Regulations Drive Change in FICC Business

Terry Flanagan

Regulations that require financial institutions to clear standardized over-the-counter (OTC) derivatives through central counterparties (CCPs) are beginning to weigh on bank P&Ls.
In particular, clearing through CCPs has caused a sharp increase in the operational costs of banks’ derivatives businesses.

“Everyone is trying to grapple with fundamental change in the fixed income and OTC marketplaces.” said Mas Nakachi, CEO of OpenGamma, which provides real-time market risk management technology. “It’s not about marginal changes to the business model, but fundamental changes.”

With overall Fixed Income, Currency and Commodities (FICC) revenues down 20 per cent last year and average revenue from interest rate trading within FICC down 40 per cent, banks are not in a position to make incremental changes to their cost structures. “Wholesale changes to their business models are needed,” Nakachi said.

One place to make a material impact on these costs is in the calculation of standardized metrics like CCP initial margin (IM).

“OpenGamma is focused purely on market structure,” said Nakachi. “We’re doing with exchanges, CCPs, and other market infrastructure entities. As regulators push OTC derivatives onto these entities, they need to remargin their book of business a lot faster. OTC is a new asset class for them, so there are challenges that our technology helps with.”

ReMATCH, an Icap-owned credit default swap (CDS) portfolio rebalancing and market risk mitigation service, has selected the OpenGamma platform to provide on-demand risk analytics for single-name CDS.
Established in 2009 to help OTC swaps market participants identify and manage legacy CDS portfolio risk, REMACTH allows client to access pooled liquidity, rebalance portfolios, and meet the new OTC market structure requirements.

“By working with OpenGamma, we are able to enhance our customer offering with a robust risk analytics capability,” said Philip Perrott, CEO of ReMATCH, in a statement. “Reconciling these numbers is a complex task, and requires high attention to detail and close interaction with our internal IT team.”

The “futurization” of the large OTC derivatives markets and the potential for increased trading volume could result in higher volumes and subsequently more opportunities for electronic market makers, Virtu Financial said in its S1 filing with the Securities and Exchange Commission in preparation for an IPO.

Regulatory changes impacting the OTC derivatives markets will require many formerly OTC products to be cleared through central clearing houses, potentially causing an increase in market-traded futures volumes. Unlike exchange traded futures, OTC derivatives have historically traded between two parties. However, increased regulatory requirements for transactions in OTC derivatives may cause some market participants to shift their trading toward exchange traded futures, Virtu said in the filing.

“The migration of these products to electronic trading will provide us with an opportunity to deploy our technology in asset classes that are not accessible to us currently including, for example, interest rate swaps, interest rate swap futures, CDS index futures and OTC energy swaps,” said Virtu.

The full implementation of the European Markets Infrastructure Regulation and the Dodd-Frank Act in the U.S. will increase transparency, liquidity and efficiency in global trading markets and encourage the further development of trading opportunities in certain asset classes in which highly liquid electronic markets remain limited or nonexistent due to historical reliance on bilateral voice trading and other inefficient processes, Virtu said in the filing.

“Once CLOBs [central limit order books] as execution mechanisms in SEFs start taking off, that could potentially bring in a whole new gene pool of market participants, specifically HFTs,” said Nakachi.

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