Streetwise Professor

March 10, 2015

Chinese Chutzpah: Using IP to Ice Cotton Competition

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Regulation — The Professor @ 7:32 pm

China is notorious for flouting intellectual property rights. From stolen technology (including notably military gear) to designer knock-offs, China pirates everything and everyone. It is therefore a rather jaw-dropping act of chutzpah for to Chinese Zhengzhou Commodities Exchange to send a nasty cease-and-desist letter to the Singapore subsidiary of ICE demanding that ICE not copy ZCE’s cotton and sugar contracts:

Intercontinental Exchange has been forced to delay the launch of its new Singapore platform after a Chinese exchange threatened legal action to stop the US group launching two commodity futures that are copies of contracts offered in China.

The move by the Zhengzhou Commodity Exchange is likely to send shockwaves through the global futures industry because it signals that China will not tolerate foreign exchanges copying its futures contracts, and comes despite the practice of offering “lookalike” contracts being accepted around the world for years.

The ICE contracts are not copies, exactly. Similar to its “NYMEX lookalike” contracts, which cash settle against the expiring NYMEX future, the ICE Singapore commodity contracts are to be cash settled based on the settlement price of the expiring ZCE future. The ZCE future is delivery-settled. Meaning that the delivery mechanism ensures convergence between physical and futures prices, and the lookalike contract can ensure convergence by cash-settling against the delivery-settled contract.

The issues here are common to all intellectual property controversies. Strong intellectual property rights impede competition. Against that, free riding off the creativity or investment of others can impede innovation.

There isn’t a one-size-fits-all answer to this trade-off. In the case of exchange traded contracts, I tend to lean towards weak intellectual property rights.  The network effects of liquidity tend to weaken competition, and to give incumbents a strong advantage over entrants. There is already a substantial stream of rents to being first that gives strong (and maybe overly-strong) incentives to innovate, making strong intellectual property rights superfluous, and indeed damaging because they place another burden on already weak competition.

The US courts arrived at a similar conclusion, ruling that NYMEX did not have property rights over its settlement prices that it could use to preclude ICE from using them to cash settle its contracts. This is one factor that has encouraged a relatively robust competition in energy derivatives, which is the exception rather than the rule.

In sum, I hope ICE is able to prevail in its battle with ZCE. In part on economic grounds, and in part on the grounds that it burns me to see IP pirates protect their turf by asserting IP, especially over something for which IP is unwarranted.

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  1. Great column, Prof. The hypocrisy by the world’s most craven IP pirates is breathtaking, as you point out, but I had forgotten all about the NYMEX settlement price court case. Thanks for the reminder.

    Comment by Steve Holt — March 10, 2015 @ 8:31 pm

  2. Argus, Platts and Heren all have copyright for their “settlement prices”, but not patents, So the IP of settlment prices is limited in scope- [although today’s Blurred Lines verdict has put that into question]. You can build any OTC contract on a private settlment price service such as Platts or ZCE, but they cannot charge more than a subscription to there information service.

    SWP, what do you think of Nasdaq’s push into Energy futures? and direct competition with CME and ICE? 50% cut in fees will not be sufficent to re-direct flow IMO.

    Comment by Scott — March 11, 2015 @ 3:08 pm

  3. @Scott-I will write about the Nasdaq initiative when I get back to Houston. Short version: they don’t have a prayer.

    The ProfessorComment by The Professor — March 11, 2015 @ 5:28 pm

  4. […] predilection for control has manifested itself in futures markets in other ways. You might recall some months ago that I wrote about China’s threats against Singapore and ICE …. Yesterday ICE announced the contracts it will launch in Singapore, and cotton and sugar lookalikes […]

    Pingback by Streetwise Professor » The Future of Chinese Futures — September 9, 2015 @ 8:19 pm

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