OTC FCM Business 2014: Momentum Stalls and Challenges Emerge

Future Commission Merchants (FCMs) that offer over the counter (OTC) clearing services are at a crossroads. Fees and volumes have both disappointed given the additional complexity of OTC contracts versus the futures equivalent.

The large and established players refuse to get involved in a race to the bottom on fees, prioritizing other areas of differentiation and focusing on key clients. Instead, their strategy is to encourage sticky business from a select range of accounts clustered mainly around large buy-side firms that require a full range of services across asset classes. A large swath of the market is not a priority, leaving other banks with the option of creating a bespoke offering aimed at existing clients. Among these FCMs setting up an additional OTC clearing offering, business strategies differ greatly and these differences have created a competitive atmosphere that is not conducive to a wholesale change in the FCMs’ charging model beyond the current makeup.

The standard fee structure has moved from straight transaction and maintenance fees to incorporate the additional margin required for OTC contracts. Almost all FCM firms have now added a basis point fee for initial margin requirements. Beyond that, there is little consensus as to which parts of the fee structure contribute the most to revenues and in fact, the revenue outlook is murky, although several respondents indicated that their businesses were profitable on a standalone basis, individual views about the overall state of the market were more negative.

All of this combines to create a situation where wider technology offerings and collateral and clearing functionality can add value and drive revenue growth. The issue is that this comes at a significant cost, adding barriers to entry for new players and reinforcing the importance of scale.

TABB Group spoke with 13 FCMs operating in global OTC markets during the second quarter. According to the Commodity Futures Trading Commission, as of June 2014, these FCMs represented $15.5 billion in client funds held for swap trades, accounting for 50.5% of the total market.