Throwing a Curveball

CurveGlobal is making am ambitious play to disrupt the interest rate derivatives market. Joe Parsons speaks to CEO Andrew Ross about how he plans to shake up the market.

You won’t be seeing any slog sweeps or wild swings from Andrew Ross, the chief executive of the London Stock Exchange Group's (LSEG) ambitious interest rate derivatives platform.

His style is a lot simpler: to knock singles about and put the bad ball away for four. It is this cricketing style which Ross is applying to CurveGlobal.

“When it comes to growth, to borrow a cricket analogy, you get people talking about boshing sixes all over the place. Then they come out looking like blithering idiots and can't get it off the square. I am more about talking a little less, not swinging for the boundary but when the right moment comes, late cut it for four,” says Ross.

“This is a similar case, we are not going to be talking about all the products we are going to list, we’re not going to buy market share from day one, we will grow organically and be aggressive with new products and innovation at the right time.”

However, it has not been a smooth innings for the incoming platform, which goes live on 26 September.

CurveGlobal found its origins in 2014 when industry veteran Bill Templer, a former co-head of listed derivatives at Morgan Stanley, was lined up to lead the LSE’s new swap futures initiative named ‘Project Rita’. It also brought on Cathryn Lyall last year as its chief operating officer to work on the project.

Following the departure of Templer in November, the go-live date for Curve was put back from March to September. It then lost Lyall in June this year at a key time as it prepares for its September launch.

Ross, Morgan Stanley’s former European head of swaps clearing, has since steadied the ship and is prepared to take on a completely different role to the one he previously held for over 16 years. He is now the boss.

“When you are running a clearing business at a bank you absolutely have a boss, even if your boss is in New York. But here I report to the board so it is quite nice to be the boss. Ultimately the decisions I make and the success the team has stand or fail on our ability to deliver against our business plan. So I feel a real sense of responsibility that I have the CurveGlobal future in my hands. That is a huge weight of responsibility but very empowering,” he explains.

Since his appointment as CEO of CurveGlobal in February, Ross has been tasked with generating interest in the platform, bringing on market makers and independent software vendors (ISVs) to hook up to it, and ensuring testing and connectivity is all up and running at the time of go-live.

At this point, Ross says the venture is in a good position, with the majority of testing complete and market makers signed off.

“What I feel we need to do now is less building technical hardware and much more about what we have to sell and how to build up liquidity. That means more engaging with the client side and banking community rather than focusing on the very technical area of the internal build,” he says.

Curve is 65% owned by a consortium of seven banks, including Barclays, Citi, Goldman Sachs, JP Morgan and Societe Generale, 10% owned by US Chicago Board Options Exchange (CBOE), and 25% the LSEG. To a large extent, the aim of Curve is to break up the hold of Eurex and Intercontinental Exchange (ICE) in Europe’s interest rate derivatives market by deliberating making it cheaper to trade on the new venue.

Overcoming critics

Despite its optimism, Curve has received its fair share of speculation and criticism. One has to just look at the experience of Nasdaq NLX, the London-based interest rate derivatives exchange previously led by Charlotte Crosswell.

The exchange once boasted a 10% market share in Euribor futures, the world's second-largest short-term interest rate contract after Eurodollar. However its strategy of paying people to trade on the exchange has not gone down well with the market, and according to data from the Futures Industry Association (FIA), it has traded just over a quarter of a million contracts in the first half of 2016, down by almost half year on year.

In addition, the LSEG’s merger with Deutsche Boerse, has also provided a cause of concern for some participants, with both LCH, the LSEG’s swaps clearing house, and Eurex, Deutsche Boerse futures exchange, becoming part of the same joint company. While Ross notes that the merger could create a “momentary pause for thought”, the LSEG remains committed to Curve and has provided it with five years of funding.

With Eurex and Curve becoming part of the same parent company, Ross believes Curve will still have an advantage over the Frankfurt-based exchange.

“Eurex has not managed to do a deal with banks for 12 years, whereas the LSE has done a deal with banks in derivatives. That has more intrinsic value and worth far more than the current value of Curve. If Eurex really want to make markets outside of mainland Europe, they will have a joint venture vehicle with banks, so it is a win-win,” Ross explains.

Outside of the politics of the LSEG-Deutsche Boerse merger, Curve is set to join an interest rate derivatives market which has not seen the large scale migration of OTC to futures trading that many industry experts previously predicted.

Speaking at this year’s FIA IDX conference in London, panellists argued that there has not been a migration to new futures products that mimic interest rate swaps because of issues with liquidity and certain barriers to entry. Furthermore the development of portfolio compression tools, such as those from LCH, have allowed banks and trading firms to carry on using swaps.

However Ross argues that the transition from OTC to futures trading is a longer-term trend, which will make Curve attractive to swaps traders.

