Jubin Pejman is the founder and managing director of FCM360, a technology solutions provider for derivatives trading firms. He has had a varied career in the financial space, working for firms ranging from Oppenheimer to Long Term Capital Management to Trayport and GFI over the past 15-plus years. Pejman spoke about his days at Long Term Capital Management and where he thinks trading technology and energy and commodities trading is going.
Q: How did you get started?
A: My first official job on Wall Street out of school was managing a cash portfolio at Oppenheimer. Then I went to Long Term Capital Management to work on the trading desk where I was trading repos and commodities, options, and foreign exchange. It was a time when there were a lot of interesting things happening electronically.
I saw the huge difference between investing in electronic infrastructure and technology versus what I saw at Oppenheimer, and I really started working on automating the trading desk from a risk management and reporting standpoint in order to make better decisions. When I was done at LTCM, I went straight into managing American Express online brokerage services, where I was in charge of a reasonable size electronic brokerage operation. I really loved it, being able to facilitate trades, giving the end user access to technology that wasn’t really available before. From that standpoint, I started using that retail electronic trading knowledge, which was more sophisticated than anything institutional, to develop straight through processing (STP) platforms for banks, so they could immediately start doing close of day reconciliation and processing wouldn’t run into morning trading hours.
I went into venture capital at that point and worked on the Lab Morgan team at JP Morgan, which was basically to finance e-commerce and electronic trading systems. Somewhere along the line I started seeing a tremendous value in the energy and commodities business from a social and satisfaction standpoint, because it’s one of the only things in the investment business you can touch and it hits almost everyone around the world. After running my own software company for a few years, TrayPort gave me a call to help develop the commodity trading platform in the Americas. I thought it was very interesting, so for the past five years, I’ve been focusing on energy and commodities.
Q: Long Term Capital Management — were you there for the implosion?
A: I resigned a month before the implosion. It was not a coincidence.
Q: I would say it was pretty good timing that you got out of there. What did you do for them? Were you working on their automated stuff as well?
A: I was working on the trading desk as part of a three man team that managed the bulk of the positions. We did all the foreign exchange trading, all the repos and financing. I was primarily responsible for looking after the P&L for all the different portfolios. That basically meant looking at futures portfolios, commodities portfolio, futures, convertible bond arbitrage, as well as equity arbitrage. For every one of those accounts, I was looking at it from the standpoint of making sure things were running smoothly but also making sure that P&L was being afforded properly. Then there were financing responsibilities: instructing the off-shore administrator how to handle different types of inflows and outflows into the fund and things like that. It was a very small group of people touching about $160 billion to $200 billion of a balance sheet, which was very interesting to me. At that point, it was just unheard of to have nearly $5 billion under management and touching $200 billion on a balance sheet. At one point it was 50- to 60-to-one leverage. From that standpoint, there was a tremendous amount of pressure and stress that had to be mitigated by being on the ball and making sure things were running smoothly. The numbers and trades were all done accurately. Unfortunately there were just a lot of other factors there.
Q: What did you take away from LTCM?
A: The walk-away from LTCM is that it was a revolutionary time period and a revolutionary business that showed the world that a handful of smart guys who really put their brains to it could do phenomenal things. It opened my eyes up to really understanding how to implement technology within finance to make it more efficient, make it work better, and to provide valuable services. That’s one side of it.
The other thing you learn is that you can’t build a trading model and assume that it will work because you have a Nobel Prize. Just as you can’t build a car and think that it will instantly run forever just because you can get it to start and it seems to work for limited time. There are a lot of moving parts in the world and we’re not autonomous. What really hits home is that the world of finance is so complex you should always expect the unexpected.
