Hubert De Jesus, global head of market structure and electronic trading at BlackRock, talks us through the top trends to watch for in market structure this year, warns us against well-intentioned over-reaching, and explains what BlackRock is doing to futureproof its trading desk against upcoming pressures.
What are the biggest themes/developments to watch out for this year in terms of market structure? What is on your radar and why?
There is so much going on in the market structure space that it would probably be more expedient to list the items that we aren’t watching. That said, in 2024 we are anticipating the finalisation of a slate of regulatory measures; a few of the key ones are the SEC’s equity market structure proposals, Basel III endgame, and the active account requirements in EMIR 3.0. While these reforms are well-intentioned, they warrant careful review due to the possibility of unintended consequences, like reduced or fragmented liquidity, which could increase costs for end-investors.
We are also following developments in recently adopted rules, such as US Treasury (UST) clearing and the European consolidated tape (CT), because the detailed technical specifications and implementation of the FICC clearing model and the CT will be a key determinant of success for these initiatives. We believe UST clearing would benefit from expanding access to FICC sponsored clearing, establishing a done away clearing model, and updating the FICC rulebook to protect end-investors from the default of a sponsored member. Likewise, we believe that the long-term effectiveness of the CT will depend upon the creation of a proper governance structure and the addition of the pre-trade and post-trade content that investors require to interact with the market.
The past few years has also seen a resurgence in the participation of individual investors, particularly in the options markets. While a more diverse investor base is beneficial for markets, it’s important that the elevated levels of trading activity are adequately supported by the underlying market structure. We believe that there are improvements which could be made in investor education, market access, disclosures, and guardrails to create a more robust options ecosystem.
What are your views on the SEC market structure reforms – what are the key impacts on the US market and how can the reforms be improved?
We are generally supportive of the SEC’s efforts to enhance disclosures and evolve regulations to reflect modernisation in market structure. For instance, we believe that a ‘one-size-fits-all’ approach to tick sizes and access fees is suboptimal and that the content of core market data on the consolidated tape should be expanded to include odd lot quotations, auction information and depth-of-book data. Further, appropriately calibrated disclosures improve transparency, investor confidence and reforms, which promote central clearing and shorten the settlement cycle in order to reduce market risk.
However, when the reach of proposals is overly broad, even well-intentioned regulations may ultimately harm investors and damage markets. We believe that reducing the minimum pricing increment for securities which are not tick-constrained will result in greater fragmentation, increased costs for investors, and excessive message traffic that taxes market infrastructure. We also believe that expanding the definition of broker-dealers or exchanges to entities that do not truly perform those functions will be costly and burdensome for industry participants and detrimental to liquidity. It is our view, therefore, that the scope of several proposals should be narrowed considerably to avoid negatively impacting market structure.
What are the most critical elements and why?
Many of the proposed reforms are interrelated, with overlapping effects which should be evaluated holistically if they are jointly adopted. For example, a reduction in access fees will change the cost-benefit analysis of the proposal on volume-based exchange tiers. Acceleration of round lot reforms will affect the quoted bid-offer spreads used to calibrate tick sizes. Revised definitions for exchanges and broker-dealers would broaden the scope and burden of Rule 605 and best execution reforms. Further, while each proposal’s individual impact on liquidity may be limited or tangential, the cumulative effect of all these reforms may be significantly more harmful. To avoid unintended consequences, the aggregate impact, particularly to end-investors and market liquidity, across all the proposals should be rigorously assessed.
Additionally, although the requirements of each rule may be distinctly different, there’s substantial overlap in the staff required to implement these reforms. For instance, the technical or operational staff producing the disclosures for short positions, beneficial ownership, and security-based swaps are likely to be the same individuals.
We would recommend sequencing the implementation of final rules to mitigate unnecessary disruption for market participants and to allow for further fine-tuning of any intersecting effects.
T+1 is coming up in May – how will this affect global interaction between Europe and the US? How is BlackRock preparing?
We have been and continue to be supportive of the shift to T+1 settlement. A shorter settlement cycle will reduce risk, lower capital requirements, improve liquidity, and increase market efficiency for the industry. These are all positives – and some would say inevitable – in a digital world.
There’s no denying that mismatches in settlement cycles between markets in North America and the rest of the world, particularly across funds and securities, will create complexities. However, these can be resolved by the industry and our view is that centralised market facilities can play an integral role in helping to mitigate possible increases in settlement fails and financing costs for investors. As an example, extending the 6pm ET cut-off for submitting payment instructions to the CLS system, and by extension, to custodian banks, would make it easier for market participants to settle their FX funding trades on a payment-versus-payment basis and minimise Herstatt risk.
