Trading floor bustle gives way to the sound of silence
Derivatives comment: Simon Boughey
25 Apr 2011
Trading floors used to be such fun places. Even in quiet periods in the market, there would be the low hum of a hundred voices speaking into telephones, which would rise to a frenzied cacophony
punctuated by a blizzard of profanity during busy times. Now, there’s only a sepulchral hush, as lines of young men in tieless shirts stare mutely into a phalanx of screens.
For those of us who like live theatre in our daily life, this is not necessarily a step in the right direction, but the clock won’t be turned back. One of the last bastions of voice dealing can be
found at the big brokers, but even here times are a-changing.
This month, wholesale brokerage GFI Group announced it had conducted the first fully electronic Mexican peso UDI versus US dollar Libor interest rate swap. The UDI (Unidades de Inversion) is the
unit of Mexican inflation published daily, and a UDI swap is an interest rate transaction in which a floating rate of US dollars based on six-month Libor is exchanged for a fixed rate of Mexican
pesos based on the UDI index.
As such, it qualifies as a Mexican inflation swap, and is a useful hedging mechanism for any US importer of Mexican goods or exporter of US goods to Mexico that is consequently exposed to domestic
rates of inflation.
This innovation follows the first fully electronically dealt Mexican peso interest rate swap, also broked by GFI, in December last year. In these transactions, a fixed rate of pesos is exchanged
for a floating rate based on the TIIE – the Mexican interbank equilibrium interest rate. This is an interbank rate for 28-day term deposits, not unlike the Australian bank bill rate against which
floating rate payments in Aussie dollar swaps are marked.
Neither of these products would appear at first to be suited to electronic trading as neither is particularly liquid, but dealing in both markets is developing fast. In illiquid markets, banks
don’t like to show their prices on a screen for all to see as the variation between the levels shown by different banks is often too great to be healthy.
As an emerging markets broker in New York said: “The peso basis market, for example, is not very liquid. Banks don’t want everyone to know where their prices are.”
The old way of dealing by phone preserved such anonymity. Large pieces of a trade in an illiquid market could be laid off, with the help of a skilful broker, without anyone knowing. In years gone by, whenever the World Bank or the European Investment Bank sold bonds in what was then a non-mainstream currency, the lead managers would have to carefully and adroitly scour the ground for, say, natural payers of Hungarian forints, before the deal could be swapped back to US dollars.
This is not possible on an electronic platform, but GFI has come up with a method to make it possible, called matching, which allows traders to anonymously post prices and trade at mid-market
prices on designated contracts at specific sessions.
These sessions are conducted at various set times over the day and have short durations – generally only five minutes or so. The broker claims that the matching sessions “create concentrated and
deep liquidity pools that allow large volume trades to be transacted at mid-market levels”.
In this way, banks are encouraged to post prices and trade on an anonymous basis. Earlier this year, the system was used to conduct the first Mexican peso basis swap (against dollars), and since has been used to transact deals in US dollar interest rate options and non-deliverable forwards in Chile and Argentina.
The march of electronic systems even in less liquid markets seems irresistible. The crisis and the subsequent regulatory push has made it more likely that all derivative products will end up on a
screen sooner rather than later, though that was probably the way the market was heading anyway.
“This is the way the market is going, and it has been going that way for some time,” said a Mexican peso basis swap dealer in New York.
GFI also claims the matching system has proved extremely popular in both New York and Mexico. “The reception of electronically traded products has been more successful than anyone originally
thought would be the case,” said a spokesman for the company in New York.
Of course, Dodd-Frank mandates that all “cleared” swaps should be traded on a swaps execution facility, but what this will mean in practice is not yet clear. Moreover, recent developments in
Congress suggest that even if Dodd-Frank is not repealed (which remains possible) its implementation may well be delayed. But this would not stop the development of electronic trading systems even in
less liquid areas of the derivatives markets. The process has built up too heavy a head of steam for that.
All this is rather depressing news for those of us who liked the ferocious energy of a large trading floor in full swing. Alongside one of the bigger desks at a City broker earlier this year, there was a rubber skeleton hung by a telephone cord with a placard round its neck bearing the legend “The death of the voice broker”.
Brokers are known for having a midnight-black sense of humour, but in this case it was probably prescient.