2016: The year of competition?

The international futures and options markets have beencharacterised in recent decades by a handful of very large exchanges thatperiodically face and then drive out of business new entrants, only for thestatus quo to be resumed once again.

Famously there are only a small handful of examples where anew exchange has taken and, crucially, kept business from a larger incumbent.

This tendency to adhere to long-established marketconventions is not unique to the derivatives market but it is tempting to saythis 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 tradingis now pre-eminent of course) but the mechanisms of futures trading, namely theexchanges, are the same firms that our Grandads traded in the 80s.

There are some early signs that this may begin to changenext year however, and 2016 could be the year when real competition reallytakes off in the futures markets.

There are three key markets where 2016 promises greatercompetition: European rates; the energy market; and Singapore.

The European interestrates market:

The European interest rate futures markets has beendominated for decades by ICE Futures Europe, what used to be Liffe, andFrankfurt’s Eurex.

Liffe has dominated the short end of the curve with itseuribor and short sterling products and Eurex has covered the longer datedcontracts with its Bund, Bobl, Schatz standards.

ICE has established a decent little business in longer-datedproducts also but Europe is largely split between the two markets.

This status quo was initially called into question in May2013 when Nasdaq launched NLX, a new entrant trading both the short and longend of the curve and claiming hefty saving through portfolio margining.

The new trading platform saw volumes grow steadily through2013 and up to the end of last year but critics were quick to point out thiswas largely down the generous rebates NLX was offering clients as incentives.

NLX finally bit the bullet in late 2014, scrapped therebates and volumes tanked in a matter of months, falling from 1.6 millioncontracts in November to fewer than 10,000 a month six months later.

NLX’s big problem was the new venue was reliant on itsclearer provider LCH to deliver the portfolio margining that was supposed tomake NLX a game-changer.

But the Nasdaq venue received a much-needed boost in Marchwhen LSE Group, the majority-owner of LCH, said the European clearing giantwould finally support a portfolio-margining service from the first quarter ofnext year.

Portfolio margining is a technique whereby clearing housescalculate their clients’ net exposure across a group of assets with similarattributes such as interest rate swaps and interest rate futures, potentially offeringlarge derivatives banks decent margin savings.

LCH Swapclear is the world’s dominant swaps clearing houseso any futures exchange, like NLX, that clears its futures into LCH (assuming theclearing house supports portfolio margining) could be a viable alternative tothe incumbent markets.

The LSE hinted in March that it could launch its own futuresexchange to rival NLX and confirmed in October the worst kept secret in theCity of London when it said it planned to launch CurveGlobal, backed by sixbanks and CBOE Holdings, in the second quarter of next year.

Curve, like NLX, hopes to draw futures trading away from ICEand Eurex by offering banks savings as they trade their rates futures on Curveand clear them in LCH where they can be offset against the swaps in Swapclear.

NLX and Curve then look set to present stiff competition tothe 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 setto launch.

Charlotte Crosswell, the chief executive of NLX, told FOWLCH Spider and the planned European introduction of mandatory swaps clearing inJune next year are set to shake-up the market.

“We are optimistic because portfolio margining and Europeanclient clearing are around the corner. The leverage ratio is causing a hugeissue for the banks and, because of that, we’re seeing an uptick in bank teamslooking for capital efficiencies whereas they had different priorities thistime last time last year.”

Crosswell believes the draconian supplementary leverage ratiobeing imposed on banks will force them to look even harder at solutions thatallow them to cut cost, such as portfolio margining.

Michael Davie, the chairman of CurveGlobal, agreed, addingthat several factors point to 2016 being the right time to launch: “Firstly,changes in regulation have increased the cost of regulatory capital to thosetrading derivatives. Secondly, it is increasingly important for customers thattrade futures used to hedge over-the-counter interest rate derivatives sitalongside their relevant positions at the same clearing house.”

Davie said Swapclear’s 90+% swaps clearing market share makesLCH Spider attractive to firms looking “to maximise margin offsets and optimisetheir initial margin and default fund capital expenses”.

