February was a bellwether month for the futures industry. Volume on U.S. Treasury futures topped 10 million at the CME for the first time ever, and former PFG boss Russell Wasendorf Sr. moved into his new digs at the U.S. Penitentiary in Terre Haute, Indiana. His former customers, meanwhile, learned they were getting most of their money back — as are those of MF Global, although that company’s former CEO, Jon Corzine, dodged a lifetime ban from the National Futures Association (NFA), at least for now.
But the industry both men blemished still faces a slew of new regulations — and not just those flowing from their actions. High-frequency trading (HFT) is under fire from both regulators and practitioners, while Financial Transaction Taxes (FTT) are being implemented across Europe and new collateral requirements are being contemplated and implemented for banks and even FCMs.
Europe, meanwhile, is gearing up for a turf battle between its existing exchanges and two new ones, courtesy of CME Group and Nasdaq OMX.
On the HFT front, Germany looks set to begin regulating practitioners under its Banking Act (Kreditwesengesetz, or “KWG”), which means anyone practicing HFT on a German exchange might soon be required to have an office there. That also could make HFT practitioners subject to a proposed EU-wide FTT even if they’re trading futures.
That might be bad news for Eurex, which gets 30% of its volume from HFT — or it might not. Some say HFT has peaked, regardless of what regulators do. Rosenblatt Securities, for example, has long questioned the profitability of most HFT strategies, and in February they published research indicating that HFT volume is down more than 50% over the last three years, with average profits per trade plunging 75%. Like the computer-generated options strategies that Chicago Research and Trading created in the late 1970s, HFT is here to stay – but its growth appears to have hit its limits.
Financial transaction tension
Meanwhile, talk of a transaction tax has moved beyond individual countries to the European Commission itself — which wants to help states that impose an FTT collect that tax on shares traded outside their own jurisdictions. Only 11 of the European Union’s 27 member states advocate an FTT, but these include three of the EU’s four largest economies (Germany, France, and Italy). Those countries alone, however, don’t have the clout to impose an EU-wide FTT, and the United Kingdom — the EU’s third-largest economy — is glaringly absent from the list.
The Commission is considering a proposal that would let countries enforce collection of the tax across the European Union and even beyond. That means shares of a Paris-listed company traded in London would have to pay the tax, even if the United Kingdom doesn’t adopt it. It also means exchanges in the United States and other countries might have to collect the tax as a condition for listing the shares.
For people who trade with a perspective longer than a minute or two, the tax is barely noticeable at 0.1% for stock and bond trades and 0.01% of notional value for derivatives traders. For HFT practitioners, however, that amount could be deadly, which is what makes the German announcement so interesting. Under the proposal, derivatives transactions only will be taxed if they’re made by companies with an office in the country, and HFT practitioners will have to have an office in the country if the provision goes through as drafted.
For most hedgers and speculators, it’s difficult to see why currently proposed taxes would be an issue. HFT certainly has increased volumes, but it’s debatable as to whether it’s made it easier to get into and out of positions that are held for longer than a few minutes. What’s more, overall costs still will be a fraction of what they were back in the days of open outcry, and there’s a growing sense within the industry that HFT isn’t worth the headache. That sense is part of a larger debate over the relative merits of efficiency and resiliency in the marketplace.
“Basically, efficiency is the ability of a system to grow and expand and process throughput, while resiliency is the ability of a system to recover from a shock,” says former JP Morgan Managing Director John Fullerton — an FTT advocate in the United States. Senator Tom Harkin and Congressman Peter DeFazio long have been pushing for an FTT, and they’re continuing to do so. “Economics has tended to focus on maximizing efficiency, but resiliency is only now getting widespread attention.”
Then we have proposed new collateral rules for both uncleared derivatives and futures. The former were supposed to be finalized and implemented by the end of 2012, but that’s been pushed back to the end of this year. Even without the final rules, LCH.Clearnet nearly tripled its net profit last year, in part on new volume from the over-the-counter world.
On the futures front, the Commodity Futures Trading Commission (CFTC) wants to ratchet up collateral requirements for futures commission merchants (FCMs) — a proposal that the Futures Industry Association (FIA) says will kill the current business model.
The CFTC also wants to impose tougher auditing and disclosure standards on FCMs, with designated self-regulatory organizations taking responsibility for making sure customer funds really are segregated. Few have argued against that one, but the FIA says the CFTC has gone too far in requiring that FCMs mark their collateral to market throughout the day, as opposed to at the close of business like they do now.
The return of exchange wars
And finally, after years of shaking out, we have two new futures exchanges emerging overseas: CME Europe and NASDAQ OMX’s new NLX platform. Both are based in London, and both will be targeting customers from Asia and Latin America as well as Europe. Combine this with the IntercontinentalExchange’s (ICE) proposed takeover of NYSE and its derivatives subsidiary, NYSE.Liffe, and you have the makings of a fascinating new battle playing out on several continents.
Brazilian regulators have approved ICE’s plans to create an electronic bond-trading platform in Brazil, and ICE CEO Jeff Sprecher has proven time and again that he can roll with the changes better than his competitors. It will be fascinating to see what he brings to the NYSE.Liffe brand, assuming that takeover goes through.
New blood at the NFA
On the self-regulatory front, three outspoken critics of the NFA have been elected to the board of directors. James Koutoulas, John Roe and Jeff Malec have pulled no punches in critiquing the NFA auditors who failed to uncover Wasendorf’s shenanigans, among other things. Katoulas and Roe run the Commodity Customer Coalition (CCC), a non-profit that’s been shining the bright light of transparency on regulators, exchanges, and bankruptcy attorneys since MF Global’s Halloween implosion in 2011. Beyond the CCC, Koutoulas is chief executive of Typhon Capital Management; Roe is president of Roe Capital Management and Malec is chief executive of Attain Capital Management. First on their agenda: Taking stock of the NFA’s auditing process.
“The NFA has to do a little soul-searching here — especially with regard to the audit culture,” says Roe. “We’re wondering if they haven’t fallen into a tick-box mentality that focuses attention on minutiae like whether disclaimers are in the right place instead of on things that really are a threat to the market.”
The next board meeting won’t take place until May, and Roe says they’ll work within the NFA’s committee structure to get a handle on what works and what needs to be fixed.