opening-weekend box office.

Product approval is “a very different question” from exchange approval and raises “significant concerns,” Chilton said in an e-mailed statement. He said he had “reluctantly” concurred in today’s vote.

“We have serious concerns regarding the trading of media contracts and we support a very thorough review of all of these first-of-a-kind products,” CFTC Commissioner Scott O’Malia said in an e-mailed statement.

U.S. Senator Blanche Lincoln, an Arkansas Democrat, today added language banning trade in movie futures to a broader derivatives bill she is writing. Lincoln is chairman of the Agriculture Committee that oversees the commodity commission.

Media Derivatives’ market plans to begin trading in the third quarter, Stephanie DiIorio, a company spokeswoman, said before the vote.

Potential for Manipulation

Activity on the exchanges would bring about “risky and manipulative” behavior, said Patrick Leahy, the Vermont Democrat who heads the Senate Judiciary Committee, and Senator Orrin Hatch, a Utah Republican.

“I’m worried about manipulation,” Chilton said in an interview on Bloomberg Television before the vote.

Media Derivatives said in a filing to the CFTC that a movie’s cast, plot, storyline, budget and “word of mouth” would be considered before exchange officials list the film.

Professionals would use the market to hedge risk to movie investments from “catastrophic events such as the World Trade Center bombing, to climate events such as severe snow storms,” the company said. It said its initial offerings would be based on domestic box office sales in a film’s opening weekend.

Media Derivatives told the commission its proposed market could transfer financial risk from producers, studios and theaters to “a community of speculators willing to assume these risks” in return for being paid a premium.

Movie Financing

The U.S. recession has reduced financing for movies, which cost an average of $107 million each to make in 2007, by studios that face declining DVD sales, increased piracy and more criticism on Internet sites, Media Derivatives said in a filing.

“Every other segment of our economy has had a means to offset risk,” Swagger said in an interview that aired today on Bloomberg Television. “The entertainment industry has not had an opportunity for futures-type contracts.”

Movies would be required to have a content rating, and show on at least 600 U.S. screens. Contracts wouldn’t be listed more than 30 days before a release. Trading would end the day before the opening.

“I just don’t know if this is something that makes sense,” said Representative Collin Peterson, a Minnesota Democrat and chairman of the House Agriculture Committee, in a conference call with reporters.

“A kernel of wheat is a kernel of wheat,” said Peterson, whose committee oversees the CFTC. “Movies are very subjective.”

He said he had “significant questions about this whole idea.”

China Futures May Challenge U.S. as Busiest Market

China’s increased trading in equities from index futures will help the nation challenge the U.S. as the world’s busiest stock market, according to Guotai Junan Securities Co. and HSBC Jintrust Fund Management Co.

China will start trading of contracts based on the CSI 300 Index on April 16, tracking the 300 biggest stocks on the Shanghai and Shenzhen bourses, according to the China Financial Futures Exchange. The move may increase equity transaction volumes by 50 percent, Morgan Stanley predicted in January.

“It’s possible for China to surpass the U.S. in terms of trading volumes, and index futures trading is one positive factor that’s bolstering transactions,” Liang Jing, a Shanghai- based analyst at Guotai, the nation’s second-largest brokerage in terms of broking revenue, said yesterday. “China’s still a growth market, so we still have lots of derivatives to come and lots of good companies to be listed.”

China Securities Regulatory Commission Chairman Shang Fulin, said today at an event on index futures trading that the introduction will help institutional investors and provide a tool for managing risks.

Chinese equities have fallen in 2010 on concern tighter lending and a property crackdown will slow economic growth. The benchmark Shanghai Composite Index has dropped 3.9 percent, making it the world’s worst performing major stock market, after rallying 80 percent in 2009. The CSI 300 has lost 5.3 percent.

The nation’s first stock-index contracts, agreements to buy or sell the CSI 300 at a preset value on an agreed date, are designed to allow investors to bet on and profit from both gains and declines in the market.

No Short-Term Change

“I don’t expect any near-term, short-term changes in the overall volumes in the cash markets based on that,” said Paul Zubulake, senior analyst at Boston-based Aite Group LLC, who cover futures and options. “It’s still a government-controlled marketplace and you still have a currency situation that makes people a little concerned about entering that market from other places outside China. Any derivative market globally needs some feedback from outside the country.”

Some U.S. lawmakers want China to be labeled a “currency manipulator” for keeping the value of the yuan at about 6.8 to the dollar, which they say gives unfair advantage to Chinese exporters. The yuan’s exchange rate is not the cause of China’s trade imbalance with the U.S., China’s foreign ministry said this week.

Overtaking Japan

Shanghai overtook Tokyo as Asia’s biggest stock market by trading value last year. Only the Nasdaq stock market and the New York Stock Exchange have higher trading volumes than Shanghai.

About 120 billion yuan ($18 billion) of shares changed hands on a daily basis on the Shanghai Stock Exchange this year, compared with 140 billion yuan last year, according to data compiled by Bloomberg.

The daily average turnover of the Tokyo Stock Exchange is about $15 billion this year while that for the New York Stock Exchange is $27 billion, according to Bloomberg data.

“The impact in the medium to long term will be huge” said Rainer Riess, managing director of XETRA Market Development at Deutsche Boerse AG, in Shanghai today. “The interplay between derivatives and the cash market will lead to more efficient trading and price formation. Overall liquidity will vastly increase.”

China International Capital Corp., the top-ranked brokerage for China research in the annual survey by Asiamoney magazine, said last month that spot trading will increase, while the futures market has the potential to grow sevenfold over time based on the historical experience in South Korea and Taiwan.

Large Caps

Index futures and margin trading will increase demand for large-capitalization stocks and boost their valuations, according to China Galaxy Securities Co. Smaller companies on the CSI 500 have doubled the performance of their larger rivals over the past year, according to data compiled by Bloomberg.

The Shanghai and Shenzhen exchanges began trials for margin trading on March 31. Investors borrowed about 6.6 million yuan in cash and stocks from brokerages on the first day, the Shanghai Securities News reported.

“With more players on the futures market, they will build more positions on the spot market to influence futures,” Yan Ji, who helps oversee about $1.2 billion at HSBC Jintrust in Shanghai, said yesterday. “Blue chips are now at a valuation bottom and they may rise to a level you can’t imagine now.”

The Shanghai Composite’s retreat this year has sent valuations falling by 24 percent to 28.5 times reported earnings from last year’s high of 37.7 times in August, according to weekly data compiled by Bloomberg.

The first index futures contracts to trade will be for May, June, September and December, the China Financial Futures Exchange said last month. Investors must pay cash deposits equivalent to 15 percent of the contract value for May and June contracts and 18 percent for longer-term contracts. The contract values are points of the CSI 300 multiplied by 300 yuan, it said.

China has the world’s third largest stock market by market capitalization, briefly overtaking Tokyo in July 2009. New York is the biggest by market cap.