Advances in the Technology of Derivatives Trading and Clearing

Sep 8, 2016
Feeling the Squeeze

LME Looks to Reduce Trading Costs

In the face of falling trading volumes, the London Metal Exchange has cut certain trading fees by 44% and introduced several structural changes designed to lower customers’ trading costs.

The rollback marks a sharp about-face by the exchange’s owner, Hong Kong Exchanges & Clearing. HKEX bought LME in 2012 and raised the fees in 2015, citing a need to fund infrastructure expansion. However, the price hike didn’t work out entirely as planned. Amid complaints from member firms, volumes fell by 4.3% in 2015 and another 9% in the first half of this year. 

LME is still the dominant exchange for futures on copper, aluminum and other industrial metals, but it faces increasing competition from both East and West. The Shanghai Futures Exchange has become one of the largest commodity futures exchanges in the world, and in New York, the Comex division of CME Group is working hard to capture a bigger share of the market. 

An in-depth look at the volume in copper futures at these three trading centers shows the trend. After adjusting for the difference in contract sizes, LME's copper contract has moved from 72% of combined volume at the end of 2012 to 62% in the second quarter of 2016. SHFE rose from 13% to 23% of the market, while Comex held steady at 15% of the market.

After talking it over with members and other market participants for several months, LME decided on a package of measures designed to strengthen its metals markets and reinforce the value of the exchange for physical users of the metal. 

One dimension is to lower the cost of trading. The 44% fee reduction is targeted at a particular type of trading known as short-dated carries. These trades allow market participants to roll positions from day to day, which the exchange views as particularly important for industrial users. The exchange has cut the member fee for this type of trade to 50 cents per side, including clearing and trading. This brings it to the same level paid by clients and is actually lower than the 58 cents the exchange was charging before the 2015 hike. 

The LME also plans to cap charges for position transfers to $10,000, well below the $30,000 average in 2015. This will apply to both members and clients. 

Another dimension is in the area of margining. LME Clear plans to reduce the initial margin payable for LME positions by using a new margining methodology. This methodology is currently undergoing regulatory review, but the exchange expects that it will be particularly effective at reducing initial margin for aluminum and copper.  

But will these discounts be enough to lure back traders who have defected to other platforms? LME executives are cautiously optimistic, noting that the measures were discussed with members over the last few months. “We are confident that members will see the benefit from the changes we have introduced,” said an LME spokesperson.

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Platform Upgrade

Eurex Unveils Its 2017 Tech Roadmap

Eurex plans to roll out two upgrades of its T7 trading platform next year, starting with version 5.0 in June and version 6.0 in December. The upgrades will include a new trade entry system for off-exchange trades, the enhancement of the mass cancel function designed for market makers and support for total return products. T7 6.0 will also include features that make it compliant with new regulations in MiFID II (the updated Markets in Financial Instruments Directive) and MiFIR (the new Markets in Financial Instruments Regulation).

In addition to the new features, the upgrades are aimed at supporting the growth in message traffic without slowing down the processing of order messages. Since June 2013, average latency for futures transactions held steady between 180 and 350 microseconds for users of the Eurex Enhanced Trading Interface in Frankfurt, despite the fact that transaction volumes rose about 20%. Since the beginning of 2016, median round trip times have fallen 20 microseconds to around 140 microseconds.

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Retail Trading

E*Trade Expands Derivatives Offerings Via Acquisition of OptionsHouse

Sometimes it's better to buy than build. That is what E*Trade Financial chose when it announced an agreement to buy OptionsHouse, an electronic brokerage that specializes in retail options trading. E*Trade, one of the powerhouses in the online stock brokerage business, realized it had fallen behind its rivals in terms of futures and options trading, and decided to get back in the game by plunking down $725 million for the Chicago-based firm. 

"Upping our options capability has long been a goal of ours, as we relinquished a strong industry position in 2009, giving way to a competitor who completed an acquisition of an options-centric platform," said then-CEO Paul Idzik on the call. "And while today we execute around 20% of the retail market’s options contracts, and nearly a quarter of our customer trades are in options, our growth in the product leveled off some time ago."

Idzik added that the company had considered stepping up its investments in building its in-house options capability, but decided that buying an established platform would be a more efficient solution. Idzik explained that the deal would allow E*Trade to deliver a sophisticated platform for trading options, which he described as "an increasingly attractive value proposition" for retail investors. 

