By Ganesh Iyer, Senior Product Marketing Manager for Network Services at IPC Systems
The year 2013 will see many of the financial reforms, which have been long debated, drafted and legislated in recent years, come into effect. The regulations which will most impact the trading industry are Dodd Frank and European Market Infrastructure Regulation (EMIR).
The regulations have been formulated to improve transparency and reduce the high levels of risk associated with the OTC derivatives industry. Regulation of OTC derivatives trading has been a foregone conclusion for the last few years but just how prepared is the industry for the regulations? IPC recently conducted a survey among hedge funds, investment banks, broker/dealers, exchanges and other financial institutions asking this question, as well as exploring their perceptions of the impending regulations. The responses revealed that financial institutions are underprepared to meet the requirements these regulations will place on them, even as they plan to increase their trading activity in OTC derivatives.
Trading in OTC derivatives has seen huge growth in recent years. The survey found that 94 percent of firms are already trading swaps or other OTC derivatives or plan to do so in the next six months. However, only 19 percent said the industry as a whole was well prepared to meet the regulations. This is perhaps surprising given that 74 percent of respondents said they expected their firms’ trading volumes to increase in the next year. These results confirm what we have been hearing from the market and it raises serious concerns that neither individual firms nor the industry as a whole are well-prepared for the coming changes.
An area of industry debate has centred on whether the regulations will reduce risk as they are intended to. Despite a major driver for these reforms being to reduce systemic risk, only 29 percent of respondents believed that the reforms will actually result in reduced risk. However, 57 percent believe that increased market and transaction transparency will be a major benefit resulting from the new regulations. The increased availability of market data is also recognised as an important benefit of the reforms. Worryingly, 21 percent of respondents felt that there could be consequences for the future of OTC derivatives trading as a result of what they perceive to be ill-conceived rules which have not taken into consideration all elements of risk.
Key findings from IPC’s OTC Derivatives Trading Trends Survey
Trading to grow significantly
- 94 percent said their firms are already trading swaps or other OTC derivatives or plan to do so in the next six months;
- 74 percent expect their firms’ trading volumes to increase in the next year.
Lack of regulatory preparedness
- 36 percent reported that their company did not have a plan in place to deal with new regulations;
- 62 percent said their firms were not well-prepared for the impending regulations;
- Only 19 percent said the industry as a whole was well prepared to meet the regulations.
Mixed views on benefits of regulations
- 26 percent say the benefits of new regulation far outweigh any associated costs;
- 31 percent say the impact of new regulation will be negative leading to increases in the cost/complexity of trading with little or no benefits.
Increased transparency; reduced risk
- 57 percent expect new regulations to increase market and transaction transparency and 53 percent cited this benefit as moderately or critically important;
- 43 percent said that reducing systematic risk was moderately or critically important but only 29 percent expected new regulations to actually reduce such risk.
View of the future
- 66 percent expect to see trading shift to the futures market;
- 19 expect the importance and value of the OTC Derivatives market to grow.
It’s all about connections
- 62 percent say their firms are or will be connected to one or more SEFs;
- 39 percent are connected or plan to connect to more than 10 SEFs;
- 23 percent will connect to more than 20 SEFs.
The establishment of Swap Execution Facilities (SEFs) is a pivotal aspect of the regulations in the US. Dodd Frank defined SEFs as “a facility, trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants in the facility or system, through any means of interstate commerce.”
For trading firms, connectivity to SEFs will be critical not only for addressing compliance concerns but also for gaining competitive advantage and capitalising on new opportunities. Some of the industry appears to recognise this as 39 percent of respondents said that their firm is connected or planning to connect with 10 SEFs or more, and 23 percent revealed plans to connect to over 20 SEFs. However, 34 percent of firms still did not have a plan in place to connect to any SEFs.
Some have argued that the upheaval in the OTC derivatives market will drive traders towards the futures market, using new swap futures contracts which offer easier access to similar exposures and at a lower cost. While 66 percent of respondents are expecting to see a shift to the futures market, it is important to recognise that swaps were created with a specific purpose in mind. It seems more likely that the two markets will coexist, but with some swaps becoming futurised, although not every swap has an economically equivalent future. Currently swap futures do not have the liquidity or investor confidence to really challenge swaps at the moment.
