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TABLE OF CONTENTS

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EDITORIAL

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From the editors of:

Derivatives Intelligence

DEAR READER,

Electronic trading and its growth potential are nothing new. But there is the real sense in the derivatives market that we’re reaching a tipping point after which the traditional bespoke, phone-based service will become rarer and rarer. Advances in trading technology and basic speed, the downward pressure on fees and the inexorable drive by regulators to make derivatives trading more open and centralized are all driving the phenomenon.

With that in mind, the Derivatives Week/Derivatives Intelligence’s special supplement you have in your hands on electronic trading is aimed at delving deeper into all the key facets of the movement. Our Hong Kong, London and New York reporting team has taken the pulse from top traders on issues such as high-frequency trading, scoped the sellsides’ push on platforms and bottom lined regulatory developments in the U.S. under the Dodd-Frank Act and in Europe via its directives. We’ve also included detailed Q&A’s with key industry players.

We hope you value and enjoy the supplement.

If you have any feedback, don’t hesitate to drop me a line.

Robert McGlinchey, Managing [email protected]

FIX Implementation Takes Center StageRob McGlinchey, DI

The Financial Information eXchange Protocol is set to play a key role in fixed income trading. The industry is just trying figure out how exactly.

Lack Of Clarity On Pre-Trade Transparency VexesMike Kentz, DI

A number of thorny U.S. regulatory issues are outstanding with regards to swap execution facilities. Some see the market as being held back as a result.

Asia Embraces Electronic InnovationDan O’Leary, DI

Sellsiders and investors have been driving rapid Asia market penetration. Costs are falling for users as a result and firms are looking for twists to stay ahead of the competition.

U.S. Firms Bulk Up, Focus On NichesKevin Dugan, DI

The U.S. appears poised for a spurt of platforms. There has been a somewhat targeted approach so far, but that may be about to change.

Potting The Path To Real Time TCARob McGlinchey, DI

Transaction cost analysis is seen as ripe for a move into real time. That’s going to cut trading costs and alter strategies.

Platforms Expand As Regs Draw NearerBeth Shah, DI

Some players have been taking the plunge and forming multi-dealer platforms ahead of regulations being set. There are still challenges for them.

Futures On The RiseMatt Simon, TABB Group

The futures market is recording swelling volumes. Electronic trading is among the factors behind the prediction it is going to eat even more into OTC.

Q&A: WMBAA’s Chris Ferreri

84

10 14

17

23

15

21

Q&A: FIA EPTA’s Remco Lenterman31CFTC Rules On Swap Entity Registration

David Felsenthal, partner, Gareth Old, partner, David Yeres, counsel, and Inna Zaychik, associate at Clifford Chance in New York map out the shape of current CFTC rulemaking.

26

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MARCH 2012 | www.DeRivAtivesintelligenCe.CoM ELECTRONIC TRADING REPORT ELECTRONIC TRADING REPORT MARCH 2012 | www.DeRivAtivesintelligenCe.CoM

(Continued on page 6)

The request-for-quote system of trading an over-the-counter derivative allows end users to customize a trade

and find out which dealer will give the best price without any other entities knowing their identity or desired trade. Most market participants consider the system vital to the health of the OTC market. Dodd-Frank’s call for pre-trade transparency and the coming creation and use of swap execution facilities is running the risk of dismantling that system.

The CFTC and the SEC have been tasked with defining swap

execution facility and how it will function. They differ widely

when it comes to the format for RFQs.

The CFTC has published a proposal which says end users

placing an RFQ will have to post each request to five different

dealers every time. The SEC has proposed RFQs will only be

required to be posted to one dealer at a time. The CFTC’s

rules will apply to index-based credit default swaps and

interest rate swaps while the SEC’s rules will apply to single-

name CDS.

Another layer to this regulatory disparity is the pace and

form with which each Commission is attacking the rules. The

CFTC has finalized over 25 rules to the SEC’s two to this point,

according to their website, with market participants largely

split between supporting the ‘Slow and steady’

SEC and the ‘Let’s get going’ CFTC.

“The Commission and staff are working hard

to adopt effective rules as quickly as possible,

with an emphasis on getting the rules right,”

said an SEC spokesman.

“The CFTC’s on a quicker track and on the

whole we think that’s a good thing,” said Jim Rucker, chief credit and risk officer at MarketAxess in New York, a planned SEF for both index and single name CDS. “There’s considerable uncertainty, [and that] makes it difficult to make business decisions to introduce the changes that we eventually will need to.”

Regardless of the time frame, large institutions like BlackRock and MetLife are crying foul, saying that the CFTC five-dealer requirement will lead to banks front-running their trades. “SEFs should be allowed to structure their RFQ platforms on whatever basis the SEF believes will serve its clients’ interests, whether one-to-one or one–to-five,” wrote Joanne Medero and Richard Prager of BlackRock in a comment letter back in June.

“The requirement that participants solicit bids and offers from at least five swap dealers would not only fail to meaningfully increase price discovery, but would likely diminish it, particularly in markets with a limited number of market makers,” wrote Todd Lurie of MetLife.

But it wouldn’t be a debate without a flip side. Dodd-Frank wasn’t written to protect the incumbency of big banks and large institutions. It was written to safeguard the market and increase competition, meaning smaller players get to see the same prices bigger players do (via a SEF).

“[A] system that permits request for quotes from only one market participant would facilitate abusive trading practices such as prearranged trading and ‘painting the screen,’” wrote James Cawley, co-founder of the Swaps and Derivatives Markets Association and head of planned SEF Javelin Capital Markets, in a comment letter. Painting the screen means posting inaccurate prices for personal gain.

With this type of pressure coming from all angles, it’s no wonder the regulators appear to be buckling under the pressure. In late February, the CFTC delayed a final vote on the definition of the term ‘swap dealer’ because the SEC wasn’t ready, according to reports. One market participant said he has had separate conversations with high-ranking officials at both Commissions where the officials blamed their counterparts for the slow pace of rule implementation.

When the regulators do get to a final vote on SEFs, which will

Jim Rucker

Lack Of Clarity On Pre-Trade Transparency Vexes

Differences in opinion between the Securities and Exchange Commission and the Commodity Futures Trading Commission regarding the nature of swap execution facilities are slowing the

pace of regulations and drawing the ire of market participants. Mike Kentz explains.

SponSored Article

Expanding Your Global Trading Reach

Jeff Ferro

Emerging and frontier markets offer compelling opportunities, but local presence

remains key to efficient trade execution.

An interview with HSBC Securities’ Jeff Ferro, Vice President, Customized Execution Services. Americas.

Q: What are the growth prospects for emerging and frontier market trading? Given the remarkable economic development in emerging and frontier markets, it is little surprise that these countries have continued to play a steadily expanding role in U.S. portfolios. Since 2001, domestic exposure in U.S. investor equity holdings has declined from 90% to 79%. During the same period, exposure to developed foreign markets has nearly doubled from 9% to 17%, and exposure to emerging and frontier markets has grown from less than 1% to just under 5%. However, even after this historic increase, the level of U.S. investor emerging and frontier market equity exposure still remains well below the MSCI All Country World Index’s 14% benchmark weight. We think this suggests incredible growth prospects in the years ahead as allocations to these countries continue to rise.

Q: What is the breadth of your global access? Our sophisticated network offers Programtrading execution in 77 countries across6 continents, Direct Market Access in43 different countries and a full suite ofglobal Algorithms that automates specific strategies for quality execution and consistency of intended results across 36 of those countries.

Q: How does HSBC help traders access these markets? As U.S. buy-side traders have become more interested and skilled with global developed and emerging markets, they have understandably wanted to take greater control of their trades in these regions. HSBC has responded by offering its trading system to support these clients with the same industry-leading technology and worldwide infrastructure used by our in-house trading desks and investment professionals. Clients also gain access to the extensive insights and consultation of our Customized Execution Services team to help navigate these markets without having to change trading style, with 24-hour support from professionals across the Americas, Europe, the Middle East and Asia.

Q: How important is strong local presence in efficient trade execution? We think it is critical and have structured our platform with major trading hubs in Hong Kong, London, New York and Dubai, each with an extensive network of corresponding on-the-ground spokes into the surrounding regions. There are three primary risks to consider in terms of execution efficiency. The first is information leakage. HSBC is one of the largest owners of local exchange memberships, which substantially reduces reliance on subcontracting trade execution, particularly compared to systems with less direct global scope. We are also one of the largest sub-custodians in terms of presence

across various international markets. Both factors provide a distinct competitive advantage in helping to maintain trading anonymity.

The second risk involves market microstructure. Exchange access rules and local execution nuances can vary greatly in each market, and it is crucial to understand if an order might interact in a way that could risk execution quality. That is why our team continuously monitors each client trade to offer an additional checkpoint as orders are executed. When it comes to emerging and frontier market trading, it isn’t just about access; it’s about providing intelligent access that applies our expertise in local country knowledge to help our clients secure the most efficient trade execution possible. The third risk entails trade consistency across countries. The true power in HSBC’s trading system is that it centralizes our expansive regional insights across developed and emerging economies into a single platform that quite literally puts the world at our clients’ fingertips. This empowers them to concentrate on strategy and performance, while we focus on quality of execution, settlement and reporting, including trade transparency, counterparty controls, best execution checks, market anomaly detection, and pre- and post-trade analytics, all backed by the significant capitalization and stability of one of the most trusted names in global banking.

Contact information:

CES Americas: Leon McIntyre, Head of CES Americas (212) 525 3334

Jeff Ferro, Algorithmic and DMA Sales (212) 525 2430

Email: [email protected]

CES Asia: Gerry Pablo, Head of CES Asia 852-2822-3821


CES EMEA: Simon Cornwell, Head of CES EMEA 4420 7991 5616


Global Toll Free: 855 HSBC-24-7 (855 472 2247)



(Continued from page 4)

n Dodd-Frank says that all trades “made available for trading” need to be listed on SEFs. The definition of that term has sparked debate.

n Most SEFs and inter-dealer brokers believe that if a trade is clearable then it is ultimately tradable. Dodd-Frank lays out a five-factor test for clearable trades. If a trade passes that test, SEFs should be able to list it, they say.

n “If you get the rules right on the clearing mandate, then the trading mandate should just follow. SEFs will only work if the clearing mandate doesn’t get spread too broadly. [We believe that] the mandate [for available for trading] in Dodd-Frank was not meant to be an entire other definition.”– Jim Rucker, chief credit and risk officer, MarketAxess.

n The International Swaps and Derivatives Association, representing the dealers, believes the regulators should lay out a separate test for the term. Their fear is that SEFs will list illiquid

swaps if they are given carte blanche, so to speak, and damage liquidity in those markets as a result.

n “SEFs…have an economic incentive to designate as many swaps as “available to trade” as possible, and to do so as soon as possible in order to acquire market share in trading those swaps. Accordingly, there is an inherent conflict of interest between the profit incentive of SEFs/DCMs to have as many swaps as possible required to be traded on their platforms and whether there is actual benefit to the market of requiring a swap to be traded on a SEF/DCM.” – Robert Pickel, ceo at ISDA, in conjunction with two other industry trade groups.

n The CFTC followed dealer concerns and proposed an eight-factor test.

i. Whether there are ready and willing buyers and sellers;

ii. The frequency or size of transaction on SEFs,

DCMs or bilateral transactions;

iii. The trading volume on SEFs, DCMs or of bilateral transactions;

iv. The number and types of market participants;

v. The bid/ask spread;

vi. The usual number of resting firm or indicative bids and offers; or

vii. Whether a SEF’s trading system or platform or a DCM’s trading facility will support trading in the swap;

n A compromise exists. “In our opinion, there should be a one-year transition period where SEFs provide execution on products that are already traded on electronic platforms. Then we can use the previous twelve months to create a data set to figure out if any swaps should be added or subtracted from the ‘available for trading’ definition.” - Jon Williams, head of U.S. markets at Tradeweb.

‘Available For Trading’ Calls Out For Clarity Too

be in April at the earliest, the question with respect to RFQs is what rule will both protect a customer trading illiquid swaps while also guaranteeing pre-trade price transparency and increased competition.

