OTC Derivatives Reform (After a strong couple of years for the U.S. futures markets, reality has set in and business activity has slowed down. The combination of low interest rates, weak equity markets, and an overall slowing of the economy has taken its toll. But the first half of next year promises to be a turning point. The impact of an evolving regulatory environment alongside smarter and more innovative market participants is driving various strategies to embrace the asset class, and new products and market participants are entering the fray.
Both brokers and futures exchanges are adjusting to the new market realities. Exchanges are spending time educating customers about product offerings and launching new products that make sense under the changing regulatory regime. Meanwhile, futures commission merchants (FCMs)are focusing efforts on regulatory updates and helping clients transition from an over-the-counter marketplace to more exchange-listed products.
Yet one of the harsh realities of the new world is that it favors different winners than in the past. Regulatory scrutiny of traditional FCMs, including how they oversee and use client assets, is creating pressure on how they earn clearing and net interest income. Meanwhile, a more agency-focused business can create new opportunities for exchange clearinghouses, custody banks, and FCMs that provide customers with services that replicate the environment customers had previously known (minus the greater risks).
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11 Comments to "Evolving Futures Markets Could Squeeze Out Traditional Players":
KATY HANSEN
19 October 2012
Hi Matt - This looks like an excellent report. Does Barclays have access to this research? I have been trying to retreive it but have been unable. katy.hansen@barclays.com
msimon
19 October 2012
Hi Katy. Thanks for the comment. You will be hearing from us shortly (if not already). Regards, Matt
Comments (23)
crammond1964
22 October 2012
their business plan ;at futures exchanges ; was ill planned and dased solely behind ATS and HFT to provide volume and liquidity . Sadly they have provided neither and exchanges at last looking at a plan B to restore faith and confidence in our markets . Seriously low interest rates are NOT the reason for low volumes ! ....................... Finally certain exchanges have at last realized the problem and I believe our markets should be restored to their pre 2005 levels of equality .
Comments (252)
nealwol
22 October 2012
Matt, I think the issue you are discussing is immensely important to users of futures markets. Following many years of commission cutting by FCMs, when a low interest environment took hold, some were tempted to invest customer funds in riskier assets as permitted by CFTC Reg. 1.25. Some stole the money. Unfortunately, the misuse of customer funds by two fcms has hurt the ability of non-dealer fcms to compete, and has undermined customer confidence in the industry's ability to maintain safe custody of customer funds. Unless something is done to revive the ability of the non-bank fcms to compete, customers with smaller accounts, or doing business in commodities rather than interest rate futures, have few places to turn in order to do business. Banks don't want their accounts, and the other fcms are scary. Unless we want the brokerage side of the futures markets to become one-dimensional and have limited competitiveness, something needs to be done to allow the independent fcms to continue to serve the vital role they serve. I believe the answer is including the futures industry within the SIPC program (see http://www.marketsreformwiki.com/mktreformwiki/index.php/Featured_Commentary_-_Futures_Industry_Insurance_Fund_-_Neal_Wolkoff,_August_2012 ) . The futures industry will continue to lose volume, suffer from a crisis of customer confidence, and not see a healthy diversity of competing fcms - whatever the interest rates are - unless and until a confidence restoring measure is taken. The status quo is bad for the industry. Without an insurance fund, the bank fcms may think they've won by seeing the independents leave the business, but the reality is that they will have lost - the missing customers, volume, and information flow will not help anyone's business grow.
Comments (3)
John Harris
23 October 2012
I agree with you, Mr. Wolkoff, that market participants have lost confidence in FCMs, but doubling down on the bad idea that is government-mandated, taxpayer-backed, account insurance will not help. If FCMs want to offer insured accounts, they are free to do so. If consumers want to pay for such arrangements, they will. It isn't necessary to make victims of third parties who choose not to participate, which forced arrangements such as you propose would do.
nealwol
23 October 2012
John, in my linked piece which spells out the specifics of the proposal, there is no taxpayer involvement. It calls for an extension of SIPC to include futures so that costs are spread out across industries in amounts that will not be disruptive. I don't believe that person by person actions will resolve the issue of confidence.
Comments (3)
John Harris
23 October 2012
Thank you for your response, Mr. Wolkoff, but I have to correct you: SIPC is backed by taxpayers, and always has been. Under the Act that created it, the SEC is authorized to borrow money on the full faith and credit of the United States to supplement the (woefully inadequate) SIPC fund as necessary. If memory serves, this borrowing authority is presently 250% of the fund balance. And even aside from this explicit taxpayer backing, who can reasonably believe that SIPC would have survived 2008 without the multi-trillion-dollar bailouts of broker-dealers at taxpayer expense?
I did read your piece and would also take issue with your idea that other industries should subsidize the futures industry. The futures markets provide services of proven value. Its producers are more than capable of creating account safeguards funded by their customers. Forcing third parties to subsidize the market makes no economic sense on any level.
nealwol
23 October 2012
The SEC is authorized to lend money to SIPC should the need arise. Whether this is taxpayer support is questionable. I do not believe the futures industry is an island separate and apart from the securities industry, and I have no hesitation in recommending that accounts for both be protected under a common insurance fund. Since SIPC exists, in my view it is the most straightforward means of providing such a fund, although having Congress act, and the regulators coordinate, are tall propositions, I know. We seem to have some rather strong differences of opinion, and I certainly respect your views, but I see the current status in the futures industry to be a threat to its well-being, and would like to see some remedial action.
Comments (3)
John Harris
23 October 2012
In fairness, I don't think it's "questionable" whether financial support from the SEC amounts to taxpayer support. The SEC is a government agency, supported by taxpayers. Further, the mechanism provided by SIPA provides for the SEC to borrow the money in turn from the Department of Treasury, which would issue bonds to fund the loan. Reasonably, this should settle the issue of whether SIPC is backed by taxpayers.
I agree with you that now that consumers have figured out that their supposedly-segregated funds are not in fact segregated and can be used by FCMs for FCM purposes, the industry has a problem. But respectfully, why is it reasonable, fair, just, or even economically sensible to force third parties to fund the solution? There are numerous ways of solving this problem without forcing others to bear the costs, the most obvious of which is caveat emptor. If consumers wish to pay for FCM account insurance, let them sort that out with their FCMs.
lkovach
24 October 2012
Related: CFTC Proposes New Regulations and to Amend Existing Regulations to Enhance Protections for Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations http://www.cftc.gov/PressRoom/PressReleases/pr6396-12
Comments (31)
John Harris
24 October 2012
Thank you for posting this. I just skimmed the release and read the related FAQ document posted on the Commission's website. So this proposal deals in substance only with customer accounts holding positions on foreign boards of trade. With respect to U.S. boards, it imposes additional supervisory and disclosure requirements. I do not see how any of this gets to the heart of the matter, which is that we have a regulatory framework that practically invites FCMs to speculate with customer funds.
As I have often noted in this forum, regulation is never what it purports to be, which is protection for consumers from predatory businesses. Fraud, theft, and trespass are already common law crimes. No regulation is needed to create new crimes beyond those three, in the realm of economics. Instead, incumbents agitate for regulation to protect their franchises from competition and to robe themselves in the mantle of government approval for their actions. All the CFTC was ever going to do in the aftermath of MF Global was create an appearance of addressing consumer concerns, without actually solving the problem. The CFTC doesn't work for consumers. It works for big exchanges and FCMs.