The respondents to the survey came from both buyside and sellside firms and covered a broad range of roles supporting the full trade lifecycle from order initiation and execution to clearing and settlement. Respondents came from the front, middle, and back office and included people involved in both the business and technology sides of trading operations.
There is still a great deal of uncertainty and lack of clarity around these regulations which understandably has resulted in institutions delaying their planning. As yet trading firms do not have a clear picture of what they need to do to implement and comply with these regulations. Originally the market expected clarification from the regulators by the end of last year. The delays mean that 2013 is the year when these issues will be resolved and the industry should receive the clarity and direction needed to allow them to implement systems to manage and comply with OTC derivatives regulations.
Barclays announces new trade finance platform for corporate clients
Barclays Corporate Banking has today announced that it is working with CGI to implement the CGI Trade360 platform. This new platform will provide an industry leading end-to-end global trade finance solution for Barclays clients in the UK and around the world.
With the CGI Trade360 platform, Barclays will provide clients with greater connectivity and visibility into their supply chains, allowing them to optimise working capital efficiency, funding and risk mitigation. By utilising cloud based functionality for corporate banking clients, Barclays will also be able to offer a leading client user experience through easy access and real-time integration to essential information, combined with the latest trade solutions as the industry-wide shift to digitisation continues to accelerate.
This move underpins Barclays commitment to supporting the trade and working capital needs of their clients and reinforces a commitment to innovation that has been central to the bank for more than 300 years.
James Binns, Global Head of Trade & Working Capital at Barclays, said: “We are delighted to announce our move to the CGI Trade360 platform and to have started the implementation process. We have a longstanding partnership with CGI, and the CGI Trade360 platform will mean we can continue delivering the best possible trade solutions and service to our clients for many years to come.”
Neil Sadler, Senior Vice President, UK Financial Services, at CGI, said: “Having worked closely with Barclays for the last 30 years, we knew we were in an excellent position to enhance their systems. Not only do we have a history with them and understand how they work, but part of the CGI Trade360 solution includes a proof of concept phase, which is essentially seven weeks of meetings and workshops with employees across the globe to guarantee the product’s efficiency and answer all queries. We’re delighted that Barclays chose to continue working with us and look forward to supporting them over the coming years.”
What’s the current deal with commodities trading?
By Sylvain Thieullent, CEO of Horizon Software
The London Metal Exchange (LME) trading ring has been the noisy home of metals traders buying and selling for over a hundred years. It’s the world’s oldest and largest metals market and is home to the last open outcry trading floor. Recently however, the age-old trading ring, though has been closed during the pandemic and, just a few weeks ago, the LME announced that it will remain so for another six months and that it is taking steps to improve its electronic trading. This news fits in with a growing narrative in commodities about a shift to electronic trading that has been bubbling away under the surface.
Something certainly is stirring in commodities. The crisis has affected different raw materials differently: a weakening dollar and rising inflation risks bode well for some commodities with precious metals being very attractive, as seen by gold reaching all-time highs. Oil on the other hand has had a tough year and experienced record lows from the Saudi-Russia pricing war. It has been a turbulent year, and now prices look set to soar. While a recent analyst report from Goldman Sachs predicts a bullish market in commodities for the year ahead, with the firm forecasting that it’s commodities index will surge 28%, led by energy (43%) and precious metals (18%).
Increasingly, therefore, it seems that 2020 is turning out to be a watershed moment for commodities, and it’s likely that the years ahead will bring about significant transformation. And whilst this evolution might have been forced in part by coronavirus, these changes have been building up for some time. Commodities are one of the last assets to embrace electronic trading; FX was the first to take the plunge in the 90s, and since then equities and bonds have integrated technology into their infrastructure, which has steadily become more advanced.
The slow uptake in commodities can be explained by several truths: the volumes are smaller and there is less liquidity, and the instruments are generally less exotic, essentially meaning it has not been essential for them to develop such technology – at least not until now. This means that, for the most part, the technology in commodities trading is a bit outdated. But that is changing. Commodities trading is on the cusp of taking steps towards the levels of sophistication in trading as we see in other asset classes, with automated and algo trading becoming ever prominent.