Javelin, for one, plans to offer anonymous RFQ and anonymous request-for-market options. Anonymous RFQ means the customer puts in a request for pricing on a customized trade but does not include its name. Anonymous request-for-market means the customer withholds both name and the direction of the trade. That means the customer asks for both sides of a particular trade, including the size, but without the name. That way, conceptually, there will be no clear opportunity for front-running and less risk of ‘painting the screen.’

Rucker at MarketAxess said his firm was “working on facilitating things to make that happen, but we’re not

ready,” adding that the firm would wait for more regulatory clarity. Tradeweb, a provider of multi-dealer credit default swap and interest rate swap execution and another planned SEF, “is not currently planning” to offer ARFQ or ARFM. The reason, they said, is that their clients have not asked for that functionality and they would wait until it became a regulatory requirement before taking such steps.

TeraExchange, which is planning to execute all CDS and

IRS, is “bypassing [the] RFQ model and rolling out a fully anonymous central limit order book” for non-block trades, said Christian Martin, ceo at the firm in Summit, N.J. Bloomberg’s AllQ platform for index-based CDS and IRS will “adapt the platform to the SEF protocols once they have been finalized.” Ben MacDonald, global head of fixed income

trading, products, and services at Bloomberg in

New York, added the firm views the five-dealer

requirement as “problematic.”

As for the SEC, whose low public profile

to this point has unnerved some market

participants, the market will wait to see if their ‘one-to-one’

SEF trading requirement changes either. Officials familiar

with the regulatory discussions said the SEC is satisfied with

its approach and that the one-to-one requirement doesn’t preclude or require the use of ARFQ or ARFM, though a spokesman declined comment.

Lost in the shuffle of all this lobbying is the concept that many OTC market participants may begin to exit the stage left to populate the futures market no matter what. SEFs, regardless of a buyer’s ability to cloak its name and trade direction in an RFQ, may struggle with the ability to confirm trades in real-time considering each customer will have the choice as to which clearinghouse they use. That concept of vertical integration is something the futures market can still boast. n

Ben MacDonald

Christian Martin

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CM

MY

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CMY

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CDSToolbox_II_2Q12.pdf 1 3/6/2012 9:52:35 AM



The emergence of new trading venues, such as swap execution facilities and organized trading facilities,

on the back of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act and the proposed update to the E.U. Markets in Financial Instruments Directive, have reinforced the need to promote the increased use of Financial Information eXchange Protocol, the global language used by firms to facilitate electronic trading. Already the standard language in markets such as the equity markets, the need to promote FIX for credit default swaps and interest rate swaps has grown in importance as such instruments are increasingly becoming fast tracked to electronic trading.

“SEFs are going to be a new concept as part of Dodd-Frank. Today, you have existing platforms and some support CDS and IRS,” said Lisa Taikitsadaporn, chair of the FPL Global Fixed Income Technical Subcommittee and managing partner at Brook Path Partners. “The challenges the banks are facing with these platforms is that the interfaces to these platforms are in proprietary formats. So with this initiative, the banks are encouraging the SEFs to move away from only offering proprietary formats, they are saying that they want to use FIX.”

“It’s very important we start to look at different paradigms and it has been clear that we needed to aim at a world of hyper connectivity where if you really want to communicate, that it’s not only about the broker and trader on the phone, but it is going to be increasingly about electronic systems that can talk to each other,” said Francesco Cicero, head of eTrading at GFI Group. “To talk to each other they need to talk the same language. So it goes without saying that any initiative facilitating that transition was welcomed by us.”

Some of the trading venues already operating offer FIX connectivity for IRS and CDS, however more venues are expected to emerge after MiFID II and Dodd Frank implementation. Other venues typically offer so-called proprietary application programming interfaces for sellside firms to connect to. The interfaces can typically be time

consuming to support and lead to increased costs for the sellside.

Yann L’Huillier, cio at Tradition, which already offers FIX, noted that developing proprietary protocols are a step in the wrong direction. “If everyone came up with a proprietary protocol, then it isn’t standard at all,” he said. “Today, what you have, if

you look at the financial markets as a whole, is the FIX Protocol everywhere. If you look at equity, for example, FIX is the standard. Why would we invent a different set of connectivity when people are trying to reduce the costs and issues with connectivity with FIX Protocol?”

According to market participants, by adopting FIX, new and existing venues will reduce costs for the market by minimising the costs of market entry and reducing switching costs. With the completion of the project, firms will also be

FIX Implementation Takes Center Stage

Last June, 12 investment banks, supported by FIX Protocol, came together to launch the Fixed Income Connectivity Working Group to promote the increased use of FIX

when trading fixed income products. Rob McGlinchey looks at how the project has been developing and what efforts trading venues are making to implement FIX.

FICWG ExTEnDS To CASH BonDS

The Fixed Income Connectivity Working Group is to promote standardized protocols for the electronic trading of cash bonds in 2012.

The scope of the initiative includes standardization of protocols for pricing and trading government bonds, such as U.S. Treasuries, eurozone government bonds and gilts, as well as sovereigns, corporates, high yield and emerging markets.

“This initiative will increase transparency and efficiency in fixed income OTC markets by promoting greater technical standardization and openness across the industry,” said neil Chinai, head of global rates and emerging markets technology at Barclays Capital. “Among

market participants, the initiative will provide a more cost efficient and

faster integration process, which is a key requirement in today’s rapidly

changing environment.”

Francesco Cicero

Yann L’Huillier

MARCH 2012 | www.DeRivAtivesintelligenCe.CoM ELECTRONIC TRADING REPORT



able to speed up their integration with SEFs and OTFs.

The FPL Global Fixed Income Technical Subcommittee, which is part of the Global Fixed Income Committee, has established best practices documents for applying FIX in CDS and IRS. “We took the base FIX standard out there and we took a look at how it can be applied to the work flows and the nuances of trading CDS and IRS, and then established the recommended ways of using the FIX messages across these products between the venues and the banks,” added Taikitsadaporn.

Trading venues are now looking at implementing FIX across CDS and IRS. Market participants note that the implementation process will take time as both the trading venue and the end client would need to introduce changes. These could also entail thorough testing and possibly operational upgrades.

GFI, for example, is working on adapting its APIs to make them compliant with best practices and then release them to clients. “It will take some time to implement all of the recommendations, but with the extra push generated by

Dodd-Frank and MiFID in Europe, at this point in time is when a lot of banks are deciding how to connect and who to connect to, so it’s all coming to fruition now,” said Cicero. “It will keep evolving as we introduce more products and sub-asset classes, but it is definitely going in the right direction.”

BGC Partners is another firm working on implementing FIX in CDS and IRS, and already offers FIX in U.S. Treasuries. The next focus, however, for the firm is working with the industry to apply FIX to fx options.

“BGC has been a strong proponent for the inclusion of fx options into the work streams for CDS and IRS being managed concurrently by the FIX Working Groups. FIX is a standard already widely in place for fx, so fx options require only slight tweaking to add the required FIX fields and to deploy them dynamically, such as trading vols instead of a price and adding deposit rates to the legs,” said Borys Harmaty, head of integration services at BGC Partners in New York. “FIX is now used much less in CDS and IRS and therefore it is much more of a community effort to agree on best practices which is well underway for the benefit of all.” n

Market participants took issue with

some of the proposed rules from the

European Commission in the updated

Markets in Financial Instruments

Directive, particularly around pre trade

transparency, at the FIX Protocol EMEA

Trading Conference in London on March

13. They said some of the proposed rules

could be detrimental to the way the

market operates.

Denzil Jenkins, head of compliance

and regulation at the London Stock

Exchange, said on the regulation panel

that the proposed requirement to inform

the European Securities and Markets

Authority in advance to utilize a waiver

was of particular concern. “When you look

at the requirement of pre-trade waivers,

it is a requirement that the use of pre-

trade transparency waivers will potentially

have to go through a process of where if

anyone in the industry wants to utilize

one of those waivers, they are going to

have to inform ESMA at least six months in

advance,” he said. “That is not going to be

beneficial to innovation.”

“One of the surprises around the draft

was that they took so long and they got

so much of it wrong,” noted Stephen

McGoldrick, co-chair of the FPL EMEA

Regulatory subcommittee and director in

market structure at Deutsche Bank. “There

is lots of good stuff, but there are some

things that display a fundamental lack of

understanding over how the market works.”

McGoldrick highlighted one example

where he took a senior policy officer

around Deutsche Bank’s trading floors to

show the differences between the equity

and fixed income markets. The realization,

from the policy officer, was that regulation

for pre-trade transparency that works in

an equity market cannot be presumed to

work in fixed income.

Separately, panelists noted they were

increasing becoming worried over the

ability of ESMA to establish policy and

technical standards for regulation due to

budgetary constraints and a lack of staff

and expertise. Concerns have increased

given the amount of projects the pan-

European regulator is dealing with to meet

G20 deadlines.

“I fear that ESMA whilst I agree there

is a lot to be applied…has not got the

staff and the resources or the insight

to legislate some of the things that

are being delegated to it. Some of the

things that have been passed to ESMA

are so fundamental that they relate to

policy, they don’t relate to technical

implementation,” said McGoldrick. “I

think the industry increasingly stands

ready to help the regulator adopt or

develop standards to implement agreed

direction. But a lot of what is coming

down to ESMA is not agreed direction; it’s

about collaboration of things such as pre-

trade transparency waivers and the rules

surrounding those. How those ESMA rules

fall out will actually define the policy.”

InDuSTRY STRIkES ouT AT uPDATED MIFID PRE-TRADE RuLES



Asia Embraces Electronic Innovation

S ingle-dealer electronic trading platforms have become

the new world order. They are tools that aim to

reduce costs and increase efficiency for clients. Platforms

offering derivatives trading have been operating in Asia

for around nine years, with Barclays Capital’s BARX,

the Royal Bank of Scotland’s Marketplace and uBS’

Equity Investor amongst the platforms currently offered

locally. During the last year, firms have been aggressively

expanding their e-trading teams and product offerings on

these platforms.

At the same time, Asian investors have been increasingly

flocking to platforms and dealers are increasingly

recognizing the growing potential and suitability for such

platforms in the region. What makes Asia so prime for the

development of electronic trading platforms is that they

give greater diversity to an investor base already at home

with a fragmented market. Jump in an airplane and fly an hour in any direction from Singapore and you can find

yourself in a completely different world with different

products and systems of law and governance.

“The fact that a client now is able to have access to

various markets and various exchanges and facilitate

both inbound and outbound business, in addition

to their domestic market, makes it even more

compelling,” says Leanna Raja, head of South Asia

sales for Barclays Capital’s BARX platform in Singapore.

“Yes, [fragmentation] is an obstacle, but it’s also an

opportunity,” she said. Some emerging markets in Asia

present a challenge, due to the lack of technological

infrastructure, “Such as a lack of Internet connectivity,”

she noted. “Yes, it does make it more difficult to get

the client base to trade electronically within their own

country. But once you overcome the connectivity issues,

we’ve seen rapid uptake from clients who have a desire to

leverage the benefits electronic trading offers them.”

According to Raja, the uptake in electronic trading has

been most pronounced in fx, while fixed-income and

commodity derivatives are also rising in popularity in the

region. “There’s definitely more and more recognition

in Asia as to what electronic trading platforms actually

bring to clients,” she said. “The drive has been from private banks and hedge funds, but we’re also seeing the client base open up to the possibilities to the benefit of electronic trading. They’re the real money and increasingly corporate accounts.”

Credit Suisse and Barclays are examples of two firms that have been expanding in the region to meet the growing

demand for electronic trading from clients while also

broadening the potential client base.

Credit Suisse launched its Asia-focused electronic trading

platform Spirit Asia in April 2010. The click-and-trade

platform was initially only available to Credit Suisse’s

internal private bank, but has since been rolled out to

over 800 private bank subscribers. Min Park and kenneth Pang championed the development of the e-trade

platform when they came over from UBS in 2009 as

co-heads of equity derivatives and convertibles for Asia.

