Futures commission merchants prep for post-trade system boosts

DEEP LOOK | Improvements in post-trade processing technology are set to play a major role in the evolution of the breed of derivatives-market intermediaries known as futures commission merchants. Paul Golden looks closer.

Earlier this year, Acuiti and ION Markets published the results of a survey of 59 futures commission merchants. (A futures commission merchant is an entity that solicits or accepts orders to buy or sell futures contracts, options on futures, retail off-exchange FX contracts or swaps and accepts money or other assets from customers to support such orders).

One of the key findings was that more than 90% expected to make additional investment in post-trade processing technology over the next four years as they seek to increase capacity to meet expected volume spikes in the wake of higher volatility.

Technology clearly plays a role in increased market preparedness, although every futures commission merchant and client is different in terms of the maturity of their infrastructure. 

It is fair to say that some industry platforms have faced challenges in relation to the allocation process and the transparency around that process, which can be problematic when firms that are in good shape have to give out positions to other providers who may not be at the top of their game.

Industry initiatives such as the Futures Industry Association’s Tech Trade Data Network aim to improve post-trade processing in exchange traded derivatives and increase transparency across the trade lifecycle. This initiative aims to achieve this by unifying trade data from buy side, brokers, clearing houses and clearing members into a common, secure, standards-based ledger.

Improved since the pandemic

Coming out of the pandemic, the Futures Industry Association worked with the industry to establish the Derivatives Market Institute for Standards. This body encourages widespread adoption of standards in the exchange traded and cleared derivatives industry designed to make markets more efficient, resilient and competitive. 

“Establishing a framework for building consensus and collaboration among all segments of the industry requires broad participation including clearing firms, executing brokers, exchanges, clearinghouses, customers and technology vendors,” explains Walt Lukken, president and CEO of the Futures Industry Association.

He adds that during recent market volatility, the cleared derivatives markets managed the surge in volume significantly better than during the pandemic.

“While some trades had delays in settlement, they were resolved relatively quickly,” says Lukken. “Moving forward – and building on the success of early Derivatives Market Institute for Standards initiatives – we will work with the industry to continue to strengthen and standardise post-trade processing and other aspects of market operations.”

Around a decade ago, Citi moved off an industry platform onto Citi Fusion Clear, a proprietary futures matching and clearing platform. It remains one of very few futures commission merchants to have developed such a proprietary platform.

“We saw the value of not being over-reliant on industry solutions and bringing that transparency in-house as well as to our clients,” says Thomas Treadwell, head of futures, clearing and FX PB product EMEA at Citi. “We want to make sure that our platforms can handle significantly higher volumes and that isn’t going to change because we are continuing to see higher peaks.”

Keep perfecting those STP rates

The top global custodians have been pretty well equipped to manage volume growth amid recent stock exchange volatility. However, Matteo Dadda, global head of banking services operations and corporate trust operations, securities services at BNP Paribas acknowledges that there is always room for improvement – for example in relation to straight-through processing rates which, while high, can be further increased for settlement/cash transactions.

“As part of the continuous improvement programme at our securities services business, we have invested in advancing process mining tools, which accelerate the STP rate marginally but effectively,” he says.

The view that increased investment in post-trade processing technology is required to cope with anticipated volume growth is shared by Clayton Passero, managing director and head of futures online at StoneX.

“Industry-wide, we must continue to invest in technology to keep pace with rising volumes,” he says. “We saw record volumes in April and the markets held up well. But sustained growth requires ongoing enhancements so automation and scalability are critical themes going forward.”

Obviously, whenever there is significant market volatility the CCPs and exchanges tend to react quite quickly to ramp up margin. This time round, market participants showed they had learned from the volatility caused by the pandemic and various conflicts.

“Clients are much better prepared in terms of liquidity and operational process,” says Treadwell. “Clearing brokers are also very focused on how we run our businesses, making sure we have buffers in place.”

Significant volatility tends to lead to a material spike in volumes where clients are either hedging or preparing their risk position. Depending on how long it lasts and how much uncertainty there is you may see a risk-off position as has been the case of late.

Tackling margin calls better

The last thing clients and brokers want are open or out positions unreconciled when the market is volatile so there has been a lot of emphasis on catching up to high volumes on the reconciliation side.

“Because such trading conditions have become more commonplace, the market is a lot better at dealing with increased margin calls or intraday margin calls,” adds Treadwell.

The exit of a number of large clearing brokers from the futures commission merchants market over the last few years is a reminder of the scale of the technology and operational investment required, especially as capital requirements continue to evolve.

Some new entrants have emerged, focusing on specific products that enable them to avoid certain capital requirements. But the number of real money-type clients using OTC derivatives to hedge their underlying businesses over a long timeframe suggests there is room for more competition.

Just over three quarters of respondents to the Acuiti/ION Markets survey expected competition to increase over the next four years.

$350 billion held

According to the Futures Industry Association, the total amount of customer funds in futures accounts at US futures commission merchants reached $351 billion in March, an increase of 10% over the last five years. The number of futures commission merchants holding customer funds in futures accounts dropped from 53 to 49 over the same time frame, indicating that more money is flowing into fewer firms.

“Capital requirements play an important role in the economics of client clearing,” says Lukken. “The increases that were under consideration in the US last year – the so-called GSIB (global systemically important bank) surcharge and the Basel end-game – would have made the economics much worse for the banks that offer client clearing. Those proposals are now off the table, but the future path of capital requirements is uncertain.”

While there has been consolidation and a decline in the number of futures commission merchants over the past five years, customer demand for the services they provide remains strong because of the access they offer to derivatives markets globally.

This year alone, StoneX acquired RJ O’Brien, Kraken completed the acquisition of NinjaTrader and Ripple announced that it was buying Hidden Road. The Futures Industry Association expects competition to increase with potentially a rise in number of providers.

Passero accepts that the futures commission merchant space has seen meaningful consolidation over the last decade but adds that for the first time in several years we are seeing new entrants – both traditional and non-traditional – joining the market.

“As capital requirements evolve, balance sheet efficiency and return on capital will remain key differentiators,” he says. “Futures commission merchants that can manage these effectively while still investing in growth and service will be well-positioned competitively.”

One of the most interesting propositions in the futures commission merchant space is the European agent trustee model, which is intended to be comparable to the agency model in the US. The concept was unveiled in June 2024 by the Futures Industry Association and is designed to ease European banks’ capital requirements.

Different continents, different clearing volumes

From an OTC clearing perspective, the principal model in the UK and Europe is two back-to-back transactions where the notional of those transactions is factored in – unlike in the US where the clearing broker is not principal to the transaction but instead acting as agent to the client who has a transaction with the clearinghouse. The difference in capital treatment has led to a massive disparity in the volumes cleared under the US clearing model compared to Europe.

Lukken observes that the new client clearing model has been designed with cleared OTC derivatives in mind.

“With the help of external counsel and the central clearing counterparties, we are in the process of finalising legal and other deliverables for the European agent trustee model for English and German clearing members,” he says. “We will hold an in-person session on the model during International Derivates Expo in June.”

Treadwell says the momentum behind the model has accelerated over the last 12–18 months, although significant challenges remain.

“There is a lot of work to be done from a legal perspective in terms of the relationship between clearing brokerage jurisdiction and client,” he adds. “It won’t be a ‘big bang’ but it will be positive for  clients who may have portfolios that look much better under the US clearing model but maybe don’t want exposure to the US as they are more familiar with UK and European regulations.”