Yet, as commodities trading institutions are upgrading their systems, they will be beginning to discover the extent of the job at hand. It’s no easy task to upgrade how an entire trading community operates so there’s lots to be done across these massive organisations. It requires a massive technology overhaul, and exchanges and trading firms alike must be cautious in the way they proceed, carefully establishing a holistic, step-by-step implementation strategy, preferably with an agile, V-model approach.
The workflow needs to be upgraded at every stage to ensure a smooth end-to-end trading experience. So, in replacement of the infamous ring, these players will be looking to transform key elements of their trading infrastructure, including re-engineering of matching engines and improving communications with clearing houses.
However, these changes extend beyond technology. For commodities players to make a success of the transformation in their community, exchanges need to have highly skilled technology and change the very culture of trading. All of which is currently being done against a backdrop of lockdown, which makes things much more difficult and can slow down implementation.
What is clear is that coronavirus has definitely acted as a catalyst for a reformation in commodities. It is a foreshadowing of what lies ahead for commodities trading infrastructure because, a few years down the line, commodities trading could well be very different to how it is now, and the trading ring consigned to history.
Afreximbank’s African Commodity Index declines moderately in Q3-2020
African Export-Import Bank (Afreximbank) has released the Afreximbank African Commodity Index (AACI) for Q3-2020. The AACI is a trade-weighted index designed to track the price performance of 13 different commodities of interest to Africa and the Bank on a quarterly basis. In its Q3-2020 reading, the composite index fell marginally by 1% quarter-on-quarter (q/q), mainly on account of a pull-back in the energy sub-index. In comparison, the agricultural commodities sub-index rose to become the top performer in the quarter, outstripping gains in base and precious metals.
The recurrence of adverse commodity terms of trade shocks has been the bane of African economies, and in tracking the movements in commodity prices the AACI highlights areas requiring pre-emptive measures by the Bank, its key stakeholders and policymakers in its member countries, as well as global institutions interested in the African market, to effectively mitigate risks associated with commodity price volatility.
An overview of the AACI for Q3-2020 indicates that on a quarterly basis
- The energy sub-index fell by 8% due largely to a sharp drop in oil prices as Chinese demand waned and Saudi Arabia cut its pricing;
- The agricultural commodities sub-index rose 13% due in part to suboptimal weather conditions in major producing countries. But within that index
- Sugar prices gained on expectations of firm import demand from China and fears that Thailand’s crop could shrink in 2021 following a drought;
- Cocoa futures enjoyed a pre-election premium in Ghana and Côte d’Ivoire, despite the looming risk of bumper harvests in the 2020/21 season and the decline in the price of cocoa butter;
- Cotton rose to its highest level since February 2020 due to the threat of storm Sally on the US cotton harvest, coupled with poor field conditions in the US;
- Coffee rose 10% as La Nina weather conditions in Vietnam, the world’s largest producer of Robusta coffee, raised the possibility of a shortage in exports.
- Base metals sub-index rose 9% due to several factors including ongoing supply concerns for copper in Chile and Peru and strong demand in China, especially as the State Grid boosted spending to improve the power network;
- Precious metals sub-index, the best performer year-to-date, rose 7% in the quarter as the demand for haven bullion continued in the face of persistent economic challenges triggered by COVID-19 and heightening geopolitical tensions. In addition, Gold enjoyed record inflows into gold-backed exchange traded funds (ETFs) which offset major weaknesses in jewellery demand.
Regarding the outlook for commodity prices, the AACI highlights the generally conservative market sentiment with consensus forecasts predicting prices to stay within a tight range in the near term with the exception of Crude oil, Coffee, Crude Palm Oil, Cobalt and Sugar.
Dr Hippolyte Fofack, Chief Economist at Afreximbank, said:
“Commodity prices in Q3-2020 have largely been impacted by COVID-19. The pandemic has exposed global demand shifts that have seen the oil industry incur backlogs and agricultural commodity prices dwindle in the first half of the year. The outlook for 2021 is positive however conservative the markets still are. We hope to see an increase in global demand within Q1 and Q2 – 2021 buoyed by the relaxation of most COVID-19 disruptions and restrictions.’’
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