According to TABB Group in a new industry benchmark study, “Trends in US Futures Trading: The Buy Side Perspective,” the US futures industry is set to rebound in 2010 after trading volume suffered its first decline since 1995.
The combination of stricter risk controls across the brokerage industry and closure of hedge and proprietary trading funds – “more than 2,000 have blown up or disappeared in a cloud of smoke” - were key factors behind the 23% volume decline in 2009. Based on TABB estimates, trading is projected to surge 14% in 2010 as interest rate volume recovers.
While risk management has always been critical, traders tell TABB they have a new view of risk and reward, says Andy Nybo, a principal at TABB, head of derivatives and author of the study. “True, the bad news is that volume’s down, but there is plenty of good news ahead. Trading activity is beginning to stabilize, with pockets of strength in core asset classes such as energy, commodities and foreign exchange beginning to accelerate. As trading volume returns, rising open interest indicates that participants are using futures for ‘longer term’ risk management and commercial strategies.”
Nybo believes that futures will continue to become a more important weapon in the trader’s arsenal of tools used to manage risk and enhance exposure in desired asset classes. “The events of the past year are clearly focusing attention on the use of futures as a way to better manage exposures across a broad range of asset classes.”
The study also highlights the continued importance of technology in futures trading, which Nybo expects to ultimately have a significant influence on the shifting market structure. “As more trading is facilitated through direct market access (DMA), FIX-based trading schema and the increased adoption of execution algorithms, futures markets will increasingly become dominated by automated trading strategies.” He adds, “Trading will accelerate, and technology will become a prerequisite for actively trading in the futures market.”
According to Nybo, the role of high-frequency trading strategies in futures is destined to play an even greater role. “Low latency strategies relying on co-location and optimized technology infrastructures play a large and growing role in the futures markets but the current market structure has mitigated their impact. Exchange competition, fragmentation and especially fungibility are the keys that will invigorate a whole new class of futures traders.”
He also points out that the intense scrutiny of the OTC derivatives industry by global regulatory officials will provide additional momentum to the industry. “The increased regulatory focus on OTC instruments will eventually become an all-out stimulus package for the listed-derivatives industry, and the futures market stands to benefit greatly, as strategies that have historically used OTC instruments shift to the more transparent, listed futures marketplace.”
In the study’s conclusion, Nybo points out that the futures market is on the verge of a structural shift, as the combination of technology, the changing regulatory environment and a resurgence in risk management practices will drive market participants to reevaluate current market practices. “The drive to move OTC instruments on to exchanges is a key factor behind this shift, and the industry will be keeping a close eye on Washington to see what legislation ultimately becomes final.”
The data and 35 charts for this study are based on 54 interviews with traders at asset managers, commodity trading advisors CTAs), and hedge funds utilizing a broad range of futures trading strategies. The firms participating in this study have more than $2.1 trillion in assets under management and in aggregate trade an average of 200,000 contracts on a daily basis. Data was supplemented by information collected through conversations and interviews with institutional broker futures trading desks, independent futures trading system vendors and multinational exchanges.
Discussions also covered a wide range of topics including lingering effects of the credit crisis; how the marketplace has changed during 2009; challenges faced in sourcing liquidity; types of tools and systems used across the trading process; average number of futures commission merchants (FCMs); top five mentioned FCMs used by hedge funds, asset managers and CTAs; preferred execution channels; types of assets traded through their execution management system (EMS); futures execution algorithms; ELX Futures’ impact as a new challenger to the CME and ICE; factors influencing electronic trading; and views on the evolving market structure.
The 36-page study is available for download by TABB Group Derivatives Research Alliance clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx. For an executive summary or to purchase the report, please visit http://www.tabbgroup.com or write to info@tabbgroup.com.
Other related TABB derivatives research includes: “US Futures Markets: In the Crosshairs of the Algorithmic Revolution”; “US Options Market Makers: Evolution or Extinction?”; “US Options Market Structure: The Shifting Exchange Landscape”; and US Options Trading 2009: Resilience in the Face of Crisis.”