The presence of principal trading groups (PTGs) in the exchange-traded derivatives market, and their absence in thecredit and rate swaps markets, are both the cause and effect of turnover frequencies.
TABB Group estimates that proprietary trading (including bank proprietary trading) accounts for 55 percent of futures trading by contract volume and 41 percent of U.S. Treasury (UST) trading by notional. The electronification of these markets increased turnover frequency enough to encourage PTGs to enter, which in turn increased turnover frequency and ultimately liquidity, which led to more entrants in the field, and so on.
Contrary to popular belief, PTGs are not new to the swaps market. Although equities and exchange-traded derivatives made them famous, PTGs play a huge role in the cleared OTC energy swaps market. Although their presence took a hit following the credit crisis and the decline in oil prices, they still drive nearly a third of the volume on ICE’s OTC energy platform.
As with the push for central clearing of fixed-income swaps, the move to central clearing for energy came from an economic catastrophe. Post-Enron, counterparty risk and transparency were huge concerns in the energy market, which ultimately resulted in the establishment of ICE OTC and CME’s ClearPort.
PTGs came into the market around 2005 and quickly picked up market share. For those intimate with the details, the energy swaps market is the prime example of how an OTC-traded, cleared market should work: Two main clearinghouses exist in CME and ICE. Each carries similar contracts in natural gas, crude oil, etc. Those swaps can be traded virtually anywhere: over the phone, via an interdealer broker platform like GFI’s EnergyMatch® or ICAP’s ICAPture®, or via platforms owned by the exchanges.
Once executed, the trades are sent directly to the clearinghouse. Contracts are not fungible — meaning you cannot net a CME natural gas swap with one from ICE. Many larger brokers, though, provide services to essentially move positions from one clearinghouse to the other through a quick buy and sell.
PTGs entered the energy markets as market makers.As liquidity developed they made the move to arbitrage trading. The positive end result has been that spot, futures and swap prices in the most liquid energy markets remain in line with one another as arbitragers performing basis trades keep prices tight. The same progression is on the way for fixed-income markets. Market making will lead to arbitrage trading and ultimately to more efficiently priced markets.