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Trading

OTC Derivatives Industry underprepared for impending regulations

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Ganesh-Iyer

By Ganesh Iyer, Senior Product Marketing Manager for Network Services at IPC Systems

Ganesh-IyerThe 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.
BOXOUT

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.

 

 

 

Trading

Economic recovery likely to prove a ‘stuttering’ affair

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Economic recovery likely to prove a ‘stuttering’ affair 1

By Rupert Thompson, Chief Investment Officer at Kingswood

Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.

As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.

Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.

We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.

Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.

Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.

China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.

Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach an agreement on an economic recovery fund.  As is almost always the case, a messy compromise will probably end up being hammered out.

An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.

Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the summer and autumn with equities remaining at risk of a correction.

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Trading

European trading firms begin coming to terms with the new normal

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European trading firms begin coming to terms with the new normal 2

By Terry Ewin, Vice President EMEA, IPC

In recent weeks, the phrase ‘never let a good crisis go to waste’ has received a large amount of usage. Management consultancies, industry associations and organisations, including the Organisation for Economic Co-operation and Development (OECD) have all used it in order to discuss how the current crisis, caused by the Coronavirus pandemic, presents an opportunity for new and worthwhile change.

The saying is also commonly used to indicate that the destruction and damage that is caused by a crisis gives organisations the chance to rebuild, and to do things that would not have previously been possible. This has the potential to impact financial trading firms, where projects that this time last year would not have made much sense now appearing to be as clear as day. In Europe, banks and brokers alike are beginning to think about what life will look like post-pandemic, and how their technology strategies may need changing.

We can think of three distinct phases when it comes to a crisis. Firstly, there is the emergency phase. This is followed by the transition period before we come to the post-crisis period.

Starting with the emergency phases, this is when firms are in critical crisis management mode. Plans are activated to ensure business continuity, and banks and brokers work to ensure critical functions can still take place so as to continue servicing their clients. With regards to the current crisis period, both large and small European banks and brokers were able to handle this phase relatively well, partly due to the fact that communications technology has reached the point where productive Work From Home (WFH) strategies are in place. For example, cloud-connectivity, in addition to the use of soft turrets for trading, has enabled traders from across the continent to keep working throughout lockdown. From our work with clients, we know that they were able to make a relatively smooth transition to WFH operations.

In relation to the current coronavirus crisis, we are in the second phase – the transition period. This is the stage when financial companies begin figuring out how best to manage the worst effects of the ongoing crisis, whilst planning longer-term changes for a post-crisis world. One thing to note with this phase, is that no one knows how long it will last. There is still so much we don’t know about this virus. As such, this has an impact on when it will be safe for businesses to operate in a similar way to how they were run in a pre-pandemic world. But with restrictions across Europe starting to be eased, there is an expectation that companies will start to slowly work their way towards more on-site trading. For example, banks are starting to look at hybrid operations, whereby traders come in a couple of times a week, and WFH for the rest of the week. This will result in fewer people in the office building, which makes it easier to practise social distancing. It also means that there is a continued reliance on the technology that enables people to WFH effectively.

Finally, we have the post-crisis period. In terms of the current crisis, this stage is very unlikely to occur until a vaccine has been developed and distributed to the masses. Although COVID-19 has caused mass economic disruption, many analysts are predicting a strong rebound once the medical pieces of the puzzles are put into place. It may not be entirely V-shaped, but the resiliency displayed by the financial markets thus far suggests that it will be healthy.

Currently, many European trading firms are taking what could be described as a two-pronged approach.

The first part of this consists of planning for the possibility of an extension to phase two. Medical experts have suggested that there could be some seasonality to the virus, with the threat of a second wave of COVID-19 cases in the Autumn meaning that the risk of new restrictions remains. If this comes to fruition, there would be a need for organisations to fine-tune their current WFH strategies and measures, and for them to take greater advantage of the cloud so as to power communications apps.

