Exchange trader incentive schemes are inventive and compelling programmes offered by most major derivatives exchanges that encourage qualified professional traders to explore new products by dangling the carrot of reduced exchange fees. With these programmes, exchanges aren’t targeting sophisticated algorithmic traders and in fact, such algorithmic business is generally barred from participation. These measures have been designed to reach smaller players and have been successful incubators. Of course exchanges also offer a wide variety of programmes that reward high volume and high frequency members, though for the sake of this article, these programmes are considered to be out of scope as they form part of exchanges’ core business.

Targeting individual traders certainly isn’t a new strategy for most exchanges. However, targeting individual traders in geographically distant locations is a relatively new development for many. Globalization and electronic trading has made it possible, and profitable.

Global customers have a number of incentive programmes at their disposal in order to get greater access to products and discounted pricing. The programmes typically target participants in emerging markets or other geographical areas in which exchanges would like to expand their distribution networks. Alternatively, some exchanges emphasize product-based incentive schemes as a way of steering liquidity into targeted, usually new, products. The shared key component of most programmes is that they offer fee rebates proportional to traded volume. And some expire after a certain time frame so as to encourage high volume users to pursue exchange membership.

With the rise of futures trading in emerging markets, proactive exchange players have been active in establishing footholds, especially in hot BRIC countries. Leading exchanges have relied on local exchange partnerships and joint ventures to establish a presence in emerging markets. And in the last several years, they have supplemented these regional efforts with trader incentive programmes in order to reach individual traders. Note that these programmes are not limited to BRIC countries and some are available in a wide variety of locations, including the US.

A view from emerging markets

Exchanges in emerging markets also offer programmes to incent business from traders located in Europe and the US. In the age of international exchange tie-ups, these incentive programmes help generate important cross-border trading activity. But trader incentive programmes are just one component of global efforts to increase volumes by reducing barriers to entry for new trading participants. Subsidised technology solutions, customised membership packages and assistance in establishing broker relationships are other parts of the equation. Brazilian exchange BM&F, for example, has developed various DMA connectivity alternatives to help traders deal with the challenges of cross-border connectivity.

Jorge Alegría, chief executive of MexDer says that it currently offers product-based incentive programmes but that when the exchange’s order routing agreement with the CME goes into effect in the third quarter of this year, MexDer will expand its incentive programmes, “When the North-South order routing agreement goes live, we will accompany that launch with an aggressive programme to generate new business. From our standpoint, we feel that it is essential to reward first movers with a combination of fee discounts and other economic incentives to promote participation and increase liquidity.” And rewarding new business is a win-win proposition for exchanges and traders alike.

A Receptive Market

Active participants in such incentive schemes praise exchange efforts to reach out to them. Tyler Cleveland, an active individual trader based in the Midwest who has been involved in ICE's Russell incentive programme since its inception, is enthusiastic about the benefits of such programmes. "The ICE programme enabled me to transition to a new marketplace that I was interested in at rates that were attractive. The programme was an important consideration for me when I initially began trading the ICE Russell contract, and continues to be a factor in my involvement." Such programmes are building impressive track records of helping an increasing number of traders transition into new products and markets.

Smartly, exchanges leverage their brokerage members to reach individual traders, which gives brokers another sales tool. Bill Harrington, executive vice president at Advantage Futures concurs that these programmes add value, “Advantage clients participate in numerous incentive programmes at the CME Group, Liffe, Montreal, ICE US, Eurex and NYSE Liffe US. High frequency traders rely on these programmes in establishing profitable strategies. Advantage helps clients navigate these complex incentives to identify those most advantageous.” As the number and complexity of available incentive programme grows, being able to guide traders towards the programme that are best suited to their needs adds real value.

Meeting Changing Demands

As the markets continue to develop, exchanges are generally proactive in re-tooling programme to better meet customer demand. Bryan Durkin, chief operating officer and managing director of products and services at CME Group underscores the need for flexibility, "The continued evolution of our programme emphasizes CME Group's commitment to listening to customer feedback and growing our business internationally. As demand for our benchmark products in non-U.S. trading hours have grown, we remain dedicated to providing access and greater liquidity for our customers around the world," he says.

Skeptics ask, if the programmes are geared towards smaller professional traders, are they worth the effort? According to Vassilis Vergotis, executive vice president at Eurex Exchange and head of the exchange’s Americas operations, the answer is a resounding yes. “Since our Trader Development Programme was introduced back in 2007, 650 trader participants have generated over 33 million contracts of new volume. We’ve built on that success and today’s version of the programme counts 247 trader participants from 13 countries and four million contracts of new volume in 2010. Our programme has turned subsidized participants into long-term traders on our exchange. And that’s a real success story of sustainable revenue growth.”

As noted, exchanges are interested in promoting the long-term involvement of new participants and education is another way they help reach their goals. Educating market participants is a long-term strategy that is designed to increase traders’ profitability, which potentially can increase their volumes. Though in many cases educational efforts have been centered in emerging markets, exchange representative report that traders in mature markets have accepted educational offerings enthusiastically as well.

Most exchange educational efforts focus on disseminating product information, but several provide information on trading strategies and techniques in order to give new market participants a better picture of the markets they are entering, e.g. breakdown of proprietary versus agency business, statistics on typical trade size, pace of calendar rolls, etc.

What’s more, as a result of their educational outreach, exchanges form connections with traders that can influence their future selection of products and markets. According to Daniel Gramza of Gramza Capital Management, Inc., who has taught a number of international participants in such programmes “Typical participants are new traders to a firm or seasoned traders looking for new applications for their existing trading strategies. I have observed that once they become familiar with a given exchange’s product offering, they are more likely to continue to trade it.” And that preference is just what exchanges are hoping to foster with their educational programmes.

Many exchanges, among others in the trading community, share the conviction that education is key in developing a future customer base. That’s why in parallel to trader incentive schemes, exchanges actively support professorships, coursework, trading rooms as well as subsidised market data for training students at universities around the globe. Prominent local universities in major financial centers around the globe benefit as a result and exchanges benefit from the early exposure that students receive to their products.

Eurex, for example, partners with a number of universities, like the Chinese University of Hong Kong with which it set up a real-time finance trading laboratory as a part of its new training an education initiative in Asia. Another of its partners is the Cardiff Business School. Michael Shirley, managing director, OSTC Wales, sees direct business benefits from this Cardiff sponsorship in the form of better-qualified local trader recruits. "Eurex’s support of the Cardiff Business School is a great example of how academia and commerce can come together for a mutually beneficial partnership. The school and students benefit from a realistic trading environment, the exchange benefits by exposing a class of high-potentials to its products and we trading firms get graduates who are steps ahead of the competition.” Firms around the globe applaud the major exchanges’ educational efforts as they significantly enhance the available pool of local recruits.

Low-Risk Growth Drivers

But emerging market incentive programmes aren’t just altruistic ways to foster trading talent. They are low-cost ways to test local markets for interest before exchanges make large commitments in marketing and sales expenditures. By leveraging brokers, usually commission-based and driven, as multipliers, exchanges are playing their cards well.

These programmes are also one inventive answer to the question “how do you grow membership in a world in which most of the major high-frequency players, at least those domiciled in major financial centres, are already connected?”