Welcome to Futures Industry
Sarah Rudolph
Published 10/2/2007

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The Chicago Mercantile Exchange will soon offer new functionality that will help improve the industry’s ability to manage trading risk, particularly with respect to highspeed customers.

The exchange says it is planning to institute “drop copy” functionality in the fourth quarter of this year that will give clearing firms an instant record of all order messages transmitted by their customers to the CME. In the current atmosphere, where electronic trading occurs at lightning speed, access to this information is critical for real-time post-trade risk management at the clearing firms. The drop copy functionality will apply to all futures and options listed on Globex, including the New York Mercantile Exchange’s energy and metals products, according to CME spokesman Allan Schoenberg. The drop copy functionality also will be available for the foreign exchange contracts traded at FXMarketspace, the CME’s joint venture with Reuters. A key feature of the service is that clearing firms will be able to download the information into their internal risk management systems, which will allow them to apply their own risk calculations on client positions.

The CME has not finalized the details of the offering, but several clearing firms are testing it on a preliminary basis. The service will provide information on both filled trades and resting orders, giving clearing firms a better picture of the risk exposure from their clients.

Barclays Capital is one of the firms that has been working with the CME on developing the new function. Stephane DiTullio, the firm’s head of electronic futures and equities, believes the service will be invaluable. “It allows me to do live reconciliation between my risk management system and what the CME knows. I can know within milliseconds everything the client does on the CME. This is very beneficial for the FCM community.” The development of this service comes in response to the demand among a small number of high-speed trading firms for direct access to the CME. These so-called “black box” firms use algorithms to spit out hundreds of order messages per second. Every millisecond counts for these firms, so they want to transmit orders to exchanges at the fastest possible speed, and frequently they will install their own infrastructure to connect to the exchange. But this instantaneous trading makes managing risk more difficult for the clearing firms that stand behind the trades.

Clearing firms usually use pre-trade filters to assess the risk of customer trades before they are executed. But if a client is sending order messages directly to the exchange, risk assessment must be done after an order is transmitted, which means the clearing firm needs to catch any problems as soon as possible. (See “Fast and Furious: Risk Management in a DMA Environment,” by Nina Mehta in the July/August 2006 issue of Futures Industry.) At present, clearing firms receive trade information from the CME’s clearinghouse with a delay of several minutes. The new functionality will bring that down into the millisecond range, said Schoenberg, who declined to provide a more precise estimate. Some firms have already developed their own “drop copy” functionality to manage the risks of this type of client. For those firms, the CME’s feed will provide a useful additional layer of protection, says Michael Meagher, managing director - information technology at Penson GHCO.

Meagher also points out that the feed will be in FIX format via the exchange’s iLink architecture. That will readily lend itself to equities traders coming into the futures business. “Everyone in equities speaks FIX,” he says.

Russell Abramson, executive director at J.P. Morgan Futures in New York, also welcomes the CME’s drop copy functionality, but wants the exchange to go farther. “It’s a significant step in the right direction,” says Abramson, who is responsible for client connectivity solutions for equities and futures worldwide as well as electronic trading strategy for futures and options.

“If exchanges allow customers to make direct connections to the matching engine, they should provide tools for appropriately managing the risk,” he says. “I would like to see all exchanges that allow direct market access to include some kind of pre-trade risk filter at the exchange level and apply that uniformly to all direct access clients that are not clearing members.”

A key issue for clearing firms will be the cost of the new service. The CME plans to charge users a monthly fee, but has not indicated what it will be. J.P. Morgan’s Abramson believes exchanges should not charge for this type of functionality because it helps protect the clearing system by reducing the risk of a customer default. He also points out that the CBOT does not charge for the use of its MTM functionality.

Sarah Rudolph is a freelance reporter based in Chicago. She has covered the futures industry for more than six years for such publications as Securities Week and SFO Magazine .
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