The futures industry has seen both extreme highs and lows in trading volumes over the past 12 months. Paul Zubulake of Aite Group sheds light on the recent market upheaval and what’s in store for ‘09.
What was the most significant change for the futures industry in ‘08? Will this trend continue in the next 12 months?
The de-leveraging of the global economy which negatively impacted futures volumes specifically interest rates at the end of the 2008. The volume decreases have been across the board including fixed income, futures and equity options.
We saw record-breaking high volumes of futures trades each month preceding the recent decline. We are still experiencing this correction now. I do not believe we will ever get back to the high level of volumes we saw in mid ‘08. In fact, volume correction will remain for some months to come and my concern is that the market will continue to correct. It is too early to say if this will happen, but I think that by the end of the first quarter we will have a very good idea of the industry’s growth potential going forward.
What about volume changes in specific futures instruments?
Interest rates have received the most press because they have taken the biggest hit with the dramatic decrease in interest rate future volumes and options volume. The recent dramatic action by the Federal Reserve will help the currency and commodity sectors as the massive re-flation attempt will bring back speculators into those markets.
Despite my overall concern about growth in volume there are some signs of hope. The additional issuance of government debt that will occur next year will help stabilize volume in the interest rate sector. The Treasury Department hasn’t specified what they will do but they have discussed a more creative style of issuance, which could mean additional issuance in the longer part of the yield curve and beyond or they may issue massive amounts of Treasury bills. The bottom line is with rates at an all-time low and issuance at an all-time high, volume in interest rate futures should stabilize and actually should experience a bit of growth going forward. The current level of interest rates is not sustainable and the potential for a reversal in the interest rate market is very high in 2009.
Is there any regulatory change expected industry participants should be aware of?
The introduction of such a change depends on what broader changes to the regulatory structure are introduced in ’09. Right now it is still uncertain how the agencies will be setup and how it will affect the futures industry in the coming year. The most significant change that could occur could be the mandated opening up of the futures industry by forcing the CME to accept futures trades from other venues that are fungible so other exchanges could trade the futures that are currently traded exclusively on the Chicago Mercantile Exchange. The chance of this happening is remote.
The OTC derivative market is where the action will be as the regulators are looking at mandating an exchange style of clearing for credit instruments. This will benefit the futures exchanges as they already are clearing many OTC products. The concern for futures clearing entities is the co-mingling of monies from the existing futures clearing house with the funds from the new margin money from the OTC credit contracts.
The rapid increase in commodity prices in 2008 caused uproar with blame going to the speculative community. Talk of changing regulation with respect to speculators in the commodities markets has died down as the markets reversed. Speculators are vital to the market’s liquidity and any regulatory change that mandates any forced delivery would be harmful to the industry.
Are there any other developments we should anticipate for the next year?
This isn’t a regulatory change but more a Congress related item, but I suspect there may be talk in Congress of introducing a transaction tax on futures. Every few years this idea of a new transaction tax on futures trades come up in Congress. I assume Congress will look for new ways to gain revenue including additional taxes.
Now, a transaction tax on the financial markets might seems like viable tax especially since Wall Street is viewed as a cause of the economic slowdown, but the consequences of such a tax would be dire.
For the high frequency traders of futures (who are responsible for most of trading volume), a new tax is the last thing they need. The revenue gained on each future trade is small and any transaction tax would cut into profit margins and the end result would be that these traders would move their business abroad to foreign markets significantly reducing the volume in the U.S. futures market.
I think people need to realize that the futures industry has actually had a great year and has come out solidly despite the market turmoil. The exchanges and clearing houses managed the volatility as best as possible so we didn’t read about any firm defaulting within this exchange model. The bottom line is that we don’t need to create regulation or significant changes that will cripple a good business. Besides, if the industry is functioning well then why would you want to change it?
*Paul Zubulake is an analyst and Aite Group and author of a research report entitled: ”Futures Overview: From Front to Back.”