the global derivatives magazine february/march 2014 · audit bureau of circulations. abc reference...

THE GLOBAL DERIVATIVES MAGAZINE FEBRUARY/MARCH 2014

SUPPLEMENTPROPRIETARY TRADING

Everything you need to know about getting started in

proprietary trading

In association with:

www.fow.com

ghfinancials.com

[email protected]

Chicago: +1-312-544-0316 ext: 2102

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FOW prOprIETArY TrADING supplEmENT | FEBruArY/mArch 2014

IntroductionIntroduction 3ProP trading suPPlement

Welcome to the FOW Guide to starting out in the proprietary trading business.Proprietary trading has been at the heart of the futures markets since the early

days of locals on the trading floors of exchanges in London, Chicago and other major financial centres.

Today independent traders continue to grow in importance and, despite the financial downturn, the number of prop traders active in the market is at or near an all-time high.

This is a great time to join the prop trading industry.The recent improvements in market conditions and strengthening outlook have

set the platform for significant growth over the coming years. Interest rate movement is expected to return to Western markets in the near

future while volumes and liquidity are rising as global economies recover, providing greater opportunities for proprietary traders.

At the same time, the barrier to entry into the business is falling and proprietary trading is valued more than ever today by exchanges, brokers and technology providers.

Being an independent trader gives you the opportunity to shed the corporate straightjacket and work for yourself in a fast-pace and exciting environment with the potential rewards that can bring.

The markets today are more global yet more accessible than ever before. New products and new opportunities to suit a variety of trading styles are emerging by the day. Independent traders will trade commodities in Asia one minute and indices in the US the next. It is a truly global industry.

Technology has been a key enabler of the globalisation of the markets and crucial to the success of any new business is making the right technology choices.

Stellar Trading Systems has been at the forefront of the market evolution for over a decade and we look forward to continuing to bring new products and innovation to the global proprietary trading community.

Steve Thomas, managing director, Stellar Trading Systems

Editor Luke Jeffs +44 (0) 20 7779 8728 • [email protected]

Senior reporter Jonathan Watkins +44 (0) 20 7779 8042 • [email protected]

Reporter Joe Parsons + 44 (0) 20 7779 8859 • [email protected]

Subscription sales Mark Lupton +44 (0) 1277 636 904 • [email protected]

Head of Events Helen Seidenberg +44 207 779 8351 • [email protected]

Designer Antony Parselle • [email protected]

Business development manager, Americas Nicole Berkland +1 312 494 7783 • [email protected]

Managing director FOW TRADEdata: Mark Woolfenden [email protected] • +44 (0)1277 636928

Publisher William Mitting +44 (0) 20 7779 8350 • [email protected]

Business Group Manager Stewart Brown +44 (0)207 779 8184 • [email protected]

Divisional director Roger Davies

Directors: Sir Patrick Sergeant, The Viscount Rothermere, Richard Ensor, Neil Osborn, Dan Cohen, John Botts, Colin Jones, Diane Alfano, Christopher Fordham, Jaime Gonzalez, Jane Wilkinson, Martin Morgan, David Pritchard, Bashar Al-Rehany

Annual subscription rates: £650/ €750 /$1100

No part of this magazine can be reproduced without the written ap-proval of the publisher. Although Euromoney Institutional Investor PLC has made every effort to ensure the accuracy of this publication, neither it nor any contributor can accept any legal responsibility for consequences that may arise from errors or omissions or any opinions or advice given. This publication is not a substitute for specific advice on deals.

Printed by Buxton Press

©Euromoney Institutional Investor 2014

The time is now to join the prop business

Futures and Options World is a member of the Audit Bureau of Circulations. ABC Reference 22400/20110903BMS6/17475710

Contents

Sponsor contact directory: page 14

4 Taking the plunge | For the right person, the proprietary trading business can provide a long and hugely lucrative career. However, there are a number of things that anyone getting into the business needs to be aware of. We take a look at the common routes into the business and how to avoid the pitfalls.

6 Know your rights | Get the legal side of things wrong when starting out and even the best trading business can fail. This article looks at the key legal considerations anyone starting out in the prop business should be aware of from incorporating a company to signing agreements with investors.

8 A clear choice | A proprietary trading business relies on its clearing firm for everything from funding to information about new markets. It is no surprise then that choosing the right clearing firm will be one of the most important choices a new firm makes. We investigate the options.

12 Crunching the tech | Even the most traditional point-and-click trader relies on technology in the modern market environment. An almost limitless array of choices faces a new business starting out in prop trading when it comes to tech. Finding the right price and technology for each business is essential.


4 ProP trading suPPlementTaking the plunge

This guide serves as an introduction to the mechanics of proprietary trading. It is intended to give anyone interested in get-ting into the business the key information they need to get started. This is not about how to trade, but how to get your systems and infrastructure in place from the basic legal requirements to starting to trade on day one.

The proprietary trading business varies across the globe and many terms are used interchangeably to describe different con-cepts. This guide is focused on the London and European market and certain sections will apply to that market exclusively. Others will be universally applicable.

Defining the tradeProprietary trading in its most simple terms refers to an individual or entity that

trades its own money. Within that definition there are vast differences in application. Proprietary trading businesses today range from multi-national groups making mar-kets for products across the globe to sole traders plugging in to what has traditionally been called a trading “arcade” but is better termed and described hereon as a prop trading hub.

