Hedge Fund Indices: A helpful tool, but can cause confusion
By Don Steinbrugge, Founder & CEO, Agecroft Partners
Although hedge fund indices can be a very useful tool, indices can also create confusion if their construction and composition are not well understood. Take for example hedge fund industry performance: what does this number represent? The hedge fund industry is not an asset class, rather, it is a fund structure that may be used in a broad array of strategies. It is like calculating the performance of the mutual fund industry into a single number by combining the performance of money market funds, bond funds and equity funds. In addition, in any given month, one hedge fund index could report positive performance for the industry while another could be negative. Reporting discrepancies also affect industry information such as total number of hedge funds, total industry assets as well as performance reporting for individual strategies. These inconsistencies are the result of three different ways hedge funds indices are constructed and differing universes of hedge funds that participate in each index.
The 3 different ways hedge fund indices are constructed:
Equally weighted. For an equally weighted index, the performance of each fund included carries the same importance regardless of fund size. Performance is calculated based on the average performance of all funds included in the index. This structure best reflects the performance of the average hedge fund globally.
Asset weighted. For an asset weighted index, weight in the index is distributed based on the asset size of a hedge fund, where a $10 billion hedge fund will have a hundred times the weighting of a $100 million fund. This leads to the index performance being dominated by the largest funds and more closely reflects the performance of all assets invested in hedge funds. Since small and mid-sized hedge funds have outperformed large hedge funds over time, this structure tends to underestimate the performance of the average hedge fund.
Investible hedge fund Indices. Investible hedge fund indices typically include a daily NAV. In order to create these daily valuations, the index company creates managed accounts of managers from a subset of the broader industry. There is some adverse selection, because a number of managers do not want to participate in these indices for various reasons. In addition, these managed accounts typically do not run pari passu with the main hedge fund, because they do not include less liquid securities.
Following the Madoff fraud, these liquid indices have become more popular because of their greater transparency, liquidity and the independent custodial and administration of the fund. The media also likes to use these indices to report industry performance, because of the timeliness of data. Although there are many positives to investible indices, many have significantly underperformed in comparison to more traditional hedge fund indices over time. This is most likely due to a combination of the omission of less liquid securities, which often contain greater inefficiencies and expected returns, along with the additional administrative costs allocated to the fund for running these structures.
Unlike indices of the equity market, (S&P 500, the Dow Jones Industrial Average, EAFA), hedge fund indices are completely voluntary and information on performance must be submitted by the manager on a monthly basis. Due to the voluntary nature of information gathering, many of the top hedge funds, along with hedge funds that have recently closed to new investors and many underperforming hedge funds will not report their data. There are also a lot of managers that don’t want to participate in indices for confidentiality reasons or they don’t want to spend the time and effort of submitting their data. We estimate that approximately 50% of hedge funds do not report their performance to any hedge fund indices. In addition, most of the hedge funds that do participate in databases do not report their information to all indices.
The negatives with hedge fund indices include:
1. Hedge fund aggregate industry performance is not very useful and there is a wide disparity in hedge fund industry performance across indices.
2. Aggregate information, in regards to industry assets and number of hedge funds are under reported because only a portion of the market is captured.
3. Performance relative to individual strategies can vastly differ across various hedge fund indices. This is due to varying manager participation rates, but more importantly, the lack of an industry standard for categorization. Two separate index companies can label managers in two completely different strategies.
As long as hedge fund allocators understand the limitations of indices, they can be extremely useful. For example:
1. Hedge fund indices do a great job of reporting hedge fund industry trends in assets under management and numbers of hedge funds over time, as long as the same index is used.
2. Investible indices are a great tool to get an approximation of strategy performance intra month.
3. Strategy level performance data can be useful as a benchmark with which to compare individual hedge funds, provided the fund definitions and composition of the index are clearly understood. With that said, investors should fully expect a high quality hedge fund to outperform the strategy index by a wide margin. There are low barriers of entry to the hedge fund industry, and a vast majority of funds are of poor quality.
Index level data from most hedge fund database firms are free to investors and are available on their website. If an investor wants access to premium content, which contains useful data at the fund level, there is an annual charge. Anyone focused full time on hedge fund research should consider subscribing to a couple different databases to broaden out the number of funds captured.
While bitcoin washing has dogged the industry, it has been difficult to prove. However, new research derived from leaked data from Mt Gox shows that more than 2% and up to 33% of all transactions were washed on the exchange, before it collapsed in 2014. according to a new report from French based NEOMA Business School and US based George Mason University.
