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    FINANCIAL TIMES SPECIAL REPORT | Monday October 10 2011

    www.ft.com/exchanges trading clearing 2011 | twitter.com/ftreports

    With his fondness for cigars, flowers anda pet monkey, Caesar Czarnikow cut anunusual figure in 19th century London.The German-born banker was one of agroup of financiers who founded theLondon Produce Clearing House, theforerunner of todays LCH.Clearnet.

    In those days, clearing the essentialplumbing that underpins equities,derivatives and bond trading wasassociated in the minds of Citycommentators (including the FinancialTimes) with the gambling of sugarbrokers such as Czarnikow.

    It took two financial shocks the stockmarket crash of 1987 and especially thecollapse of Lehman Brothers in 2008 toram home that it has been a vital, if dull,pillar of the financial system.

    This book, by a former FT journalist,tries to focus attention on how clearinghouses could contain the seeds of thenext financial dislocation and that weshould be concerned.

    Combining the best of gumshoereporting with an eye for colour, Normandisplays dogged patience as he researches

    a subject whose dry complexity does notmake it an obvious subject for a book. Hetravels to Le Havre to unearth the originsof modern-day clearing in the French portcitys coffee markets and to Chicago forthe narrative of the earliest grainclearing.

    There is a gripping account of thewind-down of Lehman Brothers Europes

    portfolios at LCH.Clearnet in London inthe days after the banks collapse.

    One of the books many strengths is theinterweaving of the history of clearingwith its relevance to the current financialcrisis.

    In their zeal to clean up after the 2008crash, regulators of the G20 countriesinsisted that clearing houses, or central

    counterparties (CCPs), take on the job ofclearing vast swathes of over-the-counter(OTC) derivatives to remove the balance-sheet risk from the banks that hadcontrolled them up to that point.

    This shift is set to concentrate newrisks in CCPs, since it will createsystemically important institutions thatcould become single points of failure.

    The sums of money tied up in CCPs aremind-boggling. The value of tradeshandled by members of LCH.Clearnetin 2010 amounted to 480bn ($639bn),equivalent to Switzerlands yearlyeconomic output.

    Yet should CCPs really be run asexchange-owned, for-profit businesses,when they are set to play such a key roleas market utilities? Such questions raisethe uncomfortable possibility of anothertaxpayer bail-out the very outcome thepost-crisis clean-up is trying to avoid.

    Norman points out that CCPs have astrong sense of commitment andresponsibility to the markets that theyserve not a quality you could pin onmany traders these days.

    But, as we now know from the frantic

    days of the Lehman default, luck hasplayed a role in averting problems atCCPs more than once. There is noplaybook for dealing with unprecedentedmarket conditions. As the currenteurozone crisis shows, unprecedented isthe new normal.

    Jeremy Grant

    History of plumbingoffers salutary lessons

    As delegates gatherfor the 2011Futures IndustryA s s o c i a t i o n

    Expo in Chicago, and inJohannesburg for the WorldFederation of Exchangesannual meeting, there islikely to be a sense of bewil-dered exhaustion.

    T hi s y ea r h as s ee n amaelstrom develop aroundthe business of trading,exchanges and clearing broadly known as marketstructures that is exercis-ing even the most nimbleand energetic players.

    A wave of regulationsfrom the G20 countries, cov-ering ov er -the-counter(OTC) derivatives and clear-

    ing, is washing over thebusiness, with key detailsstill to be finalised, as USregulators decide how toimplement the Dodd-FrankWall Street Reform andConsumer Protection Act.

    The industry is strugglingto keep up, and regulatorssuch as the CommodityFutures Trading Commis-sion (CFTC) are battling tomeet already delayed dead-lines to complete the neces-sary rule-makings.

    Keeping up with the newDodd-Frank regulations islike drinking from a firehose, says Gregory Mocek,former director of enforce-ment for the CFTC and nowa partner at Cadwalader,Wickersham and Taft, a lawfirm.

    E ur op e i s s om ew ha tbehind as it pushes forwardwith equivalent reforms

    embedded in the EuropeanMarket Infrastructure Regu-lation (Emir) and a new ver-s io n o f t he M ar ke ts i nFinancial Instr umentsDirective (Mifid).

    While the broad outlinesof the reforms are clear,important pieces are miss-

    ing, such as how the clear-ing houses that will handlevast swathes of OTC deriva-tives are to be governed andwhat financial membershipcriteria they should adopt,as well as how swap execu-tion facilities (SEFs) are tobe defined.

    Yet this is not stoppingsome from moving ahead.Inter-dealer brokers are theleaders in developing elec-tronic trading platforms inEurope. They are expectedto morph into SEFs, withTrad ition, GFI, TullettPrebon and Icap recentlylaunching live trading ofinterest rate swaps.

    Electronic trading plat-forms such as MarketAxessand Tradeweb are also gear-ing up. Lee Olesky, chiefexecutive of Tradeweb,says: Par ticipants arestarting to take the stepsneeded to comply with theunderlying principles ofmarket reform, even whenfaced with uncertain timingfor implementation.

    Yet there are growingconcerns about a lack ofharmonisation between theUS and Europe, in particu-lar regarding some of theextraterritorial aspects ofthe US rules.

    Canada and Australiahave signalled they mayneed to develop their ownOTC clearing infrastructureto allow their b anks analternative to being part ofbig institutions in the USand Europe.

    That concerns WilliamDudley, president of theFederal Reserve Bank ofNew York. We need allnational authorities toresist the temptation tofavour domestic financialinterests over achieving atrue level playing field glo-bally, he said in speech inSeptember.

    In Europe there is intensep oliticking ar ound thederivatives and clearingelements of Emir and Mifid.The issue of injecting com-petition is a hot topic, afterattemp ts b y Britain towiden the scope of Emir toinclude exchange-tradedderivatives.

    Both Dod d-Fr ank andEmir contain provisionsthat would force clearinghouses not to discriminatebetween trading venueswhen accepting OTC trades.

    T he a im i s t o e ns ur ethere is competition in thetrading and clearing of OTCderivatives leaving exist-ing exchange-trade deriva-tives as they are.

    The planned combinationof Deutsche Brse andNYSE Euronext has helpedcrystallise the issue.

    It is being looked on withd ismay b y the L ond onStock Exchange, which seesan opening in the debateover clearing in Emir andMifid to challenge the silointegrated exchange andclearing structure at theBrse, which would be bol-stered by the deal.

    The result is that Europeis discussing a subject thatis simply not under discus-sion in the US: breakingdown the vertical silo in

    futures trading. It remainsto be seen how far the LSEwill get; big users of silosoften like the efficienciesthat single pools of liquiditybring.

    Jeff Sprecher, the chiefe xe cu ti ve o f I CE , t hefutures exchange, says it issurprising that considera-tion should b e giv en towhat would amount to frag-menting liquidity in listedderivatives at a time whenregulators are concernedabout the negative effects offragmentation in the equi-ties markets.

