A lack of retail trading and market structure fragmentation has led to stagnation in Europe’s options markets in recent years. This has led Europe to trail the US.
Increasing retail participation, promoting on-screen trading, reducing cost and complexity, and market structure enhancements would all help Europe to boost its options markets, according to a new paper from Acuiti and Cboe Europe Derivatives. The findings are drawn from interviews with senior executives and trading heads at 57 firms operating in European and US listed derivatives markets across the hedge fund and proprietary trading markets.
FIA data shows that trading volumes for European equity options in 2023 were 798 million, a significant drop compared to the 1.2 billion recorded in 2012 (although 2023 did represent an increase from 2022’s 769 million, the market’s lowest level since 2004).
By contrast, US equity options recorded 11.2 billion trades last year, representing more than 250% growth from the 3.5 billion traded in 2008 and more than double the 4.9 billion contracts that were traded in 2019.
The costs of trading as well as other considerations are also a factor, the research found. Nearly three-quarters (71%) of respondents say they would prefer to execute their options trades on-screen but are prevented from doing so due to prevalence of liquidity in OTC markets. On-screen exchange-trading would increase Europe’s attractiveness to external sources of flow, such as the US and APAC, the research suggested.
Nearly two-thirds (62%) said Europe’s fragmented market structure had impacted their trading strategies in European options, with 50% allocating more to other regions as a result. Cost was also a factor, with 88% of respondents saying US options were significantly or somewhat cheaper than European options due to wider spreads associated with European options.
Looking ahead, one fifth of survey respondents expect a contraction in European listed equity derivatives markets over the next five years.
To understand the disparity between the two regions, analysis has focused on the lack of retail participation in Europe compared to the US where individuals take a more active approach to their wealth management. In place of options, retail investors in Europe trade alternative products such as CFDs and warrants. While CFDs offer a simple way for retail investors to access exposures, many national regulators have taken action to restrict the promotion and distribution of these products to retail investors, which could drive retail investors towards listed derivatives where both spreads and counterparty risk are significantly lower.
Fragmentation was the second most important factor for the lack of growth in European derivatives markets. In the words of one US portfolio manager running a volatility fund: “Because of the fragmentation, European options markets are too small, and the fees are way too high.”
In order to trade exposures across Europe, firms are required to onboard to multiple venues and clearing houses, develop the infrastructure to handle multiple pre and post trade workflows, as well as pay market data fees and post collateral across multiple venues. Firms also raised concerns over the cost structure and the fragmentation of European CSDs, with settlement charged on a per ISIN, per day basis.
Regulatory fragmentation is also a barrier. Despite a mooted Capital Markets Union, creates friction between local rules and market structures in areas such as payment for order flow, which is currently legal in some countries but not in others.
The paper also suggested increasing interoperability in the clearing of exchange traded derivatives (ETDs), which would allow derivatives exchanges to compete through technology, functionality, and product innovation while increasing post-trade efficiencies and choice. Additionally, open access to CCPs would reduce friction and increase competition but there is also scope for European CCPs to pursue cross-margin agreements between positions at other CCPs to promote capital efficiencies when investing in European ETDs.
©Markets Media Europe 2024