Some prop businesses are members of the exchanges they trade, some trade

through a broker or futures commission merchant. Some prop strategies involve manual trading of a single asset class on a single exchange, others pursue multi-asset class, global, ultra-low latency algorithmic strategies. Some trade futures, some op-tions. Some firms employ traders, others work purely on commission. In short, there is no single definition or description of a typical prop business.

But all prop businesses have one com-mon denominator: traders. Prop traders are drawn from a variety of backgrounds but the most common entrants into the business are new graduates, traders from trading desks at banks and high end retail traders seeking to trade professionally.

Each entry point poses different chal-lenges. Probably the most common entry (and exit) point for younger traders is through a graduate training scheme. Grad programmes are making a comeback as investment banks cut back their trading operations thereby reducing the trading opportunity for new graduates within banks and more prop firms recognise the benefits of well-run schemes.

As with the prop industry as a whole, grad training programmes have evolved and many have become more professional. Grad programmes in the prop market once had a bad reputation. At best they were process-ing factories in which 100 traders began a training programme with 90% being cut before the course completed.

At worst, they were scams in which eager graduates were charged thousands of pounds for training courses of dubious benefit with little hope of employment at the end.

Neither of these have gone away entirely but the industry has consolidated and a number of firms now offer decent graduate training programmes with real job opportu-nities at the end of them.

Prop trading firm OSTC, for example, works with universities in the markets in which it operates to find suitable gradu-ates, offering extensive training courses during university and beyond with the re-ward of a salaried job at the end of it. Most of its graduates are drawn from these universities and the firm prides itself on its training programme, from which the vast majority of those who enter are employed.

However, salaried employment in the prop business is rare and for a success-ful trader might not always offer the most efficient means of employment. Many other of the larger prop trading hubs in London and beyond offer extensive and reputable graduate training programmes where suc-

Born out of the pits of Liffe and the Chicago exchanges, the proprietary trading business has undergone a transformation over the past 15 years. Once seen as the Wild West of the trading world with a reputation to suit, the prop business today is professional, sophisticated and for the right person, offers the potential for a long and lucrative career.

“If you are coming into this business worrying about costs, you are not going to last long”James Sullivan, Divento Financials

Taking the plunge: getting started in the prop business


Introduction5ProP trading suPPlement Taking the plunge

cessful candidates will join the firm and be hired on a profit share basis (for more on this, see page 10).

Banking on successAnother popular route into the business is from trading desks at banks. As banks cut back on their proprietary trading opera-tions, this route is likely to become more popular. However, the transition is not a simple one.

“We have seen some fantastic bank traders come and sit with us and fail,” says one proprietary trader. “The difference is that it is one thing knowing where a market will be in a month’s time or even where it will close that day.

“What you don’t know is how the market will go up and down in the interim. You might be pretty sure a contract will close higher but can you afford to see it through it if it is volatile and it is your money in the trading account?

Bank traders are also used to getting their salary at the end of the month and then a bonus at the end of the year. In the prop world you have to make it day after day after day. Some months you will lose money and there is not the comfort of a salary. It is hugely mentally draining.

“You are only as good as your last day; you can have a record month but the mo-ment the next month starts you are back at zero. Some traders struggle with that,” says the trader.

Any bank trader that wants to make the switch has to understand the differences: “a total switch in mind-set,” says Ollie Jones, co-head of Professional Trader Ser-vices, a division of Marex Spectron, which provides market access, clearing services and a range of standard or bespoke trading facilities to individual traders or prop busi-nesses.

“There is no flow here, there are no customer orders or sense of what is going on in the market elsewhere. It is you and a screen, you have to make your own deci-sions,” he says.

“A lot of people thrive on that but some come from banks and find it very hard without that flow. People have to make sure they understand that and can trade the markets without the flow before they make the switch. It is vitally important that you find an environment that supports you.

“We offer mentoring, teaming and a range of other tools to help make the tran-sition. It’s important to consider the softer factors: they can make a huge difference.”

For traders coming out of banks, adapt-ing to a lower leverage environment away

from the comfort of the bank balance sheet can also be problematic and trading strate-gies might have to be adapted.

Retail therapyFor retail traders looking to make the step up, the question is how serious are you about trading. The shift into futures trading again represents a shift in mind-set from trading a few retail currency products to spending 12 hours a day screen trading in the real markets.

But if you want trading to be your sole source of income and a job rather than a sideshow, it makes sense to invest to work in a professional environment and gain access to the connectivity and IT infra-structure, economies of scale and earn the leverage that will increase your chances of

success and maximise your profits. The costs of setting up at home will far

outweigh those in a trading hub and a hub has the additional benefits of offering an environment in which you can share knowl-edge and immerse yourself in trading.

Funding the moveIf you are setting up independently, you are going to need at least £150,000 in your trading account to get started on a basic trading strategy. For graduates, there is no need for the initial investment however as you will be funded or seeded by the firm that is training you up but for retail traders or traders coming from banks or funds, £150,000 is the minimum for a sole trader.

Ideally you will have more. James Sullivan, founder of Divento

Financials, a prop trading firm, says: “If you are coming in worrying about costs, you are not going to last long. You need to be thinking long term from the outset and to be overcapitalised from the beginning.”

