Steve Grob is the Director of Group Strategy for Fidessa, where he is also the brains behind the Fidessa Fragmentation Index. SmartBrief sat down with Grob last week at the International Derivatives Expo in London to discuss regulatory reform and other issues he sees affecting the marketplace.
How will regulatory reform efforts like Dodd-Frank affect the derivatives market and is the market ready?
What is becoming increasingly evident is that slowly but surely people are starting to understand the enormity of the changes that are going to hit the derivatives industry. The parallel I use is when multi-market structures were introduced in European equities markets with MiFID. A lot of people slept walked into that one and hit a brick wall. … People seem to think its all about connecting to a bunch of swaps execution facilities (SEFs) or futurization via SEFs. And if you are thinking that, you are miles off the pace.
What Dodd-Frank is doing is removing the dividing line that has existed since derivatives markets began — where OTC and exchange-traded work flows were separated. They might start with the same trading decision, but then you go down completely separate paths. As that barrier gets lifted out, wherever you are in the food chain your thinking about how to protect what you know and love and how to go get what is now getable. Whether you are a venue, an interdealer-broker, a futures commission merchant, a technology firm, everyone is slowly saying ‘My world has completely changed.’
So where do things go from here?
It comes down to two things. One is, the world is moving to standard and custom contracts as opposed to exchange-traded and OTC. In standard, you’ll have futures, futurized swaps and other creative products that are starting to come out. What you end up doing is picking between a bunch of economically similar but not identical standard contracts. And the decision you make won’t be based on just price, but clearing efficiency. Whether people trade on SEFs or futures exchanges, they’ll need to post more margin. A collateral crunch is coming, so people are going to have to figure out how to get the greatest efficiency out their margin because there isn’t enough of it to go around.
You end up with almost a reverse business model where you have to have sight of your clearing positions right up at the front of the trading decision. … We think doing that is all about having connective work flow.
You recently authored a white paper that looked at the evolution of buy-side business models. Tell me more about that?
We looked at how the economics of this business have fundamentally changed. And the changes have been structural changes, not cyclical changes. The structural changes are greater complexity where liquidity is — which has already happened in the equities markets and is now happening in derivatives — lower volumes and commissions and an acute churn of regulation.
What is interesting from the buy-side perspective is that just at the point where their job got more complicated than it’s ever been and they want to reach out to a sell-side sales trainer to speak to a human being, they find the sell-side has kind of stepped back from that and is offering no-touch, DMA products because their economic model has changed.
There is a sense of alienation on the buy-side. The enlightened firms are ones that are stepping through that and trying to sort some of these issues out. They have to feed better information into the portfolio management systems. Compliance becomes a competitive differentiator when it comes to winning mandates if you can prove you take a proactive approach. … People are looking at how to generate more efficiencies post-trade. That was usually a sleepy area that people didn’t worry about. But now people are seeing the inefficiency there that has to be squeezed out.