The COVID-19 pandemic has led to the financial services industry completely reassessing existing operational procedures and modes of trading. This is likely to prompt market professionals to adopt new models that were previously not considered. For buy-side interest rate swap traders, the move towards central limit order book (CLOB) trading is likely to gather pace, writes Philippe Dudon, Chief Operating Officer of Trad-X.

We are more than halfway through 2020, and as I write this from my home in London, I can’t help but reflect on how previously unthinkable ways of trading, managing risk and communicating with clients have become the new normal so quickly. Who would have thought this would be the case for the derivatives industry in 2020?

Maybe we shouldn’t be surprised. This industry has successfully evolved its operating models and practices considerably over the decades. While noisy trading floors with traders and brokers shouting into two phones remain commonplace, we’re also accustomed to slightly quieter working environments where electronic trading screens complement the old ways of trading. 

Such a shift would have been unthinkable a little over a decade ago. But the industry needed a push to make it happen. That came via the infamous 2009 G20 statement on derivatives trading, which led to global regulatory reform and the common practices we see today. There is little doubt that the highly liquid and multi-lateral trading facilities (MTFs) that facilitate all-to-all trading have improved the market and made it more efficient, resilient and transparent.

As trading floors around the world lie empty due to the COVID-19 pandemic, what was previously unthinkable is not only a temporary reality but is potentially the future of work. 

Buy-side playing catch-up on CLOB adoption

From my position as an operator of one of the hybrid MTFs that emerged post-2009, I speak to banks (also known as dealers) and a range of buy-side derivatives traders (also known as non-dealers) regularly. From these conversations, I believe we’re on the cusp of change, particularly with respect to the execution silos that continue to exist between these two customer segments.

Central limit order books (CLOBs) have been around for almost a decade, but they’re heavily favoured by dealers which used it primarily for hedging their own positions. For non-dealers, the model doesn’t suit their trading requirements; the only option available to them was request-for-quote (RFQ). To this day, these two execution methods continue to dominate the market.

The RFQ model is long-established and has clear benefits. However, information leakage and market impact remain key concerns, with many non-dealers exploring and experimenting with alternative models that mitigate these downsides.

Prior to launching our dealer-to-client (D2C) CLOB earlier this year, dealers and non-dealers alike were curious about how our model worked and what benefits it offered. While it was new to them, a handful of participants were prepared to experiment with the model. This cautionary approach wasn’t a surprise – changing long-established behaviour is not easy, and progress will ultimately be measured in years, not weeks or months.

While that still remains the case today, COVID-19 has accelerated interest in alternative and new ways of working, and models such as ours are attracting interest. We have seen momentum grow rapidly from the buy-side, and dealers are seeing that this group has an appetite to execute on the CLOB model. 

Change and disruption are inevitable, and it’s crucial to stay on top of emerging market trends to ensure you’re not left behind. The former CEO of General Electric, Jack Welch, once warned that companies should change before they have to, and the past few months have given proof to that phrase. 

While technology and client behaviour continue to drive substantial innovation and changes in models, the pandemic has brought forward industry-wide changes and accelerated the adoption of models in a few months that may otherwise have taken several years. 

So, as you read this from the comfort of your home, or perhaps as you re-enter the office for the first time in months, ask yourself: is your institution equipped to adapt to the structural changes will emerge over the coming years? If not, perhaps it is time to change before you have to.

Philippe Dudon is Chief Operating Officer at Trad-X