“It’s over,” said one guest at the dinner table on Sunday.
He was speaking candidly about the futures industry and its prospects. Rather than facing a rebuttal from the other six industry professionals at the table, he ended up with three others on his side and three more willing to listen.
The argument went something like this. This is an industry with legacy business structures, especially at the FCM level which is being saddled with new regulations that sap critical capital from those firms, and increases costs on already cost-wary customers. Not only is regulation turning into strangulation, but we are facing an industry with few market opportunities, as long as the US Federal Reserve Bank and other central banks continue holding interest rates near zero. (And that looks likely for some time.)
And look at the capital requirements now being dictated by EU policies from European Market Infrastructure Regulation (EMIR) to Basel III capital requirements. To some, the punch bowl hasn’t been taken away, its been systematically drained and the empty vessel is being smashed over the head of every European banker. The simple question now is: What do we do now? Answer: Not much, just sit tight for now.
Another chimed in that hedge funds and CTAs, not to mention other key institutional players from the buy-side, are not participating in the markets as much, or sometimes not at all, given the low- or no-interest rate environment, the regulatory straitjacket and one other key missing ingredient: a lack of opportunity.
One could argue the financial industry may have hit the proverbial wall that many other industries have encountered. Perhaps the gentleman is right – gone are the days when speed provided a big edge, and volatility or trending markets provided real returns. As such, many of those firms that used to participate – such as banks which have seen commodities get clipped from operations and portfolios – have left or been barred from participating in the futures markets. Instead, they’ve jumped into physical markets, which may be trimmed from them as well. Beyond tepid markets and central bank policy, one wonders if traditional market participants have simply looked at all available asset classes and concluded that it’s simply easier to make money elsewhere.
Many in this industry may scoff at that idea, saying “Where else can you buy natural gas, sell corn, buy an index futures and sell an Aussie/US dollar futures contract but here in the futures markets? We have it all covered, globally from one trading screen!” True, but if the expense is too high and effort too burdensome, those markets will lose out to say, the US or London real estate market. And by the way, institutional investors have been investing billions in single-family homes in the US, where they are seeing double-digit rises in prices.
Toss in a few more comments about the lack of innovation in the industry – how technology providers are now in limbo – stuck between unfinished regulations and confused FCMs; or the ongoing issue of customer confidence two years after MF Global’s collapse and three weeks after AlphaMetrix imploded. If one thinks that retail and some of the long-time players such as farmers, ranchers and high-net worth investors are not worried about the safety of these markets, they are deluding themselves almost as much as those institutional players who keep saying we don’t need them in our markets.
And what of the optimists at the table? It is in these difficult times when innovation occurs. Today, there are real opportunities for firms with solutions to problems, rather than firms with solutions in search of a problem.
Among the most compelling arguments from one of the optimists at the table was that deeply entrenched interests have created an impediment to progress and that real structural change is needed. He said that, considering all the talk over the past two years about the FCM model being broken, perhaps the solution is for legacy FCMs to disappear or change. He went on to say FCMs are, by and large, stale leftovers from the pre-electronic age when exchanges were private clubs, and the business was labor-intensive from execution to back office, which made FCMs a valuable intermediary. Now, he says, the disintermediation of FCMs would facilitate the blazing of a path of innovation. It’s either that, or they have to figure out how to add value in new ways.
That would put more power and control in the hands of the exchanges, but given the new regulatory environment, perhaps they are best positioned to offer the trading, clearing and settlement efficiencies that may ultimately lower costs. This idea will certainly be hotly debated and thought of as ridiculous. But business as usual isn’t an option, given the regulation and the market environment.
Many in Chicago for FIA Expo would argue differently. But a debate should be stirred, solutions discussed and the future better focused to answer this question: What will it take for this industry to recover and thrive? There may be many a dinner conversation about that this week.