    Meanwhile, London has

    become a focal point forexchange consolidation.

    The attempted takeoverof Australias ASX by SGXof Singapore was blockedby Canberra, while the LSEhad to abandoned a tie-upwith TMX Group of Canada.A joint Nasdaq OMX-ICEattempt to break up theBrse-NYSE Euronext dealalso foundered.

    Benn Steil, director ofinternational economics atthe Council on ForeignRelations, the think-tank, inNew Yor k says: First,nationalism is alive andwell in many markets cer-

    tainly it has played a signif-icant role in Australia andCanada.

    Second, the antitrustauthorities in the US, UK,and EU are taking a muchmore critical perspectivethan they did in the past.

    Third, investors, whohave been burnt by previ-ous promises of magicalsynergies, are much moresceptical of managementclaims and motives.

    CME Group, operator ofthe Chicago M er cantileExchange, sat out the con-solidation game, insteadmaking a virtue of forging

    looser alliances with foreigne xc ha ng es s uc h a sBM&FBovespa, the Brazil-ian exchange, M exicosBMV bourse and the Osakaexchange that involvecross-distribution of eachothers products.

    In London the LSE is bid-ding, with SGX as a minor-ity partner, for LCH.Clear-net, the European clearinghouse. In July, ICE took astake in Cetip, the Brazilianclearing house. Both dealshighlight how post-tradebusinesses now may holdm or e p ro mi se t ha nexchanges.

    Industryin themidst of amaelstromUncertainty overreforms is not

    stopping a brisk trade in clearing,says Jeremy Grant

    InsideQ&A We talk toLars Ottersgard(above), head of markettechnology at NasdaqOMX Page 2

    Asia Competition isloosening control ofmarkets Page 2

    Profile Nanex, thedata feed companyPage 3

    High frequencytrading Speed may notbe the problem Page 3

    Clearing Uncertaintyover detail of reformsremain Page 4

    Profile QuantHouse,supplier of systemsto enable trading inmicroseconds Page 4

    More on FT.comTechnology and dataThe future of regulation

    0

    100

    200

    300

    400

    500

    600

    HI

    OTCOn-exchange

    Sources: Oliver Wyman; Morgan Stanley

    Development of global on-exchange vs OTC derivatives

    1998

    1998 -2006

    2006 -2010

    OTC On -exchange

    2000 02 0604 08 10

    Notional amounts outstanding

    Notional amounts outstanding ($000bn)

    14%

    21%

    6%

    22%

    President Barack Obama signs the Dodd Frank Act into law. In the year since, the industry has battled to implement it AFP

    The Risk Controllers:Central Counterparty Clearingin Globalised Financial Marketsby Peter Norman, 400pp

    John Wiley & Sons, 45

    FT Trading Room

    Our online hub, editedby Jeremy Grant,

    focuses onmarket structures

    and includesvideo and

    interactive chartsft.com/tradingroom

    EXCHANGES,TRADING & CLEARING

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    2 FINANCIAL TIMES MONDAY OCTOBER 10 2011

    Exchanges, Trading & Clearing

    Your company, anexchange operator, isknown as much fortrading in shares andequities as for its

    technology business.How big is that?Technology is about 25 percent of our revenue, butthat includes corporatesolutions. When you lookat selling technology toexternal customers, that isabout 10-12 per cent of the

    group. This year we willmake about $174m in thisbusiness, just fromexternal technologycustomers.

    It is growing by 5-10 percent. This is not rapid, butit is growing and it isprofitable. The key thingthat we do is to run thisas a business that is notcross-subsidised. It is atechnology business.

    We are growing in twoways. We have a largenumber of long-term, loyalcustomers.

    We have about 70customers in the exchangeand clearing houses space,but we also have about65 brokers. We haveclearing technology, andsettlement and depositorytechnology.

    We have now acquired

    Smarts [the Australianmarket surveillancesoftware group], so wehave world leadership inmarket surveillance forexchanges, brokers,regulators and compliancedepartments.

    What are you seeingfrom emerging marketsexchanges is this is anAsia story or is it a LatinAmerica story?I think you have variouslevels of maturity inemerging markets.

    You have the Asia story:that is a big market that isnot yet as competitive.

    Regulators are restrictingit more than in the US andEurope, but these marketsare opening up and yousee more competition. Chi-X [the alternative trading

    platform] is coming intoJapan and Australia.Change obviouslygenerates demands fortechnology.

    Then you have the evenmore emerging markets,the Middle East, Africa andLatin America, where wewon our first contract in2007 with the Colombianexchange. In the MiddleEast, they are upgradingbecause they have very oldtechnology in most of thecountries.

    To what extent is this newbusiness in these areas acase of winning contractsfor the first time inexchanges? Or are youupgrading their systems?I would not say the timewhen it was pure start-upsis gone, but all markets

    today are somehowelectronic. They are atvarious stages of maturity.So when you upgrade inAustralia, they wereobviously alreadyextremely mature and hadit all. If you compare thatwith breaking into an

    emerging market, theymay have quite simplesystems, but there are stilltechnologies that we arereplacing.

    Do you come up againstany resistance from these

    emerging exchanges? Dothey talk about developingin house technologybecause it gives themsome control?Yes, our biggest competitoris in-house [technology]and not only in emergingmarkets.

    The biggest exchangesin the world have aperceived need to owntechnology or have thecontrol of it. Some marketsin the emerging worldhave that need, too.

    I think many of them do

    understand the complexity:the ability to maintaintechnology in the frontend, over time, is verycumbersome, veryexpensive, it is hard tofind the competence andthe resources. So theyhave a lot of interest

    in acquiring technologyfrom us.

    And of course there arealso the independentsoftware vendors who arenot controlled byexchanges and who do notcome with the baggagethat they might becomecompetitors down theroad.I think that, yes, there aresome neutral vendors, butI think it is a very smallproblem. I think we havean advantage in being an

    exchange that is apromise in itself that ourtechnology will continue tobe developed all the time,as we sell what we use.

    If youre purely asoftware house, you areneutral, but where are theguarantees that you will be

    big enough so you cancontinue to invest in yourtechnology to be always atthe forefront? Its always atrade-off.

    And of course regulatorsare worried abouttechnology, because theysee it as having goneahead of their ability tostay on top of it.I cannot comment onwhether they are behindthe curve or not, but Idefinitely believe that theyshould talk to key

    technology providers likeus. We have a goodrelationship with severalregulators around theworld. Being the numberone provider of marketsurveillance tools forregulators is a good way toopen discussions.

    Technology sales turn a healthy profit for US exchangeQ&A

    Jeremy Granttalks to Lars Ottersgard,head of market technology atNasdaq OMX

    Last month, two key figuresinvolved in the regulatory over-haul of the over-the-counter(OTC) derivatives markets inthe US each gave a speech justtwo among many that havebeen delivered since the passageof the Dodd-Frank Act last year.

    Conrad Voldstad, chief execu-tive of the International Swapsand Derivatives Association(Isda) the trade body for thederivatives market spoke athis organisations annual North

    America conference in NewYork.

