Wednesday, 1 October 2014
Last updated 54 min ago
Jan 14 2010 | 6:43am ET
By Andy Nybo -- The futures markets have clearly experienced a number of ups-and-downs during the past two years. Elevated volatility has changed, hopefully for the long term, how traders view risk and reward.
Traders have learned that they need to more actively manage risk exposure and they tell TABB Group, which recently published a benchmark industry study, Trends in US Futures Trading: The Buy-Side Perspective, that they are taking the necessary steps to better manage exposures and activities in the new market environment.
The combination of stricter risk controls across the brokerage industry and closure of hedge and proprietary trading funds were key factors behind a 23% volume decline in 2009. However, based on a TABB Group projection, US futures trading is forecast to surge 14% in 2010 as interest rate volume recovers.
The volatility and related upheaval had a dramatic impact on the makeup of the futures trading industry. More than 2,000 hedge funds, CTAs and proprietary trading firms are no longer in business, as volatile market conditions and a greater focus on minimizing risk exposures across the industry eliminated a significant source of liquidity. These accounts may resurface and come back to ply their strategies in the futures market of tomorrow; however, the increased regulatory focus on eliminating wanton speculation means that many leveraged strategies will not survive.
The specter of a new market structure is also plausible as regulatory and legislative efforts to make derivatives markets more transparent – and less risky – will drive much of current over-the-counter (OTC) derivatives activity into exchange-sponsored clearing solutions. At the same time, the exchanges will be trying to influence derivatives traders to replicate OTC strategies through the use of listed instruments in an effort to gain market share.
True, the bad news is that volume’s down, but there is plenty of good news ahead. Trading activity is beginning to stabilize, with pockets of strength in core asset classes such as energy, commodities and foreign exchange. As trading volume returns, rising open interest indicates that participants are using futures for ‘longer term’ risk management and commercial strategies.
The market is also beginning to see the inklings of fragmentation, as both new and existing exchanges focus on introducing new venues in an effort to wrest market share away from the CME. These efforts are just beginning to evolve and although they face significant hurdles, the stars may finally be aligning to allow their activities to see some success.
The role of technology cannot be underestimated, especially in a marketplace which has slowly but surely embraced a low-touch trading environment. Technology is increasingly becoming a delineating factor among FCMs and buy-side traders are seeking to leverage best of breed solutions to automate their trading. The battle for future order flow will revolve around the provision of sophisticated tools to manage execution, as well as post-trade clearing and settlement requirements. After all, minimizing risk has become the name of the game and who better to facilitate that effort than the FCMs that are integral to futures traders across each and every firm.
High-frequency trading (HFT) strategies in the futures markets are destined to play an even greater role in the futures market of tomorrow. Low latency strategies relying on co-location and optimized technology infrastructures play a large and growing role in the futures markets but the current market structure has mitigated their impact. Exchange competition, fragmentation and especially fungibility are the keys that will invigorate a entirely new class of futures traders.
The data we used in the study was based on one-to-one, lengthy conversations with 54 US futures traders at a range of asset managers, commodity trading advisors and hedge funds utilizing a broad variety of futures trading strategies. The interviews were supplemented with data collected through conversations with futures exchanges, futures commission merchants, institutional broker futures trading desks and futures trading system vendors. The firms participating in this study have more than $2.1 trillion in assets under management and in aggregate trade an average of 200,000 contracts on a daily basis.
The discussions covered a wide range of topics including the lingering effects of the credit crisis and how the marketplace has changed over the past year, challenges they face in sourcing liquidity, the types of tools and systems they use across the trading process, and how they view the evolving market structure. Discussions also delved into prospects for the futures industry, including the possibility of fragmentation among new and existing execution venues, as well as the drivers behind future growth. We also discussed factors influencing the selection of futures commission merchants, the types of execution management systems they used, needed improvements to these tools and the factors dictating the selection of low- and high-touch execution channels.
The futures market is on the verge of a structural shift, as the combination of technology, the changing regulatory environment and resurgence in risk management practices will drive market participants to reevaluate current market practices. The drive to move OTC instruments on to exchanges is a key factor behind this shift, and the industry will be keeping a close eye on Washington to see what legislation ultimately becomes final.
Andy Nybo, principal and head of TABB Group's Derivatives practice, has more than 20 years of experience in research and technology applications in the global capital markets. He has been with TABB Group since August 2006 and currently focuses his research efforts on OTC and listed-equity derivatives markets, examining how technology is playing an increasingly integral role on both buy-side and sell-side desktops. Prior to joining TABB Group, he was the head of marketing and communications at MarketAxess Corporation; a senior analyst with TowerGroup; and vice president and director of research at The Bond Market Association.
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