While Spirit Asia is modeled after Credit Suisse’s European

equivalent, Spirit, the system is slightly different and uses

its own structures and IT. The platform’s product suite

covers equity-linked structured notes, such as vanilla

and variable options, plain vanilla and knockout ELNs,

Electronic trading in derivatives and structured products in Asia is well established and the region is increasingly becoming a major driver of growth.

Daniel O’Leary reports.

“By doing this, we automate so much that the issuing cost is quite minimal. Our system has one of the lowest launch

sizes on the street.”

— Min Park




accumulators and range and fixed-coupon notes.

“With this system, it basically means everything can be

much quicker. Everything will be much more efficient,”

said Patricia Lau, head of private bank sales, Hong Kong

and Singapore at Credit Suisse. “Previously, the way that

private banks get quotes is the client will call the private

banker and the private banker

will have to call their products

desk at the private bank and

then the private bank’s product

desk will have to call us. And

then we have to get back to

the private bank’s structured

products desk, which then has to

get back to the client. Normally

it goes back and forth a few

times, depending on the client’s

needs.”

The turnaround time for the

platform’s development was

swift after Park and Pang arrived, according to Lau. “We

wanted to bring in an electronic platform to improve

the experience of our private bank clients,” she said. Lau

noted electronic trading platforms empower the private

banker. “They’re able to get their own pricing quotations,

they’re able to place orders by themselves,” she noted.

“While the private banker speaks to the client over the

phone, they’re able to get different pricings and price

variations as they speak to the clients.”

Credit Suisse is planning to broaden the product suit it

makes available to investors as the market landscape

changes, with structured products such as callable

variable reverse convertibles and drifter notes expected

to be added to the platform this year. “We’ll also be

adding more underlyings and more features,” said Lau.

“These products don’t have as much volume as our other

products, but it’s important that we have a very broad

product suite. We need to cover as much as possible on

the platform, even if client demand is in small tickets. We

want to cover that.”

Barclays, like Credit Suisse, has also been developing the

capabilities of its platform. One development has been

the addition of pricing and execution capabilities for fx

and commodities to its Comet equity structured product

platform, which sits within BARX Investor Solutions.

The broadening of the client base is being driven by the

development of the platform, said Raja. “What we are

offering currently in regards to Asia is more and more

complete,” Raja noted. “In the Singapore market, for

instance, not only can clients trade [U.S. dollar/Singapore

dollar] spot, forwards and futures over the Singapore Exchange, but they can also have access to exceptional

liquidity in Singapore bonds, Singapore interest rate

swaps and Singapore credit. So the completed product is

encouraging more uptake.”

Barclays is also looking to expand its emerging markets

electronic offering after launching CNH spot, forwards

and options on the BARX platform in 2011. “I think with

fx options, we’ll continue to develop our suite of products

and functionality,” said James Cowell, head of efx trading

at Barclays Capital. “A lot of development over the last

12 months has been around Asian currency options and

emerging market options and a lot of that is driven by

Asian demand.”

If you take into consideration the challenges currently

facing market participants—higher costs from impending

regulation and increased capital requirements—the

increase in electronic platform expansions makes

economic sense. “Also, this front end automation, isn’t

just efficient execution,” Park said. “It can also generate

documents automatically and automate back office

bookings.”

The automated process means Credit Suisse is able to

handle much smaller order sizes than before. “And then

our end doesn’t have to wait to get certain minimum sizes

to launch the product. Now we can lower the minimum

price to as low as USD25,000.”

The system also lowers issuing costs. “If we don’t have the

proper size we cannot cover the cost,” Park noted. “By

doing this, we automate so much that the issuing cost is

quite minimal. Our system has one of the lowest launch

sizes on the street.”

Lau said investors have been increasingly turning to lower

order sizes as a consequence of the financial crisis. “But

they also don’t want to put all their eggs in one basket

and they want to diversify,” she added. “Without this kind

of platform, doing trades like this would never be possible

from either the investment banking side or the private

banking side. It doesn’t really make much sense for either

side of the trade to handle such small orders.” n

“We need to cover as much as possible on the platform, even if client demand is small. We want to cover that.”

— Patricia Lau

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The Golden Age of Cross-Asset Strategies

By Gary Stone

Relative value arbitrage (RV) exploits

the difference between two or

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Gary Stone

Figure 1

make possible direct access to global

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If you want to stay competitive, you

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Figure 2

Nothing in this document constitutes an offer or a solicitation of an offer to buy or sell a security or financial instrument or investment advice or recommendation of a security or financial instrument. Bloomberg Tradebook believes the information herein was obtained from reliable sources but does not guarantee its accuracy.

This communication is directed only to market professionals who are eligible to be customers of the relevant Bloomberg Tradebook entity. Communicated, as applicable, by Bloomberg Tradebook LLC; Bloomberg Tradebook Europe Limited, authorized and regulated by the U.K. Financial Services Authority; Bloomberg Tradebook (Bermuda) Ltd.; Bloomberg Tradebook Services LLC. Please visit http://www.bloombergtradebook.com/pdfs/disclaimer.pdf for more information and a list of Tradebook affiliates involved with Bloomberg Tradebook products in applicable jurisdictions. The BLOOMBERG PROFESSIONAL service (“BPS”) is owned and distributed by Bloomberg Finance L.P. (“BFLP”), except that Bloomberg L.P. and its subsidiaries distribute the BPS in Argentina, Bermuda, China, Japan, Korea and India. Bloomberg Tradebook is provided by Bloomberg Tradebook LLC and its affiliates and is available on the BPS. BLOOMBERG, BLOOMBERG PROFESSIONAL and BLOOMBERG TRADEBOOK are trademarks and service marks of BFLP or its subsidiaries.



S ince the summer of 2010 when the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed,

the market has seen significant developments in the way derivatives are traded, fuelled by a demand for more automation from industry participants.

The U.S. legislation mandates that all cleared swaps must trade on an exchange or a swap execution facility. Many multi-dealer electronic trading providers intend to register as SEFs when the regulation is implemented. In Europe, the E.U. has proposed the introduction of organised trading facilities, which are similar to SEFs. OTFs are defined as platforms operated by a market participant which is not a multilateral trading facility, where multiple third-party buying and selling interests in financial instruments are interacted that result in a contract. An OTF would include a broker crossing system and a derivatives trading platform.

“I think there is a move towards e-trading in markets generally. As markets become more efficient and more transparent this is a natural progression,” said Robin Poynder, head of regulation for the marketplaces group at Thomson Reuters. “Not only is there a regulatory push

but there is clearly a commercial incentive for the buy-side in terms of operational efficiencies,” said Eric kolodner, managing director at Tradeweb in London.

The volume of derivatives traded on electronic platforms has grown over the last year. ICAP, for example, has

seen record numbers in 2011 on its BrokerTec platform for repo and fixed income, while Tradeweb has seen record highs of trading volumes in interest rate swaps during last year. Multi-dealer platform providers have also had to develop their service to deal with the increase in trading volumes, and have also been expanding their asset class and instrument offering.

Tradeweb is one firm that has been developing product offerings in different asset classes and tradable instruments.

The firm recently launched fx options on its platform allowing customers to buy and sell plain vanilla options and multi-leg strategies across G10 currencies. It comes hot on the heels of three-way trade confirmation functionality on its U.S. tri-party repo trading platform.

“We have been focused on derivatives in particular, not only growing our existing products such as interest rate swaps, but expanding into other asset classes within derivatives--credit default swap indices, fx options and equity derivatives--so that is one way in which we are looking to capitalise on regulatory change in efforts to expand our business,”said Kolodner. “We have a lot of different products with different timing protocols depending on the asset class and on what is feasible and doable because as a multi-dealer platform we can only offer what dealers are actually capable of responding to,” said uwe Hillnhütter, director, interest rate swaps at Tradeweb in London.

As the proposed legislation comes into force there is going to be a requirement to centrally clear qualifying credit default swap trades. MarketAxess has been trading CDS on its electronic platforms since 2005. “We have developed a range of solutions to improve the reliable trading of CDS and the proposed legislation is tending towards encouraging, if not enforcing, the industry to trade in the same ways that we were already proposing,” said Joe Feerick, head of European product management at MarketAxess in London. “We have already built links to the main clearers that market participants will be required to clear through once the SEF rules come into practice,” he added.

MarketAxess already had its CDS products live, with 10 dealers streaming executable CDS index pricing onto its platform; however, they also intend to expand into streaming prices for single names CDS. “An area where the industry

Platforms Expand As Regs Draw Nearer

The trading of derivatives on multi-dealer platforms has grown over the last year as regulation in the U.S. and Europe will require the migration of the majority of over-the-counter swaps and derivatives to electronic trading platforms. Beth Shah examines how would-be swap execution facilities, or organised

trading facilities as they are known in Europe, are expanding, and what challenges still remain.

“Some people are creatures of habit, others have felt that they will be able to find better liquidity on the phone.”

— Joe Feerick

Robin Poynder




hasn’t developed yet electronically is single names CDS. We have developed a functionality to support streaming markets for single names and we have been offering electronic trading of single name CDS via our RFQ protocol since last year.” said Feerick.

Like CDS and fx, interest rate swaps have also seen increased volume on electronic platforms. “A lot of IRS trading is voice-broked at the moment, but it is being moved towards electronic trading in Europe and the U.S. because of regulation,” said Poynder. “IRS as we know are largely cleared in the inter-dealer space so this lends itself very naturally to that [e-trading] model,” he added.

E-trading, however, still faces tough competition from the conventional telephone: observers estimate 15% is electronic. “In IRS it is a matter of increasing volumes, numbers of dealers, and buyside clients on the platform, as well as expanding its functionality according to client needs—effectively expanding the connections between the market participants interacting on our platform,” said Kolodner.

“One of our biggest competitors is still the phone,” he added.

Some investors worry about disclosure issues if they were to use electronic platforms. “Some people are creatures of habit, others have felt that they will be able to find better liquidity on the phone,” said Feerick. Over-the-counter derivatives, as their name suggests, are often bespoke. “There is always a reason for bespoke trades and by the nature of them they are not liquid, they are bespoke and they don’t lend themselves to electronic trading,” said Poynder.

There are also other challenges facing the growth of electronic trading. “The biggest challenge that we face, and that everybody faces, is that there are a lot of different scenarios [arising from regulation] that you could run depending on what the final protocols are,” said Ben MacDonald, global head of fixed income at Bloomberg in London. The final regulations could have an impact on the competitive landscape depending on how prescriptive the rules are. This creates uncertainty and it poses difficulties in

allocating resources. n

The Dodd-Frank regulatory reforms in the U.S. have

made electronic trading the way of the future,

whether anyone likes it or not. Though firms are not

obligated to move some of their derivatives trading

to electronic platforms until next year, those who are

heading the e-platform businesses are looking to capture

the market before end users have a swell of choices.

“It’s a chicken-or-the-egg problem,” said Ron karpovich,

managing director in e-commerce Royal Bank of

Scotland. “Is it now? Is it in the future? As one goes, the

rest will follow.”

Firms racing to beat the market on two fronts, with the

bet that the first and most flexible single-dealer cross-

asset electronic trading platforms are going to define

the way users trade for years to come. As such, firms are

looking for ways to lock in a target user base and keep

them with a competitive edge. uBS has rolled out a

first-of-its-kind platform for buyers and sellers of credit

default swaps to make markets on a bilateral basis.

RBS will soon launch cross-asset trading for its Agile

platform, which targets futures traders by giving them an

automated way to hedge gamma.

Firms are looking to capture the market before end

users have a swell of choices and many are

currently formulating platforms and keeping tight lipped about their form. “We know we’re

not the only firm out there selling electronic

trading,” said Daniel Ciment, head of

electronic trading solutions for the Americas

at JP Morgan. “As a leader in electronic

trading, we know that someone out there is

trying to take market share.”

Electronic trading has been a part of fx and equities

options trading for years, but Dodd-Frank is driving

firms to move some of over-the-counter derivatives

trading business online. “It will change the economics

on the trade, change the way we do business and

generate revenue,” said Jon Butler, head of equities &

U.S. Firms Bulk Up, Focus On NichesThe backdrop of the Dodd-Frank Act looms large on the U.S. landscape. Ahead of regulatory

deadlines, firms are looking to steal a march on each other. Kevin Dugan reports.

