How FCMs Can Make the Most of Trading Technology

The exchange-traded derivatives business faces increasing challenges, from the front office all the way through to clearing. Old business models are broken, but the brave new world of technology comes with its own problems yet to be solved. A hybrid in-source/outsource model can help FCMs and their clients navigate the changing landscape.

The traditional global structure of derivatives trading is coming apart. A fiery blend of regulation, negative interest rates, wholesale technology change and industry consolidation sees FCMs and their clients battling to maintain already paper-thin margins.

[Related: “Outlook for US FCMs Finally Brightens”]

Regulation has reached into almost every corner of the markets, but derivatives have been impacted particularly hard. Servicing some clients has become more and more difficult as capital requirements have ballooned, shrinking the FCM industry, which in turn further hinders the appetite for servicing smaller clients. This is, of course, a poor result for the end customer, which finds it increasingly difficult to get efficient service. And it’s a poor result for the industry, too, which misses out on those early stage clients that might grow to be marquee clients in the future.

Local regulations are problematic as well, with grey areas leaving the door open for the regulator to come knocking. A prime example is executing or managing US derivatives for a US-domiciled client using the follow-the-sun model. If the executing firm is not a member of a self-regulatory organization (SRO), this may leave both firms open to regulatory action.

Night desks themselves are as beset as they have ever been. Teams are often executing in foreign markets where the nuances require deep local knowledge, with little or no IT or help desk experience. In follow-the-sun models, remuneration models mean many sell-side personnel don’t consider executing their offshore colleagues’ order flow part of their day-to-day business. This leads to internal complacency and the client suffers, and also leaves firms open to errors.  

Technology has been touted as the panacea for all these issues, and indeed the industry has been quick to respond – the past few years have seen a rapid increase in the onboarding of direct market access (DMA) clients. But the promised land of seamless follow-the-sun trading is still far from here. Generally speaking, high-value employees’ workflows are inefficiently dealing with tasks below their core expertise. Firms are not geared internally to take full advantage of all that their system has to offer, and their clients may not be ready to take all – or any – of their orders from manual to electronic processes. A vital step is being missed – building capacity within the FCM to get the best out of its new technology, and managing change with clients to ensure the best possible uptake.

This is where a hybrid in-source/outsource model can be particularly useful. Any FCM clients who don’t want – or need – help using the electronic system can be catered to by a third party, for a much lower cost than hiring additional resources. Such a relationship also helps clients execute orders in markets after hours, in cases where internal compliance does not authorize electronic platform access from outside its offices.  

A hybrid model, where the outsourced firm has experience in various vendor systems, can be very useful in helping end clients migrate over time to fully electronic order management. Building the FCM’s own internal capacity in system usage can eliminate frictional trading costs and get better value out of expensive technology, while saving on personnel costs. This gives the FCM the additional benefit of nurturing potential future marquee clients through the growth phase, without having to allocate resources to them in a world where per-lot execution value is so low.

Such a model is useful for US and European sell-side firms trading Asia – avoiding additional night desk costs and frustrations by having local experts on the same system as headquarters. Asian sell-side firms trading the US and Europe can also benefit enormously by having a light, low-cost solution to trading the northern hemisphere day with the expertise necessary to be truly efficient and ensure client orders are properly managed.

The buy side is not exempt from global derivatives trading woes, and for this group, too, a hybrid model can make a lot of sense. Headcount that would have been directed to trading execution can be allocated somewhere that will add more value to the firm, while still accessing global best practices in trading. Buy-side clients may find an independent third-party executer a no-conflict execution solution.

Such an arrangement requires the third-party consultant-broker to integrate into the FCM’s system and compliance framework to offer a collaborative solution. With full 24-hour visibility of all their activity and an automated audit trail of chat, email, messaging, and voice calls, as well as executed trades, cancellations and trade confirmations. In this kind of arrangement the third party is completely aligned to the FCM – the FCM is the client and all client information stays with the FCM just as it would if trading were being carried out internally – but with less cost and risk, and more expertise.

This kind of relationship can be very beneficial to end clients too. The FCM can essentially white-label third-party expertise, and clients have their own dedicated expert help desk for product and trading assistance. A good consultant-broker will melt into the FCM’s own architecture, boosting efficiency and profitability, and filling the gaps between existing human resources, vendors, technology and clients.

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