Authors Jiasun Li and Arash Aloosh, assistant professors of finance at George Mason University and NEOMA Business School, respectively, based their research on the internal book of individual trader level records at the Japan based crypto currency exchange which had once dominated the field, accounting for roughly 70% of the world’s bitcoin trading.
The internal data covered complete trading records with timestamps, price levels, sizes, and most importantly, trader identities of both the buyer and seller of each trade between 2011 and 2013.
Arash Aloosh, NEOMA Business School
A wash trade is a form of market manipulation in which an investor simultaneously sells and buys the same financial instruments to create misleading, artificial activity in the bitcoin marketplace. It is illegal on regulated exchange platforms and can inflate apparent trading volume to look more attractive to d customers and boost commission revenues.
To date there has been little concrete proof of this activity in bitcoin, but authors of the report said their findings provide the first “direct evidence for the widely-suspected ‘fake volume’ allegations against cryptocurrency exchanges”.
Trade washing is not the only concern hanging over bitcoin trading. A separate research report form TokenInsight, which interviewed the executives of around 30 digital asset exchanges, also pointed to lack of a targeted compliance framework, decentralised liquidity of different trading markets, the absence of custody leading to opaque assets and manipulation.
While market participants believe that global regulation is likely to be the long-term solution, enhanced market surveillance and data to provide a holistic view of an exchange are seen as suitable short to medium term responses to curtail wash trading. For example, factors such as order-book depth, bid-ask spread, web traffic estimates, API quality and cyber-security practices could provide investors with greater transparency and insight.
On 22nd July, 2020 a panel of market participants discussed the detailed implications of the Central Securities Depository Regulation (CSDR).
The panel comprised, J.R. Bogan, Senior Product Manager, Investment Operations Outsourcing EMEA at Northern Trust; Derek Coyle, European Custody Product Manager at Brown Brothers Harriman; Alex Duggan, Platform Head of Brokerage, Fees and Billing at Cognizant; Matthew Johnson, Product Management & Industry Relations at the Depository Trust & Clearing Corporation (DTCC); Philip Slavin, Chief Operating Officer and Co-founder of Taskize and was moderated by Lynn Strongin Dodds, Managing Editor of Best Execution magazine.
Traditional transaction cost analysis (TCA) is no longer fit-for-purpose in the predominantly algo-traded, fragmented liquidity world of wholesale capital and debt markets, and should be replaced by a new measure – transaction quality analysis (TQA), according to a new report ‘The Sunset on TCA is Nigh; The Dawn of TQAis Here’ from Greyspark Partners.
Russell Dinnage, GreySpark’s managing consultant & head of the capital markets intelligence practice and author of the report, argues that the data and the models used in TCA, particularly for fixed income securities, “are inherently stale from the get-go.”
Russell Dinnage, GreySpark
He says this is because is the market and trade information applied to pre- or post-trade activities is typically garnered from the market participant’s own recent intake and output of relevant variables to a model based fundamentally on assumptions.
Other challenges buyside firms are grappling with are the absence of a standard definition for fixed income TCA as well as a lack of transparency in certain securities such as corporate bonds. It also notes there is little understanding of what constitutes an indicative price versus a firm price, and this can often cause confusion.
The report contends that TQA is a better measurement as it revolves around the ability of firms to know –and not guess – what the market impact of either a book of axed trades or a collection of block-size bonds and swaps orders would be on the entirety of a firm’s available liquidity.
This is both from a liquidity provider-by-liquidity provider basis as well as across all the available execution pathways and venues.
The other main advantages of TQA include enhancing order execution outcomes as well as enabling asset manager bonds traders to consolidate bank broker-dealer Indication of Interest (IOI) or Request for Quote (RFQ) response rates. It also allows for objective assessments of the consistency and effectiveness of bank counterparties when executing orders on behalf of the firm in the external marketplace.
Looking ahead, Greyspark believes the success of fixed income-specific TQA services provided by either the sellside or non-bank brokers or vendors, will depend on the ability of asset managers to individually answer two questions over the next five-to-10 years.
The first centres around volume weighted average price and whether “this form of predominantly composite analysis currently provided by direct to consumer marketing (D2C) venues is sufficient for regulatory compliance purposes?”
