Electronic derivatives markets scope out new products

Tradeweb, the financial markets operator, has added European equity futures to its multi-dealer-to-client equity derivatives platform to streamline the current phone-based, over-the-counter trading model for block trades.
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Tradeweb, the financial markets operator, has added European equity futures to its multi-dealer-to-client equity derivatives platform to streamline the current phone-based, over-the-counter trading model for block trades.

Equity futures can be used by buy-side traders to rapidly build a position in a market or sector at low cost, that can later be unwound as a stock position is built.

“To buy £100 million of UK equities takes a long time, but to buy £100 million of FTSE 100 futures takes a matter of minutes,” said Adriano Pace, Tradeweb's director of equity derivatives markets. “Your market impact is smaller and speed of execution is quicker.”

Exchange prices give a fair valuation for trades in liquid equity futures, Pace says, but for less liquid derivatives, such as sector or single-stock futures, or when trading in large size, buy-side firms typically have to call dealers up to get a best price, which can result in a lengthy, manual price discovery process.

Not only are the equity derivatives priced by different members of the sell-side equity team, the slowest response from a broker can also dictate the time that the auction takes. The longer the price takes to come back, the greater the risk that the underlying will move.

“A typical equity derivatives auction often takes more time than it does with other instruments, but clients like to have more certainty and structure to the process,” Pace said. “That's why we designed an electronic marketplace that would provide a faster auction, in which clients receive responses from dealers within five minutes.”

The done deal

Manual price discovery can also introduce errors but on the Tradeweb platform, buy-side firms put up to five dealers in competition through a request-for-quote (RFQ) trading protocol, on a single screen. The traders on the sell-side receive the request at the same time as their salespeople, asking for a bid-offer spread, cutting out the delay and the potential for error in manual processing. The request note includes a time limit for the auction, which can be fixed. The trader sends the spread back directly, and prices are aggregated on the buy-side screen.

The trades are then submitted to the major derivatives exchanges for final pricing, clearing, and settlement.

“Equity futures are a valuable enhancement for many of our clients that trade synthetic equity,” said Pace. “We plan to further expand the range of delta one products available on the platform.”

Liquidity is provided to the platform, which has been trading equity derivatives since 2010, by: BNP Paribas, Bank of America Merrill Lynch, Barclays Capital, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, J.P. Morgan, Morgan Stanley, Nomura, Société Générale, RBS and UBS. They cover all listed and “flex” futures on all eligible European exchanges, and clients can trade using outright or calendar spread strategies.

Credit execution

Meanwhile MarketAxess, the electronic marketplace for US and European fixed income securities, has launched an enhanced institutional credit trading system that includes new functionality for credit default swap (CDS) trading.

The firm, over 55% of whose transatlantic client base is asset managers, says that it now has much of the core technology needed to meet the anticipated regulatory requirements for registration as a swap execution facility (SEF) and security-based swap execution facility (SB SEF) under the Dodd-Frank Act in the US. Tradeweb also plans to register as an SEF.

SEFs are trading venues specifically designed, according to principles laid out by the Commodity and Futures Trading Commission (CFTC), for derivatives transactions that are currently executed bilaterally. Their development is part of the US commitment to the Group of 20 agreement, made in September 2009, to move trading of standardised OTC derivatives contracts onto electronic platforms with centralised clearing.

The CFTC set out the principles for SEFs in December 2010, which allow them to operate order books, much like stock exchanges, or RFQ models. The effective date for derivatives regulation was extended from July until December 2011, after industry bodies and politicians voiced concern that development of the rules was being rushed. Work still to be done includes defining certain terms – including swap, security-based swap, and security-based swap agreement.

Rick McVey, chairman and CEO of MarketAxess, said, “We are confident that these changes to our platform, in addition to our independent governance structure and our extensive efforts to ensure that we comply with the regulators' other core principles for SEFs and SB SEFs. We are also closely following the evolution of the European regulations to ensure we can address those requirements as they are further established.”

The latest trading system provides live, streaming prices from multiple dealers for active contracts as well as RFQ for index and single name swaps, increased pre-trade price transparency, and the ability to designate clearing house and clearing member.

“With this increased functionality, we now have a highly sophisticated CDS trading platform for both index and single-name contracts, providing enhanced pre-trade price transparency, a variety of flexible trading protocols and the ability to fulfill post-trade connectivity requirements,” said Nick Themelis, chief information officer of MarketAxess.