Derivatives traders are backing future interest-rate driven growth as BofE hikes rates to highest level in 15 years

Acuiti report suggests the interest rate environment could reverse a decade-long decline in the number of futures commission merchants (FCMs).

Futures Commission Merchants (FCMs) are to see business growth on the back of rising interest rates – with many looking to grow revenues even further through increased spreads, an Acuiti report commissioned by ION has found.

The survey – which includes responses from senior executives at 61 sell-side firms – found that more than half of market participants are confident that higher interest rates will be sustained long enough to make medium to long-term decisions about business expansion.

According to Acuiti, survey responses indicate that even if rates do come down in the coming years, most FCMs are “secure in their revenue streams emanating from interest rates”.

Jerome Kemp, president at Baton Systems, told The TRADE that while interest rates will likely offer revenue generating opportunities, they also present operational challenges relating to the margining process.

“With the cost of funds no longer being close to zero, higher rates have shone a very bright light on the need for FCMS to optimise the mix of cash and non-cash they post to satisfy margin requirements across their CCP memberships,” he said.

“Manual processes, poor visibility of the data that ultimately drives economically intelligent decisions, and the inability to quickly mobilise and move both cash and securities carry an opportunity cost that FCMs should be addressing.”

Amid this expected growth, over a third of firms surveyed by Acuiti, including almost half of Tier 1 banks, said they would consider adjusting the spread they charge on client balances if interest rates rise.

Elsewhere, only 18% of FCMs responded that they were not passing on the increased cost of capital to clients. A majority of 82% confirmed that they were charging extra for the cost of capital in some way to some clients.

The report explained that it would take rates falling by more than 2% before FCM would see their interest income negatively affected, explaining: “The significance of the interest rate increases is that under current models for charging spreads on client funds, FCMs are well hedged if interest rates fall slightly from current highs as the economy weakens”.

Following turbulence in the market over several years, interest rates are on the rise. On Thursday, the Bank of England rose interest rates to their highest level in 15 years.

With this, comes increased scope and reach of FCM clearing as well as economic growth in the business, Acuiti’s report found.

Understandably, respondents reported that this flow is set to open the door to new FCM entrants, with more than 40% of those interviewed agreeing or strongly agreeing that increased competition would be of benefit to the overall market.

Additionally, FCM’s were demonstrated to be increasing their clearing memberships, with 60% expecting a slight expansion in the number of clearing memberships over the next three to five years and a further 3% anticipating a significant expansion.

Around 95% highlighted “client demand and/or increased volumes on specific exchanges” as the top motivator, followed by “organic growth of company” and “increased interest rates”.

For Kemp, aggregated data is essential for FCMs looking to extend the number of CCPs they work with.

“Without this an FCM will find itself exceptionally challenged to derive greater value from its treasury operations,” added Kemp. “At Baton we are proud and excited to be accompanying the growth of numerous FCMs by providing them with the tools and technology that allow them to optimise the opportunities presented by a sustained higher rate environment.”

On the other side, for the firms looking to decrease the number of memberships – which are in the minority – and for FCMs looking to enter the market, capital requirements were found to be a high barrier to entry as the cost of operating in this space is high.

The report explained: “Post the financial crisis reforms and new rules such as SA-CCR have, in many instances, increased the capital required to run clearing businesses and continues to put pressure on existing firms and create a hurdle for new entrants.”