Article: Capital Markets Currents: Electrification, China Rising and Regulations16 December 2014 | Sol Steinberg
We feel an electricity in the air, particularly in OTC markets. As we move into December we view the ongoing battle between CME Group and BGC to acquire GFI as one sign of the trend toward increasing electrification in OTC markets. The latest swaps execution facility (SEF) data further underscores that point. October saw a dramatic increase in SEF adoption for credit default swaps trading. In other swaps categories where trading volumes didn’t jump, liquidity seemed to pool on SEFs that emphasize technology-based trading. The two other main trends catching our attention as the year draws to a close are growing opportunities in China, and growing frustration with regulators. While Bloomberg reports that China is headed for its slowest full year of economic growth since 1990, we see this as a prime opportunity to take a closer look at what is happening in China. OTC Markets has its ear to the ground in China, as we have been working closely with major Chinese players and regulators who are interested in establishing bonds with Wall Street to learn how to better develop Chinese markets. Meanwhile the one trend we see that is putting a damper on the end-of year outlook is an ongoing frustration with regulation. State Street’s recent announcement that it is exiting swaps clearing because tight regulations are making customers reluctant to invest in swaps, is one example of how this building frustration could start to impact business decision.
Increased electrification in the OTC markets (combined with low trading volumes) has had a noticeable impact on interdealer brokers in recent months, with large players like ICAP and Tullet Prebon announcing trader layoffs over the summer. But the battle to acquire GFI brings the technology issue to light in a new way. Whichever suitor eventually wins GFI, in the end, it looks like a win for technology. In one corner, there is BGC, headed by Howard Lutnick, who runs the company that brought eSpeed to the Treasury market. Speaking at the KBW Securities Brokerage conference in New York last month Lutnick pointed out that his team has a history of moving voice brokerage toward electronic trading. “We have had tremendous growth, which will only be accelerated if you take GFI’s voice brokerage and layer it on our technology,” he told the audience. Meanwhile, GFI’s other suitor, CME Group, is only interested in GFI for its technology. If CME wins the battle to acquire GFI, immediately after the deal goes through CME plans to shed the wholesale brokerage by selling it back to an investor group led by GFI senior management. CME will retain only GFI’s Trayport and FENICS businesses, which are technology assets for energy trading and FX futures and options modeling.
Technology is a factor fueling market growth in China as well. News about hiccups along the way in establishing the Shanghai-Hong Kong Stock Connect may have obscured the intensity with which many players in the Chinese markets are looking to modernize. OTC Markets has seen strong interest from our Chinese clients in working with Wall Street firms to develop their businesses to be on par with top tier firms. Interest is so strong, that we are starting a business line to address the growing demand. At the request of our Chinese clients, we have launched a service through which we introduce major players in the Chinese market to Wall Street firms willing to collaborate with them in developing the tools needed to become top global players. There are increasing signs that the market in China may soon begin to fuel Chinese firms’ enthusiasm.
Although growth in China stumbled this year, Bloomberg reports that mainland investors are opening stock accounts at the fastest pace in three years. In addition, monetary stimulus from China’s Central Bank may be starting have an effect. Morgan Stanley sees potential for an “ultra-bull” rally, in which shares prices could double in 18 months. Although volume on the Shanghai-Hong Kong Stock Connect dropped after the first day, there increasing signs that the market is opening up in other ways as well. China’s Ministry of Finance reports that projects worth $29.3 billion have opened to foreign and domestic investors in areas ranging from healthcare, to sports to urban infrastructure.
In the case of the OTC swaps market, one could argue that the growing embrace of technology may have been prompted somewhat by post-crisis regulations that have mandated central clearing, the availability of central limit order book trading, and increased transparency. But the line in the sand of where regulations stop becoming useful and start becoming burdensome remains a top issue for the industry.
Wall Street is showing signs of increasing frustration. Currently, firms have been trying to further delay of a rule that would require them to move certain derivatives out of units of the bank that can receive government support. Firms say the rule is a major burden. There is uncertainty about what kind of business unit to move the instruments into, and firms see major headaches in conducting regulatory compliance around these units. Similarly, in a speech last month, Anne Le Lorier, first deputy governor or the Bank of France, noted that regulations aimed at protecting the market from the problems at global systemically important banks could potentially introduce as many risks as they mitigate. Reforms aimed at systemically important institutions may have the effect of turning a “gross competitive advantage into a net competitive disadvantage,” and there are downsides to that model as well, she said. The struggle with regulations may be further exacerbated in the new year by divergent rate regimes. While the US is ending quantitative easing, Europe seems poised to move toward further belt tightening.
Despite regulatory challenges, we see strong potential in the year ahead. We at OTC markets are able to help, whether it be with finding the way through regulatory issues, liaising with major players in the Chinese market, or learning how excel with electronic trading models. We continually track trends and top issues in the market to help our clients stay ahead of market shifts and find opportunities within them. We are happy to discuss any of the issues outlined in this article, or any other trends affecting OTC markets, visit my profile page and click the icons on the right for email, twitter and LinkedIn.