So what makes a good prop trader? According to Jonny Aucamp, chief executive of OSTC, the right culture and values lie at the heart of a successful trading operation. “We have a strong value set within our business and are looking for people with similar values. One of the main themes that runs through our business is ‘highly driven, highly disciplined’. This is more important today than ever before.

“The task of staying ahead is that much more demanding, the market is getting more sophisticated. But for the right people with the right skill-set there is an awful lot of money to be made. It is not just about money, it is about the lifestyle. It is a tough job and if you don’t get the balances right, you can burn out.”

He warns against going in with wrong attitude. “People try and make money too quickly rather than spending time learning how not to lose money. If you focus on not losing money, you will make money. If you don’t lose money you are safe, you will keep learning and you will make money in the long run,” says Aucamp.

Reports of 25 year olds driving Ferraris draw people in to the prop trading busi-ness. But the reality is there are many more former prop traders driving taxis than Ferraris and those dreaming of a quick buck would have a better chance in their local bookies than on a prop trading floor. But for the right person with the right temperament, the prop business offers the chance of earning great money doing a job that thrills.

Jonny Aucamp, OSTC: the right culture and values lie at the heart of a successful trading operation

“The task of staying ahead is that much more demanding, the market is getting more sophisticated. But for the right people with the right skill-set there is an awful lot of money to be made.”


6 ProP trading suPPlementLegal requirements

For graduates getting into the business, legal issues will be handled by the firm you are training with so the main thing is to ensure it is a reputable firm that you are joining. For those individuals looking to set up on their own, meeting your legal obliga-tions from the outset is essential.

For any traders working within a related organisation, the first thing to do is to establish the existing legal and contrac-tual obligations to the current employer, including non-competes and non-solicitation covenants and make sure you don’t draft or quantify strategies or speak to others about a new venture in breach of those provisions.

Business structure Once you have established how you can leave your existing organisation without breaching any covenants, you will need to give some thought to what legal entity you wish to trade under and in which jurisdic-tion that entity will be registered.

At this stage you should consider any in-vestors’ potential considerations if you plan to seek external funding for the venture. The markets on which you wish to trade and whether any founders are non-domi-ciled are also among the factors that will influence your decisions, says Sam Tyfield, a partner at law firm Vedder Price.

If you are setting up on your own, remaining a sole trader might be a sensible route, although a number of avenues (such

as membership of trading venues) will not be open to you. If you are a part of a group of traders you will likely seek to incorporate as a distinct entity. The most common forms of entity are limited companies and limited liability partnerships in the UK.

“Used appropriately, LLPs may have some advantages, particularly in relation to employer’s National Insurance Contribu-tions, if the founders are members rather than employees,” says Tyfield.

Depending on the business structure you will certainly need to consider retaining accounting and tax advisers, especially if it is likely trading will be conducted or income received from outside the founders’ home jurisdiction.

At this stage you should speak to potential clearing and broking firms to discuss plans – most have groups that are experienced in providing commercial sup-port to founders about getting started (see next section).

Trading contractsWhile the entity is being incorporated, the new business will need to draw up contracts with between directors and any employees of the organisation.

Vincent Mercer, a consultant to law firm Speechly Bircham, says: “It is not unu-sual to see non-competes in contracts. A trading group will have a particular trading strategy and in the cases of high-frequency and algo trading, there is intellectual prop-

erty and real value in those systems. “Even traditional point-and-click traders

today may have some sort of automated order execution system and this needs to be protected if they are proprietary systems. Remember that non-competes are enforceable to the extent that they are reasonable.”

Traders forming a trading group should consider not only their collective position with the investor but also their individual positions with their co-founders - this is especially pertinent when considering restrictive covenants and ‘good/bad leaver’ provisions, says Tyfield.

The relationship between you may not always be rosy - people frequently move or underperform and it is better to plan for easy resolution of conflict than deal with it after the event.

At some point in the process leading up to signing legal documentation and setting up the entity, founders will need to be prepared to resign from their existing employment and comply with their post-termination restrictive covenants – it is unlikely a founder will be able to walk out of one job on a Friday evening and into another, paid, job as a founder of a firm on Monday morning.

Consider who bears costs of negotiation of legal documentation relating to set-up - typically, founders and investors bear their own costs until the establishment of an entity, after which costs are often borne by the entity.

Whilst it is not always possible to amend or negotiate agreements with third party suppliers, in particular broking/clear-ing and exchange membership arrange-ments, care should be taken to understand all obligations on the individual founders and the new entity set out in them; legal advice at this stage is important, says Tyfield.

Be prepared to comply with myriad rules governing actually running a busi-ness, including employer’s H&S obligations, operating bank accounts, tax registrations, accounts filing, payroll, employer’s liability

Legal obligations: getting it right from the outsetGetting the legal basics right when starting out is essential to any new business but the stakes are even higher for proprietary trading businesses and no matter how good your strategies, legal mistakes could sink your new venture.


Introduction7ProP trading suPPlement Legal requirements

insurance, potential pension obligations.

Seeking investmentSome firms will require investment and determining and identifying particular types or groups of investors is the first step in this process.

