Index-Based EFP Order Book With Automated Residual Allocation
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Solution Overview
Problem
There is a need for new products and strategies that expand futures for physicals (EFP) transactions into new markets, particularly through index-based EFPs that allow for continuous and anonymous trading with market maker support and comprehensive clearing mechanisms.
Innovation Solution
A central order book system for EFPs based on index futures and corresponding shares, enabling simultaneous trades with automated price allocation and clearing, supported by market makers, and utilizing a clearing facility for both futures and cash legs.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Productivity
If EFP transactions are conducted over the counter (OTC) with manual processes, then trading flexibility is maintained, but trading efficiency and market liquidity are limited
Solution Approach 1:
The patent replaces manual OTC trading processes with an automated electronic trading system. The matching engine automatically matches buy and sell orders, and the allocation system automatically distributes residuals to market makers based on their quotes. This substitution of mechanical manual processes with automated electronic systems dramatically improves trading efficiency while managing complexity through standardized algorithms.
Solution Approach 2:
The system enables market makers to automatically receive residual allocations based on their quoted prices. The allocation system automatically calculates and distributes residuals without requiring manual intervention, allowing market makers to benefit from their pricing decisions automatically. This self-service mechanism improves efficiency by eliminating manual allocation processes.
2Reliability
If a central order book system is implemented for EFPs, then trading transparency and liquidity are improved, but system complexity and operational requirements increase
Solution Approach 1:
The patent divides the EFP trading system into distinct functional modules: the matching engine for order matching, the allocation system for residual distribution, the market maker management system, and the clearing facility. Each module operates independently with well-defined interfaces, improving reliability through modular architecture while managing complexity through functional separation. The segmentation allows each component to be optimized and maintained independently.
Solution Approach 2:
The patent introduces a central clearing facility as an intermediary between traders and the market. The clearing facility acts as a counterparty to all transactions, guaranteeing performance and reducing counterparty risk. This intermediary structure improves market liquidity and reliability by providing a trusted third party that manages settlement and reduces transaction risk, while the complexity is managed through standardized clearing procedures.
3Adaptability or versatility
If automated residual allocation is implemented based on market maker quotes, then market maker participation and liquidity provision are incentivized, but calculation complexity and processing requirements increase
Solution Approach 1:
The patent changes the allocation parameter from equal distribution to distribution based on market maker quoted prices. Market makers who provide better prices receive larger residual allocations, creating a direct incentive alignment with market liquidity provision. The system calculates residuals as a percentage of the basis and allocates them proportionally to market makers based on their quote quality. This parameter change improves adaptability to market conditions while the calculation complexity is managed through standardized formulas.
Solution Approach 2:
The system implements a feedback mechanism where market maker residual allocations are directly tied to their quoted prices. Market makers receive feedback on their pricing decisions through the residual allocation process, encouraging them to provide competitive quotes to maximize their residual receipts. This feedback loop aligns market maker incentives with market liquidity provision, improving overall market adaptability while the feedback mechanism is managed through automated calculations.
Data Source
AI summary
Systems and methods for performing an exchange for physicals (EPP) may comprise receiving, with a matching engine module in communication with a processor, EFP data comprising an amount of securities to be traded and a price. The matching engine module may calculate a first delta percentage between the EFP data and an index based on the amount, the price, and an index value. The matching engine module may calculate a residual delta based on the first delta percentage and an index notional value. The matching engine module may attribute the residual delta to the securities.