Attention over-the-counter (OTC) energy traders who think there’s no prominent high frequency trading (HFT) presence in their section of the market.
A Tabb Group research piece on how HFT practices are likely to creep into credit default and interest rate swaps once the market becomes centrally cleared, automated and standardised has made a striking discovery over the course of its data gathering.
HFT firms, it seems, have been honing their lightning fast trading strategies in swaps via the OTC energy markets for a long while now.
Kevin McPartland, director of fixed income research at TABB Group, discloses the finding whilst discussing the expected evolution of HFT trading in the swaps market in a video on the TABB website.
As he explains (our emphasis):
Everybody’s initial focus will be market making, providing liquidity, that’s where most of the proprietary trading firms have entered into some of the other makrets as they’ve grown and that’s where they’re going to enter into the rate and credit swaps markets as well. One of the interesting findings that we sort of realised is that swaps trading is not new to these proprietary trading firms. They are actually very very active in the OTC energy swaps market, making up about a third of the overall volume in that market. So taking what they’ve learned there, and that sort of OTC traded cleared market, they’ll be relatively straight forward to take some of the lessons learned and move that over to the interest rate swap and credit default swap market. Once the more vanilla pieces of those markets become more automated and centrally cleared.
This, of course, will be news to many in the energy market.
For one thing most energy traders only realised that HFT traders were present in their futures market very recently. Until a year ago the view was largely that algo trading didn’t really occur in commodity markets (despite the futures market being highly automated, electronic and standardised now for many years). Information on the scale of the practice, meanwhile, is still hard to come by, even though many firms though are known to specialise in exactly such practices.
Yet the OTC market is very different to futures. It’s considered relatively bespoke and dominated by voice brokered deals.
Not that headway hasn’t been made on electronic clearing and bespoke matching of bilateral deals. The Intercontinental Exchange, for one, has worked hard on this front for years.
Indeed, FT Alphaville mused about the possible rise of HFT strategies thanks to exactly such developments back in July, 2009.
The Tabb Group now seemingly agrees. HFT prop firms have not only benefited from the increased automation and standardisation that clearing has brought — allowing them to step into what were previously impenetrable markets like those of energy swaps — they’ve learned valuable lessons from those adventures, and are now looking to apply them to credit default and interest rate swaps too, according to Tabb.
Of course, it’s hard to make too many conclusions from McPartland’s comments. We’d love to know more about the specific markets they’ve been operating in and how exactly they’ve deployed those strategies.
Unfortunately we haven’t got a copy of the full report. If we get our hands on it, we’ll hopefully bring you more.
Related links:
Electronic trading and commodity prices - FT Alphaville
Ice-y tactics in commodities – FT Alphaville
PR flashing at ICE - FT Alphaville
GLG goes physical – FT Alphaville