Things are looking pretty glum for exchange traded derivatives right now. The scandal at Peregrine Financial Group this month came just nine months after the collapse of MF Global and at a time when volumes on most Western exchanges are falling in the face of continued economic and regulatory uncertainty.
The year-on-year drop in volumes for the first half of 2012 has been quite pronounced. The CME Group posted a 12% dip in volume, Eurex’s volumes decreased by 11%, NYSE Liffe’s European volumes were down 20% and Nasdaq’s derivatives volumes were 16% lower than the same time last year. ICE was the only one of the larger Western exchanges to buck the trend, although even its increase was only marginal.
The significant decline in volumes was felt in the final quarter of 2011. In December, total monthly volumes on the CME, Eurex and Liffe’s London operations fell below 300m for the first time since August 2010 and only the sixth time since the start of 2007. By February, volumes on the three exchanges were down to 285m, the lowest February volume since 2006.
Total futures volumes on exchanges in North American and Europe fell to their lowest levels since August 2009. While futures volumes on Western derivatives exchanges picked up in May, rising from 409m in April to 525m, they fell back to 500m in June.
Options volumes on exchanges in North American and Europe fell to 413m in April, the lowest April volumes since 2007.
Uncertainty gripping the industry
Speak to anyone in the market and they will tell you that uncertainty is the root cause of the decline in volumes. While limited uncertainty is the fuel that drives the markets, what the industry is faced with now, to adapt a famous phrase from London Mayor Boris Johnson, is the wrong kind of uncertainty.
“Typically, the worst thing that can happen in the market for people who ultimately drive volume, which in very simple terms are investors, is when you have a lot of uncertainty,” said Ralf Roth, global head of Elektron transactions and enterprise solutions strategy at Thomson Reuters.
Both economic and regulatory uncertainty pervades the markets. At the same time, market moves are being driven by statements from governments and central banks rather than historical trends, making it very difficult to trade and rendering many models moribund.
The continued uncertainty over the future of the EU is forcing many investors to sit on the sidelines of the derivatives markets, preferring cash or short and medium-term bonds to derivatives products.
Regulation forcing changes
Regulatory change is exacerbating uncertainty in the markets. Jerome Kemp, Citi’s global head of Citi futures and OTC clearing, said: “The regulatory reforms that are sweeping the market could be a contributing factor to depressed market volumes.
“There is a considerable amount of uncertainty over the impact of the reforms with questions persisting over extraterritoriality and the application of US regulation to non-US domiciled market participants being a particular area of concern.”
Nowhere is the force of regulatory change being felt more keenly than in the banking sector. A combination of capital requirement regulations and moves such as the Volcker Rule to end proprietary trading is forcing deleveraging and a reassessment of their trading models.
“We are already in the process of converting to the new world order,” said the head of trading at a leading bank.
Roth added: “If you look at Basel II and Basel III in particular, large sell-side institutions are going to have to fundamentally re-think their business model because the capital requirements that they have with the assets that they hold and their balance will require them to change.”
This model will be based on client flow rather than proprietary positions, reducing liquidity on global exchanges.
Lack of innovative contracts
Another reason behind the declines on ETD volumes is a lack of new contract launches from many of the major exchanges. Two years ago, exchanges were focused on technology upgrades, last year on mega mergers and this year on OTC clearing.
This has led in part to a lack of innovation around new contracts. According to data from FOWintelligence, 50% of contracts launched last year failed to trade. Heads of trading houses complain that while contract launches are plentiful, most fail to bring something new to the market and many fall by the wayside after a few weeks.
In the CME Group’s second quarter 2012 earnings conference call, Derek Sammann, senior managing director, financial products and services at the CME, also revealed that the loss of volume suffered by the exchange in the first half of this year has been primarily on contracts that are only one or two years old.
In contrast he said that products that were launched between three and five years ago are still experiencing good growth, but that this growth is not enough to offset the diminishing volumes on the newer contracts.
Contracts that have innovated have performed well this year despite the lower volumes. Eurex’s OAT French debt contract has been the most successful European launch so far this year in terms of volumes. Coming as it did in the weeks preceding the French elections, it enabled traders to take a punt on the result. Elsewhere, NYSE Liffe US’s GCF Repo futures contracts continue to gather pace.
Crazy August?
August is traditionally one the quieter months for volumes. However, last year volumes exploded on the back of the S&P downgrade of the US government. Records on US and European equity options exchanges were smashed in three crazy days as markets responded to the turmoil in the financial markets.
2007 also saw a boom in volumes as the ECB pumped liquidity into the market following the closure of two BNP Paribas hedge funds and the continued fallout from the collapse of two Bear Stearns funds, which heralded the start of the financial crisis.
August might once more prove to be a crazy month for trading as the Eurozone lurches towards the seemingly inevitable defaults of Greece and Spain.
A spate of volatility in the global financial markets would increase volumes on exchanges but a fundamentally different market structure is being forged in Washington and Brussels, which will inevitably lead to lower volumes as the market adapts to the new world order.
But, while one hand of regulation takes away, the other giveth and the boost to exchange revenues from CCP is not the only gift from the G20. The “futurisation” of OTC contracts, a trend already well underway with pioneers such as Eris Exchange futurising swaps and ICE yesterday announcing that its suite of energy swaps would be converted into futures contracts, should ultimately provide a further fillip for exchanges.