Futures sat down with ELX Futures CEO Neal Wolkoff a couple of weeks after the launch of ELX to discuss how ELX got out of the gate, what it must do to succeed and the regulatory landscape. Here is what Wolkoff had to say.
Futures Magazine: Who is trading on ELX?
Neal Wolkoff: So far most of the trading volume has come from the investors. A lot of that volume is coming from the trading firms, the algorithmic traders who are not investors. A lot of the trading is in the form of arbitrage between the CME and ELX. We are getting some volume coming from dealer desks. We are not getting volume yet from the traditional customer base like a hedge fund base or institutional base.
What we need to do is develop more depth in the market. What we have done successfully not withstanding some of the comments by some of the more biased people in the market, we have been very successful in mirroring market pricing, especially during the traditional U.S. trading day. From 7:30 to 3:00 our price is dead-on the CME price and our depth of market is anywhere from 20% to 30%. In the two-year and five-year, we are very strong, less so in the 10-year and 30-year.
FM: By depth do you mean the size on the bid and ask?
NW: Yes. If you see a 200 by 300 market on the CME, you can see a 40 by 60 market on ELX. You will see a smaller market at the same price. We are looking to put in more size at the same price or better pricing. When I say better pricing, I am not being arrogant about it but when we are tying the cash market together with the futures market we believe that in weeks we’ll have the potential to be at, or better than, the CME price in size. Because the correlation between cash and futures is tight enough with ELX and cash and tighter than with CME and cash, the cash market will be reflected on the ELX screen and not on the CME screen.
Our price from time to time will be independent of the CME price. It will be more interesting looking at ELX than it is right now because rather than just being a mirror of CME, we will be independent many times of the CME. Independent means we will be as good, or we will be better, we will not be worse.
FM: Is that based on the eSpeed cash platform?
NW: Yes. It is the cash against futures. If you look at eSpeed, which only does benchmark products, they do about 50% benchmark to benchmark. As customers arbitrage their markets to ELX, I have seen a 7% ELX share derived from the eSpeed platform and that will grow.
FM: Are prop traders a big part of your volume?
NW: “Absolutely. The proprietary business is the foundation of what we are looking at right now. By foundation I mean building the depth of our book. [That] is what ultimately the agency type business is going to look for as far as being able to execute what they need to. As you see a hedge fund or any kind of an outside institution needing to execute customer business, it’s going to say, “can I get that business executed in size at ELX the way I can get it executed in size in the Chicago market?” The answer right now is probably not. It is going to start executing in phases, it will start turning routers on because we certainly are offering price competition [and] cost competition.
I see the Chicago market dismissing us in earnings calls and in interviews. That is just fantasy. ELX is here, it has arrived , it is growing, it is developing customer relationships. I am signing approval letters on a daily basis for collocation customers, for direct market access customers. The ISVs are looking for alternative marketplaces. ELX has definitely made a splash in the marketplace. This is something that is a force to be reckoned with.
FM: How are you different from past challengers?
NW: There is no point of comparison. It is pointless to bring those markets up anymore. They failed, we haven’t. We are adding users; we’ve got continued interest from ISVs, continued interest from direct market access customers, continued interest from new investors. Chicago markets can dismiss us as they want but it doesn’t work.
FM: What’s different?
NW: It is different owners. We have trading firms, they didn’t. We have the history of those failures, they didn’t. We have the experience of failure to guide us. Right now all the customer base is dealing with is a single entity, they had multiple entities. The success of BrokerTec was on the cash side where there was a monopoly and they understood their backs were up against the wall and they were dealing with a single entity they had to overcome. On the futures side they had two financial futures markets. They weren’t happy with either of them but there was the potential for competition. Right now, they have a single entity and that entity has shown an unwillingness to deal with the marketplace the way the marketplace wants products to be offered. We are there because there is a lack of innovation and a lack of product offering.
FM: What do you mean by that?
NW: For example [Credit default swaps]. We are not doing CDS but CDS is a tremendous example of how the market saw a product that was extremely important to the marketplace and it was being offered not the way the market wanted it to be offered but by the way the exchange wanted CDS to be offered. That was a vivid example of how every product in the future was going to be given to the market.
It is clear that once you the give the marketplace an opportunity to have choice, the market always picks choice. It did this in energy. The capitalist market always wants choice. It wants the benefits of competition. Competition brings all kinds of positives. To fashion a market [with a] single provider is always going to fail. There is always going to be a way for a competitor to come into a market and succeed.
FM: What about block trading?
NW: We haven’t done any yet. We will do block trades because we provided for that in a commercially reasonable mechanism. Block trades will occur once the market realizes what the block trade rules are (1,000 lot increments on ELX as opposed to 5,000 lots at CME in the two- five- and 10-year notes). They are always going to be a relatively insignificant part of our offering.
FM: What are the benchmarks for success for ELX?