Daniel Ciment



structured retail technology and change at RBS. “But most

importantly it will require infrastructure to accommodate

all of the changes.”

To pave the way, banks have been building out their

electronic platform teams. “We’ve grown our team over

the last 12-18 months pretty significantly,” said JPMorgan’s

Ciment. A recruiter in New York who is familiar with the

electronic trading market said hiring for some firms has

been going on for even longer.

CLIEnT CALLS

Firms design electronic platforms to make trading easier

for clients. There are brainstorming sessions, solicitations

for client opinions, conference calls. Some platforms

are designed to bypass the traditional voice brokers and

screen watchers that end users have traditionally relied

on. “Electronic trading is all about being efficient and

doing more with less,” Ciment said.

The efficiency race has also set firms to focus on specific

areas of the market, and finding ways to capture market

share. This means developing platforms that are unique

to users’ needs in trading specific financial instruments.

In December, UBS launched such a platform, called the

Price Improvement Network-Fixed Income. “One strategy

we decided to pursue, among other things, is to be quite

aggressive and forward thinking

in developing a meaningful

electronic trading platform for

customers of CDS,” said Paul

Hamill, managing director of

matched principal trading at UBS.

It allows end users to hit or lift

prices on about 300 names, see

where the most liquidity is in the market, and give users

the ability to see where there is activity in the market.

“Customers know that they can trade with each other, so

it’s all-to-all and they never have to have [International

Swaps and Derivatives Association agreements] with each

other,” Hamill said. As of mid-February, the platform

had approximately 50 users, and about USD1.2 billion

has traded over about 200 trades. The platform is also

designed to adapt to where the markets have concentrated

the most liquidity in the future.

Hamill said clients will be able to access PIN-FI through an

application programming interface for algorithmic trading.

When traders are required to go through swap execution

facilities for off-the-run instruments, like a legacy roll of

the Markit investment grade credit default swap index,

the platform is designed to consider different clients’

eligibility for which prices it has available.

RBS has also been looking to capture market share by

increasing the capabilities of its current platform, FX

Agile. UBS is planning on integrating other asset classes

on its Agile platform in order to give traders the ability to

monitor gamma, or correlation risk. “When you’re doing

cross-asset trading, you’re looking at correlation risk,”

Karpovich said.

Agile is designed to give futures traders greater ability to

set limits on gamma and, he said, hedge more efficiently.

“It’s a speed issue,” he said. A futures trader may hedge

gamma three or four times a

day. Agile allows the trader to set

up the parameters for gamma

and time and the number of

hedges can increase to 70 trades

a day. “The number increased

dramatically because it catches

every component. The system

looks at every small parameter in

price. It is a significantly better

hedging strategy by hedging much

more minutely.”

“The easy way to look at it is that gamma risk is correlated

to price,” Karpovich said. “So once you give us a gamma

number, we can hedge correlation. You can do that

with any two assets once you calculate the correlation.

It’s naturally cross-asset when you start working out

correlated prices.”

But launching novel electronic platforms for assets that

have not seen much, or any, electronic trading does not

come without its own risk. Some firms may not want to

open up a platform when markets might not be ready to

embrace electronic platforms just yet. “Regulations aside,

with equities it took 10 years to get fully electronic,”

Butler said. “There’s a big debate as to how fast it’s going

to happen in all asset classes.” n

“There’s a big debate as to how

fast it’s going to happen in all asset classes.”

— Jon Butler

“We know that someone out there is trying to take market share.”

— Daniel Ciment




A s interest rates begin their ascent from zero, Dodd-Frank is implemented and market conditions improve,

futures trading will become a more important portfolio tool for institutions. Many of the largest and most sophisticated investment managers, including top mutual fund companies and hedge funds, are expecting to either start trading futures or increase their futures trading levels.

Likewise, U.S. futures exchanges announced record volumes in 2011 and TABB Group expects this momentum to carry forward into 2012 (see Exhibit 1). Of the 12 million futures contracts traded per day in 2011, nearly 50% were executed by buy side traders. From just a few years ago until today, the percentage of trading by the buy-side continues to increase.

Rising volumes in the U.S. futures market is a clear indication of hedge fund speculators that are once again on the rebound, post-credit crisis. In addition, traditional investment managers facing increased competition from hedge funds and passive investment strategies are running more-complex portfolios. And pension funds are increasing their allocations to commodity trading advisors, as investing in futures has the potential to provide better alpha returns as well as capital preservation.

EvoLvInG PoRTFoLIo DEMAnDS

Going forward, the regulatory push for centrally cleared and exchange-traded instruments will add to volumes, as will provisions within the Dodd-Frank Act that are transitioning OTC swaps trading to more transparent swap execution facilities (SEFs). As swaps trading becomes more automated, the ability of traders to use interest rate futures and other

related instruments as part of overall strategies becomes attractive, especially for correlation and relative value strategies that look to profit from price changes in other asset classes.

Another factor behind the increased adoption of futures is the need by portfolio managers to generate and retain

alpha. With a rise in ETFs and beta-replicating strategies, there is significant pressure on asset managers to increase returns as investors choose between active and passive management. Futures provide leverage and exposure to asset classes and markets that historically have not been in the active management sweet spot. The ease and flexibility of using futures to access these markets provide an efficient way for firms to expand their strategies (see Exhibit 2).

An additional incentive for the buyside is to better manage capital. Dodd-Frank opens up a world of opportunity for investment managers, especially for firms already trading OTC interest rate swaps. Interest rate futures will become both a complement and an enabler for strategies that have traditionally relied on OTC swaps for returns. Similarly, equity managers continue to struggle with putting cash inflows to work in today’s fragmented equity markets, and futures are an effective way to achieve this objective.

Futures are also gaining greater prominence among traditional asset managers as an effective hedging vehicle, and are becoming more important to managers looking to protect against unanticipated movements in asset prices. As volatility and market uncertainty become the new market norm, traders are gravitating toward a new crop of volatility products that can help manage this market environment. And as investment portfolios become global, fluctuations in

Futures On The Rise

U.S. futures usage is tipped to rise among hedge funds and mutual fund players. Market conditions and the regulatory drive to create open markets, such as with swaps, are key factors behind the prediction. Matt Simon, a senior analyst at TABB Group, outlines what is in store.

Millions of contracts traded on US exchanges

629

851

1,043

1,324

1,653

2,044

2,645

2,850

2,328

2,765

3,056

Total Other/Metals FX Commodities Energy Equity

3,354

2001-2008

CAGR 24%

2011-2012e

+10%

-18%

US Futures Trading Volume (2001-2012e) Exhibit 1 U.S. Futures Trading Volume (2001-2012e)

Source: Futures Industry Association, TABB Group


SponSored Article

Alpha Profiling – A Better Way for Institutional Traders to Choose Execution Strategies

By Henri Waelbroeck, Ph.D., Director of Research, Aritas Group, Inc.

New techniques in business intelligence have been empowering

businesses to turn their data into intelligent information and optimize their operations. This process has spurred a revolution over the past decade that has helped companies post record profits while keeping inflation in check. This trend is expected to accelerate over the next decade, as so-called big data solutions are deployed. The institutional trading desk is deeply engaged in this revolution. In this article, we will describe how the analysis of historical trading data and new techniques in Transaction Cost Analysis today are helping portfolio managers capture alpha, and soon will enable further gains through feedback on market timing, trade selection or substitution.

Trading desks for a long time have been well aware that there are differences in the order flow from different managers. While some managers tend to initiate orders with a high risk of adverse price moves that need to be executed with urgency, others are more likely to trade contrary to the flow to capture opportunities created by impatient traders on the other side; these require patient execution and should not suffer any implementation shortfall (IS). The root cause of the similarities and differences between portfolio managers lies in the coherence in thinking amongst industry participants. Whether acting from a common signal or following similar lines of reasoning, portfolio managers often respond to the same events, information, and opportunities in similar ways: broadly speaking, one group will hold consensus views while another group will hold

contrarian views. A particular portfolio manager may be more likely to be aligned with the consensus or contrarian view, and this characteristic is persistent on a timescale that is sufficient to enable the optimization of execution strategies.

Yet it would be wrong to describe all orders from a portfolio manager as sharing a common signature: a portfolio manager typically initiates orders for a number of different reasons; as these orders reach the market they encounter different environments – to understand the urgency of a trade requires knowledge of both the portfolio manager’s historical profile and the current market drivers. Indeed, for each portfolio manager one can identify several classes of orders. Orders within a class share similar attributes and a historically-consistent short-term alpha pattern. Market microstructure variables such as the order flow imbalance acquire a very different meaning when they are considered at or shortly after the start of a new institutional trade. The supply and demand imbalances that are revealed in the order flow observations at this particular time reflects on whether a particular portfolio manager is more likely to be aligned with or contrarian to the market consensus in this particular trade. The market is generally well-arbitraged, so order flow imbalances provide limited alpha in other circumstances, but the arrival of a new institutional trade represents private information for which arbitrage arguments do not apply.

Alpha profiling is a systematic statistical analysis aiming to identify classes of trade

arrival that share common features and for which the same execution strategy is optimal. In a simplified example, one might have to choose between only two execution strategies: a slow one, such as a VWAP algorithm, or a fast one such as a front-loaded IS algorithm. Looking at each trade in a historical dataset it is possible to estimate in hindsight what the cost would have been using one or the other strategy. One might find for example that trade arrivals on weak sector-relative momentum tend to have low urgency. More generally, data mining techniques use Bayesian classifiers to identify statistically significant associations; expert knowledge can be introduced as a second step to select rules that have an economic underpinning and therefore are more likely to generalize in the future. The factor universe comprises both attributes of the order arrival itself (size of the order, stock, side, PM instructions, for example) and market factors such as momentum, sector, the presence of news, etc.

Ultimately an alpha profiling system will partition the feature space into domains that are associated with low urgency trades and other domains that are associated with high urgency trades. In each domain, one can compute the historical average impact-free return as a function of time, called “alpha profile”, and marry an execution strategy to this statistical profile in order to minimize overall cost.

A practical implementation of alpha profiling must deal with more complex questions than simply the decision of whether to execute fast or slowly. A

SponSored Article

minimal set of design parameters must include:

• Execution speed; or equivalently, target completion time

• Front-loading / back-loading of the implementation schedule

• Granularity (execute continuously over time or in bursts as opportunities arise)

• Block exposure (accept or reject opportunities to cross)

• Sector-relative stability (slow on sector divergence?)

All of these strategy design items represent critical decisions, in that each one can cause an execution to be vastly more expensive than it should have been. The institutional trader is tasked with making these decisions today but must do so without quantitative tools that provide insight on the likely outcomes.

It is possible to assign execution parameters at trade start based on historical analysis, as we illustrated with the example of execution speed. However, some of the most valuable information is revealed after the start of trading. Indeed, if one believes that portfolio managers seldom act alone, there are likely to be other orders in the same or opposite direction that are sitting on order management systems and have not yet been expressed on the market. As a trade begins to execute, its impact on price automatically creates urgency for other orders on the same side that may have been waiting for price or liquidity opportunities. Or in the case of a contrarian trade, the discovery of hidden liquidity may foretell opportunities for further price improvement. A successful application of alpha profiling requires a “hypothesis validation” step where the initial trade classification is revisited after the early execution results have expressed themselves. If the new information

contradicts the original hypotheses, the trade may need to be re-assigned to a different execution plan.

Does the application of hypothesis validation in alpha profiling create unstable markets? The risk of instability certainly exists if strategies are poorly designed so that they reinforce coherence. For instance, one possible action plan in the case of coherent PM signals is to execute relatively fast, say at 20% of market volume… if several parties come to the same conclusion the competition for liquidity can cause price to overshoot its

target. Properly-designed alpha profiling systems must not only determine whether or not short-term alpha is likely to be present but also estimate its amount, in order to determine how many basis points of sector-relative price appreciation should be considered acceptable within a front-loading stage. If price overshoots this level, the strategy should realize that the expected alpha has been exhausted and automatically pull back to a more passive execution plan. A properly-designed execution framework incorporates the relative value safeguards that ensure stability. Ultimately, the role of the institutional trader remains vital to oversee the process and take control where needed, or to look for opportunities to add value in situations where unique

circumstances invalidate the quantitative analysis. With an interface that provides transparency and control, alpha profiling

places Artificial Intelligence at the service

of the trader, and not vice-versa.

