A new report from Acuiti and ION suggests futures commission merchants (FCMs) are raking in hundreds of millions of dollars thanks to dual tailwinds of higher interest rates and large increases in market volumes.
FCMs are also anticipating more competition as crypto asset and retail market entrants eye clearing memberships to expand their offerings despite facing several barriers to entry such as capital charges and regulatory compliance.
Acuiti’s head of research Ross Lancaster said: “The continuation of the current conditions is likely to reverse the long-term declines in the number of firms providing services to the market.”
As well as higher interest rates, FIA data shows that over the last five years, exchange traded derivatives volumes increased from 25.2 billion contracts in 2017 to 83.9 billion contracts in 2022.
Thanks to these conditions, The Growing Opportunity in Derivatives Clearing report found that almost two-thirds (63%) of futures commission merchants (FCMs) plan to expand their number of clearing memberships over the next three years.
Non-bank FCMs and Tier 1 banks were marginally more likely to be planning an expansion than Tier 2 banks and regional banks. Client demand was the main driver for membership expansion across all FCMs.
As well as expanding memberships, incumbent FCMs are looking to increase profitability by optimising the allocation of cash and collateral pledged to cover client margin requirements.
The FCM business model was hit by more than a decade of zero or negative interest rates following the global financial crisis of 2007/08.
Prior to this, FCM revenue was drawn from the net interest income firms earned on client margin, with some estimates pegging the amount at one quarter to a half of clearing firms’ revenues.
During this period of low interest rates, volumes also plummeted in the wake of central bank support of global markets.
As a result, the number of FCMs globally declined from around 170 before 2008 to 70 today.
More than half of respondents believed that higher interest rates were here to stay – certainly long enough to make medium to long-term decisions about business expansion. Less than 10% of respondents felt the opposite way.
But the case for expansion does not rest entirely on higher interest rates, with incumbent FCMs, in particular, facing an opportunity to use funds from interest income to expand into new markets and expand their memberships, creating a virtuous cycle.
Jerome Kemp, president at Baton Systems, said that while higher interest rates present an opportunity for FCMs, they also add operational challenges to the margining process.
“With the cost of funds no longer being close to zero, higher rates have shone a very bright light on the need for FCMs to optimise the mix of cash and non-cash they post to satisfy margin requirements across their central counterparty clearing house (CCP) memberships.
“Manual processes, poor visibility of the data that ultimately drives economically intelligent decisions, and the inability to quickly mobilise and move both cash and securities carry an opportunity cost that FCMs should be addressing.
“An FCM seeking to extend its CCP relationships should be seriously considering the steps it needs to take to better access, aggregate, normalise and optimise real-time data across the universe of its memberships. Without this an FCM will find itself exceptionally challenged to derive greater value from its treasury operations.”
©Markets Media Europe 2023