    Isda has supported many ofthe reforms put forth by globalregulators as they try to removerisk from the financial system.Unfortunately, some of thesereforms are either very costly ormay actually increase risk, hesaid.

    He was referring to Dodd-Franks mandate to bringgreater transparency to OTCderivatives markets by requir-ing that standardised swaps betraded on formal trading plat-forms not bilaterally betweenbanks and that such instru-ments be channelled, where pos-sible, through clearing houses.

    About a week later GaryGensler, chairman of theCommodity Futures TradingCommission (CFTC), the USregulator charged with produc-ing detailed rules for imple-menting Dodd-Frank, gave aspeech at Georgetown Univer-

    sitys McDonough School ofBusiness.

    He said the CFTC and its staffwere working day and night toput up the necessary streetlamps to bring the swaps mar-ket out of the shadows, and thetraffic signals to protect thepublic from another financialcrash.

    A year after the Dodd-Frankreforms became law, there arethose who might like to rollthem back and put us back inthe regulatory environment thatled to the crisis three yearsago, he continued.

    The two mens comments directed at each other, somemight argue highlight the gulfthat has emerged between regu-lators and the industry onwhich it is attempting to imposenew rules.

    In the early stages of Dodd-Frank implementation, thememory of the 2008 crisis wassufficiently fresh and publicanger at Wall Street still rawenough that the dealers wererelatively cautious as they lob-bied regulators.

    But the dealer banks havebecome less shy about makingtheir case as the CFTC has bat-tled with a huge workload.

    Those involved in OTC deriva-tives banks, exchanges, opera-tors of electronic trading plat-forms such as Tradeweb andMarketAxess have struggledto deal with a torrent of arcaneproposals, such as how to definea swap dealer, procedures forreporting OTC trades to specialelectronic databases and mem-bership requirements for clear-ing houses.

    The banks were furtheremboldened after the Republi-cans took control of the USHouse of Representatives latelast year, giving support tothose in the markets whooppose what they see as draco-

    nian regulations that could end

    Wall Streets hold on the OTCderivatives markets.

    Mr Genslers speech was aveiled reference to such WallStreet interests. He insists thatDodd-Frank be implementedwithout being watered down,because the US financial systemremains interconnected throughthe swaps market in the US,Europe and in Asia.

    It was this interconnectednessthat was one of the main causesof the financial crisis of 2008, hepoints out, centred on the badderivatives bets made by formerinsurer AIG.

    Yet Isda and others argue thatthe CFTC and other regulatorsshould have carried out a cost-benefit analysis on key aspectsof Dodd-Frank before movingahead on implementation.

    Isda has even started to comeup with alternatives to somekey elements of the act, includ-

    ing as Mr Voldstad said in hisspeech floating the idea ofstudying a system for bilateralcollateralisation of OTC tradesfor some non-bank market par-ticipants instead of them havingto use clearing houses.

    Isda believes that this mightbe cheaper and as effective asclearing for such participants such as asset managers thatmight otherwise be faced withwhat it believes could be expen-sive collateral requirements.

    Such issues are likely only toemphasise how politicised theprocess of implementing Dodd-Frank has become, at a timewhen market participants arealready dealing with another biguncertainty: the timing of whenit will be completed.

    Daniel Marcus, managing

    director of strategy and busi-ness development at Tradition,an interdealer broker, says:The uncertainty surroundingthe timing of rules implementa-tion means that prematureinvestment could be punished,as business cases are stressedby lack of revenue generation.

    Equally important is howDodd-Frank will mesh withEuropes equivalent reforms,enshrined in the European Mar-ket Infrastructure Regulation(Emir) and an updated versionof the 2007 Markets in FinancialInstruments Directive (Mifid).

    Harry Eddis, counsel at lawfirm Linklaters, says: One ofthe main questions that dealerscontinue to grapple with in themove to mandatory centralclearing is the extra-territorialreach of Dodd-Frank, Emir andother similar legislation and thedifficulties of compliance in aglobal trading model.

    Such regulatory uncertaintiesmay hel p e xp la in why77 per cent of asset managers,pension funds and other so-called buyside firms surveyedby SimCorp, a financial soft-ware company, said they wereunprepared or were not surethey had the right systems inplace to support compliancewith Dodd-Franks OTC deriva-tives trading and clearing

    requirements.

    Regulators andindustry unsureabout rulesReforms

    Uncertainty about thereach of Dodd Frank leaves traders feelingunprepared, writesJeremy Grant

    When Chi-X, thealternative tradingplatform, beginsdealing in Austral-

    ian shares this autumn, traderswill for the first time have achoice of exchanges.

    The decision by regulators toallow a competitor to break themonopoly of the AustralianSecurities Exchange has alreadysparked improvements on theSydney-based bourse.

    Looking to fend off Chi-X,ASX cut its fees and is buildinga data centre to attract high-frequency traders, among othermeasures.

    Traders and brokers have wel-comed these improvements,which bring Australias marketstructure closer to the standardsof technology and cost set in theUS and Europe.

    Yet the entrance of Chi-Xhighlights one of the reasonswhy Asian markets have laggedbehind developed markets.

    Regulators in Asia worriedabout the impact of new tech-nology or inclined to protectnational exchanges have beencautious in allowing competi-tion between trading venues. InEurope and the US, regulatorshave been promoting competi-tion, most recently in Europewith the enactment of the Mar-kets in Financial InstrumentsDirective in 2007.

    A huge barrier to advancedtrading are the various types ofregulatory barriers, says NeilKatkov, senior vice-president forAsia at Celent, the financial

    consultancy. Those regulatory

    barriers are much more impor-tant right now than the state ofinfrastructure for enabling moreadvanced trading.

    Australia had previouslyblocked a proposed A$8.4bn($7.9bn) takeover of the ASX bySGX, the Singapore exchange,on the grounds that the dealwas not in the nations interest.

    Exchanges, however, have notbeen complacent. Some haveupgraded their technology andlaunched new products to staycompetitive and resilient involatile times.

    The Tokyo Stock Exchangeslaunch of its Arrowhead tradingplatform in January last yearput pressure on other exchangesto think about their tradingspeeds, says Ryan Holsheimer, amanaging director at Bank ofAmerica Merrill Lynch.

    SGX is adding co-locationfacilities (allowing traders toplace their computer serversnext to an exchanges matchingengine to shave milliseconds offthe time it takes for trades to bedone) , and in August i tlaunched Reach, which itdescribes as the worlds fastesttrading engine.

    Asia is also the fastest grow-ing market for listed deriva-tives, with 26 per cent growthlast year, according to DerekOvington, an analyst withCLSA, an Asian equity broker.

    Steve Grob, director of groupstrategy at Fidessa, the tradingtechnology group, says Asiaslinks with the raw materialsboom in China and India havedriven high demand for riskmanagement tools.

