Chapter 3: Market Structure Flashcards
What is Europe’s largest exchange?
Euronext
What is Euronext’s trading platform called?
Optiq
Which entities clear Euronext trades? (2)
LCH SA
EuroCCP
In which UK exchange is open outcry still used?
London Metal Exchange
What is the CME?
Chicago Mercantile Exchange
What is the largest US options exchange?
CBOE - Chicago Board Options Exchange
What is the world’s largest derivative exchange?
Eurex
Which exchange introduced LEAPs?
CBOE - Chicago Board Options Exchange
What are the 3 main exchange membership categories?
Brokers
Dealers
Broker-dealers
What can a broker do?
May only trade for third parties
What can a dealer do?
May trade for their own account, and other members if approved by regulatory body
What can broker-dealers do?
Trade for their own account and third-parties
What do all exchanges have?
A clearing house
What does a clearing house do?
Acts as a central counterparty (CCP) to all trades executed on the exchange between clearing members
What is the benefit of a CCP?
No counterparty risk, clearing house guarantees all deliveries
What are the two types of clearing member?
General Clearing Members (GCMs)
Individual Clearing Members (ICMs)
What are General Clearing Members (GCMs)?
Can clear their own principal trades, on behalf of clients and other non-clearing members
What are Individual Clearing Members (ICMs)?
Only able to clear their own principal trades and trades on behalf of their clients
What is clearing?
The correct and timely transfer of securities and funds between buyers and sellers
Which type of clearing member is required to have a higher level of financial resources?
General Clearing Members (GCMs) over Individual Clearing Members (ICMs)
What other terminology for members do some exchanges use?
Clearing members (CMs) or Trading members (TMs)
What can Trading Members (TMs) do?
They can collect collateral and execute trades from clients but must have a relationship with a CM.
What is an OTC market?
A decentralised market in which participants trade directly between two parties without a central exchange or broker
Who acts as market-makers in the OTC market?
Dealers
Why is hedging a key utility of OTC markets?
Allows for hedging without significant margining requirements, tailor products
What is the difference between ‘high-touch’ and ‘low-touch’ trading services?
OTC considered high-touch as often desks will provide 24/7 advice to clients whereas exchange trading is more automated
What is pit trading?
Open outcry / Ring trading
Face to face trading, where traders will quote prices
Orders shouted out
Who can pit trade on LME?
Must have membership, these are valuable due to limited availability.
Can be leased / sold
For what kind of trades is CBOTs open outcry trading floor used for?
Complex trades as they are difficult to quote electronically
Who uses telephone trading?
Only between clients and executing brokers
Trader at broker will then go on to execute the trade in the market
What is specified in an open outcry order?
- the asset
- whether it is a buy or sell order
- the size of order (number of contracts or lots)
- the expiry month, and
- price conditions (if any)
What is a market-if-touched (MIT) order?
Combination of a limit and a market order.
Market order executed if price crosses a limit
What is an opening order?
Order with or without a price that is executed in first two minutes of trading
What is an immediate or cancel order?
Fills immediately or will be cancelled, fill-or-kill
What is a cross trade?
Where a match has been established by negotiation prior to entry in the system
What is a basis trade?
Exchange of financial asset with a futures contract in a privately negotiated transaction
When must block trades be reported?
Between 5 mins to an hour of execution
What are the four main advantages of trading OTC?
Products can be uniquely made to fit requirements
Confidentiality, as trades can be negotiated between client and broker
Mitigated counterparty risk
Lighter on BO teams, as no daily margin
What is risk pricing?
Requesting a quote for a whole large order from an OTC counterparty to prevent slippage
How has counterparty risk in OTC transactions been mitigated since 2008?
OTC trades have to be reported to a facility which is allows for surveillance by regulators
What are the three main downsides to OTC trading?
Lower liquidity
High cost to complex trades
Higher credit risk
What is the process called where a clearing house becomes counterparty?
Novation
What is cash settlement?
Net cash payment on the difference between the final positions closing price and the previous closing price
What is cash settlement often known as?
Contract for difference (CFD)
How is a buyer selected for physical settlement?
Randomly by the clearing house
Why do long-dated gov bonds differ from most financial futures?
Multiple underlying assets can be delivered
Exchange will have a list of eligible bonds
Who initiates delivery in futures vs options?
Futures - Seller
Options - Buyer
How does delivery work for commodity futures?
Exchanges will have authorised warehouses
What is dual capacity?
The ability of a member to act as either principal or agent in any transaction
What is cross trading?
When a brokerage firm matches a buy order of one customer against the sell order of another, when one side is non-competitive (where customer has not specified a price)
When is cross trading permissible?
When executed in accordance with the Commodity Exchange Act, Commodity Futures Trading Commission (CTFC)
When can cross trading take place? (2)
when a member
* has a buyer and a seller for the contract at a given price, or
* is willing to deal with a client as principal.
member takes the trade as principal
What is an opening trade?
One that creates a position in the market, and incurs obligations
What is a closing trade?
One that offsets an existing position, extinguishes any obligations
What is open interest?
Total number of contracts for any delivery month that remain open
Does open interest include short positions?
Open interest is the sum of all open long positions or the sum of all open short positions, not the sum of both.
What is OATS?
Order Audit Trail System
Exchanges track all orders
What is trade registration?
When the trade is reported into the administration system that is used by the exchange.
What is the house account?
For all proprietary trades of the clearing member, no client positions
What is pre-registration?
A member firm indicating that a deal it is doing should be allocated/given-up to a second member
What is pre-registration sometimes known as? (2)
Allocation/Give-up
What is a give-up?
Give-ups are the sending of a trade to another member of the exchange.
How is risk mitigated with allocated transactions?
Master Give-Up Agreements
Set the legally-binding framework that governs the relationship between members in a give-up.
Includes compensation clauses
Why else may give-ups be performed?
Shortages of trading staff at a give-in firm
Preserve anonymity
Why are give-up trades performed?
Separate the execution and the clearing function.
A customer might wish to trade (execute) through one exchange member but state that the trade should be given up to the customer’s usual clearing broker.
GIVE UP EXAMPLE
Example
Member firm ABC executes, confirms and matches a trade which it pre-registers, notifying the system that the trade should be allocated to firm DEF (another member).
ABC gives up the trade to DEF. In turn, DEF will claim the trade, which will be registered to DEF as a house, segregated or non-segregated transaction.
What must member firms do to remain compliant with exchanges?
Compile trade reports and sent to the exchange within a certain time frame
Are OTCs subject to exchange reporting?
Nope, but they must be input into internal systems so they can be managed
What are the kinds of trades that need to be manually reported to exchanges?
Block and basis trades, rest are done automatically
To who are exchange price feeds available?
Quote vendors - Bloomberg
Members
What does each futures expiry month have?
A unique identifier
Jan - F
June - M
Dec - Z
Why is it important for clients to monitor open interest?
So they are aware of their exposure at all times, they can have a credit limit with their broker
