The international futures and options markets have been characterised in recent decades by a handful of very large exchanges that periodically face and then drive out of business new entrants, only for the status quo to be resumed once again.
Famously there are only a small handful of examples where a new exchange has taken and, crucially, kept business from a larger incumbent.
This tendency to adhere to long-established market conventions is not unique to the derivatives market but it is tempting to say this industry has changed less in the past decade than any of the currency, government bond or equity markets.
The method of trading may have changed (electronic trading is now pre-eminent of course) but the mechanisms of futures trading, namely the exchanges, are the same firms that our Grandads traded in the 80s.
There are some early signs that this may begin to change next year however, and 2016 could be the year when real competition really takes off in the futures markets.
There are three key markets where 2016 promises greater competition: European rates; the energy market; and Singapore.
The European interest rates market:
The European interest rate futures markets has been dominated for decades by ICE Futures Europe, what used to be Liffe, and Frankfurt’s Eurex.
Liffe has dominated the short end of the curve with its euribor and short sterling products and Eurex has covered the longer dated contracts with its Bund, Bobl, Schatz standards.
ICE has established a decent little business in longer-dated products also but Europe is largely split between the two markets.
This status quo was initially called into question in May 2013 when Nasdaq launched NLX, a new entrant trading both the short and long end of the curve and claiming hefty saving through portfolio margining.
The new trading platform saw volumes grow steadily through 2013 and up to the end of last year but critics were quick to point out this was largely down the generous rebates NLX was offering clients as incentives.
NLX finally bit the bullet in late 2014, scrapped the rebates and volumes tanked in a matter of months, falling from 1.6 million contracts in November to fewer than 10,000 a month six months later.
NLX’s big problem was the new venue was reliant on its clearer provider LCH to deliver the portfolio margining that was supposed to make NLX a game-changer.
But the Nasdaq venue received a much-needed boost in March when LSE Group, the majority-owner of LCH, said the European clearing giant would finally support a portfolio-margining service from the first quarter of next year.
Portfolio margining is a technique whereby clearing houses calculate their clients’ net exposure across a group of assets with similar attributes such as interest rate swaps and interest rate futures, potentially offering large derivatives banks decent margin savings.
LCH Swapclear is the world’s dominant swaps clearing house so any futures exchange, like NLX, that clears its futures into LCH (assuming the clearing house supports portfolio margining) could be a viable alternative to the incumbent markets.
The LSE hinted in March that it could launch its own futures exchange to rival NLX and confirmed in October the worst kept secret in the City of London when it said it planned to launch CurveGlobal, backed by six banks and CBOE Holdings, in the second quarter of next year.
Curve, like NLX, hopes to draw futures trading away from ICE and Eurex by offering banks savings as they trade their rates futures on Curve and clear them in LCH where they can be offset against the swaps in Swapclear.
NLX and Curve then look set to present stiff competition to the incumbents Ice and Eurex -- NLX in the first quarter when the margining service, known as LCH Spider, goes live and Curve in the second quarter when it is set to launch.
Charlotte Crosswell, the chief executive of NLX, told FOW LCH Spider and the planned European introduction of mandatory swaps clearing in June next year are set to shake-up the market.
“We are optimistic because portfolio margining and European client clearing are around the corner. The leverage ratio is causing a huge issue for the banks and, because of that, we’re seeing an uptick in bank teams looking for capital efficiencies whereas they had different priorities this time last time last year.”
Crosswell believes the draconian supplementary leverage ratio being imposed on banks will force them to look even harder at solutions that allow them to cut cost, such as portfolio margining.
Michael Davie, the chairman of CurveGlobal, agreed, adding that several factors point to 2016 being the right time to launch: “Firstly, changes in regulation have increased the cost of regulatory capital to those trading derivatives. Secondly, it is increasingly important for customers that trade futures used to hedge over-the-counter interest rate derivatives sit alongside their relevant positions at the same clearing house.”
Davie said Swapclear’s 90+% swaps clearing market share makes LCH Spider attractive to firms looking “to maximise margin offsets and optimise their initial margin and default fund capital expenses”.
