Technology, Transparency and Choice Drive Buy Side’s Investment in U.S. Options

Technology, Transparency and Choice Drive Buy Side’s Investment in U.S. Options

Volumes in the options market are estimated to increase by more than 5 percent as electronic trading fuels access to the U.S. marketplace.
The U.S. market for exchange-traded options took off during the past decade. The buy side is increasingly looking at options as instruments to hedge risk exposure and generate alpha, according to TABB Group’s recent report on the state of the U.S. options markets. In fact, TABB estimates that volumes will increase by more than 5 percent by year-end, even as market volatility wanes. So what is continuing to fuel growth in the options markets?

[Related: “Buy Side Is Getting Smarter at Trading Options”]

Market transparency and growing adoption of electronic trading technologies are key contributing factors. The changes in regulation and increasing use of electronic trading helped raise volume an average of 21 percent a year from 2000 to 2010 on seven U.S. options exchanges. Today, the options markets are supported by 12 exchanges and electronic venues where traders can access legitimate, reliable prices and order information so they can confidently and quickly execute a trade.

While the increase in trading venues has increased competition and lowered transaction costs for investors, fragmentation has also forced continued investment in technology on both the sell side and buy side. One area of investment on the buy side is platforms that help aggregate liquidity across multiple counterparties and exchanges. To access liquidity and capitalize on momentary market opportunities, institutional investors are adopting electronic platforms that offer integrated pricing monitors, trade analytics, risk monitors, and other tools. For the second year in a row, TABB’s study found Bloomberg Execution Management System (EMSX) is the most popular electronic trading platform for U.S. options. Now, I may be biased, but what I believe this reveals is that options market participants value unparalleled technology and transparency – but they also value choice.

With trading volumes stagnant in the past few years, the buy side has also sought to balance technology and commission spend with necessary efficiency drivers. Especially among hedge funds, the desire for un-conflicted choice has fueled growth in broker-neutral electronic platforms that connect to a broad network of brokers, functionality algorithms and counterparties.

From hedge fund traders looking for an edge, to long-only asset managers that use options to manage risk, electronic trading is fueling access to the U.S. options marketplace. As the industry evolves and trading options becomes even more commonplace for the institutional investor, platforms that offer the buy side choice, access and sophisticated trading tools will succeed along with the market itself.

Regulators urged to adopt principles-based substituted compliance

Regulators urged to adopt principles-based substituted compliance

US regulators need to take a less mechanical approach to determining whether to accept foreign regulatory standards for OTC derivatives trading, according to two industry trade bodies.

Derivatives trade body, the International Swaps and Derivatives Association (ISDA) and US buy-side association, the Investment Company Institute (ICI), both suggest that an overly rigid application of US regulatory standards could have a significant negative effect on markets.

Both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have said they are seeking to apply a form of substituted compliance, where US banks trading abroad would not be subjected to their oversight if there are equivalent OTC derivatives trading rules in those jurisdictions.

In a letter to the SEC this week, ICI’s general counsel, Karrie McMillan, and managing director, Dan Waters, wrote: “we urge the SEC not to apply its substituted compliance framework in an overly mechanical manner that could effectively preclude a substituted compliance determination with respect to a similar foreign regime.”

The ICI is concerned that in some areas, such as the timely reporting of swap trades, foreign regulations could fail to qualify for substituted compliance due to minor technical differences, such as different reporting timeframes or differences in trade information specifications.

“We encourage the SEC to look holistically at the foreign regulatory authority regulatory framework for reporting to determine whether it broadly achieves the G-20 goals of transparency of the derivatives markets,” the letter said.

ISDA has also called for regulators to take a less technical approach to substituted compliance. Instead of focusing on specific regulatory rules developed since the Group of 20 met to agree on international financial regulation in Pittsburg in September 2009, they should focus on whether different regulations achieve the key goals of the G-20.

ISDA said markets should instead focus on a principles-based approach, and identify whether a foreign regulatory regime meets the common principles agreed by the G-20.

“All comparisons should evaluate regulatory regimes against these common principles, rather than requiring identical or element-by-element correspondence of rules,” a statement from ISDA read.

John Bakie

OSC Staff Notice and Request for Comment on Proposed Trading Structure

OSC Staff Notice and Request for Comment on Proposed Trading Structure

On August 13, 2013, the Ontario Securities Commission Staff (OSC) published, for a 45 days public comment period, a description of the trading features that are part of the trading ecosystem that we propose to implement as part of our mission to build a new exchange in Canada. The comment period will end on Friday September 27th 2013. We commend the OSC for this initiative as it complements our approach of dialogue with industry stakeholders.

The trading features identified by the OSC Staff, while a subset of the proposition that we intend to bring to the marketplace, are an intrinsic part of our integrated trading solutions seeking to restrict predatory trading and promote liquidity through committed and sustainable market making.

OSC Staff Notice and Request for Comment can be found here.

A short description of Aequitas’ point of view can be found here.

Taking Actions

Our initiative is a unique opportunity for all stakeholders in the industry to participate in building our marketplace of tomorrow. For us, it is all about re-establishing a fair balance among the various stakeholders and promoting quality markets.

Making your voice heard is important. You can do this in multiple ways:

Send in your own comment letter to the OSC;
Provide responses to our multiple choice questionnaire and send it to the OSC;
Sign the Aequitas Letter of Support, which we will send to the OSC with all of the signatories identified.