What is the potential ROI for implementing an alpha profiling methodology? The answer depends on the particular portfolio manager. In the chart below we show IS results for Aritas’ Alpha Pro platform in 2011, for US and European markets separately. The IS results are compared to the estimated results of a 10% volume participation strategy.

The results point to savings of

approximately 10bps overall resulting from the implementation of an alpha profiling methodology. We have found this to vary quite a bit by manager, with some portfolio managers achieving savings of 40bps and others 2-3bps. The largest savings typically occur for accounts with very large orders and little-to-no short-term alpha, where a disciplined and patient approach provides the greatest benefits.

For further information about Aritas’ Alpha Pro, please visit http://aritasgroup.com/.

-40 -35 -30 -25 -20 -15 -10 -5 0

EU

US

Alpha Pro Results 2011

MAC

I/S

Exhibit 1. Average Alpha Pro realized shortfalls in the US and EU regions are shown compared to the estimated cost using a 10% participation strategy (Momentum-Adjusted Cost, or MAC). The average savings is approximately 10bps.

20 © Institutional Investor Intelligence 2012. Reproduction requires publisher’s prior permission. To receive email alerts or online access to Derivatives Intelligence, call (800) 437-9997.

MARCH 2012 | WWW.DERIVATIVESINTELLIGENCE.COM ELECTRONIC TRADING REPORT ELECTRONIC TRADING REPORT MARCH 2012 | WWW.DERIVATIVESINTELLIGENCE.COM

foreign exchange rates can be hedged with fx futures, rather than having to bear the risk of exposure to wildly fluctuating exchange rates.

ELECTRONIC TRADING IMPACT

Trading U.S. futures has traditionally required little execution expertise or special tools. Traders simply could pick up the phone to place an order with a notional value

of millions of dollars and get executed instantaneously with minimal market impact. However, as trading increases, volatility fluctuates, and products evolve, the emphasis on having the right set of trading tools is becoming essential.

Today, buyside traders are exploring the potential benefits of electronic trading tools designed for the intricacies of the futures marketplace. The buyside will first look to existing brokers for these tools, but over time they will explore more-sophisticated tools provided by brokers and vendors building out their electronic offerings.

Leveraging their experience, trading firms running futures-specific portfolios, including CTAs and hedge funds, will look to compete with more-diversified institutions by refining their execution strategies to include automated trading tools that make execution practices more efficient. One area seeing considerable uptake is algorithmic trading, with order flow executed through algorithms increasing from single-digit percentages to 10% of ADV expected by the end of 2012. Meanwhile, direct market access (DMA) trading will decline by a nearly equal amount (see Exhibit 3).

FCM BUSINESS FACES SCRUTINY

Facilitation of electronic trading will be a key gateway to a critical part of the futures business: clearing and settlement services. As transaction volumes grow, revenue earned from these services will see corresponding increases. With clearing revenues representing an even greater pool of revenue for futures commission merchants, the battle will be to attract clients with higher trading volumes.

However, the recent collapse of MF Global continues to

resonate with the buy side, and they will continue to increase their focus on the solvency of their FCMs. This creates opportunities for FCMs able to sustain strong balance sheets and also for firms with the financial wherewithal to support increasingly risk-averse clients.

Even as trading volume continues to grow, needed investments resulting from new regulatory initiatives will raise the cost of doing business. Thus, the short-term outlook for FCMs is not all rosy. Specifically, FCMs are facing an evolving regulatory environment that places more onerous compliance burdens on their operations.

Going forward, FCMs will not be able to increase revenues without a differentiated value proposition. Lower costs may initially help sway selections, but over time are not long-term differentiators. FCMs will need to bring a broad range of services to a relationship, including both execution and clearing services expertise. Fast and efficient execution capabilities are critical, but unless they are paired with trouble-free back office processing and clearing, the relationship will quickly dissolve.

SEEKING LIQUIDITY IN THE U.S. AND GLOBALLY

The domestic futures exchange landscape will expand as venues that either do not have futures trading decide to enter the marketplace, or for those that currently do have capabilities to trade futures, expand more of their functionality and product offerings.

The dominance of the CME in both trading and clearing has resulted in a marketplace with concentrated liquidity and greater simplicity. However, there is room for competition. A number of U.S. exchanges have expanded their futures product offerings in recent years and although these exchanges have seen varied degrees of success they face challenges in growing their franchises. The biggest challenge they face is simple; they need to overcome the liquidity position of the CME in the U.S. futures market.

Product innovation remains one of the key ways that exchanges can compete. In order to gain trader attention,

55% 19%

29%

4%

8%

62%

90%

18%

9%

6%

Long-Only

Hedge

Fund

CTA

Cash Flows Risk Mgmt/Hedging Alpha Exposure to Asset Class

How do the following factors influence your futures trading activities?

Exhibit 2 How do the following factors influence your futures tradng activities?

Phone; 7% FIX; 6%

DMA; 83%

Algo; 4%

Buy Side Order Flow Allocation by Channel, 2011 Exhibit 3 Buyside Order Flow Allocation by Channel, 2011

Source: TABB Group “US Futures Trading 2012”





especially as investment trends evolve, exchanges need to introduce products that capture the interest. Recently, the growth of sector-based futures, CBoE VIX futures, and Russell/MSCI index products illustrate how investor demand contributes to product adoption.

International markets also figure prominently for U.S. investors in 2012. Half the traders we interviewed said they either planned to start trading internationally in 2012 or were considering doing so, with the focus clearly on emerging markets. Participants identified a wide range of markets they are interested in accessing, including those in Europe and Asia, as well as emerging markets like Brazil, Russia, India, and China.

WHAT THIS ALL MEAnS

As buyside institutions become more involved with futures, rising demand will prompt more innovation, greater competition and ultimately a better environment for the brokerage industry. The combination of less restrictive

investment mandates and a more sophisticated investor base provides the gateway to increased revenue for FCMs over time.

However, both FCMs and buy side traders are not blind to marketplace developments. As interest rates begin their ascent from zero, Dodd-Frank is implemented, and market conditions improve, futures trading will become a more important portfolio tool for institutions with greater emphasis on trading more efficiently.

Meanwhile, as institutional volumes increase, traders will look to automate processes and self-directed trading will become the norm. FCMs with robust electronic offerings will see substantial opportunities, especially if they can find the right mix of services that appeal to the growing population of investment managers using futures in their investment strategies.

Matt Simon is a New York-based senior analyst at TABB Group, a strategic advisory and research firm focused on capital markets. n

Transaction cost analysis is a tool that provides the buyside with data outlining performance, costs and

trading behavior. It is increasingly becoming a focus for buyside firms not only to better understand the costs incurred during the trade life cycle, but also as a way of measuring the efficiency of trade execution and the performance of brokers. It has previously been used by firms as a monitoring tool for compliance.

In an environment where a few basis points may be the difference of whether a trade is successful or not, TCA can be used by firms to identify lower transaction costs that lead to higher portfolio returns. Buyside firms can then use the data from TCA to measure the performance of trades and their transaction costs, while also estimating future transaction costs.

“The reason we believe TCA is so important is because we have to measure ourselves to be accountable to our

Potting The Path To Real Time TCA

The focus on transaction cost analysis in equity trading is gathering pace as buyside firms and their institutional clients pay greater attention to trading costs and execution. Buysiders have

been focused on developing TCA on a next-day basis, but some are now moving towards having TCA real time to further improve efficiency. Rob McGlinchey reports.

TCA EvoLvInG AT FIRMS

According to a recent report from Aite Group, buyside firms see a greater need for TCA, particularly in algorithmic strategy and venue analysis.

The report, which surveyed 20 buyside firms, highlights that although TCA is more prominent in equities, it is expanding into other asset classes and instruments such as fixed income and futures. Domestic equities (100%) and international equities (84%) made up the majority of asset classes and instruments where TCA was utilized, followed by fx (50%), exchange-traded futures (20%) and fixed income (20%).



clients. Skilled traders can and do help create positive investment alpha—they enhance outperformance within a portfolio,” said Anton Aitken, a director and head trader for European equity trading at Franklin Templeton Investments. “To show this we think it’s critical to use utilize a relevant and well constructed benchmark. Transparency is clearly very important, because with it brings a high level of oversight into the execution process. So TCA assesses the quality of a trader’s decision process through the life of a trade. It creates direct accountability within the execution process.”

In the past, TCA data has been provided on a longer term basis to asset managers, either monthly, quarterly or annually. According to officials, some asset managers still utilize TCA on this basis, while others are also focused on a next-day basis. With firms using TCA increasingly in the trading process, however, real-time TCA is increasingly being developed by buyside firms.

Franklin Templeton Investments is one firm that is developing real-time TCA. The firm has been working with ITG, an independent vendor, to revise its TCA process and achieve real-time TCA. Real-time TCA would be more transparent and would allow a trader to adjust an execution strategy dynamically while giving the firm immediate feedback on the effectiveness of this change in strategy.

“TCA real-time is the next frontier for those that are willing to spend the time and effort getting there,” said Aitken. “It can carry with it a hefty cost, but we believe if you are looking

to improve your trading process, then you must understand the level of execution risk you are taking during the day, how that will impact your performance and then measure yourself accordingly. The next stage might be introducing TCA on a +1

basis for some, but for us, the next level is definitely real time.”

Robeco Investment Management is another firm that is developing real-time TCA. The firm is one month away from implementing real-time TCA. “We have been working with a third party transaction services provider that has specified all hardware, software, and tick data requirements for our project. Additionally, they will handle all of the overnight processing outside of our infrastructure,” said Mark kuzminskas, director of equity trading at Robeco Investment Management. “We have set up the environment in a way that a dashboard will reside on each trader’s desktop enabling them to monitor and adjust the order flow parameters in real time.”

Challenges exist to establish real-time TCA, with one significant factor being cost. A firm will need to invest in its network to get the required trade data to flow back. A robust system must also be implemented to analyse and make sense of the data in order to display the information in an effective and a user-friendly format for the trader.

Many buyside officials argue that the benefit, or as they call it, the ‘Holy Grail’ of real time TCA outweighs the short-term cost implications. Since real time TCA develops a profile for each portfolio manager on every trading day in different market conditions, it allows a firm to understand how the portfolio manager would act and react in a specific market.

“What excites me about real time TCA is that we are able to link it with historical portfolio manager preferences in a way that, based on back tested results, will enable us to achieve more robust trading results for our clients,” said Kuzminskas.

Aitken added that establishing an audit trail will be the focus for many firms going forward. An audit trail would internally scrutinize which venues your orders are routed to once they

RegulatorydevelopmentsintheU.S.andEuropehavebeenamajordriverinTCAbeingadoptedbyfirms.

IntheU.S.,firmsarerequiredtoprovebestexecution,whileinEurope,undertheMarketsinFinancialInstrumentsDirective,abestexecutionpolicywasdrawnupforbrokerdealersandassetmanagers.

ProposalsfromtheEuropeanCommissionforanupdatedMiFIDsetoutfurtherrequirementsintheareaofbestexecution.Undertheproposals,tradingvenueswillhavetopublishdataonexecutionquality,whilefirmswillhavetoreleasethenamesoftheirtopfiveexecutionvenuesonanannualbasis.

KEY FactS

(Continued on page 30)Source: AITE Group

TCA Reporting Time Periods Preferred By Buy-Side Users

MARCH 2012 | WWW.DERIVATIVESINTELLIGENCE.COM ELECTRONIC TRADING REPORT

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ELECTRONIC TRADING REPORT MARCH 2012 | WWW.DERIVATIVESINTELLIGENCE.COM

Q&A: WMBAA’s Chris Ferreri

Q: Which area of ongoing swap execution facility regulations do you view as the most important to the health of the over-the-counter markets and robust implementation of Dodd-Frank?