He added: “Looking at the bigger picture, rate markets have undergone considerable change in recent years, and market participants are under ever-increasing cost pressures. There is an industry-wide belief that the interest rate futures markets would benefit from greater competition for both clearing and execution.”
Cameron Goh, the head of clearing solutions, SwapClear and listed rates at LCH.Clearnet, said: “We believe competition is going to heat up next year and open access is going to be a big part of that. Exchanges have in the past tried to use their futures to attract over-the-counter flow, but LCH.Clearnet is now in a great position to use its multiple currencies, products and international pool of OTC liquidity to attract the futures market.”
LCH Spider is the most interesting thing to have happened in the European rates market for years. More interesting will be the reactions to it by ICE and Eurex.
The US and European energy market:
Nasdaq’s assault on the European rates market may only be set to take shape next year but the US exchange opened up on a different front in mid-2015 and could be set to shake up a different duopoly in 2016.
Nasdaq Futures (NFX) launched in late July, offering for trading most of the main energy contracts traded on Nymex, part of the CME Group and home of the US benchmark WTI contract, and ICE Futures Europe, the home of the European Brent standard.
NFX, which has said it will not charge trading fees for the first nine months, plans to attract volume from the incumbents with lower trading and clearing costs, offered with the Options Clearing Corporation.
The exchange also said in July that 16 brokers had signed up, naming 14: ABN AMRO Group, ADM Investor Services, Advantage Futures, Citigroup Global Markets, ED&F Man Capital Markets, Goldman Sachs, INTL FCStone, JP Morgan, Merrill Lynch, Mizuho Securities USA, Phillip Capital, Rosenthal Collins Group, Societe Generale and Wedbush Futures.
Magnus Haglind, the chief executive of NFX, told FOW in July: "We are targeting a 10% market share in the first 18-24 months. I think this is achievable."
NFX volumes have been modest so far but they are showing solid growth, having doubled in September to reach almost two thirds of a million contracts in October.
This level is still dwarfed by the vast trading books of Nymex and ICE, which trade more than that in a single day, but it’s a start.
Brokers were sceptical at the time of launch, arguing another exchange showing the same contracts as an established market but at a lower price is rarely sufficiently compelling to put a dent in the incumbent.
The lower fees are something, they argued, but the lower liquidity in the new venues often equates to additional cost which makes them less attractive than the incumbents.
NFX has a fight on its hands but with 16 of the world’s largest brokers behind it, it had a decent chance of upsetting the apple cart.
Singapore has in recent years emerged as the platform for trading Asia and the world’s top exchanges have wasted no time in piling into a market dominated by local favourite the Singapore Exchange.
The Intercontinental Exchange, normally the incumbent itself, took the plunge on November 17 and launched ICE Futures Singapore, its first Asian exchange and the first launched in Asia by a non-Asian firm.
ICE Futures unveiled a mix of contracts: a one kilo gold future; a mini Brent crude future; a mini offshore renminbi; a mini onshore renminbi; and a mini low sulphur gasoil product.
“With a range of contracts across energy, gold and FX, our Singapore exchange and clearing house provides market participants with effective tools for managing price risk locally,” said Lucas Schmeddes, president & chief operating officer at ICE Futures Singapore and ICE Clear Singapore.
This combination raised some eyebrows among rivals who questions the demand for the gold and currency products but three weeks in and the energy contracts are progressing well, according to ICE data.
ICE’s launch is potentially only the start however, as CME group has made Singapore its home and appointed in March Chris Fix, the former chief executive of the Dubai Mercantile Exchange, as its Asian head.
CME has not gone public on any plans to launch an exchange or clearing house in the region however, unlike Eurex which had initially planned to go live with its exchange and clearing hub at the end of the year but said in September it had decided to put back the launch by 18 months to the middle of 2017.
A source familiar with the matter said the decision to delay the launch had been taken to allow the exchange to focus on other "more-pressing development work," such as its clearing business, adding that the delay comes after and is linked to the organisation’s new structure under chief exec Carsten Kengeter who assumed that role in early June.
Competition is Singapore can only increase next year as ICE ramps up its business and Eurex starts to flex its muscles in the region.