Tyfield says: “Determine how to approach and negotiate with potential investors; different rules apply in many EU member states about ‘private placements’ and be aware that if you approach US investors, not only may ‘private placement’ rules apply, but unless appropriate rules are followed, even a proprietary trading form could be regarded as a commodity pool operator, in which case, it does not want to be an unauthorised CPO.”

Consider the time frame in which you want to be up and running. Factor-in regu-latory obligations and any authorisations re-quired into timetable and costs: regulatory capital requirements; regulatory reporting obligations regulatory filings; exchange fees and memberships (where applicable) and on-going compliance all cost money and take up management time, says Tyfield.

Draw-up term sheets to discuss with potential investors and, if possible, draft a rough document suite to send to potential investors.

“Investors will likely be looking for P&L projections, head count projections and an understanding of their day-to-day roles and oversight of the business on a strategic basis,” adds Tyfield.

Your legal adviser will be instrumental in the process of drawing up your pitch to investors. In addition you will need non-disclosure/confidentiality agreement for, and be prepared to sign one with, potential investors.

Registration and regula-tionProprietary trading firms have traditionally been relatively unregulated compared to other financial service firms. Currently the regime for prop firms differs across Europe and in the UK there is no requirement for a prop house to be regulated unless they are offering dealing services to the public, which does not include trading anonymously on an electronic order book.

Despite this, many firms do choose to be regulated. Some FCMs insist on it while some start-ups may do so for prestige purposes, especially if you are seeking to take on non-director traders. Some also sense the regulatory winds are blowing in the direction of greater regulation for prop firms.

The upcoming update to the Markets in Financial Instruments Directive (Mifid II), requires prop trading firms that are direct members of a market, HFT or provided with direct market access to be authorised and regulated by their home state.

Depending on the style of trading you employ, the new regulatory framework will have a differing impact with high-frequency and commodity traders being the hardest hit from the European Markets Infrastructure Regulation (Emir) and Mifid II. However, almost all firms are likely to experience increased regulatory oversight in the coming years.

“Whilst there are likely to remain a number of exemptions that some firms could rely upon to stay outside the net for compulsory authorisation, by the end of 2016 these exemptions will be signifi-cantly curtailed even for proprietary trading firms,” says Tyfield.

“The rules and regulations will remain in a state of flux for some time (with signifi-cant detail being left to technical guidance and standards that will be released over time), so founders who are considering HFT or market making strategies or becom-ing a member of a regulated market or an multi-lateral trading facility should take the approach that they will need to become authorised and regulated.”

Two speed EuropeFurther complicating the regulatory envi-ronment for some firms is the fact that Germany has moved ahead with separate legislation for HFT firms, which will require them to be a Mifid authorised firm or to register in Germany.

William Garner, a partner at law firm Speechly Bircham, says: “Mifid exempts many prop trading firms and derivatives traders from being regulated. However, [German regulator] Bafin is seeking to regulate HFT firms trading on German exchanges. If you are not regulated in Ger-many you need a Mifid passport to trade or seek an exemption on a case by case basis.

“For those firms in the UK that are regulated as non-Mifid firms, UK deriva-tives locals for example, it was unclear how the case by case basis would work. Currently most exemption applications have been rejected meaning that firms will have to be regulated in Germany or regulated in the UK under Mifid.”

Tyfield warns that other EU member states may follow Germany’s lead in the run-up to Mifid II.

Being regulated under Mifid brings a number of requirements ranging from the

need to have financial statements audited to having to report trading information to the Financial Conduct Authority. However, the greatest burden, for smaller firms at least, is the requirement to hold e730,000 of minimum capital, which may be a greater requirement than a clearing firm imposes.

Some regulatory requirements will apply whether or not a firm is authorised and regulated – for example, under Emir, all EU firms have been required to report their exchange traded transactions from February 12.

Other legislative processes are in place, too, which will affect proprietary trading firms (and in particular algorithmic trading firms), including the review of the Markets Abuse Directive and the Protection of Undisclosed Know-How.

“Venues rules are changing to keep in line with proposed regulation and advances in technology,” says Tyfield. “There are a large number of developments which any proprietary trading firm needs to keep up with, relying on your FCM for all information may no longer be viable.”

And then, of course, there is the spec-tre of the financial transaction tax, which is haunting the European and US markets. Hopes that proposals would go away in Eu-rope after the German elections are fading and the political and popular will to imple-ment an FTT if anything grows stronger.

The scope and terms of the tax are yet to become clear but the possibility of its introduction should be a consideration for any business looking into the costs of set-ting up in the business, says Tyfield.

The proprietary trading market is becoming more sophisticated and profes-sional by the day but the greater regulatory oversight will increase costs for some firms and the need to seek legal advice from the outset increases with the regula-tory burden.

Key legal points to consider:

• Haveyoucompliedwithyourexistingemploymentcontract?

• Doyouneedexternalinvestmentinthenewbusiness?

• Aretheagreementsbetweendirectorsinplace?

• DoyouneedtoberegulatedunderMifid?

• HaveyouplannedapossibleFTTinyourbusinessplan?

• Doyourthirdpartycontractsmeetyourneeds?


8 ProP trading suPPlementClearing

“Your clearer is your best friend in this business. You have daily conversations and they are at the heart of your business,” says Neil Crammond, a veteran in the London prop market.

No wonder then that choosing your clearing firm is one of the most important decisions any new prop business will take. A clearing firm will be responsible for a range of services from providing technology and exchange connectivity, to setting daily margin levels and leverage, and, in some instances, renting the desks from which you trade.