    Hong Kong Exchanges &Clearing (HKEx) is vocal aboutits need to upgrade to keep pacewith developments, despite dom-inating equities and derivativestrading in Hong Kong.

    HKEx, the worlds largest

    stock exchange by market

    value, is building a data centreand launching a matchingengine to ensure it is no longera laggard, Charles Li, theexchanges chief executive, saidat a September conference.

    The competition that HKExseeks to fend off is not fromEurope or the US. Rather, it

    needs to compete with Shanghaiand Shenzhen to attract Chinesetraders once mainland capitalcontrols loosen, he adds.

    Hong Kongs first renminbiinitial public offering launchedthis April and the exchangesees further opportunities intrading and clearing renminbi-

    denominated products.

    In some ways, we dont needto introduce high-frequencytrading, we just need those guys[from China] to show up, saysMr Li.

    With Asian economies grow-ing and high-frequency tradingprojected to slow in the US butstill largely untapped in Asia,the rewards for traders could behigh if markets liberalise.

    Traders and brokers say theyhave been meeting with regula-tors around the region, not onlyto try to persuade them to allowadditional competition and newtypes of trading, but also tolearn about their concerns.

    After the flash crash [in theUS last year], there was aheightened awareness amongregulators about what couldhappen in their markets, saysGabriel Butler, a director of glo-bal execution services at Bankof America Merrill Lynch.

    Towards the end of last year,Hong Kong began trackingtrades that crossed in dark pools

    (private trading venues owned

    by banks and brokerages), andMr Butler says both HongKong and Singapore are particu-larly active in checking inwith brokers after unusual orlarge movements in shareprices.

    India is a particular focus ofbrokers interest now, says IanSmith, a managing director onthe Asia electronic executionteam for Citi, the bank.

    The country only recentlyallowed smart order routingbetween its two exchanges,which makes it easier for trad-ers to choose the exchange offer-ing the better price. But thepaperwork required to registerin India is still more time-con-suming than in the rest of theregion, says Mr Smith.

    A key challenge is the verydistinct markets and regulatoryenvironments that make upAsia, each implementing apotentially different view ofwhat is practical, efficient andsensible for its own market,

    says Mr Smith.

    Competitionhelps toreduce

    barriersAsia

    Sarah Mishkin findsmarkets in the regionare liberalising slowly

    With economiesgrowing, the rewardsfor traderscould be high ifmarkets liberalise

    When Tom Sosnoff f irstapproached the Chicago BoardOptions Exchange in 2005 withthe idea for weekly options, hehad in mind what he thoughtwas a terrific marketing gim-mick.

    I wanted to call them quick-ies, recalls Mr Sosnoff, whocame up with the idea whilerunning Thinkorswim, theonline options brokerage he co-founded in 1999. I thought itwould be good for business, butthey thought it had too manysexual overtones.

    While he concedes the CBOEmay have been right to rejecthis naming idea, contracts witha weekly duration are the raci-est thing to have happened tothe options industry in severalyears.

    US regulators gave the CBOEpermission to launch weeklys

    on stock indices in 2005, but thecontracts only took off last year,when the pilot programme was

    extended to weekly options onindividual shares and exchangetraded funds.

    At the same time, the stocktickers used to identify optionswere being overhauled, makingit easier to link a weekly option

    with the more traditionalmonthly or quarterly expira-tions on the same underlyingname.

    The result has been an explo-sion in trading. Weekly optionsvolumes had been growingsteadily, reaching about 3 percent of overall SPX (S&P 500options) volumes by early 2010,but in the past year they havebecome the fastest-growingoptions product, now account-ing for about one-10th of alloptions volumes in the US.

    In some single stocks, such asApple, weeklys now make uptwo-fifths of all options volume.

    Indeed, the expansion of trad-ing in weeklys has been a signif-icant driver of overall optionsvolumes, helping to put theindustry on course for a recordyear, with 3.1bn options con-tracts changing hands so far, up22 per cent on last year.

    Without weeklys , wewouldnt have had any growth

    at all this year, says BorisIlyevsky, managing director ofthe International Securities

    Exchange, the USs third-biggestoptions-trading venue, owned byEurex, the derivatives arm ofDeutsche Brse. In fact, wewould have had a decline.

    Weeklys are also proving a bighit in futures. CME Group, the

    USs biggest futures exchange,now lists weekly options onfutures on stock indices andinterest rates, as well as agricul-tural products such as maize,soya beans, wheat and cattle.

    In the world of equity options,

    weeklys have proved particu-larly popular with retail custom-ers. In particular, they havefound favour with active, moresophisticated investors, whosestrategies such as earning pre-miums by selling covered callson shares or ETFs that theyintend to hold for the longerterm are an ideal fit with theaccelerated time decay thecontracts offer.

    Every week, you now havethe ability to trade as if it wasexpiration week, and theres a

    lot of clients that have expira-tion week strategies, notesPaul Stephens, the CBOEsdirector of institutional andinternational marketing.

    Many such traders have beenable to profit from the growth of

    weeklys, by collecting more inpremiums from selling callsevery week rather than once amonth. For traders on the buy-ing end, weekly options offer alower-cost, more flexible alter-native to longer-dated contracts.

    Because of the increase theyhave brought in volumes, thegrowth in weekly options hasalso been welcomed by optionsexchanges and brokers.

    However, in spite of the signsthat weekly options havebrought new business, theyhave also cannibalised some vol-ume from longer-dated tradi-tional options markets.

    Weeklys have also fragmentedliquidity further reinforcing aconcern voiced by exchangeswhen the contracts were intro-duced. They have also addedconsiderably to electronic bid-and-offer messages that marketparticipants have to supportwith ever more processingpower.

    Nevertheless, the march ofweeklys seems unstoppable. Theprogramme may well be

    expanded from its currentregime, which allows each ofthe USs nine options tradingplatforms to list 15 weeklyoptions of its own, as well asthose listed by competitors.

    That begs the question of

    whether options contract dura-tions could shrink further. Lastyear, the CBOE sought regula-tors permission to list dailyoptions, but the Securities andExchange Commission has yetto rule. If the equity optionsindustry introduced dailys, itwould be following the futuresmarkets: CME offers dailyoptions on futures on crude oil,natural gas and gold.

    The idea of dailys disturbssome observers, who argue theywould lead to pure directionalbetting not founded on the fun-damentals of the underlyingasset. If we go to dailys andhourlys and micro-events, even-tually someone will get hurt not because theres anythingtechnically wrong, but peoplewould get uncomfortable as itwould feel and look more likegambling, says Mr Ilyevsky.

    Mr Sosnoff, who now runsTastytrade, an online financialnetwork, is dismissive: Its ridi-

    culous. If its true, then all trad-ing is gambling. Dailys are inev-itable.

