The business model for Future Commission Merchants (FCMs) is
undergoing radical change. Cost pressures and regulatory
burdens with fragmenting liquidity and evolving client demands
pose major challenges.
FOW and Object Trading brought together key figures from the
global listed derivatives market to discuss the evolving
business models facing FCMs and how they are tackling the
challenges in the market today.
Four key themes emerged, all interlinked but all posing
individual challenges to firms. Taken together, they highlight
a new business model for FCMs, one built around technology and
delivering efficient risk and capital management.
Rising costs underpin everything FCMs consider when
reviewing their business models today. They are waging a battle
on numerous fronts with challenges from increased trading fees,
technology requirements, costs of compliance and requirements
Uncertainty over the cost of capital is paramount. New
margin requirements for over-the-counter derivatives and
significantly higher capital charges for trading have seen many
FCMs pull back from the certain services and some exit clearing
In exchange traded derivatives markets, clearing was
traditionally relatively straightforward in terms of both
processes and revenues for the FCM. That is now changing with
the return on and cost of capital at the forefront of every FCM
This is creating pressures for FCMs over which clients they
clear for and where they clear. The process of on-boarding
clients is also becoming more challenging.
With exchanges selling the benefits of their new offerings
on margin efficiencies and segregated accounts mandated by
European regulators, FCMs need to ensure they can meet
expectations and requirements.
FCMs have sometimes been reluctant to sell products to
clients that result in higher costs and complexity. But today
they have no alternative due to new mandates and more
communication between exchanges and clients.
Internally, FCMs are restructuring with clearing at the
centre of their service. Collateral management tools, which
might once have sat within niche or targeted product lines, are
now at the heart of the modern business model that brings
futures, clearing and collateral together into one service.
FCMs have faced rising costs and lower margins for a decade
but have been squeezed more than ever over the past two years
by falling volumes.
As exchanges grapple with lower volumes, some are seeking to
hike fees on auxiliary services such as market data.
But FCMs complain this is counterproductive and means higher
costs, lower margins and lower volumes, which is bad for
Exchanges insist they invest this revenue in services to
make their users more efficient. But many FCMs feel unable to
pass on cost to their clients, exacerbating their cost
Others however, have restructured how they present costs to
clients to help them understand what is being charged and
One FCM said his firm had moved from offering one price for
the total service to a breakdown of clearing fees, execution
fees and commissions so the client can see costs.
This has helped clients understand where the FCM is charging
and what is a standard cost they would face elsewhere, an
approach that may become the standard model for firms in the
Reforms to force over-the-counter contracts onto electronic
platforms and clearing are changing the business models of FCMs
but also for exchanges, which has implications for FCMs.
A new age of competition is dawning across Europe as
exchanges seek to capitalise on the changing market. In the new
world, decisions on where to execute will be made based on
where firms want to clear, providing trading venues with the
opportunity to wrest liquidity from incumbents on a scale not
seen since the advent of electronic trading.
While the market broadly welcomes competition, increased
complexity is inevitable, as is the fact many new products and
venues will ultimately fail.
The launch of Swap Execution Facilities in the US and
upcoming launch of Organised Trading Facilities in Europe
increases this complexity.
One panellist said maybe only nine of the Sefs that had
launched would attract material liquidity in the long term. But
the challenge for ISVs and brokers is choosing which to use
before it is clear who will survive.
One challenge for Sef operators has been how to link to
FCMs. For many Sefs, this is a new relationship and comes in
addition to building out to CCPs and trade repositories.
Ultimately the market will move towards a smaller number of
Sefs connected directly to numerous FCMs but it will take time
and lost investment to get there.
Almost a year after the introduction of Sefs, the market has
not significantly changed with incumbents still strong in their
The need for margin efficiency across venues and asset
classes becomes greater with increased fragmentation. FCMs are
expected to offer services that incorporate new contracts and
To do this with efficient use of margins, FCMs need
transparency from clearing houses about how they build their
risk models and calculate margins.
One FCM said third parties will be able to develop
calculators that run as industry utilities enabling FCMs to
calculate margin requirements across CCPs.
Changing attitudes to technology
Increased complexity and cost is changing attitudes to
technology. FCMs were reluctant to outsource technology as it
was seen as a risk taken to reduce costs.
But outsourcing today is increasingly common as the cost and
complexity of inhouse technology rises while vendor systems
Specialist providers are taking a more collaborative
approach with their clients, working more as a partner than a
But outsourcing also provides challenges and complexity. One
FCM that chose to work with a number of vendors said decisions
were taken based on existing client loyalties.
Attitudes to technology outsourcing are changing too as
services become commoditised. Market connectivity has become a
commodity, said one FCM, whereas firms had no choice but to
build in-house ten years ago.
Hosting has resulted in lighter operational requirements for
No longer are they required to run teams focused on
maintaining and upgrading connectivity. The vendors have taken
on much of that work, reducing the cost for FCMs.