They will also be the main point of contact for any firm setting up in the prop business from the outset so a decision on who to clear and trade via with should be made as early as possible.

Clearing firms operating in the pro-prietary trading market range from the large investment banks to specialist firms exclusively focused on the prop market. In addition to the main clearers, a number of firms operate proprietary trading hubs offer-

ing infrastructure and funding to prop busi-nesses but clearing through a third party.

Leveraging your tradesClearing members assume full financial and performance responsibility to the clearing house and are responsible and account-able for every position a prop trading client places on to the market.

Prop firms that are not members of an exchange route their orders through their clearers to the markets through order routing facilities provided by the clearing

member so the prop trading firms do not access the market directly, they obtain access via the clearer who typically also clears all the trades they place onto the markets.

Whether it is a direct clearing member or a proprietary trading hub that clears through a direct member, these firms set the daily leverage and manage margin calls controlling the oxygen supply to a prop business.

Levels of leverage granted to prop houses have fallen dramatically over the past five years and anecdotal reports sug-gest a typical overall leverage today will be around 4:1.

However, this varies significantly de-pending on what you are trading and who you are. A trader with a long track record trading liquid products should expect higher leverage than a novice trading obscure products.

Ollie Jones, co-head of Professional Trader Services, a division of Marex Spec-tron, says: “We provide intraday leverage

Trading places: choosing your clearing partnerYour clearing firm will be the heart of your business providing a range of services and support in the early days and beyond. There are a number of firms out there vying for your business and choosing the right one will depend on your needs and ambitions.

“You have to earn the leverage but it is an important part of your business as it can triple or quadruple profitability”Ollie Jones, Marex Spectron

The information published in this publication is for general information purposes only. It is not intended to constitute investment advice nor is it intended for solicitation purposes.Eurex is not responsible for any errors or omissions contained in this publication. Before trading, persons should consider the risks involved and the legal requirements of therelevant jurisdiction. Not all products mentioned in this publication are currently available for offer or sale to, or trading by, United States persons. Korea Exchange, KRX, KOSPIand KOSPI 200 are registered trademarks of Korea Exchange Inc. BSE and SENSEX are trademarks/service marks of Bombay Stock Exchange (BSE).

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Eurex Reappraisal, FOW Prop Shop, February 2014_FOW 24.02.14 14:54 Seite 1


10 ProP trading suPPlementClearing

on a case by case basis. We very rarely provide overnight leverage. The amount of leverage will vary from individual to individ-ual and is largely based on the track record we have with that person or firm and the type of strategy they want to employ.

“We have to understand the style of trading and get to know the trader. You have to earn the leverage but it is an important part of your business as it can triple or quadruple profitability. We are very much of the opinion that earning that leverage should be a slow process.”

Your clearing or hosting firm will also set your trading limits and monitor your trading on an intra-day basis. Mark Phelps, global head of sales at G.H. Financials, says a factor in setting trading limits will be how much capital a firm has. “Typically the larger the capital on deposit, the larger the limits that are granted,” he says.

“Undercapitalised firms have smaller limits than well capitalised firms, these firms then have less firepower in the market and access to fewer markets, so it’s harder to make money. Historically this issue was less of a factor as there were more opportunities for margin financing from clearers, but this is less and less common these days.”

Negotiating an agreementCosts for clearing firms vary from a simple commission per trade to a range of fees for desk rental and profit share as well as rates depending on a number of factors from trading volumes to the amount of kit required.

If you are renting desk space from your clearer, you will pay a desk fee that covers the basic costs of the hardware on your desk and the cost of keeping the lights on. Desk fees vary from firm to firm but will typically be bundled in with your technology costs.

Clearing firms will also facilitate your technology requirements often providing the infrastructure to trade. All will also have a roster of independent software ven-dors that they work with to provide a range of services including connectivity, charting and market data.

More information on technology options can be found in the next section but costs for desk fee and the basic technology pack-age including exchange connectivity, charting and market data will generally be around £1500-2000 per month for a sole trader with the bulk of that going on the technology.

You then have to pay a commission per lot that you trade. Most clearing firms will reduce the fees as the volume increases but every clearer will charge a commission per

lot depending on products and currencies. You then have to pay exchange fees – all

the exchanges are vying for business so look to see if you can join any new trader participation programmes in which the ex-changes will give you an amount of volume free (for more on this see the section on technology and exchanges).

Depending on the capital you are putting up, the leverage given and the limits being provided, a clearing or hosting firm may ask for a profit share. Traders that are fully funded and trading 100% of their own capi-tal constantly within their limits generally wouldn’t be charged a profit share.

Most firms and individuals, however, will require some leverage and the profit share will be dependent upon the indi-vidual circumstances but will range from around 50% for a non-salaried, seeded graduate who has come through a training programme to 10% for a firm or individual that requires little financial backing.

Choosing the right partnerClearing firms and trading hubs compete in a number of areas with leverage and fees being at the top of the list. Cost is obviously an essential for any new firm but make sure that you understand the total costs embedded within the agreement. Some firms may advertise a low headline fee but not pass on exchange rebates for example so ensure you have a holistic view of charges.

