Power shiftDid the failed NYSEEuronext-DeutscheBörse mergerweaken Europe?Page 2

Inside »

Competitionhots up in swapsReforms opensector to newcontendersPage 3

Cultural nuancesInterview with thefutures industry’srepresentative onbusiness in AsiaPage 4

Exchanges, Clearing& Transaction Services

Tuesday September 17 2013 www.ft.com/reports | @ftreports

Delegates at this week’sannual Sibos conference inDubai are gathering at anapposite moment. Fiveyears ago market infra-

structure – the trading, clearing andsettlement institutions on whichfinancial markets rest – was throwninto the spotlight amid the falloutfrom the collapse of Lehman Brothers.

As the worst subsided, global policymakers homed in on the huge andusually uninsured one-way positionsin over-the-counter (OTC) derivativesthat went unnoticed by banks until itwas too late, in part because the opac-ity of the market allowed brokers toreap huge rewards.

To prevent a repeat of this oversightthreatening the financial system, the

G20 mandated more standardised OTCderivatives, traded on transparentvenues. Deals should be processed,they concluded, through clearinghouses and reported to data ware-houses known as trade repositories.

In the interim the industry has grap-pled with one overarching challenge;how financial burdens associated withthe new market structure should be

shared between clearing houses, thebanks that act as intermediaries andthe end-users of derivatives, while stillguarding against systemic risk.

In the past year some decisions onkey rules in the US and Europe havebeen made. Whether the process isfinished is another matter.

“It’s the most seismic thing to hap-pen in years,” says Barney Reynolds,

a partner at lawyers Shearman &Sterling. “The momentum has carriedthrough some pretty meaningfulchange but that is running out.

“As this beds down and the markettakes off again, how will financialinstitutions manage to get an accepta-ble return in a heavily regulated and

Continued on Page 4

Markets tallycost of saferglobal trading

After ‘seismic’ regulatory change, themarketsare grapplingwithways to reduce riskwhileturning a profit, saysPhilip Stafford

FT SPECIAL REPORT

The prospects of a return tothe good old days continueto fade for Wall Street’sfastest gunslingers. Theseare the trading firms thatdart in and out of shares atrapid-fire speeds usingsophisticated technology tomake fractions of a penny.

Nearly five years havepassed since cumulativeprofits peaked for high-fre-quency trading (HFT) com-panies that buy and sellstocks at millisecond speedson the US market, accord-ing to industry estimates.

As competition has stiff-ened between those thatsurvived the downturn, theconditions that allow com-panies to thrive have deteri-orated since HFT’s mostprofitable days.

Optimism that daily UStrading volumes will returnto pre-crisis levels hasfaded, as have the franticbursts in volatility thatsend shares in divergingdirections, creating theopportunities that lured somany entrants into HFT.

“It’s been a tough market.High-frequency tradingcompanies are struggling[to cope with] a lack of vola-tility and trading volume,competition and a coststructure that continues togo up,” says Larry Tabb,founder of the consultancyTabb Group.

“The ability to generatereturns, especially in theUS equity market, is prettychallenged. They are mov-ing overseas and into otherasset classes,” he adds.

The maturing of the USequity market as far asHFT was concerned wasconfirmed this year asGetco, one of the largestand most prominent compa-nies to emerge from theHFT boom in the last dec-ade, revealed a multiyearslowdown in its proprietarytrading business.

The company, known justa few years ago for itsrelentless investment in thetechnology and knowhow tobeat other speed traders,decided it would move in adifferent direction.

It acquired in DecemberKnight Capital, known forits client-facing tradingbusiness, for $1.8bn.

“Getco and firms likeGetco that grew out of theelectronification of the mar-kets in the first decade ofthe century also grew withan explosion of volume andvolatility,” says Daniel

Coleman, who led Getcoand is chief executive ofKCG, the combined com-pany that formed followingthe acquisition of Knight.

Mr Coleman says thecompany’s backers realisedthat opportunities to pros-per in HFT relied on a com-petitive technological posi-tion – which was expensiveto maintain – and favoura-ble market conditions.

KCG will instead concen-trate on applying the once-secretive trading tech-niques and technologies itused for Getco’s ownaccounts to help clients exe-cute trades.