Scila In Strategic Relationship With FIMAS

Scila AB is pleased to announce a strategic relationship with FIMAS GmbH, as an implementation partner for Scila Compliance in the German marketplace.

via Pocket July 20, 2013 at 03:47PM

FINCAD and Techila partner to enable derivatives analytics on Windows Azure Cloud Platform

The calculations for pricing derivatives and measuring risk are becoming increasingly complex under regulatory reform. Collateral requirements and capital charges will not only transform the industry, but they also change the day-to-day pricing of instruments and portfolios.

via Pocket June 21, 2013 at 03:39PM

ESMA Clarifies Boundaries of CRA Regulation

The European Securities and Markets Authority (ESMA) has published new guidelines for the EU Credit Ratings Agency (CRA) Regulation in an attempt to clarify the rules that fall under its remit, who can issue a credit rating in Europe, and to better explain the exemptions, disclosure recommendation

via Pocket June 18, 2013 at 09:25PM

Trayport® launches Whitepaper: EMIR, REMIT, MiFiD and more.

Trayport, a leading provider of energy trading solutions to traders, brokers and exchanges worldwide, today announced the launch of its European Regulatory Whitepaper: EMIR, REMIT, MiFiD and more. ‘Big Compliance’ Meets Energy Trading.

via Pocket June 17, 2013 at 01:43PM

Single dealer platforms poised to survive

Ralph Achkar, a director at MarketPrizm, looks at why the death of SDPs is greatly exaggerated. The advent of Single Dealer Platforms has provided numerous benefits to end users by integrating information and liquidity across asset classes and from multiple sources.

via Pocket June 15, 2013 at 06:27PM


Be Open, or Be Closed Down from the TABB GROUP

Be Open, or Be Closed Down

Global regulators are demanding more transparency into financial firms’ activities, creating a new operating paradigm that emphasizes recordkeeping, surveillance and reporting. Firms that can’t provide the required transparency are likely to incur regulators’ wrath.
Regulators have drawn a new blueprint for capital markets, and it is not benign. Global regulators want a transparent and connected market that gives them more transparency into, and tighter controls over, systemic risk. This trend can be seen from the highest perches within the international regulatory organizations, down to the examinations and inquiries being conducted by local regulators and enforcement agencies. It will not take years to see how these regulatory changes are going to impact the industry. Change can be felt now.

The overhaul in market structure and stringent regulatory requirements open the door for new types of business models and allow greater competition within existing businesses. But no matter whether a firm is an incumbent or an agitator, there is a new paradigm for the way in which businesses must operate. There is an emphasis on recordkeeping, surveillance and reporting.

Financial institutions need to embed three elements into the heart of their regulatory and compliance philosophies: open, searchable and synchronous. Open is the willingness to change the way in which a firm delivers on its value proposition, as well as having technological agility rather than being inseparable from a particular type of software or architecture. Searchable means that any speck of information that resides within the enterprise is accessible to analysis in near real-time and that the data is stored in a way that allows relational and non-relational searches. Synchronous requires a combination of internal consistency of data and process and industry collaboration on standardization.

Let’s focus on openness for a moment. The plight facing OTC market participants is emblematic of the need and challenge of openness. Change is occurring on multiple fronts: voice to electronic, swaps to futures, discretionary access to impartial access. So to even continue to provide the core value proposition requires a strategic shift. At least one interdealer broker, GFI, is launching a futures exchange. Swaps dealers are also preparing to act as sponsored access providers.

If it is true that because the market is more open, companies need to be more open in how they provide their services, it is equally true that they need to be more open in how they operate their business, technically and organizationally. In capital markets, technology mirrors the business and is rarely the driver of true reform. The OTC derivatives market was opaque and closed and this character was reflected in the technologies that supported that market. Businesses were run as silos, with lots of overlap and redundancy, as divisions of the same bank would compete with one another. While it may seem inefficient now, it was a rational approach at the time, as revenue opportunities outpaced the need for efficiency. Not anymore. Financial institutions are going to need to operate more like fashion companies, which typically do not own a stitch of the production chain.

But openness cannot work well without a highly synchronous operating model. Operational complexity may have been acceptable in a highly fragmented, growth-oriented era. Unfortunately, that is not the era we live in, and even if it is cyclical, it is going to be an extended cycle. We now live in a period of consolidation and stagnation where standardization and economies of scale will be more important success factors than creativity and differentiation. Synchronicity will not be enabled through stronger glue alone. It requires a simpler infrastructure. The re-emergence of vertical integration between hardware and software is indicative of the demand for synchronicity.

Finally, the searchable enterprise is the end game of transparency. Regulators are increasingly focusing on unstructured data for evidence of misconduct. During the LIBOR scandal, for example, banks had emails that showed traders asking one another to manipulate rates. During regulatory examinations in 2010, requests to financial services firms for social media rose 65% compared to previous years. Even not sufficiently documenting emails can be cause for penalty in and of itself. This is pushing firms to look at NoSQL solutions for unstructured content. NoSQL allows for greater specification using intelligent pattern recognition to conduct searches, and, as importantly, does not require a technologist to write a query. NoSQL allows the end users themselves to search.

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