Electronic-trading volumes in the capital markets and Investment banking (CMIB) industry, having returned to precrisis levels, should continue to rise, This growth will be driven largely by pending regulations that treat electronic trading as essential for meeting tougher standards on transparency, execution, and reporting. Other factors will include the increasing need to service clients with cost-effective business models and the ongoing growth of high-frequency trading (HFT). Let’s take a closer look at each of these drivers.
Regulations. Regulators across the globe are intent on forcing trading in OTC products—valued annually at more than $600 trillion—onto transparent exchanges and centrally cleared platforms. This shift will certainly lead to an increase in electronic flow across all asset classes, most significantly for rates, credit, and foreign exchange. In our view, there is ample room for migration from voice to electronic. For example, in FX, voice accounted for just under half of daily trading volume in 2010. Overall, there is potential for growth in both single- and multidealer platforms. (See the exhibit below.)
However, the lack of clarity around some proposed regulations has created uncertainty. Most critical is the future of single-bank platforms relative to the expected rise in multibank-platform flow owing to multibanks’ natural positioning for central clearing and qualification as swap execution facilities (SEFs). The simple answer is that both sets of channels will benefit in terms of overall volume. However, dealers will likely find it increasingly difficult to remain profitable in what will be a tricky e-commerce-platform balancing act.
Central counterparty clearing (CCP) regulations will prove both a blessing and a curse to overall profitability. On the one hand, capital requirements will be reassigned to the CCP, providing a natural deleveraging force and significantly reducing costs associated with credit risk. However, any transfer of business from single-dealer to multidealer channels will lead to lower profit margins. Also, the developing dispute among regulators over CCP location requirements could result in considerable market fragmentation (if a co-op style oversight body for CCPs cannot be agreed upon), significantly reducing the expected volume increase.