There were two key things in my mind. The model itself was not a panacea and could not maintain a positive return. The other thing is, there acts of God, acts of presidents and acts of people that run governments and other things in this world to take into account. When Boris Yeltsin came out and said Russia was going to default on its sovereign debt, it just destroyed their market. Right before I left, we were putting on Euro-Russian bonds. When you look at that, you’re taking a huge exposure that’s extremely leveraged and you’re assuming that the sovereign nation will not default on its debt. That’s part of the equation. That’s like when you take a mortgage out and you don’t think you’re going to get laid off your job. It’s pretty likely to happen at some point in your life. These are the kinds of things where you have to expect the unexpected. Don’t count on academia to solve your problems, because academia works well in a bubble for a few years. But after that, the fund itself was not really profitable after a certain amount of time and no one in the public really understood that.
When you’re losing year after year, when you’re betting against the S&P 500 and short for two straight years because the model says you have to bet against it even though the market is telling you no, it’s going higher—that is the type of thing you really need to check yourself on and you why you need that rule set. You need to really do risk management outside of the model.
Q: Let’s talk about FCM360. Tell me about the firm.
A: Basically what FCM360 does is provide low latency trading infrastructure, proximity hosting and exchange connectivity for financial companies. It means that we manage your systems and facilitate your electronic trading. We can run your front end trading system for you, install your risk systems and put any of your corporate platforms into different data centers that suite your trading needs. We try to differentiate ourselves in that we’re really good at the financial markets, and the people we work with at FCM360 have a pretty long track record of either being traders, brokers, or working on high-frequency trading infrastructure.
We can provide low latency access to over 50 derivatives and equity exchanges. FCM360 is sort of like a hedge fund hotel without the trading desk chairs because it can provide an entire electronic infrastructure and access to what you need to run your business. We can put the trading and phone turrets in your different locations to connect your offices, whether you’re in Chicago, London or New York. It is really an infrastructure-slash-low latency connectivity play.
Q: I’m going to focus on the energy side of your clients. What’s happening in the energy space today and how does FCM360 kind of fit in with that trend?
A: The nature of the business of the energy and commodity sector has been on cruise control for a long time and has been a very overlooked sector for decades. A lot of money has poured into fixed income and equity from a systems and regulatory standpoint and most of what you have heard in the news has been about Treasury bonds, corporate debt, junk bonds, stocks that are imploding, and it really hits home with legislators over time and hits home with the US population.
Now you see tremendous growth in the energy and commodity space. In 2008 we saw a record level in petroleum prices, natural gas, crude, sugar, all the different commodities. Now there’s a huge focus on regulation. This affects your price at the gas pump, affects price on a loaf of bread and if you want to buy a t-shirt. That’s the kind of stuff Americans really care about. Until it started hitting the pump and the price of bread, Americans really didn’t pay attention to the commodities or energy sector. All of a sudden it became, “my 401k is very important to me.” So basically what went on is that there’s a huge push to actually start regulating these markets.
Now you see the CFTC making comments on electronic trading. Does this hedge fund or equity firm have a tremendous edge or unfair advantage over another entity or individual investor in the futures market who is not co-located in a data center near the exchange? They make general statements like that and say hedge funds and other organizations have a greater advantage in having better executions because they are co-located. The funny thing is, I don’t think anyone besides IT professionals even knew what co-location meant. But now all of a sudden you hop around the different funds or brokers and they say, “I want co-location because I want to get a fair fill.”
Where we come in is being a turn-key solution for that. We can say “All right, you can still do your voice brokerage, and electronic brokerage, but you’re not going to hire 20 or 30 people for your organization to try to figure this out. There are people that know systems and electronic trading really well and can help you install the systems you need for compliance. Just like we went through different SEC compliance there’s going to be a lot of CFTC compliance.” It goes hand in hand with what happened in Europe, where they are in a better position for any changes in the market because they already have the systems in place, have a head start and are used to using the system. There’s going to be a huge learning curve for a lot of the brokers and traders now, where they’re forced to put trades in a certain system. We hope to help the smaller companies or the mid-size companies execute that.