Jamie Selway, head ofliquidity management atbrokerage ITG, says: “Firmslike Getco were very much

one-trick ponies with highlyvisible strategies that reliedon incredibly high volumesto bring in incredibly lowreturn. Their day has comeand gone.”

While KCG insists it isnot turning its back on pro-prietary trading, the indus-try appears to be headingtoward consolidation ascompanies find the climatedifficult to navigate.

Allston Trading and RGMAdvisors, two leading high-frequency trading compa-nies, were reported to bediscussing a tie-up in June.

Those that intend to bat-tle through the difficult con-ditions in the US equitymarket must contend withthe constant cost of upgrad-ing expensive infrastructureand freshening up theirtrading strategies to stayahead of the pack. The HFTcompanies must fight tokeep top engineers and pro-

grammers from beingpoached by rivals and thebroader trading industry,which has spent heavily tobecome more sophisticated.

“The techniques that HFTshops are using are notexclusive to them anymore,” says Joshua Walsky,chief technology officer atBroadway Technologies,which provides software totrading companies. “If a tra-ditional bank is using thosetechniques, they are essen-tially competing.”

He adds that companiesmust factor in the cost oftrading errors that canamass rapidly because of aglitch or problem with acomputer system, such asthat which caused Knightto lose $460m in a matter ofminutes in August 2012 andled to its takeover by Getco.

Goldman Sachs inadvert-ently accumulated hun-dreds of thousands ofoptions contracts lastmonth.

Mr Walsky says: “Theindustry is seeing thatthere is a real cost to [mak-ing] errors, which we callsystem risk.”

Meanwhile, companiessuch as Virtu Financial,which have spent heavilyto push into new marketsand asset classes, haveemerged as the leaders ofthe industry.

The consolidation andgeographic expansion is notexpected to have any signif-icant impact on the highlyfragmented nature of theUS equity market, whichhas grown to 13 exchangesand dozens of alternativetrading platforms, to accom-modate speed traders.

Mr Tabb says: “You areseeing a number of playersconsolidate, but the venuesremain separate.

“What we’ve learned isthat when you consolidatemarkets, you hurt liquidity.I’m not sure we’re going tosee a whole lot of consolida-tion of trading venues andliquidity pools. You mayjust see fewer people onthem.”

Business gets tough forWall Street gunslingersHigh-frequency trading

Rivalry amongdownturn survivorstakes its toll, writesArash Massoudi

The costs of a software glitch led to Knight’s takeover

‘The ability togenerate returns,especially in the USequity market, ispretty challenged’

2 ★ FINANCIAL TIMES TUESDAY SEPTEMBER 17 2013

Exchanges, Clearing & Transaction Services

The financial industry is inthe process of movingderivatives trades to centralclearing but the act ofsourcing the billions ofdollars of high-quality assetsthat will be needed to backthe transactions has becomebig business.

Under the new clearingrequirements, companiesand funds that usederivatives will have topost collateral to centralcounterparties as securityagainst their trades.Estimates for the extracollateral needed haveranged from $500bn to$10tn, leading to a numberof industry offerings to easeany potential shortage.

“[The new rules mean]counterparty risk ismitigated by high-qualitycollateral, and there’s onlyso much of it in the world,”says Marianne Brown,chief executive of Omgeo, apost-trade services providerthat has been bought bythe Depository Trust andClearing Corporation(DTCC), itself owned by agroup of banks.

That has led to theemergence of a growing andincreasingly competitivebusiness of managing,optimising and even creatingthe needed collateral.

“Any time that there’s ademand for somethingscarce, everybody’s going tofigure out a way to provideit,” says Ms Brown. “Ofcourse there’s a price.”

Earlier this year,Euroclear, the Brussels-based settlement house, andthe DTCC announced a jointventure that could end upcreating the world’s biggestpool of collateral. Theagreement allows DTCCcustomers to accessEuroclear’s collateralmanagement system – the“collateral highway” – whichholds more than €20tn.Euroclear customers will beable to tap into a similarsystem at the DTCC knownas the margin transit utility.

The offering from two ofthe world’s biggest post-trade services providers has

the potential to open upaccess to trillions of dollarsworth of collateral aroundthe world, and allowscustomers to “optimise”portfolios held in differentplaces. It is an ambitiousproject,which faces intensecompetition.