Choosing the right firm for your busi-ness is also about more than just the fees. Culture varies significantly from firm to firm, especially where desk space is rented out.

Some firms promote a culture of sharing information and helping out other traders, others promote internal competi-tion. Choosing the right culture for you is essential for a happy and mutually profit-able relationship.

When it comes to clearing, smaller prop houses could benefit from choosing a firm

focused on them. Some of the larger clear-ing firms will not take on start-ups with low volumes of trading and no trading track record. However, there are a number of firms set up to target the prop market.

G.H. Financials’ Mark Phelps says choosing a firm with experience of new start-ups is important. “One of the main considerations is finding a clearer that will be able to give them the attention they are going to require, especially during the first few months when there will no doubt be bumps to iron out.

“What you don’t want when you are starting your business is to have to wait long periods for fairly minor issues to be resolved, such as changes to limits or to obtain an ISV licence. This can slow you down and throw your projections for trading and hopefully making money off track.

“It’s also vitally important that you find a clearer that can give you access to all the markets you want to trade. Firms should also consider the experience of the clearer in the sector they want to trade.”

Once you have selected your clearing or hosting partner, you will need to sign ac-count opening documentation. You clearing firm will need to do Know-your-customer checks on you and you will have to agree the terms of business, generally based upon the standard Futures and Options Association documentation with any additional profit share agreements embedded within that.

You will talk to your clearer more than you talk to your family in the early days of the new venture so choosing the right firm for you is essential. Fees, culture and a deep understanding of your business and its requirements are the key components for a healthy and profitable clearing rela-tionship.

Key clearing points to consider:

• Howmuchleveragedoesyourstrategyneed?

• Canyouproveyourtradingtrackrecordandstrategy?

• Haveyouunderstoodhowmuchmarginyourstrategyneeds?

• Areyouplanningonrentingyourownpremises?

• Howmuchmoneydoyouhaveonhandtoputintoyourtradingaccount?

• Whatservicesdoyouneedfromaclearingmember?

• Areyourealisticaboutyourprofitshareexpectations?

“Undercapitalised firms have smaller limits than well capitalised firms, these firms then have less firepower in the market and access to fewer markets, so it’s harder to make money.”Mark Phelps, G.H. Financials

From our o�ces in all major financial and government centers in the United States and London, Vedder Price delivers the breadth of legal services that proprietary trading firms need throughout their life cycle.

Seamless,E�cient,Practical.Cross-Border Legal Counsel for Proprietary Trading Firms

Chicago • New York • Washington, DC • London • San Francisco

Vedder Price P.C. is affiliated with Vedder Price LLP, which operates in England and Wales, and with Vedder Price (CA), LLP, which operates in California.

www.vedderprice.com

What can we do for you?

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12 ProP trading suPPlementTechnology

“Markets have moved on, driven by a change in technology. People coming into the market today are not just required to understand market fundamentals and point-and-click,” says Ollie Jones, co-head of Professional Trading Services at Marex Spectron.

“They have to take their understanding and analysis further and use bespoke tools to help them better understand the market and where the opportunities are. All our clients have become more sophisticated and new prop traders need to keep up.”

The good news is the cost of technology is falling and growing competition within Europe means exchanges are keener for your business than ever before resulting in generous incentive schemes for new trad-ing businesses.

“It has never been simpler to set up a prop business from a technology per-spective,” says Steve Thomas, managing director of Stellar Trading Systems. “One of the key reasons for that is the evolution of hosted services.

“If you were setting up five years ago, you might have had a dozen servers and your own lines to the exchanges. Now you can just have one line to your clearer or possibly just one line to your vendor and get a fully hosted offering.”

Host with the mostHosted IT infrastructure is offered by a

range of providers and has significantly lowered the barrier to entry for new pro-prietary trading businesses. Aside from outsourcing the technology infrastructure, ISVs offer a range of hosted services that will help any new prop business.

An ISV will typically help with setting up user groups and hierarchies, work with the clearer to help establish trading limits, manage exchange connectivity, assist with any additional requirements such as lower latency services and colocation and prepar-ing any algorithms.

Firms seeking lower latency no longer need to establish direct contact with a data centre and take out a cabinet themselves. Now they can approach an ISV and arrange a hosted colocation service directly with the one supplier and gain advantage of the economies of scale that an ISV will have with the data centre and exchange.

So what differentiates ISVs? Obviously cost is a key issue for any new prop house and that will be a consideration. The good news is costs in the front end are generally coming down. Last May, Trading Technolo-gies made headlines with a fee reduction, the first in its history and ISVs are increas-ingly offering more for less.

“Another key differentiator can be service,” says Thomas. “Some vendors will simply sell you a screen, others will partner with you to ensure that you get a system best suited to your needs with functionality

that has been customised for proprietary trading.

“Proprietary trading firms in particular are early adopters of new concepts and need a vendor who is innovative and able to respond quickly to their requests.”

Other considerations are the look and feel of the technology platform, the number of exchanges the software connects to, the importance of which will naturally vary de-pending on the strategies and scope of the trading business and any additional func-tionality such as spreading or algo building that you may need for your strategies.

Clearing firms and brokers tradition-ally provided technology to their clients but in recent years there has been a more distinct division of labour as clear-ers outsource the technology to specialist software providers. This has coincided with the move towards hosting from ISVs.