Q: We both know the energy sector is still pretty largely a voice broker business, so how do you see the voice broker vs electronic trading trend going in that sector?
A: You’re going to see a lot more people getting into energy. Just look at what happened with the ETF market. I don’t know the exact number of ETFs there are focusing on grains and commodities right now but about 20 years ago there were something like 200 hedge funds in this country, and by 2008 there were around 2000-plus hedge funds. The same trend is happening in ETFs. There was exponential growth particularly in the energy and commodities sector ETFs between 2003 and 2007. You see a lot of people putting money there.
But we’re about four or five decades off from the average investor saying, “Oh, I have a grains fund.” And it rolls off their tongue as easily as, “Oh, I’ve got a value fund” or “I’ve got a cash fund.” That sort of evolution is happening now. Again, 20 or 30 years ago this started happening when a lot of companies started introducing retirement plans and the 401k law was passed. We will see a lot of that going on in the future and there are going to be a lot of people trying to capitalize on it.
Q: So to wrap that around a voice broker versus an electronic order entry type of trend, are you saying because of this flood of capital into these markets, that we’re just going to need more automated tools to use?
A: I’ll give you an example. We’re helping some brokers right now in Chicago to gain access to the Latin American grain markets. The ideal scenario for them is to have a lot of deal flow in both (voice and electronic), but that’s going to mean we’re going to be installing some systems down in Latin America to provide proximity hosting and that means that the brokers are counting on high-frequency trading being a draw in a new market. So of course everyone can gain access to those Latin America grain markets but when you are bundling the core service with the high-frequency trading service or co-location, that means that your clients are all going to be guaranteed a fair shake at the exchange. So, to answer your question, yes technology will keep advancing and you’ll see a lot of countries in Latin America like Mexico, Brazil, Argentina and Chile putting a lot of infrastructure investment into their matching engines. You will also see a lot of cross corporation partnerships and cross market product lifting and eventually cross margining between the larger derivative exchanges and the US and Latin America. There’s a tremendous amount of money to be made by voice brokering the contracts that way. So there will be growth in both.
Q: Everybody’s talking about speed of execution depending on what type of firm you are. So what are firms looking for when they come to you now and what do they need in terms of high-speed or high-frequency trading today?
A: The two types of traders we deal with the most are high-frequency and low-latency traders. There is the kind of firm that trades from London to New York to Chicago having their people sitting in London and needs a low-latency ring to facilitate basic electronic trading. The generally accepted low-latency stamp that you would put on something is 18 milliseconds between Chicago and New York and 68 milliseconds between London and New York. When you look at it in terms of high-frequency or algorithmic trading however, that really doesn’t cut it. So that’s why we’re seeing companies from Ireland and UK actually collocating in New Jersey so they can get access to different foreign exchange matching engines that are sitting just outside of New York.
I’ll give you an example. We have a data center in Secaucus, NJ and we have a data center in Jersey City. In that distance right over the Internet, the quality of our lines are so good that we can get less than one millisecond latency round trip between our cages in those two data centers without a dedicated connection. Now if we used a fixed fiber connection between those two locations we we would be substantially lower than 500 microseconds round trip. My point is, if you’re an FX trader and you want to hit the liquidity pool in the US, you don’t want to do high-frequency trading from London to New York or New Jersey. You want to co-locate in New Jersey so you can actually hit that entire New York metro area.
If someone’s looking for low latency or high-frequency trading infrastructure like exchange proximity hosting, I think a lot of the traders probably would not be able to take advantage of it in terms of making money. The advantage of having top notch Internet, top notch bandwidth, power redundancies, backup and all that is actually buying security and peace of mind so that no matter what you want to do, it will be the best and it won’t fail you. That’s the thing that should really hit home with a lot of traders and brokers. They won’t be able monetize a lot of the differences in latency unless their algo is really geared towards that. But the thing it will do is insure them in times of trouble where if they were trading over the Internet or between different locations a thousand or two thousand miles away, those same problems could not pop up because there’s so much less in between that can break.