    Weeklys drive options volumes growthShort contracts

    A record year is inprospect but thereare some concerns,

    says Hal Weitzman

    In some singlestocks, such asApple, weeklysnow make uptwo fifths ofall options

    volume

    The Hong Kong exchange is building a new data centre to fend off competition Bloomberg

    Some of the reformsthat try to remove riskare either very costlyor may actuallyincrease it

    Conrad Voldstad,Chief executive, Isda

    As anexchange,ourtechnology

    will continueto bedeveloped

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    FINANCIAL TIMES MONDAY OCTOBER 10 2011 3

    Exchanges, Trading & Clearing

    There is a widely held beliefthat the recent spike in vola-tility and volumes has been abonanza for traders who move

    in and out of stocks, futures and cur-rencies at microsecond speeds.

    Analysts at Birinyi Associates, astock market research firm, comparedthe effect of high-speed traders onhigh-volume days in August with holi-day crowds in shopping malls.

    The noise level rises, heat and

    space are less available and the realpurpose of the mall to engage incommerce by selling shoes and ham-burgers is not enhanced and actu-ally made more difficult, they wrotein a recent letter.

    While there were no serious disrup-tions reported at exchanges duringrecord-volume trading days, regula-tors in the US and UK have in recentweeks announced fresh efforts toinvestigate the role of high-speed deal-ing in extraordinary volatility.

    Th ose t yp es o f v ola til edays . . . form an important part ofhow we think about market structureissues, even if nothing bad or brokenoccurred, says one person close to abig securities regulator.

    But conversations with market par-ticipants suggest that far from beingthe drivers of volatility, some high-speed traders were actually victims.Early studies also suggest that high-speed trading performed as many aca-demic studies predicted: smoothingprice moves when fundamental trad-ers were buying and selling en masse.

    This is a reflection of the fact that anumber of diverse strategies areloosely defined as high-frequencytrading. While some traders simplyseek to ride the momentum of marketvolumes, others try to use models topredict where prices will move, basedon historical relationships betweenstocks in the same industr y, orbetween futures and stocks.

    People have been losing money byexpecting things to revert to themean, like those who expected mar-kets to calm down after the US debtdeal. That hasnt happened, saysMark Longo, a former trader who now

    runs The Options Insider, an educa-

    tional website.Will Mechem, managing director of

    Pan Alpha Trading, a securities trad-ing and technology firm based in NewYork, says that fear-driven tradingmakes it difficult to rely on marketmodels on cer tain days. At suchtimes, mass selling or buying meansthat all stocks move in the samedirection, rather than following theirown fundamental logic, as they typi-cally do.

    There are defensive models,designed to be market-neutral. Onsome days they are saying sit on thesidelines because the markets arentmaking any sense, he says.

    Henr i Waelbroeck, director of research at Pipeline Trading, whichoperates a dark pool (a private tradingvenue owned by banks and broker-ages) and sells algorithms, says thatAugust bore no resemblance to theevents of May 6 2010, when unusualtrades and confusion about marketdata led to a sudden 6 per cent drop inshare prices.

    From a microstructure viewpoint,

    August was full of normal days, hesays.

    Pipelines algorithms predict thepattern of quotes sent to markets. MrWaelbroeck said that his models showthat high volumes amplify, but do notalter those patterns. Strategies thatearned 4 basis points normally earned8 on many days in August.

    Some critics say they still saw unu-sual patterns in August. Nanex, amarket data firm in Chicago, saysthat there were an unusually smalln um be r o f q uo te s i n t he o rd erbook of many of the most heavilytraded markets, such as instruments

    tracking the Standard & Poors 500index.

    This shallowness, they say, couldhave caused a flash-crash event underthe right conditions.

    But Mr Waelbroeck says it wasorder-flow imbalances caused by insti-tutional and retail investors (whowere responding to the same risk-onor risk-off signals) that generatedprice movements, rather than large

    orders interacting with thin liquidity.What really happened here is more

    related to the coherence in inflowsand outflows into mutual funds.

    Those who needed to make with-drawals on a day everyone else didsold at a horrible price. Thats thepump that feeds the high-frequencytrading game, he says.

    Such real money traders were, byoutward evidence, happy to pay forthe liquidity provided by market-makers. Prices offered by market-makers were not appreciably differentfrom those demanded by traders.

    This differ ence, measur ed by

    spreads, only rose in August on S&P500 stocks to about 5 basis points,from just below 4 basis points in July,according to figures from CreditSuisse, the banking group.

    Ben Londergan, a member of theboard of the Chicago Board OptionsExchange, the US options market,says that the recent period of highvolatility and high trading volumes isunlikely to last long.

    Either the economy recovers,spreads tighten and volumes continueto increase, or the economy goes intoa tailspin, so well see more volumeand volatility, but at some point vol-umes will plunge, he says.

    In the leafy Chicago suburb ofWinnetka, a shingle bearing thename Nanex hangs on a heavywooden door wedged between a dressshop and a religious book shop.

    Up a set of stairs, Eric ScottHunsader sits at a table behind anarray of huge monitors, surroundedby the computer equipment he usesto collect raw market data fromexchanges. He recompiles this intousable streams of information for hisclients, typically active retail traders.

    Mr Hunsader has quickly becomeone of the most polarising critics ofUS market structure, and of thealgorithms and high-frequencytrading strategies that areincreasingly used to navigate it.

    His firm has produced a stream ofcharts and reports illustrating what

    it says are dangerous and unfairchanges to markets, such as theshrinking size of trades, an explosionin the number of quotes sent toexchanges and vanishing liquidity.

    These articles have earned Nanexplaudits from other critics, includingThemis Trading, a brokerage firm,and the blog Zerohedge and infamyamong some high-frequency trading(HFT) firms, exchanges andalgorithm producers, who disagreevehemently with its conclusions.

    A lot has changed since thebuttonwood tree, says Mr Hunsader,referring to the fabled site of thefirst trades in lower Manhattan morethan 200 years ago.

    When you trade with someoneface to face, you cant suddenlywithdraw your quote after its toolate or pretend you didnt trade withthem earlier in the day. Over time,that sort of behaviour will either getyou banned, a black eye, or both,he says.

    Nanex is hardly a group oftechnophobes. Mr Hunsader, who

    works with software developerJeffrey Donovan, has been aroundelectronic markets almost since theinception of automated trading inthe mid-1980s.

    He had early success with

    Quote.com, a dotcom era stockwebsite for which he developed thecentral charting code.

    He cashed out of his stock before

    the crash, before founding Nanex in2000. The company is in partnershipwith Telvent/DTN, a technology firmthat provides non-software services.

    Nanex collects daily data on thebillions of quotes entered across USstock and futures markets. In recentmonths, according to the company,this has sometimes neared oneterabyte a day that is 1mmegabytes. (A floppy disk held about1 megabyte.)

    Recently, Nanex caught theattention of the markets after itproduced an analysis of the May 62010 flash crash a sudden plungein the Dow Jones Industrial Average,followed by a quick rebound.

    The company highlighted problemswith market data feeds as the spark,rather than the unusually large tradevolumes singled out by USauthorities.