"The more technology we can outsource, the better," said one
FCM. "We just have to work to ensure the outsourced technology
interfaces with our other technology."
He added that as clients demand more asset class coverage
and a one-stop service from their FCM, outsourced technology is
increasingly the enabler.
ISVs are then able to draw on the collective requirements of
clients to develop new products and services, mutualising the
cost of that development.
The introduction of Sefs in the US is an example of how an
outsourced collaborative approach to technology can solve a
CFTC rule 1.73 mandated pre-trade clearing certainty when
trading on Sefs, creating a huge technology challenge.
Rather than every FCM running their own projects, external
vendors created credit hubs that spread the cost and created a
common platform for pre-trade risk.
Delegates said recent advances in technology allow them to
try new markets and products far more simply than before.
"We don't want to be left behind, so it’s a
case of wanting it as soon as you possibly can, as cheap as you
possibly can, and built in with your own infrastructure
you’ve got," one said.
The days of FCMs locking in a client by providing a platform
are long gone.
FCMs are having to adapt to client demands for trading new
venues or products more quickly than before, which means
understanding the business case and making a conscious decision
over how they will get that ROI happens in a shorter
Clients are becoming empowered. Exchanges now promote
initiatives directly to clients rather than the FCM.
Proprietary trading firms in particular strive to be early
adopters of markets and products and are increasingly important
in terms of the support they provide.
Linking pre- and post-trade
Some FCMs at the forum had only recently entered the market
and had therefore the chance to build technology from scratch
without the legacy technology prevalent at older firms.
Linking the front and back-office workflows is seen by FCMs
as the key technology challenge in today’s trading
Traditionally firms have taken post-trade data feeds without
reconciling those with the pre-trade lines and have, therefore,
been limited in terms of the transparency of the trade
One FCM, which recently re-launched its futures operations,
said it had mapped the entire end-to-end data model from front
to back as a starting point.
They looked at risk and surveillance as two key areas of
importance, anticipating the upcoming regulatory reform and
asked how to build a system that gave transparency of risk in
real time and across the trading architecture.
Avoiding duplication of processes was another key factor as
was the need to automate mapping across all processes to ensure
that one missed entry didn’t render the risk
picture irrelevant and straight-through-processing from
execution to settlement.
Another FCM went through the same process but from a
different angle: beginning with settlement and working through
to execution and pre-trade risk.
Clients increasingly want intra-day views of pre- and
post-trade risk as well as capital and margin allocation. FCMs
will offer multiple ISVs to clients and this creates added
complexity from a holistic risk perspective.
The average FCM will have clients using different ISVs
across different asset classes and this causes a challenge when
managing intraday positions and feeding data through to a
central risk system.
To counter this, one FCM said firms should focus on
minimising the complexity of front end risk controls and stick
to basic pre-execution rules.
But for more complex clients, pre-trade risk is no panacea.
Options market-makers send thousands of orders into a market
with little inherent risk. This requires a different way of
thinking, with the onus falling on the back office rather than
More efficient communication between pre- and post-trade
systems will become more prominent with the implementation of
Esma’s paper refers to linking pre- and
post-trade risk systems to achieve a real time credit view of
your counterparty risk for specific clients.
But different FCMs understand and calculate risk in a
different ways. Defining what constitutes a single counterparty
is also unclear.
In the US, the Legal Entity Identifier system overcomes this
but there is no equivalent in Europe. Different margin
segregation regimes in the US and Europe add to the
One FCM said more could be done to improve circularity
between pre- and post-trade risk. They said the industry should
be working towards a global view of positions across all
Some FCMs said risk controls were being used as selling
points by FCMs to retain clients, a practice that could be
countered by the industry agreeing a minimum exchange level
But others said risk controls should lie firmly in the hands
of the FCM, assuming pre and post trade risk controls are in
Risk levels vary from client to client and larger,
multi-billion dollar clients would not require real-time
But once limits are in place, they need to be conveyed to
each client in a way that enables the FCM to manage client
limits while showing those clients how those limits are
FCMs therefore must understand in real time its counterparty
exposure across every single execution channel. So, on the post
trade portal, the client can see exactly what their limits are
and what their usage is in terms of their credit with their FCM
across listed and OTC.
Once understood that has to be fed back into the pre-trade
controls, closing the loop.
Ultimately, firms need to see real time risk to make
intelligent decisions around how to manage those pre trade risk
limits, whether they are with an exchange or in various ISV
platforms in real time.
This is where real innovation will come from in the next few
To solve the challenge of CFTC rule 1.73, market
participants in the US got together and asked vendors to come
up with a solution. As technology becomes commoditised and the
market becomes more complex, the imperative to understand risk
in a commoditised format grows.
For more on Object Trading go to: http://www.objecttrading.com/nolimits