The International Money Market
The International Monetary Market (IMM) was introduced in December 1971 and formally implemented in May 1972, although its roots can be traced to the end of Bretton Woods through the 1971 Smithsonian Agreement and Nixon’s suspension of U.S. dollar’s convertibility to gold.
The IMM Exchange was formed as a separate division of the Chicago Mercantile Exchange, and as of 2009, was the second largest futures exchange in the world. The primary purpose of the IMM is to trade currency futures, a relatively new product previously studied by academics as a way to open a freely traded exchange market to facilitate trade among nations.
The first futures experimental contracts included trades against the U.S. dollar such as the British pound, Swiss franc, German deutschmark, Canadian dollar, Japanese yen, and in September 1974, the French franc. This list would later expand to include the Australian dollar, the euro, and emerging market currencies such as the Russian ruble, Brazilian real, Turkish lira, Hungarian forint, Polish zloty, Mexican peso, and South African rand. In 1992, the German deutschmark/Japanese yen pair was introduced as the first futures cross rate currency. But these early successes didn’t come without a price.
The Drawbacks of Currency Futures
The challenging aspects were how to connect values of IMM foreign exchange contracts to the interbank market—the dominant means of currency trading in the 1970s—and how to allow the IMM to be the free-floating exchange envisioned by academics. Clearing member firms were incorporated to act as arbitrageurs between banks and the IMM to facilitate orderly markets between bid and ask spreads. The Continental Bank of Chicago was later hired as a delivery agent for contracts. These successes bred an unforeseen level of competition for new futures products.
The Cboe Options Exchange competed and received the right to trade U.S. 30-year bond futures while the IMM secured the right to trade eurodollar contracts, a 90-day interest rate contract settled in cash rather than physical delivery. Eurodollars came to be known as the “eurocurrency market,” which is used mainly by the Organization of the Petroleum Exporting Countries (OPEC), which always required payment for oil in U.S. dollars. This cash settlement aspect would later pave the way for index futures such as world stock market indexes and the IMM Index. Cash settlement would also allow the IMM to later become known as a “cash market” because of its trade in short-term, interest-rate-sensitive instruments.
A System for Transactions
With new competition, a transaction system was desperately needed. The CME and Reuters Holdings created the Post Market Trade (PMT) to allow a global electronic automated transaction system to act as a single clearing entity and link the world’s financial centers like Tokyo and London. Today, PMT is known as Globex, which facilitates not only clearing but electronic trading for traders around the world. In 1975, U.S. T-bills were born and began trading on the IMM in January 1976. T-bill futures began trading in April 1986 with approval from the Commodities Futures Trading Commission (CFTC).
The Rise of the Forex Market
The real success would come in the mid 1980s when options began trading on currency futures. By 2003, foreign exchange trading had hit a notional value of $347.5 billion.
The 1990s were a period of explosive growth for the IMM due to three world events:
- Basel I in July 1988
The 12 nation European Central Bank governors agreed to standardize guidelines for banks. Bank capital had to be equal to 4% of assets. - Single European Act
This not only allowed capital to flow freely throughout national borders but also allowed all banks to incorporate in any EU nation. - Basel II
This is geared to control risk by preventing losses, the realization of which is still a work in progress.
A bank’s role is to channel funds from depositors to borrowers. With these news acts, depositors could be governments, governmental agencies, and multinational corporations. The role for banks in this new international arena exploded in order to meet the demands of financing capital requirements, new loan structures, and new interest rate structures such as overnight lending rates; increasingly, IMM was used for all finance needs.
Plus, a whole host of new trading instruments was introduced such as money market swaps to lock in or reduce borrowing costs, and swaps for arbitrage against futures or hedge risk. Currency swaps would not be introduced until the the 2000s.
Financial Crises and Liquidity
In financial crisis situations, central bankers must provide liquidity to stabilize markets because risk may trade at premiums to a bank’s target rates, called money rates, that central bankers can’t control. Central bankers then provide liquidity to banks that trade and control rates. These are called repo rates, and they are traded through the IMM. Repo markets allow participants to undertake rapid refinancing in the interbank market independent of credit limits to stabilize the system. A borrower pledges securitized assets such as stocks in exchange for cash to allow its operations to continue.
Asian Money Markets and the IMM
Asian money markets linked up with the IMM because Asian governments, banks, and businesses needed to facilitate business and trade in a faster way rather than borrowing U.S. dollar deposits from European banks. Asian banks, like European banks, were saddled with dollar-denominated deposits because all trades were dollar-denominated as a result of the U.S. dollar’s dominance.
So, extra trades were needed to facilitate trade in other currencies, particularly euros. Asia and the EU would go on to share not only an explosion of trade but also two of the most widely traded world currencies on the IMM. For this reason, the Japanese yen is quoted in U.S. dollars, while eurodollar futures are quoted based on the IMM Index, a function of the three-month LIBOR.
The IMM Index base of 100 is subtracted from the three-month LIBOR to ensure that bid prices are below the ask price. These are normal procedures used in other widely traded instruments on the IMM to ensure market stabilization.
The Bottom Line
As of June 2000, the IMM switched from a nonprofit to a profit, membership and shareholder-owned entity. It opens for trading at 8:20 a.m. Eastern Time to reflect major U.S. economic releases reported at 8:30 a.m. Banks, central bankers, multinational corporations, traders, speculators, and other institutions all use its various products to borrow, lend, trade, profit, finance, speculate, and hedge risks.