The second component consists of firms starting to think about the long-term needs of their trading systems. Simply put, they are preparing themselves for the third phase.

It is in this last sense, that the idea of never letting ‘a good crisis go to waste’ resonates most clearly.

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Trading

Currency movements and more: How Covid-19 has affected the financial markets

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Currency movements and more: How Covid-19 has affected the financial markets 3

The COVID-19 pandemic has been more than a health crisis. With people forced to stay indoors and all but the most essential services stopped for multiple weeks, economies have suffered and financial markets have crashed. Perhaps the most public and spectacular fall from grace during the early stages of the pandemic was oil. With travel bans in place around the world and no one filling up at the pumps, the price of oil plummeted.

Prior to global lockdowns, US oil prices were trading at $18 per barrel. By mid-April, the value had dropped to -$38. The crash was not only a shocking demonstrating of COVID-19’s impact but the first time crude oil’s price had fallen below zero. A rebound was inevitable, and many traders were quick to take long positions, which meant futures prices remained high. However, with stocks piling up and demand sinking, trading prices suffered. Unsurprisingly, it’s not the only market that’s taken a knock since COVID-19 struck.

Financial Markets Fluctuate During Pandemic

Shares in major companies have dipped. The Institute for Fiscal Studies compiled a round-up of price movements for industries listed by the London Stock Exchange. Tourism and Leisure have seen share prices drop by more than 20%. Major airlines, including BA, EasyJet and Ryanair have all been forced to make redundancies in the wake of falling share prices. The automotive industry has also taken a knock, as have retailers, mining and the media. However, in among the dark, there have been some patches of light.

The forex market has been a mixed bag. As it always is, the US dollar has remained a strong investment option. With emerging markets feeling the strain, traders have poured their money into traditionally strong currency pairs like EUR/USD. Looking at the data, IG’s EUR/USD price charts show a sharp drop in mid-March from 1.14 to 1.07. However, after the initial shock of COVID-19 lockdowns, the currency pair has steadily increased in value back up to 1.12 (June 25, 2020). The dominance of the dollar has been seen as a cause for concern among some financial experts. In essence, the crisis has highlighted the world’s reliance on it.

Currency Movements Divide Economies

Currency movements and more: How Covid-19 has affected the financial markets 4

In any walk of life, a single point of authority is dangerous. Indeed, if reliance turns into overreliance, it can cause a supply issue (not enough dollars to go around. More significantly, it could cause a power shift that gives the US too much control over economic policies in other countries. Fortunately, other currencies have performed well during the pandemic. Alongside USD and EUR, the GBP has also shown a degree of strength throughout the crisis. However, these positive movements haven’t been shared by all currencies.

The South African rand took a 32% hit during the early stages of the pandemic, while the Mexican peso and Brazilian real dropped 24% and 23%, respectively. Like the forex market, other sectors have experienced contrasting fortunes. Yes, shares in airlines and automotive manufacturers have fallen, but food and drug retailers have seen stocks rise. In fact, at one point, orange juice was the top performer across multiple indices. With the health benefits of vitamin C a hot topic, futures prices for orange juice jump up by 30%. The sudden surge had analysts predicting 60% gains as we move into a post-COVID-19 world.

Looking Towards the Future through Financial Markets

The future is always unknown and, due to COVID-19, it’s more uncertain than ever. However, the financial markets do provide an indication of how things may change. The performance of USD and EUR in the forex markets suggest there could be a lot more trade deals negotiated between the US and Europe. The surge in orange juice futures suggest that health and wellness will become a much more important part of our lives. Even though it was already a multi-billion-dollar industry, the realisation that a virus can alter the face of humanity has given more people pause for thought.

Then, of course, there’s the move towards remote working and socially distance entertainment. From Zoom to Slack, more people will be working and playing from home in the coming years. The world is always changing, but recent have events have made us appreciate this fact more than ever. The financial markets aren’t a crystal ball, but they can offer a glimpse into what we can expect in a post-COVID-19 world.

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