Industry experts optimistic on trading volume but concerned about capital

Executives from Tradeweb and Citi point to retail and interest rates as drivers for growth, but warn that US capital proposals will discourage hedging

14 March 2024


As the volume and velocity of global futures and options trading grow, market watchers see a variety of risks and opportunities in store – risks stemming mostly from the unintended consequences of new regulations and opportunities from advances in technology.

One of the key factors in the growth trend has been the volatility in interest rates and the uncertainty regarding the future outlook for central bank monetary policy. This volatility and uncertainty has stimulated growth across a wide range of interest rate markets, according to Thomas Pluta, president of Tradeweb Markets, a leading fixed income trading platform. “We’ve seen growth across all products, all asset classes, rates, credit, money markets,” he said.

Another key factor has been the enormous growth in debt issuance by the US government and the resulting surge in activity as bond dealers and institutional investors have absorbed this supply. Pluta commented that the total size of the US Treasuries outstanding grew from $5 trillion 15 years ago to $25 trillion today, and looks to be headed toward $40 trillion over the next eight years.

At the same time, regulation has constrained bank balance sheets, pushing more money into the market. “I think that’s contributing to a higher velocity of trading as banks are looking to get inventory off their balance sheets quicker,” said Pluta.

Pluta made the comments on March 11 during a panel discussion that kicked off the first day of FIA's annual conference in Boca Raton. The conference brought together 1,200 financial industry executives, thought leaders and government officials from more than 20 countries for three days of discussions on trends and issues in the global derivatives markets.

Another major trend affecting the level of trading activity has been a multi-year surge in retail participation. Mariam Rafi, global head of futures, clearing and foreign exchange prime brokerage at Citi, noted that the total number of futures and options trading worldwide reached 137 billion contracts last year, and she said much of the increase was driven by trades in options on exchanges in the US and India. Retail traders are especially important in the Indian market, which is distinguished by huge levels of trading and very small contract sizes.

Advances in technology have facilitated all that trading by allowing the industry to scale up its capacity to process trades, according to Kevin McPartland, head of market structure and technology research at Coalition Greenwich, an advisory and consulting company that focuses on the financial services sector. Four or five years ago, the US Treasuries market traded $400 or $500 million a day. Today, the amount traded daily is routinely over $1 trillion, he said. “And that wouldn’t be possible if we didn’t have the tools to process that level of volume, pre-trade, trade, and post-trade.”

New challenges

All this growth is driving two kinds of challenges, technological and regulatory, according to the panel's moderator, Rob Creamer, president and chief executive officer of Geneva Trading, a Chicago-based trading firm.

First, on technology, one major concern is how to fund the future. “It’s not like technology budgets are going to grow exponentially to handle all of the processing volume that’s needed,” said Bill Borden, corporate vice president, worldwide financial services at Microsoft. “How you are looking within your constrained IT budget to actually continue to invest in actually managing the business volume but also figuring out ways to actually create new business propositions around that is a super challenge,” he said.

On the other hand, tech will soon be able to accomplish even more. Borden sees progress ahead as cloud computing and artificial intelligence make data easier to access and analyze. Pluta also sees data as crucial. “There’s tons and tons of data out there for every price that’s made, every trade that’s executed, every tick change that is recorded," said Pluta. "And there is so much more information than any human being can process to make a decision. So when I think of AI, I think it’s about taking this huge amount of data and distilling it down very efficiently to make a decision that a human being would make but very quickly,” he said.

This is not science fiction. Already, Pluta said, by ticket count, more than 50% of Tradeweb’s corporate bond and Treasuries tickets are priced using AI.

End Game worries

On the regulatory front, the top concern is the set of capital requirements proposed by US bank regulators.  Those proposals are the latest in a series of moves by banking regulators since the financial crisis to increase the amount of capital held by banking organizations.  

Citi's Rafi explained that these capital requirements have had a big impact on how customers hedge their trading risks. For example, the standardized approach to counterparty credit risk adopted in 2022 was “much more of a risk-based calculation,” she said. When banks that provide clearing services for clients implemented this approach, it increased the amount of capital that they had to hold for positions held by their clients, and particularly clients that were holding large positions on one side of the market. Rafi said the switch to SACR “meant that for certain asset classes like equity futures and commodity futures, the directionality of people’s positions got very heavily capital penalized.”

Now under consideration is the so-called Basel III End Game, which the Federal Reserve and other US banking regulators proposed last year. Rafi warned that this proposal would have a direct impact on the cost of client clearing. “We see capital for clearing going up by 22%, just based on these End Game changes,” she said.

In addition, she said, there is a proposal to include client-cleared swap notional sums in the so-called G-SIB calculation, which could lead to a 58% increase in the amount of capital needed to be reserved for clearing. For banks that are covered by both proposals, capital required for client clearing would need to rise by 80%, Rafi said, citing an estimate made by FIA.    

Rafi argues that the proposed capital requirements may serve to make the financial system less secure.  “A lot of this came out of the aftermath of Silicon Valley Bank and regional banks not hedging their interest rate exposure, because it cost too much,” she said. “Well, guess what? The cost of hedging is going to go up. If you increase the capital reserve requirements so dramatically, ironically, it will have a very counter-intuitive impact on the cost of people being able to access the market and hedge and access liquidity,” she said.

Pluta agreed with Rafi and predicted that this will be a top issue for all market participants. “If banks are putting up margin and collateral for their clients, there’s a cost to that. Where is that going to come from?" he said. "There’s a lot of work to be done, and I think a lot of people in the room here are going to be involved.”

  • MarketVoice