    The problems with a lot of thedata that people use to study high-

    frequency trading is that it is eithertoo old, because things changequickly, or uses one-second, orbigger, averages. That doesnt workwhen what used to be a whole daystrading plays out over 100milliseconds, says Mr Hunsader.

    Among Nanexs most controversialclaims is what Mr Hunsader says isevidence of a dangerous algorithmthat is disrupting markets.Algorithms are used by assetmanagers and banks, not only HFTfirms.

    While he admits he does not knowwho or what might be causing thedisruption, he is worried thatprogrammers new to markets areusing codes designed only to breakthe system, not work with it.

    From reading the glossy pressreleases, youd think these complexalgos could land a man on the moon.But I wouldnt trust them to run the

    jungle cruise at Disneyworld, hesays.

    Making sense of amillion megabytesProfile

    Nanex

    Telis Demos interviewsthe founder of thedata feed company

    Youd think thesealgos could land a

    man on the moon.But I wouldnt trustthem to run the

    jungle cruise atDisneyworld EricScott Hunsader

    Speed willnotalways bring

    a bonanzaHigh frequency trading

    Telis Demos andHal Weitzman find thereis little to be gained froman overly busy market

    40

    2004 05 06 07

    Exchange average trade sizes

    0 8 09 10

    60

    80

    100

    120

    140

    NorthAmerica

    Europe

    Rebased (Q1 2004=100)

    Sources: Oliver Wyman; Morgan Stanley

    Regulators will investigate the role of high speed traders Bloomberg

    For at least a year, debateh as r ag ed a bo ut h ig h-frequency trading (HFT).Has it benefited markets, ordoes it pose dangers? Opin-ions remain divided.

    There is now a substan-t ia l b od y o f a ca de mi cresearch into the subject.The Financial Times ana-l ys ed t hi s r es ea rc h i nrecent months and foundthere is strong consensus

    among academics that HFTimproves prices available toinvestors and damps volatil-ity in equity markets.

    High-frequency tradersuse computing speed toexploit tiny movements inshare prices. They accountfor half the equity trades inthe US, a third in Europe,and are heavily involved inoptions and futures and for-eign exchange markets.

    The International Organi-zation of Securities Com-m is s io ns ( Io sc o) , t heu mb re ll a b od y f or t heworlds market regulators,has asked investors to flagup HFT strategies of par-ticular concern ahead of ameeting of G20 finance min-isters this month

    But seven academic stud-ies in the past two years,which employ mathemati-cal models as well as data

    sets from US and Europeanmarkets, suggest that whenH FT s a ct a s ma rk et -makers, quoting prices atwhich they are willing tobuy and sell, they offerclear benefits to investors.

    In order to attract trading,market-makers compete tooffer the best quotes. Eachtime a market-maker im-proves on the price offeredby a rival, the spread ordifference, between the bestbid and best offer price shrinks, so investors can geta better deal.

    Because HFTs updatetheir quotes in microsec-onds, spreads can shrinkextremely fast. A study of120 shares on the Nasdaq,the US stock exchange, byJ on at ha n B ro ga ar d, afinance PhD candidate atNorthwestern University,Chicago, found that HFTsoffered the best buy and sell

    prices available two-thirdsof the time.

    R ap id u pd at in g a ls omeant that HFT quotesclustered around the bestprice available, increasingthe number of trades thattook place at near-optimumprices.

    All the studies agree thatmarket-makers only quoteto trade in small quantities.In Mr Brogaards study,HFT quotes accounted for50 per cent of all trades, butonly some 40 per cent of thedollar volume traded.

    That leads to a trade-offbetween reduced spreadsand what is technicallycalled book depth: thequantity of shares quoted ata particular price.

    If all the quotes are fors ma ll q ua nt it ie s, t henumber of shares that canb e t ra ns ac te d a t t ho seprices may still be small. Alarge order may fill manyquotes, and the average exe-cution price might be muchhigher than the best priceon offer.

    One might worry thatthe narrower quoted spread

    simply reflects the smallerquoted quantity, castingdoubt on whether liquidityactually improves, Ter-rence Hendershott, a profes-sor at the University of California, Berkeley, said ina study of the New YorkStock Exchanges transitiont o e le ct ro ni c m ar ke t-making.

    However, his study foundthat a small trader isunambiguously better offwith the narrower spreadproduced by HFTs, andtrades beneath the averagequoted depth in his sample($71,220) are probably bet-ter off. Only the biggest

    trades would end up withhigher realised spreads.

    A k ey char ge againstHFTs is that they increasevolatility. When the DowJones Industrial Averagesuffered a flash crash lastyear , some r egulator sblamed HFTs.

    Mar y Schapir o, chair-woman of the US Securitiesand Exchange Commission,h as s ug ge st ed t ha t i nfuture, HFTs that employmarket-making strategies innormal trading, may berequired to continue offer-ing quotes, even at times ofextreme volatility.

    But a study led by AndreiKirilenko, chief economistat the Commodity FuturesTrading Commission, theUS regulator, found thatHFTs were less likely toquit the market during theflash crash than traditionalmarket-makers.

    Since they were not desig-nated as such, they werenot obliged to keep buyingas prices fell. Instead, HFTsused their speed to sell offthe net positions they hadacquired quickly, whenpanic selling began.

    That may have exacer-bated price falls in the shortterm. But once HFTs hadsold off their inventory,they returned to marketmaking activities, dampingpr ice swings, wher eastraditional market-makersstayed out of the market,exacerbating them, Mr Kir-ilenko says.

    The literature does notaddress potential abuses.

    James Overdahl, formerlyan economist at both theSEC and CFTC and now anadviser for the PrincipalTrader s G roup, a tr adeassociation for HFT firms,does not deny this possibil-ity.

    High frequency tradingi s a t oo l t h at c an b eused for any strategy, hesays. Some traders havealways sought to manipu-late markets, and regulatorshave the tools to prosecute

    them.Also, many observers con-

    flate HFT with market-mak-ing, but the two are not thesame, says Mr Overdahl.

    We n eed t o mov etowards an evidence-baseddiscussion, so people cansee the benefits.

    Academics determine thatjust being swift is not risky

    Research

    Ajay Makan givesan overview ofrecent findings

    ContributorsJeremy Grant

    Editor, Trading Room

    Telis DemosUS Equity Capital MarketsReporter

    Hal WeitzmanChicago and MidwestCorrespondent

    Ajay MakanMarkets Reporter

    Sarah MishkinHong Kong Correspondent

    Philip StaffordReporter, Trading Room

    Adam JezardJearelle WolhuterCommissioning Editors

    Steven BirdDesigner

    Andy MearsPicture Editor

    For advertising contact:Hope Kaye

    +1 212 641 [email protected] your usualrepresentative

    All FT Reports areavailable on FT.com.

    MarySchapirosays HFTs

    may have to

    offer quotes

    even at times

    of volatility

  • 8/3/2019 Exchanges, Trading and Clearing

    4/4

    4 FINANCIAL TIMES MONDAY OCTOBER 10 2011

    Exchanges, Trading & Clearing

    Profile QuantHouse trading technology group

    If understanding yourcustomers needs is one ofthe keys to success,QuantHouse already enjoysan advantage over its rivals,writes Philip Stafford.