Your model either makes money or it doesn’t. Then you have to figure out do you really need to have some microsecond latency to make money. If so, you need to be one cross-connect away from that exchange and nothing else will matter to you. The majority of traders could really live with 100 milliseconds which means that the majority of the OTC traders that I’ve serviced over time that are sitting between Chicago and London have absolutely no problem with the 76- to100-milliseconds away on their system. It makes absolutely no difference to them.
Q: Let’s touch base on the weather side of things because I know that’s a new kind of trading application. Let’s start with weather data, also a key part of the energy trading space and not just energy, we can talk about grains too. You just added some weather trading applications—can you tell me what they do?
A: We’re working with Weather Insight to co-locate their applications onto our ‘back-bone’ and offer them as a cloud-based service. In other words, if somebody wants the weather dashboard with the map overlays, we can actually give it to them in a virtual machine that they log into from their desktops, so there’s never any need to procure any additional hardware, no need to do any installs or configurations that are time consuming, and there’s no need to install anything on the local desktop which may conflict with something. If you spill a coffee or something on your computer you can just go to someone else’s computer or a backup computer and log straight into the cloud-based solution. So that does a couple of things. The cloud based solution is on a top tier low-latency backbone, so you’re going to get that government weather data as quickly as possible. It’s going to be backed up, as far as UPS goes. You’ve got redundant BGP’s mesh network which basically means that the IP that we use at our data centers is essentially creating a network fabric of all of the top tier IP providers, so any time that there’s a latency drop of about 10 percent on the actual connectivity that they’re using, it round-robins to the next fastest provider. This is between the Verizon, ATT, Savvis, Global Crossing and Level3. That’s what you’re really getting.
Now we’ll get into what the applications actually do. The applications sit on top of the weather data. Weather Insight is one of the only weather analytic companies that has archived all of the US government’s available weather data forecasts. This covers the entire history of the decade- long weather derivatives business. The dashboard allows you to look at the weather across the Americas and correlate it to all the historic energy and commodities trades. Now when it comes to trading grains and trading energy, it’s obviously very different from fixed income and equities. When a tornado hits or when certain weather changes happens, the commodity traders need to know that. What the Weather Insight platform does is render certain information faster than anyone else on that weather dashboard in real time off that super-fast backbone, giving an edge to the trader. The second thing it’s doing is correlating price movements between commodities and weather movements over time. It can help you look at how traders have reacted historically and how premiums for contracts have changed based on historic weather movements.
Q: What type of market participant would really like this kind of technology?
A: The people that have historically used the product are major utilities, but there are a lot of hedge funds and prop shops using the service now in both the US and Europe. The Weather Insight dashboard is integrated into Trading Technologies’ X_Trader as well, so anyone who’s trading power or commodities on TT now has access to this unique tool set. If there’s a trader using any different type of ISV or any type of front-end or back-end, we can actually wrap that entire system up onto a cloud instance at our data center, allow them to take advantage of all the speed, power, redundancy and connectivity for their front-end systems and the weather system together. They can put different types of platforms into one redundant space and have great access to the weather feed, or say a NYMEX feed, it even has the NYSE if they want. They can partition the whole thing the way they need. It really puts you on par with the top notch hedge fund that has millions of dollars to invest in infrastructure. That’s really the interesting thing that goes back to your other question. FCM360 can set up this entire platform for a fraction of what it costs a trading firm to do it themselves. Q: Given the technology that you have and given the technology that you’re offering, when you look at using Weather Insight, using the data center services and the infrastructure that you’re providing to customers, and then you look at some of these commodity spaces like carbon, energy, weather markets and so on, where do you think we are in the evolution?
