Friday, November 27, 2015

The futures industry ecosystem is broken

A the key strategic consulting ideas over the last twenty years has been the concept of an industry as an ecosystem. This business view states that an industry can be thought of three levels, the market, hierarchy, and ecosystem.  Markets facilitate the transaction of goods and services. Hierarchies facilitate the the control of activities that produce the goods, and the ecosystem facilitates the coordination of innovation and co-evolution of firms.  The ecosystem defines how firms interact and grow. Regulation and innovation may not allow co-evolution with the same market players or it may force changes in the hierarchy.

The futures industry ecosystem has changed significantly with new technology and regulation causes all firms to adapt. The innovation of easy electronic trading has done everything from unbundling brokerage services to cutting the cost of execution and eliminating the social network of trading. Regulation has changed the cost of playing in futures and has redefined the activities of many players. The table below outlines just a few of the changes to the ecosystem.

If you liked the old system, then you will conclude the current system is broken. The ecosystem is evolving and in the transition, old firm behavior will not work. Those who cannot adapt will fail. The former dominant species are being pushed aside and the skills to live in the current ecosystem are very different. Technological savvy behavior is more important than the trader skill of understanding the feel of the market. Understanding the regulatory environment is critical for success. If you cannot adapt to technology and regulation, you will be marginalized.

In this new environment, we may not be certain of liquidity in a crisis. We don't know whether price behavior will be the same as before. Liquidity providers will change. This is more than just saying that there is Darwinian "survival of the fittest" competition. The ecosystem is not the competitive actions of one firm but how the systems in total fits together. There are financial intermediaries that did not exist a decade ago. There are suppliers of technology for trading and risk management who did not exist. The "forest" where futures trading occurs has changed. Broken, maybe. Evolving, certainly.  

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