E*Trade's main rivals, TDAmeritrade and Charles Schwab, made similar moves several years ago, forcing E*Trade to play catch-up. TDAmeritrade bought thinkorSwim for $600 million in 2009, and today 31% of the entire firm's trades come from options and another 11% from futures. Charles Schwab bought OptionsXpress for $1 billion in 2011. That brought capabilities not only in equity options but also futures and options on futures, which account for around 20% of trading at OptionsXpress. 

OptionsHouse was founded in 2005 by Peak6, an options market making firm that decided to leverage its expertise in options by building a retail brokerage. In 2014, General Atlantic, a private equity firm with a long track record of successful deals in the financial markets, bought a majority stake in OptionsHouse and merged it with another retail brokerage firm, tradeMonster. 

As of June, the company had approximately 154,000 customer accounts with $3.6 billion in customer assets. The company's strength is in options – more than 60% of its volume – but it also has a small futures arm, and E*Trade officials said they plan to integrate futures trading into its offerings and build a "best in class" product for retail traders. 

Driving the deal is an appreciation for the growth potential in retail trading of derivatives, and options in particular. Options traders are an especially valuable customer segment because of higher commissions and more frequent trading. "When we look at derivatives base commissions, especially in the options base, the frequency of which traders engage in that space and the growth of the market segment over the past few years is something that we find very compelling about this transaction," commented Michael Pizzi, E*Trade's chief financial officer, on the July 25 call.

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Twitter Storm

CBOE Launches Social Media Sentiment Indices

Chicago Board Options Exchange is partnering with a Chicago-based technology firm that tracks social media to develop a new set of indices that measure short-term market momentum. 

The partnership is based on the idea that comments on Twitter and other social media can be used to extract predictive signals for traders and investors. CBOE's partner, Social Market Analytics, has developed a process for sifting through social media, filtering out irrelevant comments and identifying comments that indicate a trading intention. The company uses this information to generate "S-Scores," an indicator that reflects trader sentiment. 

CBOE and SMA formed their partnership in June and CBOE launched the first index in August. The CBOE-SMA Large Cap Index tracks the performance of a portfolio of 25 stocks with high S-Scores. The index is reconstituted daily, based on which large-cap stocks have the highest S-scores at the start of the day. 

“Extracting information from social media to make investment decisions represents a new and promising frontier in strategy benchmarking," said William Speth, vice president, research and product development, CBOE. “Our research suggests that there is a high correlation between the price movements in stocks and SMA’s data. Investors could potentially use these benchmarks to build strategies to enhance risk-adjusted returns in a portfolio.”  

SMA is one of the pioneers in the emerging field of companies that extract trading signals from social media. Joe Gits, the company's chief executive officer, explained how the process works in an article published in the June 2015 issue of MarketVoice.

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Real-Time Data

Montreal Exchange Unveils New Order Book Feed

The Bourse de Montréal has introduced a new real-time order feed to give clients more detail on all derivatives products traded on the exchange. The real-time binary MX Order Book Feed includes enriched data and new functionality that provides improved transparency to the Canadian options and futures markets.

In addition to organization by market order and a full-depth order book, the feed includes timestamp granularity to the millisecond, a tick table message with product increment details for every instrument and inclusion of the original trade identification in the trade cancel message, which makes it easier to trace the initial trade.

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Liquidity Pool

ICE Launches Single-Name CDS Platform

Intercontinental Exchange is betting that the credit default swap market is ready for customers and dealers to come together on a single platform. 

In August the exchange introduced an all-to-all central limit order book for single name credit default swaps. The order book, which will rely on trading technology originally developed for dealer-to-dealer trading, will consolidate orders from both buy-side and sell-side market participants, and trades will be routed directly into clearing.

ICE said the new market offers participants the option to remain anonymous or offer “name give-up” execution in the order book, giving them the ability to disclose their identity after the trade is completed. Other features touted by ICE include pre-trade credit checks and direct-to-clearing workflow.

“ICE Swap is the only single name CDS platform offering cleared-only liquidity across the credit spectrum while extending established electronic trading protocols to the entire CDS market,” said Krishan Singh, President of ICE Swap Trade. “We’re pleased that a number of trades have already been executed by both the sell-side and buy-side in the first few days post-launch. We worked closely with a range of participants to optimize our protocols to improve liquidity, transparency and confidence in this important market.” 