A: It is important to remember that the problem that frustrated regulators’ ability to determine the depth and breadth of the crisis in 2008 was the lack of position information; in other words, who owed what to whom. I’m not suggesting that there weren’t root causes of the crisis, but the fact that there was no single source of trade data frustrated any efforts to ring fence the issues and determine an effective and timely plan of action. Congress recognized that capturing these trades and sending them to a regulated swap data repository was critical to the safety and soundness of the markets. Putting those reporting regimes in place as soon as possible will deliver the lion’s share of benefits to the financial markets. Congress also recognized that the mode of execution as important, but they chose to regulate execution venues but provide participants with the choice as to how they execute their trades through “any means of interstate commerce.” Putting these reporting regimes in place as soon as possible will deliver the lion’s share of benefits to the markets.

With respect to SEFs, the provision that most puts the current OTC markets at peril is the CFTC’s proposal to limit modes of trade execution. Specifically, the CFTC proposes to classify swaps as “permitted” and “required,” and, based on the category, limit the trading of that swap to certain types of methods. We are concerned that this provision is not only contrary to the statute passed by Congress--which mandates that multiple participants have the ability to trade swaps “through any means of interstate commerce”--but that its practical impact would be to artificially restrict means of communication and hinder liquidity formation.

Q: How would you like to see that issue resolved?

A: The CFTC and the SEC were given nearly identical statutory language from Congress. The SEC proposed a much more flexible, adaptable approach, which could be used as the framework for the CFTC. Given the SEC’s

proposal, it is evident that there are less onerous alternatives to the CFTC’s proposed rule. It is important to recognize that Congress has displayed concern with the CFTC’s interpretation of the plain language it passed in July 2010. The House has been working on a bill--the SEF Clarification Act--that would provide additional guidance to the CFTC to ensure that it implements a SEF regime that provides the Congressionally-mandated flexibility with respect to modes of trade execution.

Q: Do you view the Securities and Exchange Commission and the Commodity Futures Trading Commission’s approaches to SEF regulations as convergent?

A: One area that seems to stand out is the SEC’s interpretation that the SEF definition calls for flexibility in mode of execution by the clear statutory definition of a SEF. Dodd Frank defines a SEF as “a facility, trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants in the facility or system, through any means of interstate commerce.” In the SEC’s proposal, they recognize that the SEF is only required to provide “the ability” to the participants to “execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants.” By proposing that standard, we think that the SEC has established an appropriate baseline for reviewing SEF applications for registration. It seems to be a more clear-cut threshold for SEFs to determine whether their platforms meet the regulatory standards and provides some predictability for market participants.

Q: When do you expect regulations on swap execution facilities to be completed? How many SEFs do you expect to populate the market at that time?

A: We understand that the CFTC is likely to take up its SEF proposal in June, at the earliest. We believe that there are certain provisions—like the “permitted/required”—that

Ferreri is chairman at the Wholesale Markets Brokers’ Association Americas, the industry body representing the largest inter-dealer brokers in the North American wholesale markets. Mike Kentz recently ran through the key issues for the group in relation to matters electronic.

Chris Ferreri


SponSored Article

E-trading Reaches Critical MassBy Billy Hult, President, Tradeweb Markets LLC

Sometimes change takes you by surprise. It can happen quickly. Or in the case of the move to electronic trading, it can gather a life of its own over a period of years. At a certain stage, what was once an interesting innovation for the marketplace becomes the standard way of doing business.

The globalization of markets, which we now take for granted, is another good example. It’s really quite a recent phenomenon. In the 1980s, the City of London was dominated by traditional British banking names. By the end of the 1990s, they’d almost all been sold in what had been a frenzied decade of global consolidation: Midland Bank (1992), Barings (1995), Smith New Court (1995), Warburg (1995), Schroders (2000) and Robert Fleming (2000). On Wall Street, three of the bulge bracket are foreign-owned (Barclays, Deutsche Bank and Credit Suisse); in the late-1980s there were none. The changes took place because banks realized that

scale was needed in order to compete internationally.

In the fixed income markets, the trend toward electronic trading has been driven by buy-side institutions looking to improve the way they trade. Sell-side firms have similarly used technology to drive efficiency. As with the transition to global banking, the evolution to electronic markets has become central to the trading community and has grown more interconnected, with ever more complex and fast-moving relationships. Technology has become essential for traders.

Twenty years ago, traders were happy just to have the advantage of an information terminal. Ten years ago, single bank portals still represented the majority of electronic trading. Today, clients need real-time access to multiple sources of pricing. They also need real-time compliance, trading and trade processing. Multi-dealer-to-client and electronic inter-

dealer platforms, like Dealerweb, have become an essential component of a digital workflow and now represent the lion’s share of market activity.

Increased transparencyPerhaps the most important role played by electronic fixed income markets over the past decade has been the democratization of information, specifically pre-trade transparency. Price transparency is a critical factor in the investment decision-making process, and the more there is, the larger the number of participants willing to enter a marketplace. As more counterparties have committed capital, the pool of liquidity has deepened. Greater liquidity leads to more trading.

The debate on transparency is ongoing, but market participants recognize the benefits technology can bring. All the major banks run single-dealer trading portals for fixed income instruments, and most inter-dealer trading in benchmark

Fixed income markets are increasingly global,

inter-connected and volatile. Seismic shifts

in the demographic, regulatory, technology

and economic landscapes are converging to

define the future of the markets. The focus on

electronic trading solutions to drive efficiency

and transparency has never been greater.

SponSored Article

government bonds takes place electronically. Technology investment is ever growing, while staff costs continue to shrink in many cases.

According to Gartner analysts, Wall Street’s spending on programs and writing of applications is expected to grow to $285 billion in 2012. That’s more than the GDP of Israel, Portugal or Ireland. Tech spending has grown consistently every year. The trend, like globalization and the move to

electronic trading, is permanent and

irreversible. The future is transparent,

and it is understandable that banks

want to use technology in a way

that allows them to compete most

aggressively.

GeneratIon Game

While many first movers in electronic

fixed income trading now occupy

senior positions in their firms, the next

generation of traders is universally

more comfortable with the use

of technology. Electronic trading is

mainstream for this demographic, and

the passing of the baton will accelerate

the trend toward more efficient markets.

The adoption of electronic trading is

spreading across the trading floors,

from front- to back-office, and across

various functions. The broad use of

technology in our daily lives is enabling

better sharing of data and more

efficient communication, improving the

trading process by adding insight and

transparency into the workflow. The

demographic change in the workforce further underpins the increasing demand for fixed income e-trading.

Technology is an enabler. Just as the music industry has evolved from LP to mp3, the quality and accessibility of financial instruments has improved considerably through electronic markets.

Though the telephone remains an

important communication tool for some pockets of the financial industry, these are becoming fewer and further between. And for perhaps the first time, electronic trading of derivatives has increased during periods of high volatility – particularly amid turmoil in the European bond markets in 2011.

E-markets are now being viewed as a safer, more reliable way to access liquidity in times of distress. It’s a real sign of confidence and a fundamental shift in the way the industry is trading.

reGulatory catalystSupport for more efficient, regulated electronic markets has been building. Regulatory reform in the U.S. is currently focused on the over-the-counter markets, specifically derivatives trading. But it isn’t a coincidence that the swaps markets are the only major fixed income sector that hasn’t broadly adopted the use of electronic trading platforms. Bond markets are already largely digitized, evidenced by the growth in average daily trading activity on Tradeweb’s multi-dealer-to-client platform, which has risen from $20bn 10 years ago to more than $250bn today.

But regulation, along with the evolution of technology and the trading

demographic, is acting as a catalyst for the rapid adoption of a more efficient, modern and regulated infrastructure. Over-the-counter, or bilaterally negotiated markets, have provided enormous benefits to corporations, governments and other issuers in the debt markets. They enable borrowers

to place large blocks with institutional investors, which are then supported by the market making of investment banks in the secondary market.

It is clear to see how technology, regulation and a more connected workforce are driving a real shift in trading behavior toward electronic markets. As the number of participants increases, new opportunities will be generated to create value and more efficiency. Transparency will improve even further. The speed of trading will accelerate. Competition will intensify. Handled with appropriate oversight, this will all lead to a more modern and progressive era for the global securities and derivatives markets.

0

5

10

15

20

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

$ Tr

illio

ns

Tradeweb TBA Mortgage-Backed Securities Volume Tradeweb TBA Mortgage-Backed Securities Volume



on January 11 the U.S. Commodity Futures Trading Commission approved final rules establishing a

registration process for two types of regulated swap

entities—swap dealers and major swap participants—as

required under Sections 4s(a) and 4s(b) of the Commodity

Exchange Act, which were inserted by the Dodd-Frank Act.

The final rules include a provisional registration process

to allow swap entities to engage in regulated swap entity

activities before the formal completion of the registration

approval process. The final rules also allow phased compliance by swap entities with the other requirements of Section 4s of the CEA, which include rules addressing capital and margin, trade reporting, recordkeeping, business conduct and documentation standards and segregation of uncleared swaps margin. The rules differ slightly from the CFTC’s original proposals.

REGISTRATIon REQuIREMEnT TIMInG

Although the final rules became effective March 19, 2012, a

swap entity will not be required to register until the date on which the definitions of “swap”, “swap dealer” and “major swap participant” become effective. In addition, swap entities will not be required to comply with any Section 4s Requirement until both the swap definitions and the relevant Section 4s Implementing Rule become effective. As of the date of this publication, the CFTC has finalized the Section 4s Implementing Rule regarding business conduct standards and certain rules relating to the reporting and recordkeeping obligations of swap entities.

REGISTRATIon ADMInISTRATIon DELEGATIon

At the same meeting, the CFTC approved an order delegating authority to the National Futures Association to administer the registration process. The order authorizes the NFA to: (i) process and grant provisional registration applications and withdrawals from registration of swap entities and to notify an applicant of its provisional registration, (ii) confirm initial compliance of a swap entity with applicable Section 4s Requirements, (iii) conduct proceedings to deny, condition,

CFTC Rules On Swap Entity Registration

The effective date and definitions may be up in the air, but the details of some rules on swap entities have been set. David Felsenthal, partner, Gareth Old, partner, David Yeres, counsel, and

Inna Zaychik, associate at Clifford Chance in New York lay out the framework.

should be removed entirely. If that requires a reproposal of the rule, we would be supportive of that approach. We are ready, willing, and able to comply with whatever rules are implemented, but believe the regulators should take their time to get it right first.

The SEC has not held a public rulemaking meeting in several months, so it’s harder to predict when their rule might be considered. That being said, the SEC clearly appreciates that the clear statutory definition of a SEF under the Dodd-Frank Act calls for a flexible trade execution regime, so its rule seems to be more in line with Congressional intent and the operation of OTC markets. Its proposal does not pose the same risks to liquidity formation as the CFTC’s.

With regard to the number of SEFs, I think the incumbent market operators have an advantage over newcomers. Although technology is a critical component, it is not the

only component. Those firms which have knowledge, experience and expertise in operating these markets have a distinct advantage of those that do not.

Q: Do you think there is room for banks to build electronic trading platforms that will provide robust and cost-efficient execution in the newly regulated space? or will that fall to the brokers? In either case, how might the broker or bank provide a better platform?

A: Platforms will continue to evolve and improve and will be developed by many participants of the markets. What is important is that regulators do not interpret their authority under the Dodd-Frank Act to adopt an unduly prescriptive and heavy handed regulatory regime that stifles future innovation in U.S. capital markets, driving trading activity to other jurisdictions--as was experienced in global foreign exchange and fixed-income markets. n





suspend, restrict or revoke the registration of any swap entity or applicant swap entity; and (iv) maintain records regarding swap entities.

