Examining the rise of new derivatives exchanges

July 19, 2024

Key Takeaways

  • Booming growth in retail markets has lured new players
  • New platforms leverage tech for a competitive advantage
  • Seamless operations to minimize risk is a must for incumbents and new entrants

Capital markets are more versatile, interconnected and complex than ever. None more so than derivatives, where profound technological developments and automation have democratized access to a market that was once the preserve of professional investors.

The exchange-traded derivatives (ETD) market, for example, is experiencing unprecedented growth globally, rising from 21.13 billion contracts in 2012 to 137.38 billion in 2023. This is largely driven by Asian markets, particularly India, where regulatory reforms and technological innovations have lured millions of retail investors. In March 2024 alone, the monthly notional value of derivatives traded on Indian exchanges touched USD 104.65 trillion (INR 8,737 trillion), more than double the previous year, NSE data shows.

The boom in demand from retail investors for financial products has fueled exponential growth for brokers, clearinghouses and exchanges, and these incumbents now face competition. Tech-savvy operators, from futures exchanges to central counterparty clearing houses (CCPs) for digital assets, want a piece of the global action.

Let’s examine a few of the new platforms, their advantages, and how technology partners are vital to achieving success in the new era of the digital economy.

The emergence of new exchanges

Exchanges have been around from the time stock market trading started, and online marketplaces were established with the advent of the Internet economy, but the cleared derivatives market has only recently gained significant traction owing to the rise of user-friendly trading platforms.

With the exponential growth of ETDs and other corners of the capital markets, a section of the trading community recognized that technologically driven new exchanges and clearing houses will bring better price discovery, transparency, order-matching, settlement, and clearing for market participants, especially where terms of trade are not yet standardized.

New players have emerged, leveraging technological innovation that could further advance the digital economy globally and help transform capital markets.

  • Abaxx Exchange: The Canada-based platform recently introduced centrally cleared, physically delivered futures contracts and derivatives for energy, metals, and carbon markets. These new instruments aim to provide better price discovery and improved risk management. The exchange is building advanced risk-management tools tailored to the needs of retail investors.
  • Cleartoken: This London-based start-up aims to be a CCP for the digital markets, offering the benefits of traditional market structure concepts of centralized clearing and settlement for emerging digital assets. It says CCPs in traditional finance have struggled to evolve beyond their mandates as guardians of stability for national securities and derivatives markets.
  • FairX: The CFTC-regulated exchange provides accessible futures for active individual investors. After receiving regulatory approvals in late 2020, the exchange was launched in May 2021 and was acquired by Coinbase in 2022. Its offerings include futures on the Bloomberg US Large Cap Index, the Bloomberg US Dollar Spot Index, as well as the SuperTech Index.
  • FMX Futures Exchange: This platform, which integrates the Fenics UST and FX platforms, plans to offer fully electronic trading in cash treasuries, foreign exchange, and interest rate futures from September 2024. It has partnered with LCH Limited, which holds the largest pool of cleared interest rate swaps in the world.
  • Guangzhou Futures Exchange (GFX): The new Chinese exchange launched in April 2021 and is part of China’s Belt and Road Initiative. It plans to develop and investigate features of the futures market that benefit the real economy and green development. This involves looking into different environmental products such as carbon, ESG indexes, or energy products.

Leveraging tech, less legacy

Unlike traditional ones, these new platforms are not burdened by legacy systems or fragmented data, giving them a competitive edge.

They recognize the dependence on technology as an opportunity to transform existing marketplaces, technological infrastructure, regulatory and governance frameworks and reinvent exchanges and clearinghouses.

In today’s dynamic financial landscape, partnering with a technology provider is pivotal for new players and incumbents to increase operational efficiency. By automating critical processes such as member onboarding, payments, and listings, exchanges can significantly reduce error-prone manual operations.

Moreover, modern componentized technology helps minimize latency, particularly for high-volume trading, risk management, and regulatory reporting, and it becomes easier to detect fraud using cutting-edge market surveillance systems, according to a report by Deloitte.

Retail investors also get the opportunity to participate in the markets directly using advanced data models.

Identifying the friction points

For the larger and traditional exchanges to thrive, they must move faster to take advantage of modern technology and assess the extent of business investment required, prioritizing key functions from identified strategic growth areas. A strategic, holistic approach is essential to become a next-generation exchange and help build a robust financial ecosystem.

To achieve this, it is critical to identify the current strengths and capabilities of the existing exchanges and clearinghouses. And new exchanges must address key questions: What strengths and capabilities do traditional exchanges have? Which unique capabilities should be retained, and which must be built or acquired to enable a next-generation exchange?

Additionally, next-generation exchanges need to identify and eliminate the friction points in the traditional system to make the customer experience more seamless, personal, and an intuitive experience. They also need to find methods to reduce barriers to transactions and simplify both internal and external processes.

How global exchanges flourish in the future will depend on their openness and understanding of new technologies and capacity to attract diverse participants. It is imperative that they constantly work towards improving their technology and select partners who leverage the power of the cloud to offer front-to-back solutions that streamline operations, manage risk and compliance, and connect to markets efficiently. With reliable infrastructure in place, market participants will reap the benefits and save on costs in the longer term while having the agility to respond to changing market and regulatory dynamics.

ION Markets

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