By John J. Lothian
The world of trading is experiencing a recession. If you were to define industry GDP as traded and cleared volumes times commissions and fees, we would have experienced two consecutive quarters of lower GDP in futures, equities and options markets.
Besides this metric, we are seeing proprietary trading firms start to shed traders, support staff and executives. A sure sign of a recession is higher unemployment. Crain’s Chicago Business reporter Lynne Marek yesterday reported that the venerable electronic trading firm GETCO had laid off 40 workers, including managing director Ed Boyle.
I believe the trading world is suffering from several shocks simultaneously, which is causing volumes to decline. First is the financial crisis. It is not over yet and the lasting impact of flat-lined interest rates has taken a key fundamental variable for every market and turned it into a near constant.
Secondly, the regulatory reform, spawned by the financial crisis, has created uncertainty, which in turn has slowed growth in the industry. This is where the value of principles-based solutions would have been a better solution than the regulatory drift back to prescriptive solutions.
Lastly, the MF Global bankruptcy has undermined confidence in the futures markets, brokerage firms and the foundation of segregated funds. Like the oil shock in the 1970s, the MF Global bankruptcy was a shock to the trading world which will retard volumes and trader participation for months and years to come. At the FOW Roundtable I moderated in Eurex’s Chicago offices on Monday, one participant said some traders were executing trades in the swaps markets instead of futures because the due diligence of an OTC counterparty is easier to figure out than the regulatory and legal uncertainty overhanging the futures markets in light of Dodd-Frank and MF Global.
The near-zero level short term interest rates have left our markets more highly correlated, and volatile. Trading one market gives a trader nearly the same exposure as trading many other correlated markets, where once these markets reacted to their own fundamentals.
Some people are so fed up with Dodd-Frank that the sheer ridiculousness of the size of the legislation and accompanying rules is offered as prima facie evidence of its utter ineffectiveness. Simplicity and elegance has been replaced by complexity and oafishness in regulation.
As long as I have been in the futures industry, we have experienced a dynamic, growing industry. There have been hiccups along the way, but I only remember one year when CBOT volumes were down year on year back in the 1980s. But that was more of a sector issue; overall, futures and stock volumes were up for the year, but the CBOT’s contract mix led to a mild decline. CME Group’s reported volumes for May showed overall volumes were down 2 percent from a year earlier, with its interest rate complex off 8 percent, from a year earlier. On the positive side, there are also green shoots all around us with new contracts like Eurex’s OAT contract and others.
I lived through the 1983-84 recession in the U.S. economy just as I was starting my full-time employment after graduating from college in 1983. My first job was cut short and I experienced a layoff when declining volumes and structural changes in the industry following regulatory changes earlier caused firms to pull out Knight-Ridder terminals.
We have been blessed by a wave of growth in the futures industry fueled by product innovation, technology innovation, pro-competition based regulation and fluctuating interest rates. The dearth of IPOs in the equity space, especially following the Facebook face plant, is leaving a key sector without new stories to tell.
One thing the trading world – particularly futures and options – has always had going for it is the next crisis. The next crisis is seemingly always a driver of increased volume. However, if our growth strategy is hoping for a crisis, a drought or a war, then we don’t have a strategy. What we need is a proactive strategy of innovation, education and marketing.
Rather than riding the tide that raises all ships, we are going to have to learn how to create our own waves to ride. I like to quote the late management consultant Peter Drucker who said, “Business is about two things, innovation and marketing.” We need to offer something new and different and we need to be able to tell people about it and create the demand.
How are we going to get out of this industry recession? We are going to have to innovate, educate and market.