BlackRock has been working for months to review and ensure that all aspects of our investment process continue to operate as intended under a T+1 regime. In addition to taking steps to assess our operational readiness, we have been actively engaging with trade associations, counterparties, and clearing and settlement platforms to evolve industry practices and develop global alignment on initiatives that will ensure a seamless transition to shorter settlement cycles.
Europe is finally on the road for a consolidated tape. What lessons can Europe learn from the US? How will a CT and publication of the EBBO improve access to data and (by extension) liquidity?
Every market is unique; a model which works for the US may not function as effectively elsewhere, so we would not recommend adopting a cookie-cutter approach to the CT. However, after nearly half a century of operating a consolidated tape, there are definitely a few key takeaways to note from the US experience.
First and foremost, the foundation for an effective CT is a robust and inclusive governance framework. A model that gives the entire industry, especially the buy side and the sell side, a seat at the table is essential to ensuring fair and effective outcomes and a tape that continues to operate impartially for the benefit of all market participants. Effective governance is also needed to drive sufficient investment in data quality, technology, and latency to avoid creating a two-tiered market data ecosystem.
As it pertains to content, it’s important to look at where the US is heading to meet the needs of investors in today’s markets, not where it’s been. At a minimum, the CT should contain all the essential information, such as indicative auction prices/imbalances, depth-of-book data, or an EBBO, that investors need to interact with the market; otherwise, its utility will be severely handicapped from the start. A consolidated tape only augments market resiliency if it furnishes market participants with the necessary pre-trade data to facilitate the routing of orders to other venues during a marketplace outage. Further, if investors are unable to rely solely on the CT as a standalone, authoritative source of data, its credibility will be undermined and conflicts of interest may arise with proprietary data feeds.
A CT that makes visible the true extent of liquidity and pricing when trading decisions are made will especially benefit individual investors. If implemented properly, the consolidated tape has the potential to be transformative for Europe by strengthening best execution, increasing market transparency, and improving competition between marketplaces.
What do you think are the biggest influences on the electronic trading landscape right now, and how is it evolving?
It will probably come as no surprise that the proliferation of artificial intelligence (AI) has been one of the most prominent developments in the electronic trading landscape. We increasingly see broker-dealers incorporating machine learning techniques into their algorithms and using smart order routers to identify novel data patterns, calibrate routing behaviour, and optimise performance. At the point of execution, exchanges and trading venues have also been launching new AI-driven order types or matching mechanisms.
This has been accompanied by an uptick in regulatory interest regarding AI and machine learning to understand how market participants utilise these tools. However, the language currently being used to define AI is too vague, as it could just as easily be applied to conventional econometric models generated by simple computer programmes or spreadsheets. We believe that a clear taxonomy around AI would be beneficial both in addressing this challenge and promoting innovation. Clear definitions would support regulations and ensure that they target new developments rather than traditional technologies, while also reducing the risk of disproportionate burdens for market participants.
As markets continue to evolve and become more complex, we’ve also observed a heightened need for better pre-trade analytics and data. Today’s markets require a deeper understanding of where and how to optimally access liquidity; traders need to know how much liquidity is truly accessible, how to engage with specific trading venues, or how much volume has migrated to the close. In fact, a core focus for BlackRock has been improving our suite of analytics and pre-trade tools to assimilate this data and augment our trader decision-making process with better market intelligence.
What are the key challenges for institutional buy-side firms when it comes to sourcing data – and using it effectively?
One significant set of challenges has always been the cost of acquiring data and the administrative burden of complying with licensing terms. Most data providers have exclusive rights to their content, creating an uncompetitive market that is disproportionately skewed against consumers. Data providers are unconstrained in their ability to charge excessive fees and impose unfavourable licensing terms. As a result, data is typically priced according to the value of the information to subscribers and users are charged multiple times for the same data for different categories of usage or for making the data available in different applications.
However, the biggest challenge is probably the overall effort of managing data once it has been brought into a firm. Common issues include difficulty retrieving data or struggles with poor data quality. In a large organisation, data may also be hard to locate or there could be duplicated work streams when many teams are utilising the same dataset. To pre-empt these challenges, BlackRock has focused on developing an effective data strategy and assembling a skilled team of data engineers to build a robust data architecture.
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