    Emerging from a failedhedge fund seven years ago,the French trading tech nology group has rapidlygrown in recent years tobecome a significant forcein the cut throat world ofultra high speed trading.

    Like rivals Algo Techno logies and Fixnetix, it is oneof a handful of emergingcompanies that look tosupply the weaponry forinvestors who want thecutting edge technologiesto trade in fractions ofseconds, but do not want toget sucked into the spirallingcost of developing them.

    The hedge fund closed in2004, having failed to make

    money through statisticalarbitrage trading thedifference between prices but Pierre Franois Filet,chairman and co founder.realised the technologycould be adapted.

    We had started to solvethe problems before anyoneelse, says Mr Filet.

    Another two years werespent developing it forcommercial use. Mr Filet,along with co founder PierreFeligioni, secured backingfrom Fimat, which is nowpart of Newedge, the largeglobal brokerage, and hadits first sales in 2006.

    QuantHouse initially beganby providing faster marketdata and connectivity, takingadvantage of the hugeovercapacity in state of the art telecommunicationsnetworks. Customers couldreceive prices up to five orsix seconds faster than theindustrys dominant players,such as Thomson Reutersand Bloomberg.

    Intense competition hasmeant the differencebetween QuantHouse and

    rivals is now measured inmicroseconds, but it remainsa key part of its business.

    It has market data feedsfrom many of the worldslargest exchanges, includingNYSE Euronext, NYSE Liffe,

    the London Stock Exchange,Direct Edge, Chi X Europe,Eurex and Nasdaq OMX.

    Other technology serviceshave been added. A long standing partnership withIntel, the US chip group, hasseen it decode more than2m messages per second onan Intel microchip.

    As a private company, itdoes not officially release

    earnings, but revenuegrowth is understood to berunning at 60 per cent ayear for each of the pastthree years and turnover isthought to be near 20m($26.7m).

    In the next 12 months, thecompany wants to pushdeeper into the Europeanand American markets, aswell as move into Asia.

    Mr Filet says hiringemployees to add to its

    current tally of 94 is apriority. With all small,ambitious technologycompanies, the question ofcapital arises, but Mr Filetsays QuantHouse hassecured funding for the nextleg of its growth.

    Newedge, the joint venturebetween Socit Gnraleand Calyon, the Frenchbanks, remains a supportive15 per cent shareholder. Thefounders own the majority ofthe shares.

    The case of Fixnetix, itsUK rival, hints at its longer term future. The Britishgroup is for sale andcompanies of the size ofTelefnica, the Spanishtelecoms group, IBM, the UStechnology group, and theLondon Stock Exchangehave all signalled interest.

    Far from being abackwater, these services

    are the long term evolutionof the market.

    In an industry that favoursflexibility and innovation overfamous but ponderousbrands, there will always beroom for an outsider.

    We startedto solve theproblemsbefore anyoneelse Pierre Franois Filet

    Surveying the destruction thatthe vast but opaque over-the-counter derivatives marketbrought to the worlds financialsystem, glob al r egulator spushed for the seemingly innoc-uous idea of collating more dataon trades.

    Reforms agreed by the G20group of nations more than twoyears ago highlighted the moveas a key final step in the life ofa transaction.

    They required all standardisedOTC derivatives to be traded onelectronic platforms and thetrades to be channelled throughclearing houses. Once com-p leted, the d ata wer e to b ereported to trade repositories.

    Furthermore, it would requirelittle wholesale change. Reposi-tories were existing blocks of

    the financial markets infra-structure, serving little morethan a utility role as a ware-house for details of trades.While owned by private compa-nies, authorities would b egranted access to details.

    More data, went the regula-

    tors thinking, would create anelectronic audit trail thatcould flag up potential criticalsituations before it was too late.

    But as national authorities and supranational authoritiessuch as the European Union race towards the G20s end-2012deadline, sharp divisions haveemerged over how to put thepolicy into practice, and thequestions are growing morecomplicated.

    A progress report in Aprilfrom the Financial StabilityBoar d (FSB), which wor ksunder the Bank for Interna-tional Settlements (BIS) toco-ordinate the work of nationalregulators at a global level,warned there was a substantialvariation between countriesover implementation.

    Issues such as how many

    trade repositories there shouldbe in the world, their location,regulatory access and joint tech-nical standards have been thesubject of prolonged debate.

    But the dispute does not existin a vacuum. Besides the G20-imposed deadline, the market is

    racing to build its own centralcounterparty infrastructurewithout these questions havingbeen decided. Some have lik-ened it to building the housefrom the roof downwards.

    Some issues are slowly limp-ing towards resolution, but oth-ers are still in limbo. The ques-tion of technical and legalstandards, for example, showssome progress.

    At present, there is no stand-ard way to identify parties infinancial contracts standardpractice is to assign a uniqueID to each OTC trade that isreported to a repository.

    The FSB wants to establish auniversal Legal Entity Identifierthrough international consen-sus.

    But central questions, such ashow many repositories there

    should be, remain unanswered.The US, and others, have longargued that given the globalnature of financial markets,there should be one repositoryper asset class. Why dispersedata on crucial derivatives suchas credit default swaps and

    interest rate swaps into multipletrade repositories?The Depository Trust and

    Clearing Corporation (DTCC), a

    US post-trade group, will launchan interest rate swap data repos-itory in London in November,and has others planned for com-modities and foreign exchange.

    But under the pressure tocomply with the G20 communi-qu, many trade repositories areemerging.

    Cleartrade Exchange, a Singa-pore-based commodities bourse,

    cited it as a factor behind build-ing its own repository.

    Were waiting for the emer-gence of a bigger venue, but weare still some way away fromthat, says Richard Baker, chiefexecutive.

    Serious divergence over regu-

    latory access has also increased.The US Dodd-Frank Act man-dates that US-based swap datarepositories obtain indemnifica-tion from foreign regulatorsbefore sharing information.

    The act states that a request-ing party will compensate traderepositories for expenses result-ing from any litigation thatstarted as a result of the infor-mation it held.

    The clause is intend ed toensure the confidentiality andsafety of the data in the reposi-tory.

    Larry Thompson, generalcounsel for DTCC, comments:The problem is that if informa-tion leaks, a foreign governmentcould be liable. The chances of agovernment agreeing to that arezero.

    M r Thompson war ns that

    without it, swap data repositor-ies could be precluded from pro-viding information to overseasregulators. Therefore, it wouldencourage them to create theirown repositories, reducing, notincreasing transparency.

    Top-ranking US officials, such

    as Gary Gensler, chairman ofthe Commodity Futures TradingCommission, admit the indemni-fication clause is problematicfor the US. Many are hopingEurope does not retaliate byputting a similar provision in itsown post-trade reforms, theEuropean Markets Infrastruc-ture Regulation (Emir).

