The market shocks of autumn 2008 led to two turbulent years for
futures and options markets. But while the headlines have been
dominated by depressed volumes and regulatory upheaval, much
has been changing underneath. Mark Aarons,
chairman of Actant, argues that listed
derivatives will grow steadily in volume, and that
tomorrow’s hyperfast markets will hold plenty of
opportunities, even for smaller firms.
After near-uninterrupted double digit growth for almost as long
as anyone can remember, since the end of 2008 global trading in
futures and options has levelled off.
But this masks some interesting sub-trends. Futures trading,
for example (especially in North America), has suffered worse
than options trading.
Whereas equities volumes have held up well, volumes in interest
rate products have come under pressure. After the tumult of
2008 and the quick move to near-zero rates across the developed
world, perhaps this was to be expected. And although starting
from a relatively low base, there has been a dramatic surge of
interest in trading currency products.
The fastest growing regions by far have been Asia Pacific and
Latin America, more or less mirroring an equal slowdown in
North America and Europe.
In a way, it would probably be more surprising if overall
volumes had not stalled, after such breakneck growth and such
paralysis of the whole credit infrastructure. Some major
players ceased trading all together, while others substantially
pared back capital allocated to trading.
Yet despite the temporary upsets, many of the growth themes
that were apparent in the market two years ago continue
The power of technological advance – both hardware and
software – is a given, and has allowed for a continued
drive towards zero latency trading solutions.
In practice, this has led to exchanges, telecoms suppliers,
software vendors and members focusing attention on and
massively expanding use of colocation services.
Financial markets have always rewarded players with the best
access to information and the fastest response times; what is
new is that this is now measured in microseconds.
Inevitably, under such circumstances, very large parts of the
trading process are automated beyond pure order entry and
cancellation, and there seems to be something about this which
is making regulators uncomfortable.
Will it lead to an outright ban or general speed restriction on
high frequency trading? Probably not, but already the backlash
is being felt in a suspension of flash order prioritisation,
and investigations into how trading halts can be extended when
market moves are considered extreme.
Meanwhile, the trading world awaits further ramifications from
the 'flash crash’ of this May. The interlinkage of
different markets and products – particularly
exchange-traded funds and derivatives – is widely felt
to be at the heart of what went wrong, although there is
growing evidence that the lopsided mechanics of some
proprietary internal matching algorithms played a major
The rise of internalisation and the rules by which it engages
with central exchanges is likely to come into sharp focus in
the next few years.
Regulators wade in
Another nervously anticipated change in the trading landscape
that can be traced back to the meltdown of 2008 (but would have
seemed almost unthinkable two years ago) is the mandated
separation of certain proprietary trading activities away from
investment banks and into affiliates.
It is assumed that most equity derivatives business will need
to be hived off and, although many of the world’s
largest futures and options trading houses are already
independent, such an outcome is bound to alter traffic flows at
the major exchanges.
The drive to get bilaterally traded over the counter bargains
on to centrally cleared platforms could also impact markets in
dramatic, if difficult-to-predict ways.
On one hand, a significant increase in on-exchange business
might lower bid-offer spreads and attract even more
business… on the other, the requirement to expose more
business to public scrutiny might actually reduce what is done
now, and hence also the hedging of those trades on
Sources of growth
But there are still many reasons to believe we are just
experiencing a cyclical slowdown inside a broadly intact
structural growth story.
First, as just mentioned, the growth baton has now passed to
the major emerging economies, where the drivers for increased
use of derivatives are still at a very early stage.
Second, in spite of the losses sustained by banks and others
during the meltdown and the consensus that unwise derivatives
positions were near the epicentre of what went wrong, the need
to hedge all kinds of exposures – interest rate,
currency, asset allocation etc – is not going to go
On the contrary, as fresh debates over future pensions and
longevity liabilities demonstrate, the need to identify and
parcel out risk to counterparties better placed to hold it is,
if anything, getting stronger.
Third, although the rollout of broadband internet access has
continued apace and online execution-only brokerage services
are now widely available and fairly well used, there is still
massive potential to make financial products more accessible to
In the UK, for instance, the holding company of spread-betting
firm IG Index already boasts a larger market capitalisation
than the London Stock Exchange itself.
The continuing drive to allow individuals more control over
their lifetime financial planning and the increasing popularity
of low cost passive investing tools like ETFs will encourage
growth of volumes in exchange-traded derivatives.
Exchanges under pressure
The competitive framework circumscribing the activity of market
participants and the exchanges themselves has also moved on.
Dark pools have continued to proliferate, particularly in cash
equities, although there appears little appetite to extend this
into derivatives trading.
At the same time, the market shares of the old exchanges,
particularly in Europe, are still being eroded by upstarts like
Chi-X and Bats.
One response has been to reinforce the migration towards
charging on a maker-taker basis. This model effectively
involves a cross-subsidy to liquidity providers, paid for by
price takers. As such, it has strongly encouraged the
proliferation of pure algo houses.
One very simple business model, for example, could involve just
automatically injecting buy and sell orders at the same prices
over time in order to receive exchange rebates.
Unsurprisingly, as trading in the underlyings has fragmented
and become subject to more volatile micro-movements, so have
the system requirements of derivative solutions become more
Ever smaller minimum tick sizes – such as the
extension of classes subject to penny quotes in North America
– have compounded the issue.
Software vendors have responded by building better, smarter and
faster. Price quoters can now handle valuation externally. The
ability to cache greeks for a wide range of possible underlying
prices means a great load on the system can be released and
response times speeded up dramatically.
But the demand to configure trading strategies that cross
instruments, products and markets calls for new architectures
and new components.
This is a rapidly evolving field where proprietary systems
compete against off-the-shelf products and where the life cycle
of a trading strategy can sometimes be measured in days or
This places a premium on the usability of the front end and the
robustness of safety features. Ultimately, as users require
more flexibility and speedier build and test times,
responsibility for designing and fine-tuning trading strategies
seems to be tipping back towards the trader on the desk and
away from his technical support team.
All these trends continue to lead to a blurring of definitions
between market-makers and market-takers. It is even possible to
discern a point in time, likely not far away, when distinctions
along these lines cease to be meaningful at all.
A trader will offer liquidity via two way quotes where fee
structures make this attractive, at the same time as combining
algorithmic strategies that seek out and exploit known or
While decent access to capital to support trading positions and
keep up technology spend will continue to favour the larger
operators in the short term, opportunities for less well
capitalised players should open up, as the range of
programmable trading events keeps expanding.