Despite major gains in the efficiency of futures markets over the last 20 years, a panel of industry leaders say fragmented regulation stands in the way of further efficiency.
At a panel discussion on the outlook for trading efficiency at FIA’s International Derivatives Expo in London on 19 June, five industry leaders stressed the challenges created by ever-changing regulations but also discussed how the twin forces of competition and cooperation drive improvements in how orders are executed.
Call for simplification
The growth of regulation was a common concern across the panel. Nick Garrow, chief revenue officer of Trading Technologies, one of the industry's top software vendors, noted that when TT was just starting out, the company focused most of its budget on new trading capabilities and functionality. Now that the company supports 7,500-8000 users, it must focus more resources on keeping up with the huge volume of ongoing regulatory changes.
That chimed with the findings of an industry survey released by FIA during the IDX conference. The survey, which was conducted by market intelligence firm Acuiti in partnership with FIA, found broad consensus among market participants in Europe that the combined impact of multiple sets of regulations has created a major burden for the industry.
Nikoletta Chelakidi, head of regulatory strategy at Eurex, Europe's largest derivatives exchange, called for greater harmonisation and simplification of some rules to address this issue. “We need to remove certain redundancies, we need to better prioritise and align the timelines on the regulatory level and also on the industry level,” she said.
Europe is far from alone, however. Mark Pinckers, trading manager at Flow Traders, a leading principal trading firm, noted that in Asia, most markets remain domestically focused and regulation is fragmented at the regional level. “If you want to do a trade in Japan versus China, good luck. It’s a completely different world,” he said.
Europe is more harmonised, but even in Europe, a transaction between two European players can suddenly become complicated if one sub-client turns out to be American, said Mike du Plessis, global head of listed derivatives at Liquidnet, the agency brokerage arm of TP ICAP. “And then you’ve got the interplay of a set of US rules over the top of European rules, and that is complexity cubed.” From a practical point of view, that creates a need for technology solutions that can handle the interplay of regulations across jurisdictions, he added.
Nor does having both parties in the same market necessarily resolve every regulatory quandary, Garrow said. “The tricky bit is you can be talking with two FCMs [futures commission merchants] with exactly the same rule or regulation in front of them, but you can have two different interpretations or prioritisations in terms of what they want us to do as well."
And more regulation may be coming. Garrow warned that the use of algorithmic trading tools could be one of the next targets. “There’s going to be a lot more scrutiny around how people are selecting algos, which algos are performing better versus other algos, and I think there’s going to be a lot of focus on the regulators over the coming years around how that process is actually working,” Garrow said.
Competition, innovation and efficiency
During the discussion at IDX, the audience was polled on what factors might help speed things up. The audience ranked standardisation, competition, and computing power as the top drivers of efficiency in the market.
Technology generally has had a profound impact on efficiency, argued Garrow, who said he thought “it had been and will continue to be one of the biggest drivers of game-changes in the industry.”
Looking ahead, Garrow put in a vote for artificial intelligence and the availability of “more brutal processing power to do complex risk management scenarios and risk testing, stress testing, [vulnerability assessment] testing, and a whole range of other things as well,” he said.
Christian Voigt, head of markets at Broadridge Financial Solutions, a leading provider of software for trading and connectivity, voted for competition. “We all have competitors we need to outperform. We need to justify why customers should come to us and not to others. And we constantly learn, we constantly readjust. All of this is, in my mind, the fundamental driver that keeps delivering efficiency increases.”
Gordon Ball, head of futures electronic trading, EMEA, at Citigroup Global Markets, added that competition among exchanges can lead to greater innovation, but there is a trade-off in terms of efficiency.
He contrasted the situation in the cash equity markets, where there is intense competition among many trading venues, with the situation in the futures markets, where typically one exchange has a dominant share of the market for a particular contract. That consolidates liquidity in one place, which makes trading more efficient, whereas in equities, liquidity is fragmented across many venues.
“If you look at the rich and complex set of order types that have developed in the same 20-year period in equities – trade at last, periodic auctions, speed bumps – the competition between exchanges has driven innovation," Ball said. "In futures, the non-fungibility of contracts has hindered this sort of competition, which is a downside. Then again, it makes it easier and more efficient when everything is on screen and in one venue – no smart order routers or liquidity aggregator technology required.”
Cooperation also key
Ball added that the industry’s capacity to cooperate also plays a role in driving greater efficiency. “I think a great feature of the futures market is that we are able to recognise where we need to work together and come up with standard solutions,” he said.
The development and rollout of the FIX protocol, for instance, depended on cooperation rather than competition. The FIX protocol was developed in the 1990s and has become the de facto messaging standard for pre-trade and trade communication across a wide range of exchange-traded markets.
“I can’t imagine a world where we couldn’t send orders to each other, but luckily, FIX was developed as a non-profit organisation," said Ball. "It’s a free-to-use standard. If FIX had been patented, how would the world have turned out?”
Another case in point suggested by Chelakidi: self-match prevention, a risk control that prevents one trading desk at a firm from accidentally trading with another desk at the same firm.
Several major futures and options exchanges have built this control into their matching engines, making it easier for trading firms to comply with rules that prohibit wash trades. She added that the industry can and should move towards a similar solution across the exchanges while recognising that there will be nuances specific to each market.
Pinckers agreed. “I think self-match prevention is a great example of a feature that we very much appreciate,” he said.