The second focuses on internal data management, structuring & warehousing. It asks “to what extent are asset managers willing to take ownership over the normalisation and standardisation of the wealth of historic bonds and swaps market, pricing and transactions data stored within specific operational siloes to then move to a state in which they can consistently leverage competitive advantage on a trade-by-trade basis?”
Although responses will vary, Dinnage says that “asset managers must be realistic in assessing that the fixed income TCA services offered to them by broker-run venues, by D2C venues, by exchanges and – to a degree – by bank broker-dealers amounts to little more than window dressing.”
Cyber risk threatens remote working model where vulnerable messaging technologies are deployed. Dan Barnes reports.
Banks, asset managers and market infrastructure providers have moved vast numbers of staff to work from remote locations. At the recent Annual Morgan Stanley Financials Conference, Mark Mason, chief financial officer of Citi said 80% of its staff were working remotely, while Seth Bernstein, president and CEO of buyside firm AllianceBernstein said 97% of their staff were working from home.
While many firms began to return staff back to the office in mid-June, the process has created a new, more distributed infrastructure, which has enabled a largely seamless transition to the home working environment. However, it also carries risk at several levels.
Cybersecurity is consistently in the top quartile of exchange and CCP focus, according to the World Federation of Exchange’s regular survey of membership priorities. In a statement the WFE noted “Without care and attention relating to exceptional working procedures, there is the concern that adversaries may identify and exploit new routes into the system to either compromise operations or information systems.”
Cyber risks in the current environment have increased on many levels, as working practices have been turned on their heads. When the concept of ‘bring your own device’ (BYOD) was proposed for business in the early 2000s, many security teams were aghast. The risks inherent in devices that were exposed to consumer and home activity were perceived to be far greater than for those built or bought and directly managed by the firm. Yet when traders were forced to work from home, this required improvised trading infrastructure, including personal hardware.
“My son had a gaming computer and the graphic card allowed for three monitors to be plugged into the back, so I had three monitors, happy days,” notes one trader. “But a lot of people started by trying to use their Mac laptop and iPad.”
Where home technology is used for trading, it is incumbent on the user and front office technology teams to assess and monitor its security features. Preventing any risk of contamination from one device to wider systems is also key, which is typically handled via the remote working systems employed. However, these risks are minimised where home technology is only used to access remote systems using secure measures.
One industry expert, says, “With a typical ‘thin client’ VPN solution, as long as you have a secure VPN connection you will be able to trade securely from any device. The cyber risk is targeting the VPN connection which would be Fort Knox. Once connected your office PC takes on the anti-virus checks.”
The head of trading at a European asset manager confirms, “We have tight controls around the way we access systems; it must be via a Citrix gateway, but that’s mostly it.”
The greater risks for buy- and sell-side firms are disruptions to workflows. These might allow social engineering in order to access information, using non-standard communication.
Own goals
In Accenture’s latest ‘State of Cyber Resilience for Banking & Capital Markets Report’ which used 2018 data, it warned that the number and sophistication of cyberattacks are increasing and are likely to get worse and, it is taking firms too long to find breaches.
“In 62% of firms surveyed, it required greater than 30 days to remediate the breach,” says Heather Adams, managing director for Resilience Risk & Trust at Accenture Strategy & Consulting. “The most frequent attack listed by the survey participants was an internal attack i.e. malicious insiders.”
These risks have historically stemmed from back and middle-office individuals as much as front office staff. She observes that breaking down physical supervisory structures can create motivation as well as opportunities for malicious insiders.
“In the current climate of home working, there is a risk that internal attacks could rise,” she says. “Employees are less likely to commit an internal attack when they feel a sense of belonging and commitment to their employer and are more likely to when distanced from or unconnected to their employer.”
One of the greatest challenges that trading floors have faced in recent years is from the rise of non-standard communication tools, such as chat rooms and social media apps. The risks these can create range from unmonitored communications, which may be illegal or may breach regulations, to unsecure phone applications, which have been a repeated target of hackers.
In 2019 it was revealed that 1400 users of Facebook-owned WhatsApp had been targeted by Pegasus spyware developed by NSO Group, between April and May 2019, which gained access to their devices without user involvement. The two firms are now engaged in court cases in the Northern District of California and Israel.
Getting access to controlled information may not require specifically designed software to target individuals. The finance industry is frequently the subject of targeted hacking using social engineering in order to access key systems. Several central banks have been targeted by hackers in the past, who have sought access to the SWIFT payments network; commercial banks have been attacked on multiple occasions and buyside firms report they are under threat in the current climate.
