SCALING UP FOR REBOUND?
Despite the dip in derivatives trading in 2012, trading technology suppliers are reinforcing their platforms to cope with an expected surge in volume. Dan Barnes reports.
Derivatives trading volumes fell year-on-year in 2012 following a lacklustre performance from underlying cash instruments. According to industry body the World Federation of Exchanges (WFE), primary equity markets recovered from their slump as global market capitalisation increased by 15% to reach US$54 trillion, a return to levels last seen in 2010.
This positive turn was not shared by secondary equity markets, which saw trading turnover on electronic order books (EOBs) fall by 22.5% globally from 2011 levels. By volume there were 9.7 bn trades, down 14.3% from 2011, while the average transaction size grew slightly from $8,100 to $8,300, possibly showing a move towards less automated trading. The number of derivative contracts traded on-exchange fell by 21%, the first fall since 2004.
Nevertheless, regulatory changes to the derivatives market, driven by the 2009 mandate of the G20, are intended to move as much of the over-the-counter (OTC) market onto electronic platforms as possible, while making OTC trading more expensive. Technology vendors expect that to drive electronic trading volumes back up, although the scale and speed of change is unpredictable.
“We are currently conducting a study that has confirmed that on the voice side of the broker-dealer business, the average size of a deal is around US$60 m,” says Mitch Stonehocker, director of the Front Arena platform at system supplier SunGard. “On the electronic side the average deal size is around $2m, but the total number of deals is vastly larger than on voice. It’s reasonable to conclude that the more electronic the market becomes, the higher the overall volume of trades. It is the same thing that happened in stocks.”
“There is a lot happening in the brokers’ space and it is not easy for them to understand what is going to be traded on exchange and what isn’t,” warns Emmanuel Carjat, managing director at connectivity provider TMX Atrium. “It’s very difficult for them to understand how much volume might go there; part of it is that the size of deals is extremely high. Looking back at equities five years ago the size of tickets were an order of magnitude larger than they are today. That fall is what has driven a lot of the increase in volume.”
Trading technology providers are setting themselves up to support clients in this new high volume world. The firms themselves may not have strategies that reflect trading at high speeds, but the increase in the speed of market data and price movements that high-frequency trading (HFT) firms generate, are a phenomenon that more sedate firms have to handle.
The drive to electronify the market is pushing traditional firms to adapt their operating models notes Jean-Philippe Malé, head of OTC at front-end technology provider TradingScreen. “Even people who didn’t used to trade electronically will have to get onto a platform like ours; people will be badly hurt if they don’t adapt to this new world,” he says.
David Little director, strategy and business development of software house Calypso notes that although his clients are far from the HFT end of the spectrum, including many tier two and three banks, they still need to keep up with the new market conditions.
“We are improving our low-latency capabilities to allow the processing of a large number of trades hitting the system at once and having the positions, risk matrix and P&L displays in near real time,” he says. “It’s far from algorithmic trading but it allows human traders to trade with confidence knowing their prices are up to date and the risk is getting calculated in near time.”
Traders must be able assess risk and determine profitability, react quickly to changes in market prices in order to manage portfolios and mitigate their market risk, and perhaps lock in profitability. That requires fast position updates, and measures of risk or P&L even if they are not using algorithmic trading tools.
“Our graphical user interface has to have some of the flexibility reduced in order to allow a faster appraisal of the data; you don’t want thousands of columns in the grid,” says Little. “Those screens can still be accessed for tasks where they are useful, doing reporting for example, but a trading screen is designed to be fast and complements the slower reporting screens that you can use for offline slicing and dicing.”
The trading of instruments such as swap-future products has required some additional work for system providers. These contracts have long-standing precedents at NYSE and ERIS Exchange, but CME and IntercontinentalExchange (ICE) launched new versions at the end of 2012, which provide firms with a way of getting swap-like exposure without subjecting them to the Dodd-Frank rules on swap trading, clearing and processing.
Malé asserts that TradingScreen has a very flexible system that has allowed it to adapt to these new products quickly. “Our platform was built in the early 2000s by removing all concept of an asset class from the core system; it can trade tables and chairs if we want,” he says. “We can create custom instruments with custom trading rules; for example with CME and ERIS Exchange we can trade interest rate, future-like contracts with very custom cash flows. We had a few weeks of work on our side to accommodate swaps of various types. We have done all of that and those changes are already being integrated with some of the customers.
Unlike some standard trading tools we do a lot of integration with our customers in the back office, middle office and with risk. That’s not purely for trading purposes; it’s for position tracking, for risk, to handle workflow so it is a lot more complicated than the trading part.”
The end result
By trading futures contracts with fixed tenors, firms lose out on the flexibility of trading a swap; they are also committed to trading and clearing with the exchange operator that has issued the future. Dealing with multiple venues is pushing trading technologists to adapt their platforms further.
“Software can’t be optimised for one exchange anymore,” says Mike Glista, director of order routing at trading technology provider CQG. “We’ve been continuing optimising our systems to operate with certain hardware and trying to figure out what actually occurs at different exchanges. For example at one exchange we are dealing with it is better to do a cancel/new order than to run a cancel/replace. There is a lot of tuning to the particular matching engines for the higher speed trader.”
Having a greater amount of choice also complicates the workflows that the trading systems have to provide processing for says Steve Grob, director of group strategy at platform supplier Fidessa. “At the front end you need to know how a euro swap will be traded alongside a bund on Eurex. Then that throws up issues around where you clear,” he notes. “Dependent upon your relationships with different clearing houses you may want to go down one path and not another. The concept is emerging that you might have the best price as one part of your calculation and then the optimal destination as another, when you take into account any potential risk or margin offset. That is a big part of the way the new workflow will look like.”
To reflect this, the software vendors are giving people the tools to make those decisions, with a timely level of information and the flexibility to choose a path for execution.
“It comes down to being able to put all of these instruments in one place, and make your own decisions about their equivalence or otherwise,” says Grob. “Different firms have different views on how well one instrument could offset another. People will need the kind of intelligent tools to trade in and amongst different venues that we developed when multi-market structures emerged in the US and Europe, basically a combination of smarter order routing, algos and analytics. That becomes much more important as the number of destinations and venues grows, becoming more complicated and intertwined.”