Does the reliance of principal trading firms on banks pose a risk to UK financial stability?

Published on 09 August 2019

Principal trading firms undertake automated or algorithmic trading in fast markets and rely on a small number of banks for clearing services. This creates a concentration risk that could threaten the resilience of market liquidity.

Automated or algorithmic trading, some of which takes place at very high frequencies, is increasingly common in certain financial markets. These markets, such as spot foreign exchange, equities and some derivatives markets, are sometimes called fast markets.

Principal trading firms (PTFs) are smaller, non-bank firms that trade on electronic platforms using automated trading strategies. They are prevalent participants in fast markets, and are substantial short-term liquidity providers.

Most PTFs rely on banks for clearing services. Supervisory and market intelligence, as well as UK trade repository derivatives data, suggests that a small number of banks currently provide these services to PTFs, leading to a concentration of ‘nodes’ of clearing services.

Chart A shows the concentration of clearing provision to PTFs (in purple) in the FTSE 100 futures clearing network. PTFs account for around 53% of gross trading volume in this market.

Chart A

Many principal trading firms are reliant on the banking sector

FTSE 100 futures clearing network(a)(b)(c)

Does the reliance of principal trading firms on banks pose a risk to UK financial stability?

Sources: DTCC Derivatives Repository Ltd., ICE Trade Vault Europe Ltd., Regis-TR S.A., UnaVista Limited Trade Repositories and Bank calculations.

(a) This chart first appeared in the July 2019 Financial Stability Report.

(b) Shown unscaled for 20 November 2018. Each node represents a single legal entity and the links between them represent clearing relationships between entities.

Many PTFs use the same clearing provider (in yellow). This concentration increases the risk of short-term disruption to market liquidity in the event of failure or operational disruption at one of these nodes.

However, the concentration of clearing relationships does not currently pose a significant risk to UK financial stability. PTFs’ activities are less concentrated in clearing providers when measuring concentration by gross trading volumes.

Some of the largest PTFs do not rely on the same clearer, and two of the largest PTFs are members of the clearing house and do not rely on banks for clearing services. In the event of a disruption, other market participants such as dealers and asset managers would not be prevented from accessing exchanges and could continue to trade and therefore provide short-term liquidity.

This post has been prepared with the help of Jack Worlidge, Gerardo Ferrara and Magda Rutkowska.

This analysis was presented to the FPC as part of its 2019 Q2 round.

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