“It addresses optimisationand settlement but itssuccess depends on theparticipation of the majorcustodians,” says ManmeetBrar, senior manager atSapient Global Markets, acapital and commoditiesmarkets consultancy.

JPMorgan Chaseannounced in June itsattempt to capture a sliceof the growing business ofmanaging the billions ofdollars worth of cash andsecurities that funds,financials and companieswill need to stump up toback their derivatives trades.

Its “collateral central”platform will act as a hubto allow clients to track andoptimise their availablecollateral, including assetsheld at other banks andcustodians. The bankestimated in an investorpresentation in Februarythat it could initially reap$300m-$500m in revenuesfrom the clearing andcollateral managementbusiness.

“We all have our ownbusiness mandates andprofit margins,” says MrBrar. “For each custodianthey say: ‘Here, I’m offeringthe same thing – why don’tyou hook up to all theseother platforms from myplatform?’”

BNY Mellon, another largeUS custodian bank, hasintroduced “global collateralservices” to help clientsoptimise their use ofcollateral. State Street, asmaller competing custodian,is also working on its owncollateral-related services.

“How many of these willcapture market share is forall to be seen,” says MrBrar. “We have yet to seewho the winners are.”

Tracy Alloway

Collateral management The shift tocentral clearing is creating opportunities

To mention European compe-tition policy to a seniorDeutsche Börse executive isto touch on a sensitive sub-ject. Last year Brussels

squashed the plans by Europe’sexchanges operator to merge withrival NYSE Euronext.

The merger would have created atransatlantic global powerhouse wellpositioned to exploit the opportuni-ties being created by the sweepinglegislation that will force more pri-vately traded OTC derivatives on toelectronic trading venues.

Deutsche Börse argues that the con-sequences go far beyond its own inter-est. “It is the result of European regu-lators making sure that consolidationin our global derivatives industry, forthe foreseeable future, will be verysuccessfully led by exchanges with USorigin,” Andreas Preuss, chief execu-tive of its derivatives exchange Eurex,told a conference in London over thesummer.

Nearly 18 months on from the land-mark ruling, the landscape in the oldcontinent appears to be shifting dra-matically. Overseas companies havebeen aggressively pursuing Europeanand global expansion plans, usingLondon as the hub.

In that short time, CME Group, theworld’s largest futures exchange, hasexpanded by opening a futuresexchange and a clearing house inEurope. BNY Mellon, a US custodianbank, won approval for a Europeancentral securities depository.

Overshadowing it all, the US’s Inter-continentalExchange (ICE) thenswooped on NYSE Euronext lastDecember in a deal worth around$10bn. Assuming the deal goes ahead,it will give Jeff Sprecher, ICE’s chiefexecutive, the London Liffe deriva-tives market that he has long soughtand ownership of the stock exchangesof Paris, Amsterdam, Brussels and Lis-bon. It has made ICE’s clearing houseone of the largest in Europe. DeutscheBörse, which had eyed a mega-mergerwith NYSE Euronext for four years,found itself rebuffing polite inquiriesfrom the CME about a deal.

So will a combination of new deriva-tives rules and EU competition policyusher in a US takeover of Europeanmarket infrastructure? “If you look athistory, US dominance is far fromproven,” argues Florence Fontan,head of asset managers at BNP Pari-bas Securities Services. “It doesn’tmean they can’t be successful.

She adds that attempts to “take theUS model and plug it into Europe”have “been failing” for “underestimat-ing the level of complexity” on thecontinent. “Europe is used to adaptingto differing frameworks,” she says.

Significant variances between theUS and Europe include regulationsgoverning the way clearing housesmust segregate their customers assetsand the way they collect initial mar-gin or insurance for trading.

Newcomers face a serious problemin wresting business away from localincumbents, particularly in deriva-

tives trading. Clearing of OTC interestrate swaps is dominated byLCH.Clearnet and, while the CMEclearing operations are in theirinfancy, they have yet to make a sig-nificant inroad into the local market.

Ms Fontan points to the example ofthe Depository Trust and ClearingCorporation (DTCC), which tried tocrack European equities clearing, asregulation demanded competition inequities trading.

The US post-trade service provideris in the process of selling down partof its stake in its main vehicle,EuroCCP, which is merging with theEuropean Multilateral Trading Facil-ity to cut costs.

