Futures industry weighs need for new post-trade utility

Three large FCMs say standardising trade allocations could prevent a repeat of breaks seen during Covid volatility

Trading data

An in-depth feature looking at the causes of the large number of trade breaks seen in futures markets during March 2020 can be found here.

Dealers are calling for the creation of a new utility to standardise the flow of order allocations from the buy side to futures commission merchants (FCMs) and clearing houses, to prevent a repeat of the congestion seen in futures and options markets last year, when coronavirus-induced volatility caused a huge spike in volumes, causing some trades to fail.

Volumes on futures and options contracts at some exchanges more than doubled overnight in March 2020, while certain contracts, such as benchmark 10-year Treasury note futures at CME, were multiples higher. Some markets saw a high number of trade breaks, which had to be pieced together manually over several weeks – leading to missed margin payments and give-up trades left on the books of the wrong executing brokers in the interim. Some feared a ‘systemic incident’.

Banks and some buy-side firms acknowledge that a surge in orders late in the trading day by large asset managers, which must allocate gains and losses on trades across hundreds or potentially thousands of subfunds they manage money for – and, crucially, different pieces of tech piecing the orders together – contributed to the capacity issues.

The head of clearing operations at a Tier 1 bank argues an industry utility could help standardise the flow of allocations. At present, they argue, “there are multiple ways of that allocation coming in, multiple ways of the FCM interpreting that allocation, normalising it and then doing the clearing process at the central counterparty [CCP]”.

An alternative workflow could involve a utility modelled on those that exist for the over-the-counter market, some suggest, such as the role MarkitServ performs in the interest rate swaps market. MarkitServ is a middleware platform allowing swaps counterparties to match buyer and seller records, confirm the terms of trades, and allocate aggregated trades to accounts, among other functions. The platform is also used to submit trade details to central counterparties and report transactions to swap data repositories.

The idea of a new utility for futures and options markets appears to be gaining traction across the industry. Nick Solinger, president of FIA Technology Services, a for-profit subsidiary of industry trade body the Futures Industry Association, says that the lack of standards for post-trade processes between clients and FCMs, and FCMs and CCPs, contributed to the operational bottlenecks seen last March.

Coming together around industry efforts … [is a concept] being actively discussed across the industry

Nick Solinger, FIA Technology Services

“Coming together around industry efforts – whether standards bodies and industry associations, or by developing more robust market infrastructure together as an industry – are concepts being actively discussed across the industry,” he tells Risk.net.

Walt Lukken, president and chief executive of FIA – which is spearheading industry efforts to prevent a repeat – adds: “As part of the lessons learned from the Covid-related volatility last March, FIA and its board have identified the need for more standardised post-trade operations as part of its strategic priorities in 2021. As a trade association, our aim is to work with all industry stakeholders to drive consensus solutions that bring greater resilience to the clearing system.”

At present, a hugely complex technology ecosystem connects FCMs to the buy side, with workflows that can be quite bespoke. Brokers complain of inconsistent use of messaging protocols and a variety of methods to communicate order allocations. Use of average price allocation methodologies by buy-side clients is also blamed as a cause of the blockages, leaving much of the allocation work to be done at the end of the day, just as CCPs are due to close.

There are also differences in the ways CCPs support the allocation process and average pricing, with little standardisation of timing between the close of execution and clearing between venues.

Instead of each FCM having its own proprietary tools and working practices to consume various methods of allocation, dealers say an industry utility could better standardise FCM connections with the buy side and with CCPs.

Many compare listed futures and options workflows unfavourably to the straight-through processing more prevalent in cleared OTC markets. The head of derivatives clearing at another Tier 1 bank says: “We’re part of conversations to brainstorm better solutions that we can use as an industry group to enhance workflows and reduce breaks.”

The head of clearing operations at a third Tier 1 bank agrees the industry struggled to cope with March’s volume spikes, and that a utility “might be a good hub for some of this activity to improve overall workflow and standardise allocation processing. This is top on the priority list of the industry to focus on”.

He warns, though, that it “will be a long road – and expensive”: “What is the value [of a utility]? And what does that mean from a competitive standpoint?”

What a futures market utility might look like in terms of its architecture is an open question. One senior F&O technologist suggests that, rather than clients sending separate allocation instructions to their original executing broker and their clearing broker, a single venue or hub could exist at which each party sees the instruction at the same time – similar to the function MarkitServ plays in the bilateral and cleared OTC rates workflow at present.

At present in the vast majority of cases, a cleared client interest rate trade executed with a dealer is submitted as a single trade into MarkitServ, before clients submit allocations to match against the executed swap submitted by their dealer. The matched allocations are then submitted to the CCP, referencing the account for each fund in the allocation. Once the CCP receives them, the clearing broker for the client’s funds gets a message for each attempted allocation, and accepts or rejects each one for clearing.

A CCP risk management expert casts doubt over whether the industry will find a single way to standardise futures and options allocation processing: “Obviously, some clients have a preference for a certain way they trade and how they get charged. How they’ve been filled on their orders is a very sensitive point. I think that tension between the executing broker, the client and also others in the chain, makes it very difficult. Does somebody have the right to assign contracts in one or other way?” he asks.

“If you had a utility sitting in between, the question is: would it be given information beforehand that trades are coming in?”

FIA figures show the total number of futures and options traded on exchanges worldwide reached a record level of 46.7 billion contracts in 2020, up 35.6% from 2019.

Editing by Tom Osborn

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