A year ago futures commission merchants (FCMs) were looking forward to the opportunity of getting into the cleared over-the-counter (OTC) space as it clearly would be mandated in reaction to the credit crisis — which reached its zenith in 2008 — but were a little worried that the greater mandate for regulation as a result of the crisis would add to their compliance cost.
A year later, financial reform is law, but instead of expediting the move to OTC clearing, which had already been underway, the law may be slowing momentum as players wait for rules to be written. While the Commodity Futures Trading Commission (CFTC) has been speedily writing rules, those rules need to be commented on and made final. The mid-term Republican takeover of the House of Representatives could complicate matters as many in the GOP opposed the law and could attempt to overturn it or at least defund those agencies charged with carrying it out.
FCMs see the new world as a double-edged sword with the potential to access a new class of OTC products traded on exchanges or at least cleared along with a more onerous compliance structure. As they wait for rules, 2010 appears to have been a mixed bag, with some firms showing increased volumes, especially those taking advantage of volatility in the agricultural markets in the second half of the year, and others just getting by.
"It has been slower than 2009 and 2009 was slower than 2008," says Tom Peterffy, CEO of Interactive Brokers Group.
R.J. O’Brien (RJO) CEO Gerry Corcoran says the firm is up 19% year to date thanks to expansion in Canada and Beijing and an energized ag market. "It is commodity-centric and we also have established an FCM presence in Hong Kong," Corcoran says.
MF Global CFO Randy MacDonald says the firm returned to profitability as customers who fled to a risk-free environment returned. "The very firms whose risk management systems failed them and needed to take TARP money are the firms that received assets that year. Because they had government backing, people felt comfortable moving their assets from us to them. That trend reversed this year where we saw people move their balances back," MacDonald says.
Brokers operating in both the futures and securities spaces report that futures business has been robust, which is why such securities stalwarts as TD Ameritrade are looking to futures brokerage.
"We were born a securities broker and we continue to see people on the securities side looking to broaden their horizons," says optionsXpress CEO Dan O’Neil. "They are looking beyond traditional stocks and bonds and we are starting to benefit from having all the products on a single platform."
Marc Nagel, COO of Dorman Trading, has noticed that movement as well. "Everyone is trying to make money trading futures, especially S&P E-minis. When they moved to pennies in equities, it really got hard to make money there," Nagel says.
Waiting is the hardest part
"There is the inertia of waiting for the regulators to now take what the legislators said — go centralize this — [and execute it]," MacDonald says. "Go reduce the mystery of this by forcing it to be centrally cleared."
Newedge CEO Nicolas Breteau says, "It is true that we are waiting to see what the regulation will be, on both sides, Dodd-Frank and what the European Commission will put in place in Europe."
While the actual mandate may be slowing things down, that could give FCMs time to prepare.
"We are not a significant player in the bilateral OTC marketplace, so I don’t feel like we have been held up by the rule-making process," says Corcoran. "In some ways the rule-making process that has slowed things down has been beneficial for RJO allowing us to get our ducks in a row."
Others see something more onerous afoot. "Everybody pretends to be frozen because they [are] hoping that these things will go away," Peterffy says. "The banks don’t want to talk about it. They are basically hoping that somehow it will go away and changes in the House will make it go away. Obviously they make more money when they trade these products OTC than if it is on an exchange.
"I am puzzled how the banks can convince their customers that listing the products on exchanges could be bad for them. Why? It is not their money. It is the employees that work for the large corporations, pension funds, mutual funds and local governments who enter into these trades on behalf of the shareholders and the taxpayers not on their own behalf," Peterffy says.
Still it is the uncertainty that many brokers see as a bigger problem than the regulation, especially those facing multiple regulatory environments. Breteau is concerned about cross-border regulation. "The big question for us is, when will it come into force and the convergence between the regulation [in the U.S. and Europe]. We don’t want to be caught in arbitrage between the two."
But most FCMs are excited to join the cleared OTC fray. "It is good for our business, it is good for the industry," MacDonald says. "That you can have central clearing is a huge benefit to a firm like us. Things like swaps and [credit default swaps] that we don’t participate in today, we can participate in tomorrow."
But while all FCMs not affiliated with an investment bank have been chomping at the bit to get into the cleared OTC space, much of that optimism has been tempered with the mid-October announcement of CME Group’s interest rate swaps clearing solution.