European companies have been asambitious as their US counterparts.LCH.Clearnet, its future secure afterthe London Stock Exchange Groupbought a controlling interest, is tak-ing its game to the US. It has cleared$50tn in client business since the firststage of the US clearing mandatebegan in March. Euroclear, the post-trade services provider, agreed a dealwith DTCC on collateral.

European pride may get a boostnext year when Euronext’s future isresolved. ICE’s Mr Sprecher has sig-nalled his intention to float the busi-ness, although rumours persist that itwill be sold. Several exchanges,including Deutsche Börse, the LondonStock Exchange and SIX Group havebeen linked with a bid.

Complicating the outlook is theuncertain regulatory framework in

which business decisions are beingmade. Details need to be finalised forkey Europe regulations, known as theMifid Review and Emir. Policymakerswill spend the next few months debat-ing opening access to derivativesexchanges’ “vertical silo” model, withwhich contracts that are traded at avenue are processed through theexchange’s clearing house.

To do that, policy makers wouldhave to insist that derivatives prod-ucts owned by exchanges be madefungible, or interchangeable withrival products. That could potentiallyopen CME, ICE and Deutsche Börse tocompetition in listed derivatives – andcould allow others to follow the pathopened this year by The OrderMachine, the Dutch start-up that hastaken a quarter of market share ofoptions trading from NYSE Euronextin Amsterdam.

CME, ICE and Deutsche Börse arguethat their model is better suited tomaintaining financial stability and iswhat customers want. “The questionis how does Europe grow?” said MarkHemsley, chief executive of US-ownedBATS Chi-X Europe, the region’s larg-est share trading venue. “Should theapproach be that of the US equityoptions market, which has created avibrant market for customers byreleasing exchange competition butproviding fungible products? This isnot where exchanges want to go but itmay mean that in the longer runinnovation will continue to berestricted in Europe.”

Halted mergerraises questionof transatlanticpower balance

EuropePhilip Staffordwrites on fallout fromthwartedNYSEEuronext-Deutsche Börse deal

An announcementon the DeutscheBörse and NYSEEuronext mergerin 2011. It wasstopped last yearby the EuropeanCommission

Bloomberg

FINANCIAL TIMES TUESDAY SEPTEMBER 17 2013 ★ 3

Exchanges, Clearing & Transaction Services

On FT.com » www.ft.com/ects

Latin AmericaWhy Brazil is atough nut to crackSamantha Pearson onexchanges, fragmentationand consolidation

ChicagoChange blows throughthe Windy CityFrom Milton Friedmanto the Dodd-Frankreforms. By Neil Munshi

EnergyTraders’ great leapinto the futuresGregory Meyer on howregulation triggeredan unexpected shift

Of all the changes globalregulators have sought tointroduce to guard againstsystemic risk, one of themost profound has been theincreasing importance ofclearing houses.

The emergence of theseunglamorous risk manage-ment houses has beendriven by a consensusamong the G20 that theywill help financial marketsbetter withstand the effectof big defaults. A clearinghouse guarantees a dealbetween two parties, usingthe collateral deposited bymarket participants toensure that the deal is com-pleted if one side defaults.

After four years of hardwork, the frameworks forclearing rules in the US,Japan and Europe are com-ing together. The majorityof interest rate swaps arecleared, as well as increas-ing amounts of creditdefault swaps, while dealsare also being reported totrade repositories.

Mark Carney, governor ofthe Bank of England andchairman of the FinancialStability Board, noted inSeptember that there hadbeen “good progress” but“we do need some furtherimprovement”.

Among those improve-ments would be: how themarket and regulators oper-ate amid differing regula-tory interpretations of thesame mandate; how cus-tomer collateral should behandled; and a frameworkfor when a clearing housegets into trouble.

“There is a lot of confi-dence in how the process isworking,” says EdmundParker, a partner at Londonlawyers Mayer Brown. Hecautioned: “It’s going totake five to six years to doit properly. We createdinstitutions [banks] thatwere ‘too big to fail’, but wehave now created institu-tions [clearing houses] thatare ‘too big to fail’.”

Some banks have raisedconcerns about clearinghouses’ ability to withstandmajor market shocks anddefaults. The industryadmits that an educationprocess is needed.

“There is talk of capitalreserves being the weak-ness in the fortress of clear-ing houses but in realitycapital is the last compo-nent of risk management ata clearing house and notalways the most relevant,”says Dennis McLaughlin,group chief risk officer atLCH.Clearnet.