NW: The major benchmarks are depth of market, number of users, especially non-investor users, market share and expanding daily volume. While we are looking at the Treasury complex, we are presenting to our board a plan for an additional product launch, and the board will be selecting from a slate of additional products. ELX will be expanding quickly to be more competitive in additional product areas.
FM: What products?
NW: We haven’t announced that. We are looking at a variety of products. Within the Treasury complex we are looking at options.
Wolkoff as host of a dinner to benefit Boy Scouts of America.
FM: When will Trading Technologies write to ELX?
NW: It is still an open possibility. The ISVs are an important area for us. ELX does not provide a front end to users. As we grow, it will be a business decision for TT. ELX will become much more inviting for TT users as we gain momentum and volume.
FM: Are you encouraged about what you have heard from CFTC Chairman Gensler, particularly when he calls for fungibility in cleared OTC?
NW: I am encouraged. I think he is the first chairman who talked at all about fungibility. What fungibility is, is the ability – I spent four year in the securities area where it is second nature — to buy on one exchange and sell on the other and you are able to offset those contracts and never think about it a second time. Exchanges compete with each other, there is centralized clearing, the clearing is independent of any exchange and it is a not for profit model at the clearinghouse. That is how I define fungibility in the futures area. It depends on what happens with the OTC area. I separate myself from the investors in ELX. That is an issue I am not taking a position on.
If an exchange-traded model happens, we would certainly want to be involved in trading any product that becomes tradable on exchange. If they are tradable, I am happy that they could trade on multiple exchange models and I certainly would like to see them be cleared at multiple clearinghouses. The clearing part of that model hasn’t been clarified at this point. We think that needs to be clarified as part of the fungibility discussion. That hasn’t happened. It concerns me a bit that it hasn’t happened. We think it is critical to the model of fungibility that there not only be multiple exchanges that they are cleared on but that there be mutual offsets at multiple clearinghouses. In the futures market, there is no centralized not-for-profit clearing model. I take it that the CME is not interested in having the OCC (Options Clearing Corporation), which is a non-for-profit clearing entity, be the central clearing model. That would be fine with me.
In the absence of that, if the CME wants to participate in clearing, there needs to be a mutual offset arrangement between the CME and OCC and Ice Clear and whatever other clearing entities there are that want to participate in clearing these OTC instruments that are traded on multiple exchanges. That to me is what fungibility means, not that it is traded on many exchanges and cleared on the CME. That to me is completely anti- competitive and would give the CME an enhanced monopoly in futures trading because of the impact of portfolio margining it would gain from having OTC products related to its futures products cleared through its clearinghouse.
FM: So there has to be a clearing utility or mutual offsets must be offered?
NW: Absolutely. That can't be lost in this process because of the public policy argument that there need to be cleared OTC products. I am not advocating trading OTC products. It is a complicated issue, but once that happens there needs to be multilateral trading and multilateral clearing or give the clearing to the OCC.
FM: A very eloquent spokesman for the New York Mercantile Exchange a few years back did a very good job of making a case against this model, stating the vertical clearing model is much safer. How has that changed?
NW: At that time the eloquent spokesman was employed by a vertical clearing organization in a multiple exchange market, not a single exchange market where one entity traded 96.25% of all futures contracts domestically as was the case in May, so it was a more vibrant market place. Secondly, there was no regulator who that was discussing multilateral execution of over-the-counter products and leaving open the possibility of unilateral clearing of those products in the context of a single entity trading 96.25% of futures contracts and the ability to then clear all those OTC products. [Having] such a monopoly position in futures contracts really solidifies the monopoly of futures by allowing portfolio margining of those futures against the OTC products. It shouldn’t be allowed. It is unnecessary, given mutual offset systems that are available. If you want to talk about fungibility with OTC instruments, that fungibility needs to be both at the trading level and at the clearing level.
FM: What would you like to see come out from the various congressional and CFTC hearings occurring this summer?
NW: I have very limited wants. My wants are much greater emphasis on competiveness in the statute, in the way the CFTC looks at its regulations and core principles. I think that that is what is missing. I think that customer protection, customer safety can always be enhanced. The necessity of tracking OTC trading much better than it [has] been tracked before, the ability to measure it, the ability to measure and monitor risk is important. It was done poorly in the past.
What I would also like to see that hasn’t been focused on in any way shape or form — given the fact that we have a market that has 96.25% of all regulated domestic futures and options products, which I found that alarming and shocking—is a pro competitive bent in regulation that is non-existent at the moment. It is not even being discussed.
“The SEC made its fair share of mistakes. We can learn from that. We don’t have to do everything the way the SEC did it; I am not arguing for a repeat of that model, but I certainly think that we can be more pro competitive than the way the futures industry is today.”
FM: If cleared OTC products are fungible, would that be the camel’s nose under the tent in terms of fungibility?
NW: I am not arguing for OTC being brought on to exchanges, but I am saying that if it is and it is made multilateral, it can’t be made multilateral and then have a unilateral clearing solution. That is not a pro-competitive solution, that is an anti-competitive solution.”