Summary of Last Ten Year Trends in FCM/Listed Derivatives Industry

Overview of the Last Ten Years of Segregated Funds Data for US FCM’s:

Source: CFTC, in Billion USD.

10 Year Evolution of Segregated Funds:

As illustrated above, 2011 & 2009 are the only two years in the last 10 that the US segregated funds decreased, as published by the CFTC. The percentage decrease in 2011 was 4% and in 2009 the decrease was 15%. The total segregated funds at the end of December 2008, 2009, 2010 & 2011 were 158, 134, 151 & 145 billion respectively. Over the ten year period from 2002-2011 the customer segregated funds for US markets grew at a compounded annual growth rate (CAGR) of 12%.

If one were to only look at the December 31^st figures it could be accurately assumed that the industry has not yet recovered from the financial crisis of 2008 in terms of segregated funds. However, in February and July 2011, at $160 billion, segregated funds were above the historically high year end level. Unfortunately, the demise of MF Global in late October reversed the momentum, at least for some period of time.

Corresponding 10 Year Evolution of Non US Funds (i.e. 30.7)

It is interesting to note that the customer funds held by US FCMs to trade on foreign markets evolved more favorably over the same period of time. From 2002 to 2011 30.7 funds had a CAGR of 16.6%, with an increase in 2011 of 19%. With a total of $40 billion, they nevertheless only represent 22% of the total funds held by US registered FCM’s for their clients trading.

On a related point, FCM’s US regulatory capital requirements and worldwide futures and options volumes evolved very similarly to those of the US segregated funds. (This assumes that volumes for the second semester of 2011 will bring down the average yearly progression registered over the period).

A growth rate of 12% for the US segregated funds and 16% for 30.7 funds compares very favorably to what empirically most of the other sectors of the world economy have experienced over the same period of time. At the end of 2011, the US Segregated funds figure remained 8% higher than at the end of 2007 and the foreign funds were 15% higher than 2007. This certainly illustrates the resilience of the industry, given the environment the industry has been evolving in. Specifically, deleveraging, bankruptcies of financial institutions, economic recession, and the corresponding raft of new regulations.

In our view, despite the setbacks of 2008 and 2011, the FCM/Listed Derivatives industry will experience growth again in the semesters ahead. The key drivers to this growth will be the benefit from the on-going transition of OTC products towards centralized clearing, the prevailing volatility on commodities and energy products and at some point an end to the historically low interest rate levels. The more important consideration is whether this growth will lead to improved FCM profitability.

Concentration in FCM Industry

The concentration of the business in the hands of the top players has continued to increase, and the FCM industry has never been as concentrated as at the end of 2011. At the end of 2011, the top 5 FCM’s represented 55.4% of the total customer funds – the top ten 80.6%. In 2002, the top 5 FCM’s represented 44.45% of the total customer funds – the top ten 67.61%. The total number of registered FCM’s in the last ten years decreased from 169 to 116. Today there are only 70 active FCM’s versus 102 in 2002. When compared against a growth rate in segregated funds during that period of 12% this certainly helps to illustrate the difficult nature of establishing and maintaining a profitable enterprise in the listed derivatives business.

We think these metrics can help market participants and potential investors in the Listed Derivatives Industry reflect on the recent events and provide them with a better assessment of their future strategic options. In this context there are four fundamental questions to be considered:

• If we can reasonably assume that the listed derivatives industry will continue growing in the foreseeable future will the growth rate revert to the historical average, increase from there or decrease?

• What will be the trend going forward regarding how an FCM will be reimbursed for its services? Will the historical pricing model of an FCM remain as a relatively standardized per contract fee? If this is the case, at what level? Will the yearly downward trend we have been accustomed to continue or will it be soon reversed? If one assumes that additional volume increases and reduced number of FCM’s will shrink the excess capacity in the industry, will additional fees be levied? At the moment, some firms are charging a type of custody fee for OTC cleared contracts to cover the cost of capital and infrastructure. Is there room for this for all listed derivatives clearing business? There is no doubt that the complexity of clearing OTC traded products has added expenses to FCM’s. How long will it take for these to be recouped through commission rates or other fees paid by customers?

• How will the treasury income derived from customer deposits evolve? If one expects that the level of the interest rates will not stay at a very low level across all economically developed countries beyond the next couple of years, will the income generated by a better spread on customer deposits be enough to return FCM’s to a healthy level of profitability? What will be the impact of additional regulatory restrictions which might be imposed on the way FCMs invest their customer’s money?

• Lastly, how successful will the institutions that recently entered the FCM/listed derivatives business or those who claimed renewed ambitions for their FCMs business be? What will be the different paths they will take to significantly challenge the top players? Is it possible to successfully build a listed derivatives clearing business versus buying an existing broker?

There are many open questions regarding the competitive landscape of the listed derivatives clearing business following the disappearance of a few major players and the introduction of new regulations. We have attempted to highlight above some of the significant issues which institutions in the business are attempting to address as they commit financial and operational resources to accommodate and eventually benefit from the current migration to centralized clearing. Given the uncertainty surrounding the industry at the moment, it seems worthwhile to keep in mind that the business will continue to evolve and grow, thus providing a commercial opportunity for existing participants and potential newcomers.

Atlas5 Financial will be present at the FIA conference in Boca Raton, March 13 to 15. We look forward to seeing you there and exchange views about the industry.