As market participantsinvolve themselves more inthe detail of daily use ofclearing houses, they arebecoming more attuned tothe different ways that reg-ulators have interpreted thesame mandate. For exam-ple, the minimum margin

requirements for Europeanand US clearing houses dif-fer. In futures trading,Europe is proposing thatbanks post collateral toprotect against lossesincurred over two days,while the US requires lossesfor one day.

For interest rate swaps,European regulators sug-gest market participantspost only two days of mar-gin; the US has alreadymandated five days’ worth.In both cases the differencecould be measured in mil-lions of dollars of collateral.

Another challenge lies inthe way clearing houses can

arrange customer accountsso their positions can be“ringfenced” from others ifanother defaults.

In the US, CCPs (centralcounterparties) have amodel known as “legallyseparated, operationally co-mingled”, LSOC. It allowsclearing members to oper-ate a single account for col-lateral. Europe, by contrast,requires that accounts areindividually segregated,meaning clearers such asCME, Eurex and LCH.Clear-net have been developingtheir own services.

“In the US you have one

set of rules and it creates ahomogenised approach thateveryone has built to andoperates in. It’s enormouslymore complicated inEurope,” says Andy Ross,European head of OTCclearing at Morgan Stanley.“The significant issue eve-ryone is concerned with ismarket change indigestion.

“The nightmare scenariois 10-plus major EuropeanCCPs going live withunique models within a fewweeks of each other.”

Lee McCormack, clientclearing business develop-ment manager at Nomura,said regulators knew whatthey wanted to do in theirown jurisdiction. The ques-tion was how they weregoing to marry it with otherrules around the world.

“We’re expecting Asiancountries to meet the G20rules but there are prob-lems with data protection,for example,” he says. “ForAsian rules, are they goingto be deemed equivalent tothe US and Europe, andwhen are they going tocome?” he asked.

Alex McDonald, chiefexecutive of the WholesaleMarkets Brokers Associa-tion says: “When policymakers came up with thenotion of central clearing asa mitigant of systemic risk,they certainly had mutuali-sation of risk in mind.”

“But the final clearinghouse resolution and recov-ery regimes will reallydetermine how risk isapportioned among marketparticipants.”

The new heart of a safer systemClearing houses

Confidence growsin how process isworking, reportsPhilip Stafford

‘The issue everyoneis concerned withis market changeindigestion’

Tracy AllowayUS financial correspondent

Jeremy GrantAsia regional corporatecorrespondent

Michael MackenzieUS markets editor

Arash MassoudiUS markets reporter

Gregory MeyerMarkets reporter

Neil MunshiChicago and Midwestcorrespondent

Samantha PearsonBrazil reporter

Philip StaffordEditor, FT Trading Room

Jerry AndrewsCommissioning editor

Andy MearsPicture editor

Steven BirdDesigner

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Contributors »

The financial reforms trig-gered by the financial crisisare starting to make theirpresence felt in the $300tnprivately negotiated US

derivatives market.With the counterparty risk of swap

transactions now being assumed bycentralised clearing houses, the focusof the industry is on how the tradingof swaps will develop.

A number of firms are formalisingnew transaction venues known asswap execution facilities, and these“Sefs” will compete with establishedfutures exchanges to enable tradingbetween banks and institutionalinvestors. The development is seen asopening up an industry long domi-nated by big global derivative banksto greater competition, resulting inlower trading costs for investors.

The new swap trading era pits ahost of players in open competitionagainst each other, from the well-es-tablished inter-dealer brokers such asIcap, to big platforms run by Bloomb-erg, Tradeweb and MarketAxess, to anumber of new entrants such as StateStreet and Javelin.

The leading derivative exchanges,namely CME Group and the Intercon-tinental Exchange (ICE), and othervendors are seeking to entice users ofover-the-counter (OTC) swaps towardsfutures contracts that are cheaper toclear centrally.

As Wall Street has lobbied hard towater down financial reform, anundercurrent among players in theestablished swaps industry has beenthe fear that exchanges such as CMEand ICE would emerge as the big win-ners from a wholesale evolution ofOTC swaps from a telephone-basedmarket to computers.