    As yet, it does not appear inany drafts, but the bill is yet tobe passed by the European Com-mission.

    But a new question is emerg-ing: exactly how much data isenough?

    The report last month by theCommittee on Payment and Set-tlement Systems and the techni-cal committee of the Interna-tional Organisation of SecuritiesCommissions, both part of theBIS, warned that the market is

    Divisions over audit trails as G20 deadline approachesTrade repositories

    Philip Staffordasks how muchinformation is enough

    0

    FX IRD CDS Equity

    200

    400

    600

    800 Centrally cleared

    Non-centrally cleared

    45%50%70%70%85%

    Sources: Oliver Wyman; Morgan Stanley

    By 2012-13 ($000bn)

    Forecast of centrally vs non-centrally cleared globalvalue traded in OTC derivatives

    Commodities

    2012E level of standardisation

    If there is one thingthat has been indisput-a bl e s in ce t he G 20r efor ms wer e insti-

    gated two years ago in thewake of the collapse of Leh-m an B ro th er s, t he U Sinvestment bank, it is thatmore use will be made ofclearing, especially in theover-the-counter (OTC)derivatives markets.

    But after seemingly end-less work by regulators,considerable uncertaintyr emains as to how thatshould happen.

    As US r egulators inparticular the CommodityFutures Trading Commis-sion (CFTC) race to final-ise rules designed to imple-ment the Dodd-Frank Act,the complex relationshipsbetween clearing houses,their members and thosemembers clients theusers of OTC derivatives have yet to be finalised.

    Those issues include: theminimum financial qualifi-cations for an entity tobe a member of a clearinghouse; access to clearingservices; whether member-ship should be capped toprevent big banks dominat-ing such institutions; andhow collateral the moneyposted at a clearing houseby members and clients should be handled.

    These issues highlightone thorny problem: howfinancial burdens associ-ated with the new marketstructure should be shared

    o ut b et we en c le ar in g houses, the banks that actas intermediaries and theultimate end-users of OTCderivatives.

    That burden can be seen

    in estimates for the amountof extra collateral that willhave to be tied up as thepush for mandatory clear-ing is realised. Tabb Group,a consultancy, and theInternational MonetaryFund, have said $2,000bnextra in collateral will beneeded.

    A clearing house, or cen-tral counterparty (CCP),guarantees trades betweentwo parties, using collateraldeposited by market partici-pants to ensure that dealsare completed if one sidedefaults.

    Regulators believe greateruse of clearing will helpsafeguard the financial sys-tem against the effect of bigdefaults.

    One issue lies in whetherCCPs can arr ange cus-tomer accounts in such away that their positions canbe ringfenced from othersif another defaults. EurexClear ing, the clear ingarm of Deutsche Br se,has introduced a systemknown as portabilitythat would allow customersto move their trades andcollateral to another mem-ber of a CCP if this hap-pens.

    Another issue is the rela-tionship between a CCPsdefault fund the pot ofmoney that it holds and isprovided by its members and the initial margin(IM) that CCPs ask custom-ers to put up to help guar-antee their daily trading.

    Banks that are alreadymembers of a CCP are con-cerned that CCPs espe-cially profit-driven ones

    may require members top ost high lev els to thedefault fund so that theyr el ie ve t he b ur de n o nbanks customers such aslarge asset managers onthe IM side.

    The issue highlightsthe sometimes conflictinginterests of CCPs, sell-sidebanks and their buy-sideclients.

    Jon Hitchon, global headof markets clearing at Deut-sche Bank, says: There isgoing to be a natural ten-sion here based on the sell-side firms and what capitalthey tie up in the form ofguarantee funds for clear-

    ing, versus the clients whoare basically saying I dontwant to have to have allthis IM tied up which isgoing to be a drag on myperformance.

    Clients will p ay forwhatev er r isk they areputting into the system.

    G ar y G en sl er , C FT Cchairman, has said that ifclearing is to help promotegreater transparency in theopaque OTC derivativesmarkets membership ofCCPs must b e open to arange of financial institu-tions to promote fair andopen access.

    Uncertaintyover detailof clearingreformsMembership

    Several issuesremain to be

    finalised, writesJeremy Grant

    Gary Gensler: the membership ofclearing houses must be open to a widerange of financial institutions Bloomberg

    at risk of being undermined bypotential data gaps in theinformation warehouses thatstore details on trades.

    M or e infor mation on off-exchange trades would help inassessing systemic risk andfinancial stability, it said, and

    proposed that a global minimumset of data be reported by bankson their derivatives trades.

    The data gaps it was con-cerned about included informa-tion on bilateral portfolios ofOTC derivatives transactions,which extend to d etails onexposures, amounts posted ascollateral, as well as market val-ues of open transactions and ref-erence data on affected partiesin the event of a counterpartysdefault.

    Mr Baker agrees that the cur-rent proposals lack definition,but argues it should be excludedfrom the requirements for the2012 deadline. Some of it isvery far-reaching. It shouldcome in the next phase, hesays.

    While the debate rumbles on,the clock is ticking.

    The CFTC has proposedthat CCPs set a minimumfinancial threshold formembership that shouldnot exceed $50m.

    Yet the d ealer b anksargue that this thresholddoes not take account ofwhat they say is a need toensure clearing membershave large enough balancesheets to be able to handlethe wind-down of big trad-ing positions in a defaultscenario.

    SwapClear, the OTC inter-est rate swap clearing serv-ice of UK-based LCH.Clear-net, requires members todemonstrate they have aswap trading portfolio of$1,000bn.

    This has angered non-bank financial institutionssuch as Newedge and MFGlobal, futures brokers thatplan to offer OTC clearingservices.

    Gary DeWaal, group gen-eral counsel at Newedge,says: We think clearing isb etter when the r isk isdiversified among manyc le ar in g m em be rs a sopposed to few. It is toughfor us to figure out our rolein OTC clearing if we cantfigure out if we can be amember of clearing houses.This is critical.

    The CFTC is looking atCCP membership criteria aspart of its implementationof Dod d-Fr ank and it ispossible, market partici-pants say, that the swapbook requirement could bechanged.

    M ichael Dav ie, Swap-Clears chief executive, sug-gests that if any changes

    were made his companymay hav e to r eact. Weintend to be Dodd-Frank-compliant when the rulesare finalised and imple-mented. But any changes to

    It is tough to figureout our role in OTCclearing if we cantfigure out if we can

    be a member ofclearing houses

    LarryThompson:rules regardingswap datarepositoriescould reducetransparency

    the way we manage riskhave to be considered care-fully.

    He adds: It may be nec-essary to adopt other safe-guards or rethink risk man-

    a ge me nt p ro ce ss es t oensure continued protectionfor market participants andthe clearing house in theevent of a default.

    Such dilemmas illustrate

    why, even as much clearingo f O TC d er iv at iv es i salready under way, thereare still obstacles in theway of wholesale adoptionof the process.