Opportunities and efficiencies

1. Greenwich Associates: industry mixed on centralised OTC clearing

A new report by Greenwich Associates finds broad agreement among global institutions that centralised clearing of OTC derivatives trades would enable better management of counterparty and systemic risk.

But firms participating in the consultancy's survey also indicated concerns over the shape of potential market reforms, as well as how centralisation might affect liquidity and transaction costs.

The new report, Centralized Clearing of OTC Derivatives: Devil in the Details, surveyed 330 investors and executives, and found a significant minority of respondents - 47% - either had absolutely no idea how centralised clearing proposals were shaping up or had only a vague notion of those proposals.

"As might be expected, the most active users of the OTC derivatives products at the centre of the proposed changes appear to be the best informed," states the report.

A clear majority of respondents (about 80%) felt that counterparty risk mitigation is the most important benefit of centralised clearing of OTC trades. About half of all respondents cited systemic risk mitigation as likely to improve under a centralised clearing structure (see figure 1). According to Greenwich Associates consultants Woody Canaday and Peter D'Amario, respondents cited credit default swaps as the instruments most in need of central clearing considering their high-risk effects on global markets in recent years.

When asked which providers should manage clearinghouses for centralised OTC instruments, respondents expressed clear preferences: Eurex in Europe, LCH Clearnet in the UK and CME Group in North America.

Expectations of how centralised clearing will impact volumes and costs appear mixed, according to the survey. Forty-two percent of all respondents and 44% of financial respondents did not believe centralisation would affect notional trading volumes; but if centralised clearing is mandated, roughly half of respondents expect volumes to decrease owing to anticipated higher costs and reduced ability to customise contracts.

2. Tabb Group: capital formation to drive institutional equity market relationships

A downsized asset management industry, growing use of commission sharing agreements (CSAs) and concentration of commissions among a small number of sell-side firms will drive the US institutional equity brokerage business over the next year. So finds a new Tabb Group study, US Institutional Equity Brokerage 2010: Assets, Commission Management and Concentration.

Surveying 66 head traders at major US investment management firms, the report finds that most managers will focus on improving positive relative performance, as well as absolute performance and winning back retail investor confidence.

"Buy-side funds will become heavy consumers of both execution technology and proprietary research in order to generate positive relative and absolute returns," writes Tabb Group analyst Laurie Berke, who notes that buy-side traders must manage transaction costs with smaller asset bases and less to spend on commissions.

Brokers must operate keeping in mind that client assets in the institutional equity space remain low - stock and exchange-traded funds had lost $50 billion in outflows as of late 2009, according to the report. As such, managers will be stretching their commission dollars for maximum effect.

The rise of CSAs will also affect how the buy and sell sides interact over the coming year, Berke writes. Two-thirds of respondents reported using CSAs as of 2009, up from 40% in 2007. These agreements allow buy-side firms to better manage order flow as well as sell-side relationships.

Despite ongoing concerns about counterparty risk, Tabb Group anticipates commission revenues will become more concentrated among a small number of brokers. Berke notes that starting in early 2009, investment managers appeared set to expand their execution relationships to mitigate counterparty risk; a year later, that scenario hasn't exactly played out.

Berke writes that "smaller commission wallets and the availability of CSAs to pay third parties quickly offset any lingering concerns about counterparty risk and buy-side trading desks continue to further concentrate their trading activity with the firms they consider to be their 'core' brokers."

Indeed, nearly half of all respondents (45%) report their number of core brokers to be fewer than 10 in 2009, up from 32% of respondents using 10 or fewer brokers in 2008 (see figure 2).

3. Aite Group: quant spending on high-performance databases to increase

Quantitative investment firms such as hedge funds and proprietary trading desks will increase spending to nearly $90 million on third-party high-performance database (HPDB) systems in 2010 as traders expand into new geographies and asset classes.

A new Aite Group report, Quant Strategy Development Playgrounds: The High Performance Database Sandbox, asked 12 quantitative trading firms about their use of high-performance databases, and also evaluates five major providers of these platforms: Kx, OneMarketData, Sybase, Thomson Reuters and Vertica.

Report author and Aite Group research director Adam Honoré notes that quantitative investment managers with high-frequency trading infrastructures typically deploy high-performance databases to manage two layers. First, these systems serve as repositories for time-series market data, and second, they serve as in-memory locations for data used to perform active analysis or real-time trading functions.

A third component is quickly emerging as well: complex-event processing, which can support data playback and signal generation in high-frequency environments. All vendors profiled in the report either directly support internal CEP engines (OneMarketData, Sybase and Kx) or have partnered with CEP providers.

"When asked whether they see the HPDB and CEP spaces blurring together, nearly every quant firm we spoke with indicated that they do," writes Honoré. "Even among firms that built everything internally, nearly all possessed side-by-side HPDB and CEP capabilities."

Although spending on third-party HPDB products is expected to rise (see figure 3), Aite Group found that a majority of the quantitative firms it interviewed (59%) were inclined to build their own databases, with vendors capturing the remaining 41% of the market. Respondents attributed their build tendencies to competitive advantage and cost savings.

"Saving money is a valid issue - the absolute lowest initial price we saw was US$40,000 on an annual basis," writes Honoré.

Firms that had implemented third-party HPDBs, on the other hand, reported paying on average between $100,000 and $150,000; larger quants were paying around $300,000 for their HPDBs (see figure 4). Such costs can be prohibitive for newly launched quant managers with unproven strategies; furthermore, quants that instead build proprietary databases often find them difficult to replace with a third-party product at a later date. >