“I think that we are in the short-term and some way off the migration of OTC products to the futures space. I think change is coming and that is pushing more people into standardised products. For example, if you are trading a swap on a SEF, I don't see why you wouldn't eventually think about getting the same interest rate exposure on a lower capital regime by trading a future. I think capital will continue to drive the evolution of this market into more futures products,” he says.

Building interest

One of the toughest tasks of launching a new venture is building open interest. Especially in the interest rate derivatives space where despite a swathe of regulatory reform, the use of OTC derivatives has not been swayed over listed products.

Ross believes the fact that it is listing Curve interest rate futures on the LSE Derivatives Market while also offering clearing on LCH means it will be a lot easier convincing participants to join.

“When you look at where people have tried to do this before, they've tried to do build their own vertical structure with a new exchange and new CCP, and asking people to come because of increased competition.”

As the Basel III capital rules continue to strangle banks capabilities in the space, and with the cost of capital being passed down to the buy-side, Ross believes having a venue that can achieve savings by linking up with LCH and its liquidity pool will attract activity.

“To begin with we are listing very similar products to those listed on Eurex or ICE. But we are doing that because we have been told by our clients to list and trade those first as a proof of concept,” says Ross.

Curve will start in September with listing short-term interest rate futures contracts in euribor and short sterling, similar to those currently traded on ICE Futures Europe and Eurex. It will also offer longer-term futures contracts in bund, bobl, schatz and gilts from day one.

“Secondly, we then allow people to clear LCH and the attraction there is its huge pool of liquidity. The idea is that it is low cost and easy to implement. Giving capital savings through a simple implementation route will be the key to our success,” he adds.

With the cost of trading and clearing derivatives increasingly influencing decision-making by banks and asset managers, Ross argues that the ability to cross-margin positions with listed products from Curve and interest rate swaps products at LCH through portfolio margining will be vital for firms to achieve arbitrage opportunities.

“Clearly there is a pricing basis that exists between CCPs,and we are allowing people to take advantage of reduced costs. Should there be a basis that exists between exchanges? If there is and it exists only for a moment while people arbitrage, that is great as we will have the beginnings of a successful market at that point,” he says.

A key area of focus for Ross is to break down the barriers to entry. For new venues, finding a variety of liquidity providers and linking up the ISVs and order management systems (OMS) has always proved to be a difficult challenge. Buy-siders need synthetic pricing and real-time pricing on a platform to start trading a new product.

Ross says CurveGlobal will have a market maker scheme in place and will provide financial incentives for banks to make prices. However, he says “we will not pay for order flow and we will not pay for people to trade. We will pay for people to put prices on the screen. We have four major ISVs connected, we are working with a fifth ahead of go-live. As for market makers, we have 12 that are signed up and ready to go.”

Bringing in the buy-side

Once Curve goes live in September, the next challenge for Ross is bringing in the asset managers and hedge funds to trade on the platform.

One significant area Ross thinks will attract the buy-side is Curve’s policy of providing free market data, a contentious issue with many asset managers and proprietary firms that believe the incumbent exchanges have a monopolistic hold on market data fees.

“When I go to the buy-side, I say, “it is cheaper for banks to make prices here; we have cheaper fees; we do not charge for market data, soon aggregate we are a lower cost solution that does the same thing as the existing exchanges”. And if you add in the Mifid II best execution policy, which says you need a total cost of transaction approach,” he explains.

“Yes you have to get the ISVs there and yes you have got to build up liquidity but ultimately the buy-side love the idea of competition because they don't like being charged for market data and don't like the idea of pricing going up.”

In addition, while it could be argued that Curve is largely a play by the big banks to lower fees for interest rate derivatives trading, Ross is adamant that the buy-side will play a significant role in the platform’s success.

“We cannot be successful if Curve is a bank-centric platform; we have to be focused in working with the buy-side. For hedge fund and asset managers, it is a case of first going live, become real and credible and then start walking the path of building open interest,” he explains.

“Once that happens, you will get market makers coming to you to provide on-screen liquidity and we are going to ask banks to put positions in because it is in their economic self-interest. We are going to do some block-transfer business to allow people to put blocks in and build up their risk.”

So what are the expectations of Curve in the short-term once it goes live? Ross does not expect any fireworks or a surge in activity, but rather a gradual build-up as market participants come round to the idea of Curve.

“Our model is to be funded for a long time and to slowly and surely build market share over time by individually bringing on positions that are economically sensible,” Ross says.

“I think for OTC clients of LCH that already trade futures, Curve should be a really interesting place to get them to come and express interest because there is such little liquidity risk. Because we are not building our own vertical model, we can present really exciting opportunities and innovative ideas to our buy-side clients.”