Futures Commission Merchants (FCMs), Swap Execution Facilities (SEFs), Interdealer-brokers (IDBs); the derivatives industry is certainly not short on acronyms.
New rules have seen the arrival of new trading platforms, post-trade obligations and opportunities for the sell-side. However while three letter abbreviations are increasing the number of firms operating under those titles is shrinking.
The industry has been foretelling consolidation among SEFs, IDBs and FCMs over the past few years as regulations began to grip the market, and now more than ever those predications seem to be ringing true.
Low market volatility, volumes and regulatory changes have impacted investors and subsequently IDBs over the past year, with the market failing to see a light at the end of the tunnel at present. As a result, the number of IDBs operating in the market could be set to shrink.
Sparking this potential wave of consolidation, GFI Group is currently in the process of reviewing two bids for its IDB businesses. Derivatives exchange giant CME agreed an initial bid for GFI before fellow IDB, BGC Partners, looked to hijack the deal with an improved offer of its own.
With the big five IDBs – also including ICAP, Tullett Prebon and Tradition – coming under increasing pressure as a result of market conditions, who knows which will be standing in what form over the next few years.
Subsequently there would be fewer parties sharing the risk of default in the market, representing an unintended consequence of global reforms.
As for FCMs and clearing brokers, this is also becoming a squeezed space as banks face increasing capital requirements while profits from clearing diminishes.
What will the demand be for OTC clearing? We are yet to know the answer to this along with the question of which clearing brokers and central counterparties (CCPs) will be used the most.
In the US, SEFs have also been slower to gain traction than many thought. Despite more than 20 platforms in operation, the space is being largely dominated by the major players: ICAP, Bloomberg, Tullet, BGC and Tradition.
Buy-side take-up of trading on SEFs has been slow since their formation last year and if activity fails to pick up in the near future this could be another space where we see consolidation.
Who knows? There could also be consolidation among exchanges, multi-lateral trading facilities and CCPs as the industry continues to wade through this prolonged period of systemic change.