The announcement that new derivatives exchange GMEX has received investment from SocGen reopened the debate here as to the future of rates trading and who the likely winners are going to be. Reliable data is hard to come by on exactly what is happening to OTC volumes and where they are going. Such evidence as does exist seems to show a steady increase in SEF volumes, although this is masked by several anomalies, including volume which is still transacted manually but reported to look like electronic volume.
Venues like ERIS, which offer swap futures also report steadily rising volumes too.
Some things are becoming clearer, however. When a buy-side is looking to hedge a particular period on a rate curve, it will be able to select from a range of different but economically similar instruments. At one end of the spectrum are regular futures, which are cheapest and easy to understand, but lack precision in terms of start and end dates. At the other end will be custom OTC contracts which, conversely, are the most expensive but can be matched precisely to a client’s exact requirement.
The question that remains, then, is what happens in the middle? With its launch of swap futures, the LSE is showing how it thinks it can offer the optimum blend by allowing users to offset margin within its existing pool of OTC open interest held at SwapClear. But, to paraphrase Spinal Tap’s Nigel Tufnel, GMEX aims to “go to eleven” by offering the convenience of a future and yet the precision of a swap. The challenge, of course, will be whether compliance folks in the buy-side understand – let alone approve – the concept. It may just be less hassle for them to go to the regular futures market instead.
Education of the buy-side, therefore, will be a critical success factor for new venues. This was the case in Europe, with the rise of the MTFs in the cash equities world. Without natural liquidity, HFT folks like Virtu will be left twiddling their thumbs. The crucial lesson, then, is that to be successful, any new venue needs a mixture of participants in the same way that ecosystems in nature support and require a mix of participants too.