“We have seen increased phishing scams so our security team have bolstered our email to better detect internal and external threats,” notes one buyside trader.
Robust protection
In addition to gaining access to live systems, capital markets firms have to secure intellectual property against theft, which can be more challenging if it is required to be used off-premise in order to maintain development of new tools. One specific area that capital markets firms should seek to protect from threats are their algorithmic trading models, notes Adams.
“Malicious insiders at financial institutions have a storied history of stealing this trading algorithm code, including the use of credentials stealers and malware designed to capture encryption keys for trading models,” she says. “This tendency is likely to evolve to include the alteration of these algorithms. Influencing trading algorithms to behave abnormally or ineffectively in small increments may be difficult for organisations to identify. Eventually, these changes could begin to accumulate, causing algorithms to become unstable and prone to failure.”
Given the range of potential threats that firms need to tackle, a top-down view of security is needed. There are two major cyber security frameworks for capital markets, which can provide support for firms in delivering best practice. One is the National Institute of Standards and Technology (NIST), the US cyber security framework which was established in 2014, the other is the ISO 27001 national security management standard.
“[NIST] is not a point solution, for example it doesn’t determine ‘You can use WhatsApp and don’t use Zoom’, it’s to do with the processes and the management structures that should be put in place to be certain that you are evaluating cyber risk in the right way, and then tracking any risk that exists towards mitigation and a solution,” says Sassan Danesh, managing partner at Etrading Software.
He adds, “Both of them look at scaling the cyber security processes that are required, making it a robust process. And I personally quite like the ISO model because it allows third party support, so in other words if a counterparty or provider says it is following ISO 27001, you can get third party auditors to audit that compliance level.”
Integrating the principles and practices from frameworks like these can increase the likelihood that whether working remotely or on-premise, trading operations are kept secure from malicious actors.
“The key is making sure that you have end-to-end cyber security,” says Danesh. “Historically security has been a cottage industry, with a set of people with very specialist skills who look at trying to secure various systems, processes, etc. As an industry we need to move away from this kind of bespoke crafting to a much more robust and scaleable industrial process.”
On 22nd July, 2020 a panel of market participants discussed the detailed implications of the Central Securities Depository Regulation (CSDR).
The panel comprised, J.R. Bogan, Senior Product Manager, Investment Operations Outsourcing EMEA at Northern Trust; Derek Coyle, European Custody Product Manager at Brown Brothers Harriman; Alex Duggan, Platform Head of Brokerage, Fees and Billing at Cognizant; Matthew Johnson, Product Management & Industry Relations at the Depository Trust & Clearing Corporation (DTCC); Philip Slavin, Chief Operating Officer and Co-founder of Taskize and was moderated by Lynn Strongin Dodds, Managing Editor of Best Execution magazine.
The European Central Securities Depositories Regulation was born out of the 2008 financial crisis and was designed to improve the efficiency and safety of securities settlement. More than a decade on, the CSDR continues to absorb time and resources and will become yet more burdensome as the anticipated workload includes reporting cash compensation management and workflows. Best Execution talked to leading industry figures to find out how organizations can move forward amid ongoing delays and changes.
Lynn Strongin Dodds, Managing Editor, Best Execution: We cannot ignore the impact of Covid-19. Do you expect any delays to the CSDR and what does the UK opt-out mean?
Derek Coyle, European Custody Product Manager, Brown Brothers Harriman: We received information from ESMA and other industry authorities, including Euroclear that they are considering delaying CSDR’s settlement discipline regime from February 2021 to 2022. This follows the Covid-19 impacts, including the heavy volume of trades and the market volatility from March and April. Industry forums like ICMA and AFME have also called for [Covid-19] to be considered. A delay is likely.
More time is welcome, but the CSDR must be implemented at some point. We will keep preparing and then await final confirmation, hopefully in the next month or two.
J.R. Bogan, Senior Product Manager, Investment Operations Outsourcing EMEA: There is an impact to the regulation, and to the UK saying it is not part of the regime, but there were enough issues with CSDR before the pandemic to justify a delay.
Strongin Dodds: Are fail rates, which were beginning to rise pre-pandemic, expected to increase this year? Are firms getting their houses in order?
Matt Johnson, Product Management & Industry Relations at Depository Trust & Clearing Corporation (DTCC): Firms are preparing, but there is always more to be done. The broker dealer community appointed large, established project management teams that looked at internal processes front to back, which engaged the front office because of the expensive penalties.