“Either OTC swaps or swap futurescould be the winner,” says CharleyCooper, head of exchange-tradedderivatives at State Street GlobalExchange, which has filed a Sef appli-cation, and also provides technologysupport for the Eris Exchange and itsswap futures contract.

“In our discussions with clients weheard a preference for OTC swaps andswap futures, so we are offering them

both, so we can capitalise on the wayit plays out,” says Mr Cooper.

Goldman Sachs and other dealersare supporting the CME’s swapfutures contract – which is also basedon a Goldman patent – while the Erisswap contract has the support of Mor-gan Stanley.

According to Richard Repetto, prin-cipal at Sandler O’Neill Partners,leading executives at the CME believeit is not yet clear how far theOTC market will shift towardsfutures, while the presence of dealersremains important.

“The CME believes the dealers willcontinue to play a significant role inthe trading and clearing of IRS [inter-est rate swaps], at least in the nearterm,” says Mr Repetto. “On a five-year forward view, CME believes it isstill unclear how much of theOTC will stay cleared and remain OTC

or convert to a futures-like product.”Chris Edmonds, president of ICE

Clear Credit says their credit indexfutures contract, launched in May,was developed in response to demandfrom investors who may not generallyparticipate in the OTC market. “Thisis a credit product that appeals tonon-traditional players, looking tohedge macro credit risk.”

Mr Edmonds says ICE is looking atlaunching a full suite of credit-relatedproducts that would complementexisting OTC products in the future.

As the world between dealers andinvestors converges, all prospectiveswap trading platforms will need toconnect with a wide range of partici-pants. For inter-dealer brokers, thismeans moving beyond talking to alimited number of banks. Existingplatforms such as Bloomberg,TradeWeb and MarketAxess thatalready link banks with institutionalinvestors are expected to hit theground running once Sefs are fullyoperational.

Many of the new trading venueswill not only offer streaming pricesthat enable users to buy or sell a swapon a screen with the click of a compu-ter mouse, they are also going to pro-vide a request for quote (RFQ) service,whereby an investor can seek a pricefrom a limited number of banks orother market makers.

“The winners will be those platforms

that listen to their customers and givethem a choice of ways to transact,”says James Cawley, chief executiveofficer at Javelin Capital Markets,which has filed to become a Sef. “In acommoditised market place, it is therelationship that wins.”

The use of RFQ is seen as helpingbanks to preserve their market share,but if more investors gravitatetowards an anonymous electronictrading book, it is seen as shifting themarket to an exchange model.

Chris Ferreri, a managing directorat Icap North America says while it istoo soon to tell whether the OTC mar-ket will move towards a futures-typemodel, the cost of trading is a keyfactor for users of derivatives. “If thecost to clear and margin a future isless than a swap, then it’s more of achallenge for clients to transact swapsand not futures,” he says.

Rivals angle for custom in changing world of swapsUnited States

Reforms open up an industrydominated by big banks,saysMichael Mackenzie

Users will be able to buyor sell a swap on a screenwith the click of a mouse

4 ★ FINANCIAL TIMES TUESDAY SEPTEMBER 17 2013

Exchanges, Clearing & Transaction Services

highly capitalised market?”he asks. “Will new businessmodels develop to avoidsome of the more onerousnew restrictions? Moreimportantly, will regulatorsallow this to happen?”

Underpinning policy mak-ers’ thinking was a push tomove some of the risks foreconomies and marketsthat were traditionallyabsorbed by banks to sup-posedly more stable, lessconflicted infrastructuresuch as clearing houses.They also aimed to spreadrisk around the industry. Aclearing house standsbetween two parties in adeal, ensuring a trade iscompleted in the event of adefault and its memberspay for the operator tomanage positions.

These changes are wellunder way and elementsare in force in some coun-tries, even though impor-tant problems remain out-standing.

Japan and the US, via itsDodd-Frank Act, have man-dated clearing of swaps andreporting of trades. Euro-pean regulators are workingto finalise their response,contained in the EuropeanMarket Infrastructure Regu-lation (Emir).

Perhaps most critically,in early summer US andEuropean officials agreed away jointly to police globalderivatives markets andavert a potential regulatoryturf war that threatened todisrupt the daily workingsof financial markets.

The world’s derivativesexchanges hope to benefitmost from these sweepingmoves, as they own theirown clearing house.