The delegation by the CFTC of the administration of swap entity registrations is broadly consistent with the existing delegation of similar responsibilities to the NFA in relation to other registered activities under the CEA, including,

for example, futures commission merchants, introducing

brokers and commodity trading advisors. As a consequence

of the CFTC’s delegation, swap entities will be required to become members of the NFA and thereby to submit to the NFA’s rules. Swap entities will, as a result, be required to pay annual membership dues to the NFA. According to estimates by the NFA which are quoted in the commentary to the final rules, the annual membership dues “could range between USD125,000-USD1 million per [member] based upon the size and complexity of the firm’s swaps business.” These membership fees will be on top of a one-off application fee for registering a swap entity, which the NFA estimates at USD15,000 per applicant.

PRovISIonAL REGISTRATIon

Under the final rules, a swap entity may apply for registration by filing a provisional application with the NFA. With effect from the mandatory registration effective date, only entities that have filed a provisional application or that have been finally registered as swap entities will be able to engage lawfully in regulated swap entity activities. The final rules do not provide any guidance as to whether the

provisional application process will only be available to swap

entities that submit their applications prior to the mandatory

registration effective date or if it will be available on the

ongoing basis.

As is the case with the registration procedure for existing

CFTC registration categories, such as futures commission

merchants, introducing brokers and commodity trading

advisors, a provisional application consists of a Form

7-R relating to the applicant firm, with supporting documentation, and, for each principal and associated person of the applicant firm, a Form 8-R along with a fingerprint card.

In addition to a completed Form 7-R, a swap entity applying for provisional registration is required to submit documentation demonstrating compliance or the ability to comply with Section 4s Requirements in effect on the

date of the provisional application. The supplementary documentation is likely to include organization and personnel charts, financial statements and any financial support arrangements--such as guarantees--internal operations manuals, risk management policies, forms of relevant trading documentation, trading policies and procedures, margin custody and segregation procedures, brokerage, swap data repository, clearing house and

out-sourced servicing arrangements, recordkeeping and reporting procedures, chief compliance officer procedures and other written policies and procedures reasonably designed to facilitate compliance with all applicable Section 4s Requirements. An applicant swap entity will be required to supplement its initial provisional application on an ongoing basis with additional documentation to demonstrate compliance with each rule regarding the Section 4s Requirements subsequently finalized by the CFTC.

FoRM 8-R InFoRMATIon

Each applicant swap entity will be required to disclose the following information on Form 8-R with respect to each of its principals and associated persons:

• Name and address; • Criminal, regulatory and disciplinary histories; and • Past residential, employment and education history.

FoRM 7-R AnD RELATED DoCuMEnTATIon REQuIREMEnTS

Form 7-R requires an applicant swap entity to disclose the following with respect to the firm:

• Name, address and entity type;

• Intent to engage in CFTC-regulated swap transactions;

• Membership of any U.S. exchanges;

• Location of business records (and, with respect to foreign applicants, a U.S. location where records will be available for the CFTC and NFA inspection);

• Any non-U.S. financial regulators and self-regulatory organizations that have regulated the applicant in the previous five years;

• Criminal, regulatory and disciplinary histories;

• Any previous bankruptcy proceedings; and

• Contact information.



An “associated person of a swap dealer or major swap participant” is any employee of a swap entity engaged in the “solicitation or acceptance of swaps… or the supervision of any person or persons so engaged.” Under the rules currently applicable to associated persons of existing CFTC registrants, the CFTC treats everyone in the “line of supervisory authority” of an associated person, regardless of seniority, including the president of the firm, as an associated person of a registrant.

The term “principal” is not defined in the CEA, but is defined by the CFTC regulations and the NFA. Based on the NFA guidance for existing CFTC registrants, a principal of a swap entity may be either an entity or a natural person. If the current guidance continues to apply, an entity would be a principal of a swap entity if it is the swap entity’s general partner, or if it owns at least 10% of any class of the swap entity’s securities or has directly contributed at least 10% or more of the swap entity’s capital. A natural person would be a principal of a swap entity depending on the individual’s ability to directly or indirectly control the swap entity’s business activities. Any individual who would be deemed to exercise control over, and be a principal of, such a swap entity would:

• own at least 10% of the outstanding shares of any class of a swap entity’s stock,

• is entitled to vote at least 10% of any class of a swap entity’s voting securities,

• has the power to sell or direct the sale of at least 10% of any class of a registrant’s voting securities,

• has contributed at least 10% of a swap entity’s capital or

• is entitled to receive 10% or more of a swap entity’s net profits

Similarly, individuals who hold specific positions at a swap entity, such as director, president, chief executive officer, chief operating officer and chief financial officer, or who are in charge of the business unit or division that conducts CFTC regulated swaps activity would be deemed principals of the swap entity, even if that individual cannot control the swap entity’s business as a whole.

PRovISIonAL REGISTRATIon EFFECTIvEnESS & nFA REvIEW PRoCESS

A swap entity would be deemed provisionally registered immediately upon submission of a provisional application. Upon receipt of a provisional application, the NFA will begin a formal review of the provisional application and the

applicant to determine compliance with applicable Section 4s Requirements. In the course of the review, the NFA may revert to the applicant swap entity with comments to the accompanying documentation and request any additional information. It is expected that the NFA will, prior to granting permanent registration, require each provisional registrant to satisfy certain minimum standards for risk management and compliance systems as well as competence of risk management and compliance staff. Filing a Form 7-R also authorizes the CFTC and the NFA to conduct on-site inspection of an applicant to determine compliance with the applicable rules.

Following the initial submission of a Provisional Application, a swap entity will be permitted to engage in regulated swap trading activities during the entire period of the NFA review of such application, unless the NFA notifies the swap entity of a deficiency, as discussed below. When the NFA determines that the applicant swap entity has demonstrated compliance or the ability to comply with applicable Section 4s Requirements, the provisional registration will be terminated and the swap entity will be deemed registered as an SD or MSP, as applicable.

CoMPLIAnCE DEFICIEnCIES & PRovISIonAL REGISTRATIon TERMInATIon

The final rules are ambiguous as to whether a swap entity may continue trading while it addresses any deficiencies in its provisional application. The final rules permit the NFA to notify any swap entity that is subject to provisional registration that its application materials did not adequately cover any aspect of the registration requirements. There is no limit on the number of such deficiency notices that the NFA may deliver to a swap entity prior to approving its final registration, and the NFA is not required to wait until it has completed its review and identified all of the deficiencies before delivering a notice with respect to a specific deficiency.

The finalized wording of CFTC Regulation 3.10(a)(1)(v)(D)(1) sets out three automatic consequences if the NFA notifies a Swap Entity that its application is deficient:

• The swap entity must withdraw its application for registration;

• The swap entity must not engage in any new activity as a swap dealer or major swap participant; and

• The swap entity shall cease to be provisionally registered.

A proviso to the regulation then states that if the swap

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entity does not withdraw its application or cure the deficiency within 90 days of receipt of the notice (or such longer period as the CFTC or the NFA may decide), the application will be deemed to have been withdrawn and the swap entity’s provisional registration shall cease. While the drafting is inelegant, it seems clear that the intention is to provide a 90-day cure period to mitigate the otherwise immediate effect of the swap entity’s obligation to withdraw its application and the termination of its provisional registration.

However, neither the proviso, nor the CFTC staff’s commentary on the rule, make any mention of the prohibition on new activity by the swap entity. It may be that the staff did not consider that the prohibition needed to be specifically mentioned in the proviso, because as long as a swap entity is provisionally registered, it is authorized to do everything that a registered entity may do. On the other hand, the same logic would imply that the final rule did not specifically need to include the prohibition on new activity, because any entity that is not properly registered, whether provisionally or finally, may not lawfully engage in any activity that requires registration.

The better interpretation is most likely that, during the cure period, the swap entity may continue to trade swaps and otherwise continue its business as a registered entity. The lack of clarity on such an important feature of the provisional registration process is concerning, and market participants should encourage the CFTC staff to clarify this provision as soon as possible.

It is to be expected that any swap entity operating with provisional registration will be required to comply with all applicable Section 4s Requirements as a matter of course, in the same way as permanently registered entities. Compliance failures may result in CFTC enforcement action.

no STATuToRY DISQuALIFICATIon oF ASSoCIATED PERSonS AnD PRInCIPALS

Although an associated person is required to file a Form 8-R, neither the CEA nor the final rules require associated persons of swap entities to register with the CFTC. This is different from most other CFTC registrants, such as commodity trading advisors and futures commission merchants. Nevertheless, under the final rules a swap entity may not permit any individual associated person who is a natural person “to effect or be involved in effecting swaps”

on behalf of the Swap Entity if they are subject to a statutory disqualification under the CEA.

A person would be subject to a statutory disqualification if they (i) have been refused registration within five years preceding the filing of the provisional application, or had their registration suspended (and the period of such suspension has not expired), or revoked; (ii) are permanently or temporarily enjoined by a court or regulatory order from acting in any registered capacity under the CEA or securities regulation; (iii) have been convicted of any felony that involves embezzlement, fraud, theft, bribery or misappropriation of funds in connection with any commodities or securities transactions within ten years preceding the filing of the Provisional Application or at any time thereafter; or (iv) have violated (or aided and abetted in violation of) any provision of the CEA or certain other U.S. federal —statutes, where such violation involves embezzlement, fraud, theft, bribery or misappropriation of funds.

Each swap entity will be responsible for ensuring that none of its associated persons is subject to a statutory disqualification and will be required to certify to this effect in the Form 7-R. Similarly, the NFA may deny registration to a swap entity if any of its principals is subject to a statutory disqualification. The final rules do not limit the prohibition on employing associated persons subject to a statutory disqualification to U.S. residents or U.S. swap entities.

This updated article first appeared in Derivatives Week as a Learning Curve. n

leave your trading desk as well as the performance of those venues. Such venues would include the cash desks of investments banks, traditional sales traders, discretionary and non-discretionary dark pools or other liquidity captured through the use of a broker’s smart order router.

““We are going to control all elements of the routing process including destination, size, limit parameters, and timing. Moreover, all order and execution details will be captured in our audit trail and incorporated into our real time analysis,” added Kuzminskas.

One other area where TCA is being used more is to evaluate the performance of traders and to also provide data for the traders so that they can improve their future performance. The majority of respondents, 75%, said understanding transaction costs to improve trading opportunities in the future was the main reason for utilizing TCA. n


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Q&A: FIA EPTA’s Remco Lenterman

Q: What ways is FIA EPTA trying to educate participants on HFT and what current standards is it working on?

A: High-frequency trading is not well understood and is often unfairly maligned or wrongly feared. Not all our members use this type of technology, but it is important to some of our members, so one of our main goals at FIA EPTA is to debunk the myths surrounding this type of trading. This reflects the overall purpose of FIA EPTA--to promote better understanding of the role that principal trading firms play in the financial markets. By principal trading firms, we mean those that rely on their own capital and do not have clients.

In our view, HFT is one of several methods of technologically advanced trading. While automated trading has replaced some functions previously carried out by people, the basic workings of the markets have not changed. The advances in trading technology have benefited many market participants substantially but of course there has been a negative impact for others-- for example those who had profited from higher spreads.

Aside from our principal aim of promoting better understanding of the role that principal traders play in the markets, FIA EPTA also engages constructively with regulators to arrive at the right standards in the oversight of the exchange-traded markets. We have been working with our sister organization in the U.S., the FIA Principal Traders Group, on several reports that recommend best practices for managing the risks of direct market access and automated trading. We also are participating in several advisory committees set up by regulators to analyze how technology is changing the financial markets. There is a tremendous amount of expertise on market structure and automated trading within our membership, and our goal is to bring this expertise into the regulatory discussion.

Q: Post MiFID II, do you expect the establishment of OTFs to result in an increase in equity option trade volumes from HFT firms?

A: It’s hard to know for sure until the rules are finalized, but we can already see movement towards more electronic

trading in several asset classes. This is in line with the G20 commitment to promote exchange trading and central clearing of derivatives. FIA EPTA strongly supports the objective of increasing of trading in open and transparent markets. If, as we hope, OTFs allow open access and trading in OTFs is transparent, we can expect HFT firms to participate in OTFs.

