Tabb's Nybo:"Don't Count the Broker out in the Derivatives World"

"Two thirds of equities derivatives order flow is done by phone, and most derivatives traders say they don't expect that to change over the next two years," says Andy Nybo, Senior Analyst, Tabb Group speaking at TradeTech Derivatives in NYC. Nybo gleaned his information from many traditional asset managers and hedge fund traders who trade derivatives to create his report: "Exchange Traded Derivatives, The Buy Side's Increasing Exposure." Advanced Trading coverd this report in our June issue.Despite, the traders' convictions that this statistic will remain static, Nybo says, he doesn't believe it. He expects derivatives trading to become more automated over the next two years, to what degree, he isn't sure.

Why? Nybo says, there are two many complaints from buy-side traders about the existing technology, which will bring about change. He also notes that broker-dealers are investing in derivatives trading systems, illustrating their desire to offer these tools to their buy-side customers. For example, ITG announced its intention to purchase Red Sky and BNY ConvergEx said it will buy LiquidPoint. Both RedSky and LiquidPoint offer derivatives platforms.

In derivatives trading the relationship is still king. The average number of broker-dealers a derivatives trader uses is three, and 90% of the trader's order flow generally is given to one broker-dealer, Nybo finds in his report. Derivatives traders rely heavily on their prime broker for all technology needs, capital, color and advice, he adds. This is very different from the equities space where the average trader has relationships with 19 different broker-dealers and some have as many as 75 relationships, Nybo explains.

There is a great discrepancy in the derivatives space in how large firms use technology compared with how smaller firms use technology to trade these instruments. Large firms call their brokers to execute a trade 90% of the time, Medium firms do so 78% of the time and small firms use the telephone 38% of the time. The high phone rate for the larger firms is a result of several factors. "They trade in size, they have legacy systems and are more traditional," Nybo explains. Smaller firms have to deal with less bureaucracy and they are implementing new strategies constantly, Nybo adds. In addition, they use one broker-their prime broker-for all of their technology needs and tend to be more nimble.

One third of the traders Nybo spoke with use Goldman's Rediplus systems, but traders also use an average of 11 other systems. "There are lots of different systems on the desk top today," Nybo says. There is a need for and a lack of integration among systems on the desktop. Many hedge funds are building proprietary systems to avoid the integration issues among off the shelf products. He explains, "One hedge fund told me they are going from zero automation to 100% in one month. This fund is taking matters into its own hands and developing the systems because its been difficult for vendors to integrate the many disparate systems available." The most important feature derivatives traders are looking for from technology is integration among tools OMS, EMS and analytics.

One thing is clear to Nybo and that is with the new margining requirements, which will allow funds to put more capital to work, risk systems will become more important in derivatives trading.

Technology in general is growing in importance in this space, as Nybo notes that vendors are seeing more and more demands from clients to support derivatives trading. He sums up his research by telling the audience that "Direct market access and execution management will continue to grow in importance, but don't count the broker out in the derivatives world."Tabb Group's Nybo: "Don't Count the Broker Out in the Derivatives World"

"Two thirds of equities derivatives order flow is done by phone, and most derivatives traders say they don't expect that to change over the next two years," says Andy Nybo, Senior Analyst, Tabb Group speaking at TradeTech Derivatives in NYC. Nybo gleaned his information from many traditional asset managers and hedge fund traders who trade derivatives to create his report: "Exchange Traded Derivatives, The Buy Side's Increasing Exposure." Advanced Trading coverd this report in our June issue.