The industry has beenquick to exploit the weak-nesses of rivals and addressgaps in their own servicesas evidenced by Interconti-nentalExchange’s planneddeal to buy NYSE Euronext,owner of London’s Liffederivatives market, for$10bn in cash and shares.

However, exchanges facea fierce battle. Heavy lobby-ing by banks, for whomOTC derivatives trading is alucrative business, hasresulted in some proposalsbeing watered down, orprofitable business linescarved out of the rules.Banks have voiced concernsto regulators that clearersare not sufficiently trans-parent about their opera-tions, or may compromisesystemic safety for commer-cial gain.

This is rebutted by theindustry. “As a neutralfacilitator of risk, whichclearing houses clearly are,the direction of the marketis irrelevant,” says TerryDuffy, executive chairman

Continued from Page 1

at CME Group. “What’simportant is making surethe pays and collects aredone on a risk basis andnot on a mark-to-myth oranything else.”

Authorities recognise thejob of shoring up the finan-cial system is not finished.

“There’s been goodprogress but there is still alot more work to be done,”said Mark Carney, governorof the Bank of England andchairman of the FinancialStability Board, only twoweeks ago as he outlinedthe steps regulators hadtaken to solve the “too bigto fail” problem.

“We now have to movefrom the powers to thepractical . . . we need totranslate it into actual reso-lution plans for systemical-ly-important financial insti-tutions,” he said.

He called on other coun-tries and regulators to fol-

low the US-EU agreementover swaps market over-sight. The industry has longbeen concerned that regula-tory over-reach across bor-ders could stifle a globalbusiness and force it intoregional concentrations.

The first country toundertake mandatory clear-ing of derivatives for bankswas Japan. Tokyo is thethird largest off-exchangederivatives market afterLondon and New York. It isalso taking the lead role indefining Asian responses tothe G20 mandate.

“Everyone is looking atJapan,” says Sanela Hodzic,head of strategy at CalypsoTechnology, a US tradingtechnology company thatsupplies the region’s mainclearing houses. “The G20rules are still being imple-mented but volume on theJapan Securities ClearingCorporation is bigger thanthe CME.”

The participants poten-tially facing the greatestshake-up of the OTC mar-ket are the interdealer bro-kers, who act as middlemenmoving large blocks of illiq-uid securities. US authori-ties have interpreted themove to electronic tradingvenues as an opportunity tointroduce competition inwhat had previously been aclubby, closed world.

In mandating these newmarketplaces, known asswap execution facilities orSefs, the CommodityFutures Trading Commis-sion has opened the door toentrants such as Bloomberg.

However, interdealer bro-kers such as ICAP, TullettPrebon and GFI Group saythe reforms to offset risk inthe market will simplyinstitutionalise in regula-tion a role they already ful-fil. “It will formalise manyof the trading and post-trade practices that inter-dealer brokers have had inplace for some time,” saysAlex McDonald, chief exec-utive of the Wholesale Mar-kets Brokers’ Association.

By contrast, equities trad-ing is still dealing with theconsequences of its “bigbang” half a decade ago.Reforms on both sides ofthe Atlantic succeeded butbrought market fragmenta-tion in the era of high-fre-quency trading (HFT),which sought to exploit reg-ulations or technologicalinefficiencies in the market.

Profits from HFT peakedin 2009 and have fallensharply since. For some ofthose who had benefitedfrom the HFT explosion inequities, the time had cometo branch out into otherasset classes such as cur-rencies and fixed income.

Perhaps as a sign of aloss of confidence in trans-parent markets, investorsincreasingly turned to so-called “dark pools” – off-ex-change venues where dealscould be struck in private.Institutions liked them butregulators began to growincreasingly concernedabout their ability to moni-tor a market where pricingwas not transparent. It is aproblem with which deriva-tives regulators are onlytoo familiar.

Markets tally cost of tightertrading regulation

Industry fearsthat regulatoryover-reach acrossborders could stifleglobal business

As a young man working asa trader in the foreignexchange “pit” at theChicago MercantileExchange, Bill Herder

found his height an advantage.At 6ft 8in (2m) tall, he could scan

the sea of waving arms and handsand catch sight of traders’ buy orsell signals better than many othersaround him of smaller stature.

Now, many years later, Mr Herderis using his position as head of the

industry body for the futures marketsin Asia to scan a rather bigger area.