A: Right now, there are a lot of energy companies that have been doing traditional brokerage who are now getting into the retail energy space big time. They’re trying to get into different aspects of the client chain. So they’re going to be selling power, selling natural gas, doing emissions consulting, brokering and they’re also going to be going into demand response clients and try to up-sell them the same thing. On the trading side of the business there are commodities and energy brokers starting up new futures divisions. Now when you look at traditional OTC brokers like ICAP, they’ve recently recruited some pretty senior people out of the futures world to head up what they think is the next wave of brokers in the future’s industry.
The other thing is from the energy standpoint, I’m seeing a lot of interest in the weather trading application analytics from the carbon players in the European sector. So we’ve been approached by some people on the broker side and the weather side and they’re trying to see if there are some weather products and analytics they can offer to the existing energy clients. I think that if they can incorporate some of the weather and the past patterns correlations they can provide value, transparency and increase the volume of exchanges or their desks. So they can use that weather as color to call up clients to say, “Hey, it looks like the weather’s doing this. We’ve got some information right now that’s proprietary, unique and based on the past few movements in the past few years, this is what’s happened to these contracts.”
So again, we see natural gas and electricity play into carbon. When you predict long-term trends in the carbon market you’re going to be benchmarking carbon off of the German base-load, for instance, we can tell what happened with the German base-load, we can look at contracts up in Canada and we can look at contracts here in the US, and try to add more value. The other thing I would mention is that there are a lot of carbon players that are starting to get interested in trading natural gas. So you’re starting to see a little cross pollination between the carbon guys and natural gas looking at other types of markets. Carbon trading is starting to die down because there’s not necessarily the same amount of hope in the US that cap and trade will pass in the form we were looking at years ago.
Q: So with the collapse of climate legislation in the US, have a lot of these guys gone back to trading natural gas, coal, and power?
A: I don’t think anyone left coal to go into carbon. The VC funding has dried up and investing in the carbon market is going right into solar renewable energy credits, so the S-RECs are the flavor du jour now. I’m talking to several different private equity firms right now that are very interested in financing solar projects in Texas, New Jersey, Massachusetts, Pennsylvania, and possibly California, although that is a beast of its own. So right now the New Jersey REC market is world famous. There are companies in Europe that have actually made strategic investments in construction companies and engineering firms in New Jersey so that they can grow their business outside of Scandinavia and central Europe. It’s interesting because I never would have thought that the Germans or the Dutch would have been interested in buying small companies in order to do business in New Jersey. The hedge funds and private equity firms are both saying “Hey listen, we’re not going to keep investing in the CARs or the VCRs any more, we’ll see what happens with that. RECs are trading at very high levels so I think that if the projects are financed the banks will be able to experience reasonable returns. Once government subsidies and funding ends, the banks can structure something where financing 500 kilowatts to 5 megawatts projects makes sense. This seems to be the sweet spot of what the larger banks are not looking at. Then the banks can get in and do a 10-year ownership, get roof rights and structure a 3-year deal and get cash flow in. A lot of them are claiming that they can give off a steady stream of income doing this.
Q: I think a lot of people kind of threw up their arms when all this legislation collapsed, basically walking away. But what’s interesting is when you scratch the surface a little bit, there’s still a lot going on in the renewable space even if there’s nothing going on in the carbon space.
A: I just saw a company pitching a new solar fabric that goes over landfills. So you can have a multi-acre landfill that’s generating some sort of electricity. The fabric has a 20-30 year lifespan, it drops off a certain amount of inefficiency over the years but it will also qualify you for a credit and be a good PR play. The one by-product of this failed carbon legislation is that it will help somewhat, even though the cap-and-trade did not work in the way we thought, a lot of money is getting poured into financing these renewable energy operations and it’s not coming out of taxpayer’s pockets now—it’s private. This means that if we can prove successfully that the private sector can finance the renewable industry and it actually helps the environment, you are going to have a much better chance passing some sort of legislation that looks like it can work and will not hurt the US pocketbook. So it’s a positive thing.
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