OTF obstacles facing derivatives traders in 2018

OTF obstacles facing derivatives traders in 2018

From increased competition to greater pricing transparency and investor protection, what’s not to like about moving more over-the-counter (OTC) derivative contracts onto trading venues? In theory, it all sounds great. But in a world as convoluted as derivatives, nothing is ever straightforward, writes Fraser Bell, chief revenue officer of BSO .

The much talked about January 3 Mifid II deadline signals a shift in market structure so significant, it’s debatable whether the infrastructure underpinning new organised trading facilities (OTFs), will be ready to front up to the operational challenge that lies ahead.

According to this latest report by Greenwich Associates, market participants are likely to dramatically increase their use of derivatives on venue – seeing them as a less risky option now they are regulated. This is likely to mean that more trading, which should lead to a big uptick in volumes. But while this may be good for liquidity levels across traditionally less liquid asset classes, trading these instruments on-exchange will have more than a few teething problems.

While managing volumes on normal trading days is straightforward, what about during times of market turbulence? Mifid II states that OTFs must “maintain resilient systems to facilitate continuity of trading under testing market conditions.” And let’s face it, there are no shortage of geopolitical events that could affect how European markets function in 2018.

However, managing volumes is not the only operational challenge. Like multilateral trading facilities (MTFs), OTFs have to comply with stringent pre and post-trade requirements. Specific details such as where and when OTF trades get executed, not to mention by whom, all need to be logged. The challenge is that demand for this information not only puts a huge importance on ensuring reliable market access to multiple venues, but also to a variety of different market data feeds. After all, these are venues that until now, the market has never had to connect to.

As expected, the major players such as TP ICAP have moved early – outlining detailed plans for its OTF platform. With others sure to follow, it will be interesting to see what knock-on effect an increase in the number of venues will have on derivatives trading across Europe. If the original MiFID is a barometer, an increase in the number of trading venues places an even greater importance on the infrastructure underpinning them. Trading costs and times dramatically reduced in equities, while variations in prices across different platforms triggered a surge in high-speed trading that still dominates stock markets today.

It is certainly not out of the question that the emergence of OTFs will have similar effects. Although trading derivatives is different to trading more conventional stocks or cash currencies, so only time will tell whether or not OTFs will lead to an equally dramatic shift. That said, should OTFs fail to address the underlying operational issues in less than one months’ time, then market participants will not witness the benefits of choosing to connect to numerous venues offering up different prices. If these challenges are not overcome, the European derivatives market may well run into more than a few difficulties throughout 2018.