In related news, ICE announced on July 29 that it has entered an agreement to sell the voice brokerage operations of Creditex, its credit derivatives brokerage subsidiary, to Tullett Prebon. ICE will retain the subsidiary's electronically traded markets and systems, post-trade connectivity platforms and intellectual property.

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Collateral Management

CME Teams Up with CloudMargin

CME has joined forces with U.K. startup CloudMargin to deliver an integrated collateral management service for cleared and non-cleared margin accounts.

CloudMargin describes itself as the first cloud-based software service that integrates and automates collateral management in a single enterprise. Offered to CME Clearing and CME Clearing Europe customers, the service will give them access to a consolidated view of their entire collateral inventory, which they can use for both cleared and non-cleared derivatives transactions at any given time. 

“The cloud-based collateral management service will be of particular relevance for market participants who want to fulfill all of their operational and regulatory requirements efficiently,” said Sunil Cutinho, president of CME Clearing.

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Hybrid Model

Tullett Prebon Acquires CME Trading Technology

Tullett Prebon, an interdealer broker headquartered in London, acquired a long-term license of CME’s hybrid trading technology.

Tullett executives say they plan to use the technology as the cornerstone of their new hybrid initiatives. “This purchase gives us greater control and flexibility of our key customer facing technologies, enabling us to deliver innovative and cost effective systems,” explained David Perkins, managing director of electronic broking at Tullett Prebon. 

Although Tullett Prebon already uses the CME technology, this acquisition will enable Tullett Prebon to develop it further to meet customer needs. Company representatives said the broker will be able to offer clients a choice of trading methodologies, including request for quotation, central limit order book and volume matching. 

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Fee Management

CME Launches Fee Finder

Beyond the everyday challenge of trading futures and derivatives in volatile markets, CME customers have long had to grapple with another complex issue: figuring out what they owe. To simplify tallying up fees from the CME Group’s complex fee structure, CME is working with Duco Technologies to develop an online tool that allows users to search by product name across all CME Group exchanges, including NYMEX and COMEX. The tool is limited to fees for companies that are not members of the exchange. A user can enter a product name or symbol and the tool displays an estimated fee per side. It also gives users the option of checking fees for different modes of trading: for example, through Globex as a trade or a spread, through the floor as a trade or a spread, or as a block trade or an exchange-for-risk trade. 


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Platform Migration

ASX Sets November Date for New Trading System Launch

ASX, the Australian securities exchange, plans to launch the first phase of a new electronic platform in November. In the first phase, the exchange will replace the nine-year-old ASX Trade24 platform that the exchange uses for its derivatives markets. The new platform is based on technology provided by Sweden's Cinnober Financial Technology of Sweden. Early next year it will extend the new platform to its equities markets as well.

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Low Latency

Korea Exchange in Deal with Colt for Low Latency Offering

Koscom, South Korea’s leading financial IT solutions provider, and Colt, a global high-speed financial services network owner, have announced a partnership that will provide ultra-low latency connectivity between capital markets traders in Korea and the world’s major stock and derivatives exchanges. 

Colt executives say that the partnership will create further opportunities to develop integrated financial IT and market data solutions for Korean capital markets, including Colt PrizmNet, the financial extranet developed by Colt, and STP-Hub, Koscom’s securities brokerage hub.

Colt and Koscom have been building a close working relationship since the launch of the Busan Proximity Data Center in 2012. Masato Hoshino, Vice President and Head of Product Management at Colt, said the partnership “opens an even wider path to future mutual growth for us, and more importantly, for investors looking to tap into the wealth of opportunities in the Korean capital markets ecosystem.”

The deal deepens and extends the partnership by several more years. The two companies’ multi-year agreement will make it possible for them to leverage each other’s local and global network and exchange colocation footprints, as well as sales and service resources inside and outside South Korea. 

The U.K.-based Colt network links 200 cities in a high-speed network around the world. Colt’s customers include 50 exchanges and 13 central banks, as well as many banks and diversified financial groups. 

Koscom executives believe access to the Colt network will make it easier for Korean financial services companies to offer their services to exchanges around the world, and cheaper for foreign companies to enter Korea. “This will be key in accelerating the globalization of Korean capital markets,” said Jae Wook Eom, Koscom’s head of sales. Colt also announced plans to expand its colocation facilities at the Busan data center of its subsidiary KVH.

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