DerivSource’s editor, Julia Schieffer, talked to Charley Cooper, senior managing director at State Street Global Exchange about why the custodian bank has expanded its FCM business to include futures execution and further deepen its footprint in traditional prime brokerage territory.
Q. State Street Global Exchange recently announced the expansion of the Futures Commission Merchant (FCM) business to include futures execution. This comes at a time when the derivatives market is transforming rapidly. Tell me, what motivated this step to support futures execution?
A. Client demand, above all else, is the primary motivation behind the expansion of our global futures capabilities to include futures execution. In growing our FCM business over the last five years (it launched in 2009 and expanded into swaps over the last two years), we made a series of strategic and tactical decisions about how we wanted to build out the product and what key components we felt were necessary to support our client’s needs. Time and again our buy-side clients told us that they wanted the ability to execute futures business through their custodian clearer and do so either by talking to people (voice trading), through discussing different trading strategies with traders on desks, or having the ability through Direct Market Access (DMA) and use of platforms on their desktops to support their own trading activities. It was off the back of that demand that we launched into futures execution. And rather than trying to launch something small and grow incrementally, we felt that client demand would best be served by launching a holistic offering when we are fully market ready, which we are now.
Q. In terms of optimizing electronic trading strategies for the buy-side in 2014 and beyond, why do you think your investment managers really need to optimize this now?
A. Markets are moving to electronic environments more rapidly and they’re relying more on powerful analytical tools and trading platforms to be able to empower clients to make the right investment decisions and to do it quickly.
Anyone who decides to sit on the sidelines with a ‘wait and see’ approach runs the risk of their competitors outrunning them and then constantly playing catch-up. So, I would encourage our clients to recognize that despite there still being uncertainties in regulation across the globe, markets will adapt to regulations and they are already doing so at a pace that for many buy-sides can be intimidating but also pretty impressive to watch.
It really is up to our clients to play an active role in helping shape the emerging swaps and futures markets because if they choose to sit and wait the market structures and the trading platforms will be shaped by their competitors rather than by their needs.
Q. For years prime brokers and custodians have been gradually moving into each other’s traditional territories of service. Is your move indicative of a larger trend to continue to move into the execution business in a more strategic way?
A. The driver behind the launch of State Street Global Exchange generally was to support increasing client for front-office solutions that empower them to face the markets and make the right investment decisions. State Street has already perfected that model in the middle and back office where we are the known commodity, but we have a series of capabilities, trading and clearing being two of them, where we offer support across various different asset classes and different trading platforms. And there are additional capabilities we offer, such as risk management, that strengthen the custodian’s role over the traditional prime brokerage model which up until the last couple of years has really proved dominant.
In comparison with the prime brokers and sell-side providers in this space, by and large, we have a better capital ratio out of any of them and our credit rating among the major ratings agencies (Moody’s, Fitch Ratings, Standard & Poors) is two to four notches higher than any of them. This is important to a buy-side firm who may be choosing its execution and clearing provider in these markets because as MF Global and Lehman Brothers have already proved, counterparty credit risk is a key concern for our buy-side clients. Ultimately, the custodian model, because it’s lower risk and more conservative, is a safer bet for our clients and they are very much keen to hear that message.
More importantly, we do not have proprietary trading activities in this market that would ‘compete’ in the same markets as our clients so there is no inherent conflict there. This is particularly important in the hedge fund industry where hedge funds are worried about information leakage within inside firms because their proprietary trading strategies are so important and so closely guarded. In short, we don’t run the risk of that type of information leakage to a trading desk because we have no trading desk that would be interested in that information.
Q. A big component of your futures execution service is the provision of execution consulting, research and data analytical and algorithms tools to assist firms in their execution strategies. Why was the research and data analytics so important to this launch?
A. Buy-side firms need more powerful ways of analyzing, dissecting and extrapolating data from the front office to help them power their investment decisions. That front-office analysis and data could be computer-based algorithms that look across data and help them make trading decisions; it could be analytics capabilities to look at transaction cost analysis, as an example; or risk management tools that look across the collateral impacts of various different trades. And as more of these markets move towards an electronic trading and central counterparty (CCP) clearing environment as seen in the swaps market, buy-side firms don’t always have these types of analytical tools at their disposal to support trading decisions. So, a big part of State Street Global Exchange’s front-office offering, is a research and analytical support service that will help clients better understand the data available and to be able to feed that through analytics and research capabilities (research provided via our internal research arm, State Street Associates) to assist them in making better investment decisions. There is a vast amount of data out there; however, it is near impossible make use of this data to support trading decisions unless you have an analytics and research capability, which State Street has built, so firms can morph that data into information that can be used to make actionable trading and investment decisions.
Q. What are the challenges that you expect to face in the first 18 months of launching the futures execution business?
A. Regulatory uncertainty is a challenge the entire derivatives market faces right now as regulation in the swaps market continues to evolve with the ongoing roll out of Dodd Frank, which will undoubtedly have a knock-on effect on the overall futures markets. Uncertainty as to how the futures markets will evolve in the future will impact our clients’ ability to assess market changes, adjust accordingly, which in turn will require us to develop our services to help clients navigate the transforming market. We are on the phone all the time with our regulators and various different groups in Washington trying to figure out what is next for the market. The more that we can stay ahead of that regulatory change, the easier it will be for us to adapt to it, and in turn, our clients.