He added: “Looking at the bigger picture, rate markets haveundergone considerable change in recent years, and market participants areunder ever-increasing cost pressures. There is an industry-wide belief that theinterest rate futures markets would benefit from greater competition for bothclearing and execution.”

Cameron Goh, the head of clearing solutions, SwapClear andlisted rates at LCH.Clearnet, said: “We believe competition is going to heat upnext year and open access is going to be a big part of that. Exchanges have inthe past tried to use their futures to attract over-the-counter flow, butLCH.Clearnet is now in a great position to use its multiple currencies,products and international pool of OTC liquidity to attract the futuresmarket.”

LCH Spider is the most interesting thing to have happened inthe European rates market for years. More interesting will be the reactions toit by ICE and Eurex.

The US and Europeanenergy market:

Nasdaq’s assault on the European rates market may only beset to take shape next year but the US exchange opened up on a different frontin mid-2015 and could be set to shake up a different duopoly in 2016.

Nasdaq Futures (NFX) launched in late July, offering fortrading most of the main energy contracts traded on Nymex, part of the CMEGroup and home of the US benchmark WTI contract, and ICE Futures Europe, thehome of the European Brent standard.

NFX, which has said it will not charge trading fees for thefirst nine months, plans to attract volume from the incumbents with lowertrading and clearing costs, offered with the Options Clearing Corporation.

The exchange also said in July that 16 brokers had signedup, naming 14: ABN AMRO Group, ADM Investor Services, Advantage Futures,Citigroup Global Markets, ED&F Man Capital Markets, Goldman Sachs, INTLFCStone, JP Morgan, Merrill Lynch, Mizuho Securities USA, Phillip Capital,Rosenthal Collins Group, Societe Generale and Wedbush Futures.

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Magnus Haglind, the chief executive of NFX, told FOW inJuly: "We are targeting a 10% market share in the first 18-24 months. Ithink this is achievable."

NFX volumes have been modest so far but they are showingsolid growth, having doubled in September to reach almost two thirds of amillion contracts in October.

This level is still dwarfed by the vast trading books ofNymex and ICE, which trade more than that in a single day, but it’s a start.

Brokers were sceptical at the time of launch, arguinganother exchange showing the same contracts as an established market but at alower price is rarely sufficiently compelling to put a dent in the incumbent.

The lower fees are something, they argued, but the lowerliquidity in the new venues often equates to additional cost which makes themless attractive than the incumbents.

NFX has a fight on its hands but with 16 of the world’slargest brokers behind it, it had a decent chance of upsetting the apple cart.

Singapore:

Singapore has in recent years emerged as the platform fortrading Asia and the world’s top exchanges have wasted no time in piling into amarket dominated by local favourite the Singapore Exchange.

The Intercontinental Exchange, normally the incumbentitself, took the plunge on November 17 and launched ICE Futures Singapore, itsfirst Asian exchange and the first launched in Asia by a non-Asian firm.

ICE Futures unveiled a mix of contracts: a one kilo goldfuture; a mini Brent crude future; a mini offshore renminbi; a mini onshorerenminbi; and a mini low sulphur gasoil product.

“With a range of contracts across energy, gold and FX,our Singapore exchange and clearing house provides marketparticipants with effective tools for managing price risk locally,” said LucasSchmeddes, president & chief operating officer at ICE Futures Singapore andICE Clear Singapore.

This combination raised some eyebrows among rivals whoquestions the demand for the gold and currency products but three weeks in andthe energy contracts are progressing well, according to ICE data.

ICE’s launch is potentially only the start however, as CMEgroup has made Singapore its home and appointed in March Chris Fix, the formerchief executive of the Dubai Mercantile Exchange, as its Asian head.

CME has not gone public on any plans to launch an exchangeor clearing house in the region however, unlike Eurex which had initiallyplanned to go live with its exchange and clearing hub at the end of the yearbut said in September it had decided to put back the launch by 18 months to themiddle of 2017.

A source familiar with the matter said the decision to delaythe 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 newstructure under chief exec Carsten Kengeter who assumed that role in earlyJune.

Competition is Singapore can only increase next year as ICEramps up its business and Eurex starts to flex its muscles in the region.