Software prices for the front end ISV start at around £300 a month and can reach £1000-1500 depending on the level of functionality. Synthetic spread-ing, colocation and algo capabilities will push the costs higher but the entry level multi-market access and charting will cost around £500-600 per month.

Brian Haag, group product manager for proprietary trading at Trading Technologies, says: “Your technology requirements will depend on what sort of trading strategy you are going to be pursuing. Are you going to be chasing arbitrages across different exchanges?

“Are you going to be trading statistical arbitrage where you hold inventory? How long is a trade going to last on average? The technology that is suitable for you is specific to the kind of trades you are going to be doing.”

Mark Phelps of G.H. Financials warns firms should not over-estimate their requirements. “A common mistake [for people setting-up in the business] is not properly understanding what technology requirements you have.

Get connected: Choosing the right tech for your needsTechnology is at the heart of the modern trading business and even the most traditional point-and-click traders will require an arsenal of technology behind them. From market data to connectivity, charting to spreading, any new entrant to the prop world has myriad consid-erations and options when it comes to the technology rig they use to trade.


Introduction13ProP trading suPPlement Technology

“I see some people that set up businesses convinced that they need ultra-low latency market access, co-location services, when it reality they may have been better going for one of the off the shelf medium latency options that are infi-nitely cheaper to set up.

“My advice is always, why don’t you try a cheaper solu-tion, get proof of concept for six months and then evaluate whether or not you need the more expensive solution?”

Exchange connectivityMost new point-and-click trad-ers will connect to an exchange via their ISV but if you are going to be working on low-latency strategies or market making, you will need a more bespoke connection with colocation the best option. That can be arranged directly with the exchange or via a third party provider that rents rackspace such as RTS, Stellar or Object Trading.

Colocation costs don’t come cheap and can typically be around £3500-5000 per month per exchange so very rarely does the one-man-band choose this option but for anyone in the low latency market, these costs are essential.

If you are building inhouse software, this will need to be approved and certified by the exchange. Connectivity options to the exchange range from a simple internet con-nection to a 10GB colocated line for those seeking the highest speeds.

“There is 10% of the market that can trade with just a TradeStation; the top 10% of the market has to spend millions to trade. The remaining 80% can do every-thing they need to do with tools such as ours,” says Haag.

If you are in the high frequency low la-tency game, you are looking at investments running into the millions.

“Everything is only as fast as the slow-est part of the infrastructure. Every compo-nent has to be the best in class for the sys-tem to perform at the speeds you need it to. It is extremely expensive to stay ahead. It is not unusual for firms in the extreme low latency game to spend $100,000 a day on infrastructure.”

Getting the rebatesAll derivatives exchanges will offer some sort of volume incentive to their traders and getting on the right programme could

save significant sums. Many exchanges will also offer new trader incentives as well as a number of different fee structures with some aimed specifically at proprietary trad-ing businesses.

Once you have decided how you are going to connect to an exchange, the next thing to consider is whether it makes sense to become a member of the main exchang-es you are trading on. This decision will depend on the volume of trades you will be doing and also the membership structure of the exchange.

Membership offers different benefits for different exchanges. For some, such as the Chicago Mercantile Exchange, it gives access to cheaper fees, for others it opens up additional incentives. Some charge large up-front fees, others require minimum trading volumes during a set period.

The exchange will help new members with the onboarding process. There are standard checks such as ensuring that you have the structural and legal set up that is required, the regulatory status and sufficient back office staff. A lot of these discussions will influence the decisions a new member takes over what to outsource to its clearing member and what to operate in house.

Reny Morsch, senior vice president, business development at Eurex, says: “Deciding whether to become a member depends on the business model and in particular on the volumes you are trading. If you are a prop trading firm and you are exceeding a volume threshold in a certain asset class, you can get volume rebates as a member that you can’t get as a client of a member.

“We have seen a number of prop firms that specialise in market making that become a member straight away but for manual trading firms it can take a bit

longer before they are ready to become a member.”

Many exchanges will offer incentive schemes for new traders. Eurex, for exam-ple, offers incentives for new traders via its Trader Development Programme through which member firms can offer fee waivers to new traders.

The scheme varies region by region but in Europe is available to manual traders with less than one year’s trading experience and offer free trading on contracts of up to 35,000 contracts a month dependent on volume.

Stuart Heath, executive director at Eurex, says: “We are trying to support new participants in the market but also the companies that are developing the traders. There is a significant effort put in to train-ing a new person and firms now take up to 18 months of training to get the traders up to speed and we want to support firms investing in that.”

Eurex also offers fee waivers for new members in the first year of trading as does the CME via its New Trader Incentive Programme, under which new proprietary trading firms qualify for a fee waiver for up to 50,000 trades subject to certain minimum volume and acceptance criteria requirements.

For CME Group customers the scheme is a good way of getting access to lower fees without becoming a member. Liffe, as with other exchanges, offers a range of liquidity incentives based on the volume of trades.

Technology is the crucial element in any modern trading business and the plethora of choice in the market is both an opportunity and a challenge as a new trading businesses needs to find the right technology at the right price point for their business.

Stuart Heath: “We are trying to support new participants in the market.”

Brian Haag: “Your technology requirements will depend on your trading strategy.”

Key technology and exchange questions to consider:

• Isyourtradingstrategylatencysensitive?

