- News & comment
Publication date: 1 August 2012
Author: Matt Woodhams, Head of eCommerce, GFI Group Inc.
History has proven that with regulatory change comes changing behaviour, business models, products and services. We have witnessed this in equity markets with MiFID where the sell-side has delivered innovative trading products and services. Market infrastructure participants created new liquidity venues, faster order handling and increased their efforts to create efficiencies in clearing and settlement. Today, the US Dodd-Frank Act is driving the OTC agenda, followed closely by MiFIR in Europe and more broadly in other regulatory jurisdictions.
Given the holistic nature of regulation are there conclusions we can draw other than the most generic hypotheses?
We hear and read a lot about regulation levelling the playing field, opening access, and righting previous wrongs. However, does everyone on the buyside consider themselves peers, or even want to be considered peers?
Can we compartmentalise the buyside demographic in order to draw some conclusions?
At the larger end of the spectrum are the Swap Dealer/Major Swap Participant (MSP) wannabes. In true fashion they have little intention of sitting on the liquidity side-lines. Keen to interact as directly with the market as possible, many are likely to become a new breed of market makers, many employing ex-bank trading staff in search of better deals than those available at regulation-burdened sellside banks. These firms bear many of the hallmarks of traditional sellside firms, are at least as technologically competent, and will likely favour the many-to-many trading protocols such as central limit order books and multilateral auctions for less liquid markets .
We would anticipate that these wholesale entrants will wield ever-greater control over the way in which liquidity interacts, if not individually then most certainly collectively, with the likes of the ‘Boston 15′ group of fund managers acknowledged as having ‘serious clout’. Some may say this is something of a seminal moment for the industry. ‘Tomorrow’ these firms will be entirely within their rights to knock on the door of any trading or clearing venue to seek access and there is nothing anyone can do about it.
While by any volume-based metric this buyside subset will likely represent the lion’s share, they will be relatively few in number. What of the rest, who will likely outnumber the above?
Some of them anticipate to be afforded regulatory exemptions from having to trade on Swap Execution Facilities (SEFs) and clear through Clearing Houses (CCPs) and have been vocal either as individual firms or through trade associations. However, what of the subset sandwiched between ‘new wholesale’ and the exempt? Typically, they currently trade directly with liquidity providers such as banks either through a bank’s salesforce or electronically on single or multidealer platforms. These tend to be a ’ request for quote’ model, RFQ, RFS, RFO, RFM or ultimately a ‘request for something’ approach. The unwelcome conundrum they face is that the regulation is multilateral in nature and direct bank-to-customer trading is not viewed as viable for regulatory mandated products. Yet nor are they inclined to come in and trade on a Central Limit Order Book in an exchange-like fashion. Will there be an inevitable march down the road to multibank platforms for this subset of the buyside? Maybe not; banks have proven track records at building up their franchises and have invested multiples of millions of dollars in portals and trading platforms. On the other hand, customers are often looking for services beyond simply execution and multibank platforms don’t often, if ever, meet these criteria.
An alternative is the ‘agency’ or sponsored access model where an agent or bank sponsors access to the execution venue or SEF either directly, through its salesforce or bank platforms. For some customers, this is likely to be the best of all worlds. For the incumbent sellside unable to act directly in a principle capacity with their customers, ‘at least’ this will create opportunities to provide prime brokerage and client clearing services.
It will be interesting to see how the various business models will adapt to accommodate different types and sizes of buy-side firms. Second tier banks see opportunities to become increasingly important as liquidity providers as they take advantage of sponsored access and emerging agency models. Agency firms will need to compete with the banks to offer additional services. If you offer a model funded by trading commissions alone, how can you serve a tranche of the market which may not trade frequently, but whose liquidity interaction is both viable and valuable? I believe we will see firms try to achieve scale through price competition and product innovation. Also, let’s not forget that in a world where capital requirements and liquidity management is mandated by Basel III, any price competition and service differentiation designed to help clients improve their trading performance will only be welcomed.
For execution venues, the trick will be to migrate liquidity from the old world to the new, while trying to capitalise on new opportunities. Undoubtedly this will have an electronic bias, but ultimately it will be about understanding the customer demographic and providing a choice of relevant solutions rather than simply, and somewhat lazily, a one size fits all solution.
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