As executive director of the Asiachapter of the US-based FuturesIndustry Association, the 51-year-oldgathers intelligence from regulators,market participants and exchangeson the complex and rapidly-shiftinglandscape facing the derivativesindustry in Asia.

FIA Asia was set up seven yearsago but was run from Chicago, hometo the US futures markets, until the

organisation felt it had enoughmembers in the region to warrant apresence in Asia. The first Asianoffice opened 18 months ago, inSingapore, hiring Mr Herder fromIcap, the world’s largest inter-dealerbroker, where he had been head ofoperations for the Asia Pacific region.

Mr Herder scans regulators’websites, looking for the latestmarket consultations on issues thatmay affect FIA members – mostlybanks and brokers operating in the

futures markets. The FIA reckonsthat Asia accounts for 15-20 per centof the global futures and options-on-futures markets by volume, with therest divided about equally betweenNorth America and Europe.

Mr Herder attends industryconferences and is in constantcontact with members on issues fromtax treaties in India and over-the-counter (OTC) clearing regulationsfrom the Monetary Authority ofSingapore to new high-frequencytrading rules in South Korea.

When it comes to lobbying, FIAAsia is no different from its affiliatesin the US and Europe, and will writeto regulators with members’ concernsin an effort to influence the finalshape of regulations.

Mr Herder says that culturaldifferences in Asia mean thatmembers are often reluctant towrite directly to regulatorsto avoid causing offence.

When FIA Asia writessuch letters, it willoften withhold names.That contrasts withthe more adversarialrelations betweenmarket watchdogs andparticipants in thewest, where banks areprepared to take onregulators such as the USCommodity Futures TradingCommission.

The softly-softly FIA Asia approachseems to have helped create anatmosphere of constructiveengagement. “It’s got to the pointwhere the regulators will call me andsay: ‘Can you do us a favour and askwhat your members think of this?’because they don’t want to appearconfrontational and want a positiveoutcome rather than a lot ofpotentially awkward back-and-forth,”Mr Herder says.

The opening of the FIA’s office inthe region comes at a time ofregulatory ferment. Banks, brokers,exchanges and clearing houses aregrappling with the implications ofthe Dodd-Frank act in the US, andits equivalent in Europe, theEuropean Market InfrastructureRegulation (Emir). Both prescribe

sweeping changes to the way theOTC derivatives markets are tofunction – mostly by requiring themto be traded on electronic tradingplatforms – and to be cleared, wherepossible, through clearing houses.

The changes – agreed in 2009 bythe G20 – are designed to maketrading more transparent and to helpsafeguard the financial systemagainst the fallout from any bigmarket default, such as that ofLehman Brothers in 2008.

Asia is feeling the effects of thoseregulations, as jurisdictions with OTCmarkets of their own come up withtheir versions to comply with the G20mandate, and as banks and clearinghouses struggle to work out theextent to which the Dodd-Frank andEmir provisions will apply to marketactivity in Asia.

Top of Mr Herder’s agenda – andthose of his members – in

recent months has beenuncertainty over how

Asian clearing houseswill be treated underEmir. Non-Europeanclearing houses mustapply to the EuropeanSecurities and Markets

Authority (Esma), thepan-European markets

watchdog, to be allowed toclear OTC derivatives trades for

European financial institutions.While that sounds easy enough –

the deadline to submit applicationspassed on September 15 – there hasbeen uncertainty over which clearinghouses have done so, making it hardfor clearing brokers to plan ahead.

Esma did this month recognise fourjurisdictions in Asia Pacific –Australia, Hong Kong, Japan andSingapore – as having “equivalent”rules and regulations to those inEurope when it comes to Europeanfinancial institutions using non-European clearers.

But Mr Herder points out thatdifferences between Asianjurisdictions, as well as between Asiaand Europe, are not yet understoodin the west. “The regulators arelooking at Asia as if it is part ofsome recognisable facsimile of theirown system, and it’s not,” he says.

Chicago‘pit man’surveys theAsian horizon

Interview Bill HerderThe Futures IndustryAssociation’sman inAsia talks to JeremyGrantabout its regional role and cultural differences

Bill Herder (right) has set upoffice in Singapore (above)

Dreamstime

Members are often reluctantto write directly to regulators...to avoid causing offence