• Howmuchofyourtechnologydoyouneedtobebespoke?

• Doyourtechnologyrequirementsfityourtradingstrategy?

• Doesitmakesenseforyoutobecomeanexchangemember?

• Haveyoufactoredtechnologycostsintoyourtradingmodel?

• Areyouawareofallincentivesandrebatesonyourpreferredexchanges?


14 ProP trading suPPlementContact Directory

EURExEurex Exchange is one of the world’s leading derivatives exchanges. It offers more than 2000 products covering all major as well as alternative asset classes – all tradable on one single platform. Our marketplace is gateway to the most heavily traded euro-denominated equity index and fixed income derivatives as well as providing our customers with trading opportunities in volatility and dividend derivatives. Our innovative and reliable IT infrastructure gives more than 400 participants and 7,600 traders in 35 countries worldwide access to our products and services. Eurex Exchange is a firm supporter of the proprietary trading community and will continue its successful Trader Development Program initiative supporting traders new to Eurex markets by providing fee incentives as well as educational support.

Contact: Reny Morsch, Vice President, Business Development.T: +44 (0)20 7862 7224 • [email protected]

TRADING TECHNOLOGIESProviding award-winning software and solutions for electronic derivatives trading, Trading Technologies has been a leader in the fast-paced world of high-performance electronic trading since the first version of our flagship product, X_TRADER, launched in 1994. Our innovations allow professional traders in virtually any location to access and trade the global derivatives markets from a single computer screen. X_TRADER is the front-end execution solution of choice for professional traders who want broker-neutral global market access from a single platform. X_TRADER incorporates many proprietary technologies and industry-leading features including MD Trader, the patented ladder that is the best available tool for point-and-click trading. The TT platform also incorporates high-frequency trading tools, server-based execution engines, advanced charting and analytics capabilities, powerful but user-friendly APIs, tools for risk managers and administrators and the TTNET fully managed hosting solution.

[email protected] • T: +44 (0)207 929 6161

G.H. FINANCIALSG.H. Financials has over twenty years’ experience providing Futures & Options Clearing Services as a Futures Commission Merchant. We provide a full service, professional and cost-effective clearing services for our clients on the world’s leading futures and options exchanges. G.H. Financials Futures & Options Clearing Services are used by a wide range of market participants, from large financial institutions to proprietary traders. Our technology and our ethos of working in partnership with our clients allow us to develop tailored solutions that fully meet and exceed client requirements. We have a continuing focus on using the best technology and developing client relationships so we can work in partnership with our clients to grow their business.

Contact: Mark Phelps, Global Head of Sales and Marketing.T: +1 312 544 0316 ext. 2102 • [email protected]

STELLAR TRADING SYSTEMSStellar Trading Systems specialises in producing fast and powerful trading systems for the high frequency, high volume trader. Stellar provides a complete trading system solution with an intuitive front end, comprehensive order and risk management, combined with industry leading performance. Stellar delivers cutting edge trading capabilities to the professional trader. Every aspect of Stellar, from price dissemination, to limit checks, and to exchange submission has an emphasis on speed. Stellar is easy to use, robust and scalable. Whether deployed in a 20 or 200+ trader operation, Stellar delivers excellent performance through the busiest of market conditions. Stellar acts as a consolidator, removing the need for multiple legacy systems by delivering a broad, scalable architecture that meets the needs of the whole trading organisation, from risk manager, to IT, to the individual and specialist needs of each trader.

Contact: Steve Thomas, Managing Director • T: +44 (0)20 7664 6450 • [email protected]

VEDDER PRICE

Attorneys across Vedder Price’s Investment Services, Finance & Transactions, Labor & Employment, Business Immigration, Data Privacy & Security, Intellectual Property and Litigation practices have significant experience in all aspects of the proprietary trading industry. From offices in all major financial and government centers in the United States and London, the firm’s cross-border team of attorneys provide seamless, efficient and practical legal counsel to proprietary trading firms, as well as their founders, investors, officers and employees. UK transactions are led by Partner Sam Tyfield, who has been COO and GC of an electronic trading prop shop and is a member of numerous industry organisations that draft best practices and address technological, regulatory, risk management and infrastructure challenges facing the industry. Contact: Sam Tyfield, Partner • T: +44 (0)20 3667 2940 • [email protected]

Chicago • New York • Washington, DC • London • San Francisco

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Sponsorship and exhibiting: Helen Seidenberg: [email protected] • +44 207 779 8351

Nicole Berkland: [email protected] • +1 312 480 8318 Speaker opportunities, media partnerships and press: Yasmin Okolo: [email protected] • +44 207 779 8046

For more information visit www.fowevents.com

Coming up in 2014

Why attend FOW events?

• Listen to industry experts debate the most important topics of the day during our panel discussions

• Hear unique presentations from our key note speakers

• Network with clients and industry peers during our networking breaks, lunches and drinks receptions

• Broker new business and position your company to thrive in this period of recovery

Contact us

FOW TradiNg amSTerdam25th March • The Hilton Apollolaan Hotel, Amsterdam

derivaTiveS WOrLd aSia2nd – 3rd of April • The Renaissance Harbour View, Hong Kong

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derivaTiveS WOrLd CeNTraL & eaSTerN eurOpe14th October • Intercontinental, Warsaw

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