I can’t stress enough, however, how important it is to avoid confusing the mode of trading with the purpose of trading. One type of trading strategy that typically uses HFT is market-making, and some of our firms do in fact use HFT to quote prices for equity options. For that kind of trading strategy, HFT functions as a form of risk management. The faster that a firm can cancel and replace a quote, the faster that firm can react to any information that affects the pricing for that instrument. Because of this, a firm can quote more effectively and efficiently, resulting in lower bid and ask spreads which in turn benefits all.

So coming back to your question, what we expect from the establishment of OTFs is a change in the mode of trading, and more specifically, a change in how liquidity is provided. Presumably there will still be a call-around market for some equity options that for whatever reason don’t trade well on a screen. OTFs are being created to encourage more trading on electronic platforms, with open access and transparent pricing. If that is the case, then yes, we will see more liquidity coming into the market from firms that use HFT to engage in that type of trading.

Q: EPTA has been particularly vocal regarding article 17 of MiFID II. Could you explain what specific area of that article you are concerned with and why?

A: For us, there are several issues that arise out of this proposed article. First of all, the wording “under any market condition” in that article is quite troubling and unprecedented. It would clearly increase systemic risk if a subset of firms were asked to ignore proper risk controls. Secondly, there is a problem with the lack of incentives that

Lenterman is chairman of the Futures Industry Association’s European Principal Traders Association. He spoke to Derivatives Intelligence on high-frequency trading and particular concerns around proposals to update the E.U. Markets in Financial Instruments Directive.

Remco Lenterman


SponSored Article

Staying in the Game: How Trading Firms Can Advance Market Data InfrastructuresBy Emmanuel Doe, President, Trading Solutions at Interactive Data

Since the birth of electronic trading, financial firms have valued the

competitive advantage provided by technologies that quickly access trading venues and deliver key market data feeds. As the industry landscape evolves dramatically, technological advances have radically hastened the speed of trading with transactions being completed in milliseconds. This has raised the market data infrastructure stakes for firms, who now need low-latency data feeds and support for high frequency transactions in order to stay competitive.

As they have in the past, firms can rely upon their internal development teams to help them build out their market data environments. Yet the upfront costs and ongoing maintenance and support demands of a low-latency infrastructure are daunting, causing firms to consider an alternative outsourced approach whereby a third-party provider hosts all or key components of a market data infrastructure.

There are a multitude of considerations for firms contemplating the market data as a service model. While firms will have to trust an external provider to deliver mission-critical services, they will remove the infrastructure build-out as a gating factor in getting to market faster with new trading strategies. Additionally, hosting offers firms a potentially broader range of data and connectivity services, and it shifts the challenge of infrastructure technology maintenance issues to a trusted third party.

It’s an understatement to say that the industry landscape has changed

radically during the past decade. Ten years ago, the predominant market data distribution model was based on market data feeds flowing from third-party providers to a distribution platform that updated a firm’s traders, applications and systems in real-time. The industry has since embraced the emergence of low-latency data feeds, high frequency trading technologies and advanced trading strategies. These developments, coupled with fragmented and highly volatile markets, have changed the market dynamics for trading firms.

As a result of low-latency fiber-optic networks and direct exchange feeds proliferating, trades seem to be being transacted at velocities approaching the speed of light. When firms are building or expanding their market data infrastructures, the technology options available to them are far greater than they were 10 years ago. In addition to the traditional consolidated data feeds, many firms are considering direct, low-to-ultra-low latency access to futures, options and equity exchanges, foreign exchange venues, and so-called “dark” pools of liquidity. Wide market access facilitates transactions in multiple asset classes based on a firm’s investment and trading strategies.

Firms also have more opportunities to expand their reach globally to key financial centers in Chicago, New York, London, Frankfurt and Tokyo, as well as to emerging markets. In fact, firms can establish low-to-ultra-low latency connections to these global markets by placing their trading systems and

matching infrastructure in data centers run by exchanges and other liquidity venues. By using proximity and co-location connections, firms can dramatically reduce market data latency to the millisecond level via state-of-the-art, fiber-optic telecommunication lines.

High-speed market data links are serving the needs of many traders, including electronic market makers and statistical arbitrage desks, and advanced trading platforms such as those running algorithmic-based transactions. Traditional asset managers, hedge funds, firms employing quantitative strategies and mid-market broker/dealers can also benefit greatly from low-latency links.

Yet upgrading to a 21st century infrastructure is presenting a challenge to many firms. While technology has dramatically reduced latency, it has increased the complexity and thus the costs of market data infrastructures. The demands of managing an internal, market data distribution platform feeding traders’ desktops pale in comparison to those of managing global, low-latency market data feeds, co-location and proximity connections, and the ongoing maintenance and support that are required to stay competitive.

Emmanuel Doe

SponSored Article

Market Data as a serviceThe technologies that have enabled the

internal development of low-latency

market data delivery have also given rise

to an alternative. Firms can now have a

third-party service provider host all or part

of their market data infrastructure.

The main benefit of this approach is

economic. An independent company

can offer more cost-effective hosted

data, networking and IT support services

because the associated costs can be

amortized across their entire customer

base. In addition, by working with a third

party, trading firms can keep pace with

technology upgrades and new products

from exchanges and other data suppliers.

This service offering—generally referred

to as market data as a service—can also

enable a firm to incrementally implement

changes. Firms can start with a proximity

or co-location solution to quickly capitalize

on economies of scale. As a next step,

firms might add more venue connections

and data feeds that allow them to advance

their trading strategies without having to

substantially increase their market data

infrastructure costs.

A managed services approach to

low-latency market data delivery can

mitigate the need for firms to build

and maintain direct links between data

centers and transaction venues. They can

also delegate the ongoing maintenance

of software and hardware, including

networking protocols, operating systems,

switches and routers that support state-

of-the-art deployments.

Another option for firms is shifting

the ongoing testing and quality

control for telecommunication links,

port-to-port speeds, line speeds, and

hardware and software systems to a

third party. Hosting providers can also

take over the management of expensive

upgrades to increasingly faster lines, and

datacenter services and disaster recovery

commitments become their responsibility.

In terms of secondary benefits,

third-party hosting of state-of-the-art

market data flows can allow firms to take

advantage of the consolidated feeds

that can be delivered along with the

low and ultra-low latency offerings. The

consolidated products can cost-effectively

feed analysis systems that generate

cross-market pricing comparisons. They

can also support financial modeling

of arbitrage opportunities and bolster

strategy back-testing and portfolio

analysis.

Weighing the OptiOnsBefore firms embrace market data as

a service, they have to address the

considerations that can frequently

complicate the decision to overhaul

market data infrastructures. An important

step in this process is conducting an

inventory of the existing infrastructure.

Complicated, state-of-the-art market

data infrastructures can require project

management, research and design,

trading system reviews, network

capacity and utilization reports, network

performance assessment and tuning, and

network risk analysis.

Specifically, firms need to understand

their requirements for reliability, low-

latency support and scalability. Once

these levels are clear, firms will have to

establish how much they need to spend

to achieve and maintain their goals.

They will also need to determine their

proximity and co-location requirements,

which could include connectivity to

exchanges, other trading venues and dark

pools of liquidity. They will also have to

assess their hardware procurement needs,

software configuration and installation

costs, and maintenance.

At a higher level, firms will need to

monitor end-to-end latency levels across

their infrastructures, as well as review

networking and server performance. They

will also have to anticipate upgrades and

updates of key applications and operating systems. Firms will also need controls in place to guarantee acceptable levels of service and support.

Once a firm has measured and quantified the full scope of requirements, it will be able to decide whether its market data infrastructure is better managed internally or externally with a third-party provider that offers design, procurement, installation and network hosting services for low-latency trading environments. Complexity has yielded a range of alternatives, and firms have the flexibility to devise solutions that best support their market data strategy. If done correctly, firms can lower both the complexity and TCO of their mission-critical infrastructures.

the BenefitsThe market data as a service approach allows for choice of services and great flexibility in deployment. Firms are not limited to outsourcing their market data infrastructures on a wholesale basis. They can have a mix of onsite market data implementations, hosted market data feeds, and co-located applications and systems.

Hosted feeds and co-location/proximity services can be utilized for algorithmic and quantitative trading. This range of delivery options can help firms meet the performance demands of their trading constituents and advanced strategies. By leveraging the state-of-the-art offerings of a third-party provider, a trading firm can optimize its market data infrastructure and be prepared to exploit new delivery options as they emerge.

In summary, embracing market data as a service enables firms to fully focus on seeking out new trading opportunities. They can redouble their efforts to devise new trading strategies and test them across multiple global locations while avoiding the upfront technology costs and ongoing maintenance.



are being proposed in exchange for this liquidity provision. We understand why the European Commission wants to make sure that liquidity is continuously provided into the market. However, the current rule might actually lead to a decrease in liquidity provision because it is just not possible for any firm to be providing liquidity 100% of the time. No matter how well you run your risk parameters, there always come a time when you have to step back from the market and reassess your pricing models.

We’ve taken the position that Article 17-3 should be completely deleted. We are recommending instead that the legislation should encourage exchanges and other types of trading platforms to develop incentive schemes for liquidity providers, and those schemes should operate under guidelines established by ESMA. That will achieve what we all want, which is to maximize the amount of liquidity in the markets at all times.

Q: Are you concerned that regulators could impose limits on order-trade ratios? If limits were imposed, what impact could that have on liquidity?

A: Order-to-trade ratios are designed to deal with capacity constraints of platforms and exchanges. They are different on an exchange-by-exchange basis depending on technology. When capacity is constrained, it is quite natural that an exchange distributes the available capacity fairly. We all benefit from policies that discourage wasteful use of common resources. A badly designed trading algorithm that sends thousands and thousands of useless order messages into the exchanges puts an unnecessary burden on the infrastructure set up by the exchanges to transport those messages. That infrastructure is not cheap; we all pay for it in one way or another, so it makes sense to penalize someone who uses up the capacity of that infrastructure without adding any value to the market. To put it another way, exchanges should provide economic incentives for traders to be responsible and efficient with their messaging.

The problem with a regulator deciding on a one-size-fits-all order-to-trade ratio is that it is potentially anti-competitive. New trading venues typically need very high order-to-trade ratios to compete. This is simply because they do not enjoy the natural liquidity that the established platforms enjoy. So our position is that the exchanges are in the best position to set order-to-trade ratios. After all, the exchanges are in the best position to examine the trading patterns of every firm active in their markets and measure those against the overall capacity of their systems.

Q: What risk controls do you believe HFT firms should have in place to ensure that the markets operate in a safe and orderly fashion?

A: Several years ago some of our member firms participated in an initiative of the Futures Industry Association to establish some standards in this area. That group produced a report—ironically right before the May 2010 flash crash—that has been recognized by a number of regulators as a good model for how to address the need for risk controls. The report outlined a whole range of risk controls that should be established by exchanges and applied across all trading firms with direct access to the market. In November 2010 the FIA PTG followed up with a list of risk controls that should be implemented by trading firms with direct access to exchange matching engines. That report covered such issues as access and oversight, pre-trade risk management, trading interruptions, post-execution and back office functions, physical security, electronic security, and business continuity.

Since then we have followed up with several more reports with recommendations on risk controls. In fact we are coming out with another one this week that addresses the process for installing and deploying changes to trading software and technical infrastructure. All of these reports are available to the public and we encourage feedback from your readers.

There are two main principles that I would like to emphasize in this context. The objective of all these initiatives is to improve safety and orderly functioning of the markets. If we are serious about achieving this objective, we must make sure that the risk controls should be applied by all firms that use automated trading technology and have direct connections into the market. The technology of HFT is used by many different types of market participants, and it makes no sense to apply risk controls on one type of firm and not another. Second, it is extremely important to establish certain risk controls at the level of the exchanges. There is no question that we need risk controls at every stage of the trading process, but the exchanges are especially important because of the level playing field issue. If every order message entering an exchange passes through the same risk control filter, then every message is subject to the same time delay, and no one has any ability to jump ahead of anyone else by taking a short cut around the risk filter. We have been working with the exchanges on this, and quite a few of them have embraced this idea and are implementing risk controls along the lines of what we have recommended. n


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