The concept of best execution is spreading to areas of the listed derivatives market beyond options, according to Sabrina Belkadi, executive director, Goldman Sachs Electronic Trading.
“Outside of the US listed options segment, the concept of best execution on the listed derivatives exchanges has increased in prominence,” says Belkadi. “In the US, price dissemination is handled through a composite feed and best execution often drives routing decisions.”
Although the concept of best execution is strong in some asset classes, it is still in its infancy elsewhere. In the futures markets, for example, clearing can play a bigger role in determining where a trade takes place than price.
“Even on instruments that are based on the same underlier or benchmark, such as the WTI [West Texas Intermediate, a type of crude oil used as a benchmark] on both ICE and NYMEX, the clearing decision may be a logistical consideration of where you are going to trade,” says Belkadi. Futures and options exchanges, she explains, have changed their business models to become so-called vertical silos, where they own and operate clearing services as well as execution and matching. “In this scenario, the settlement decision is often a determining factor that impacts the trading decision.”
But this could soon change. As in the equities markets, it is expected that new futures execution venues will emerge to challenge the incumbent exchanges. One example is Project Rainbow, a derivatives trading platform that is being established by a consortium of investment banks. Some predict new venues could start to appear as early as next year.
“To the extent the market evolves and introduces new competing venues that will offer truly fungible instruments, we could rapidly move into an equities-type landscape,” says Belkadi.
If credible derivatives trading venues emerge, brokers will have to update their technology to keep pace. “We will adapt our systems to route intelligently in order to give our clients generic access to those venues,” says Belkadi. “This means not only delivering tools that route orders based on the best displayed price, but also take into consideration, among other order execution requirements, exchange fees, liquidity, market impact and possibly hidden liquidity.”
One area of listed derivatives that could develop differently from the equities market is internalised block trades, where exchange members and their clients trade bilaterally and then report to the exchange. Off-exchange block trades can only take place in listed futures and options if the transaction meets specific size requirements. “This is a fundamental difference from the equity markets and I would suspect internalisation to take a slightly different form on the listed derivatives exchanges,” says Belkadi.