If you had asked at the start of this year whether the buyside was ready, I would have said absolutely not; they were still asking fundamental questions which rang alarm bells. Trade associations like the Investment Association (IA), the Association for Financial Markets in Europe (AFME) and International Capital Markets Association (ICMA) have done a fantastic job in getting members up to speed.
The DTCC saw unprecedented volumes across their confirmation and affirmation platforms. The US had record volumes, with nearly 3.3 million trades in one day across Tradesuite and well over a million on Oasys. Global platforms such as CTM saw record volumes at the end of February, with around 1.2 million transactions in a single day.
When volumes increase, fail rates tend to creep up. It could be because banks and buyside systems were creaking, or because they struggled to handle the volume. After Covid-19 hit, pretty much 98% to 99% of people were working remotely. That caused some problems.
J.R. Bogan: Firms are prepared, and if they are not, they should be. SSI storage engagements, how you interact with your matching utilities, and how you track and manage your fails process must be done more efficiently and effectively because the regime includes extra layers of information to gather and understand. If you clean up your own house it will help ensure that if things do fail, it’s not your fault.
Philip Slavin, chief operating officer and co-founder of Taskize: Most of our clients developed a two- pronged attack. First, focus on improving the settlement efficiency of your core business: Second, work to meet your obligations under the new regime for penalties and buy-in processing.
If you look at settlement efficiency, much effort goes in to increasing rates of straight through processing (STP). Depending on which product you’re trading or the region you’re trading in, rates of STP can be high. Nevertheless, independent estimates say that up to 60% of the total cost of operations is made up of people, who are a relatively low-cost unit of resource. Sometimes automating, or investing in the automation of something, goes against the cost model; it may be simpler and more cost effective to just use people to solve the problem.
So, if you improve human efficiency by a few percentage points, you can make a huge difference to the cost base of your operating model, which is a focus for Taskize. We look at how people collaborate and resolve issues more efficiently.
Audience poll
A live poll conducted during the webinar.
Strongin Dodds: How do you source and validate data?
Alex Duggan, platform head of brokerage, fees and billing at Cognizant: The data relating to CSDR is one of the most complex pieces of the puzzle that people need to solve. People need to understand the closing prices, the ISIN data, the eligibility, whether the security is liquid or illiquid. There are multiple CSDs which could have different solutions. People need a centralized view to support this. They need this data in their pre-matching fails management processing. First, so that they can understand the prioritization of the trades that are outstanding or failing; second, they need to understand the cost of the penalties that are coming in. They also need to be able to reconcile those versus the charges that are coming in from the CSD, and equally they need to be able to dispute those and accrue them so that their businesses can understand the costs that are going through and can prioritize accordingly.
People have multiple referential data systems and legacy platforms alongside different fails and inventory management tools, and stock loan collateral management tools. It’s a very big ask to build that into legacy architecture. We are looking at how we can develop a centralized data hub.
Coyle: Custodians are central to how the data flow will look with a lot of data coming from so many various points. There are 31 countries in the CSDR scope – 30 if you count the UK choosing not to apply the Settlement Discipline Regime – and beyond that, you might have multiple connection points with multiple CSDs. Our first challenge as custodians is to bring all that together. We are going to rely on certain databases, like the European central database that is hopefully going to be the reference point that provides details on securities in scope and the liquidity stages of those, so that when penalties are being measured, they are measured against that by all. Our task is to bring all this data together, balancing the effort of validation with the need to pass data on to clients as quickly as possible, so they can do their own validation and processing.
Slavin: There is definitely a data problem. Data is the oil lubricating the wheels of operations; the better the data, the better the operations. But when a trade fails not all your data needs to be shared to resolve what’s broken. So you need to ask how much data you feel comfortable sharing? Sharing important data may amplify your business or impair it?
Strongin Dodds: How should partial settlements be dealt with? How do market participants focus on reducing the financial impact of fines and penalties through proactive settlement workflow and reporting?
Coyle: First, consider penalty determination and assignment. There are two classifications of penalty that can be reported or determined: late matching and settlement failure.
If a trade failed for four days past intended settlement date, depending on when that was last touched in the process, you could end up with different responsibility and ownership. There could be different permutations within those four days. Let’s say two days of late matching penalty and two days of settlement failure penalty. It will be a challenge to determine responsibility and try to settle based on those timestamps and touchpoints.
Partial settlements are key because no matter how much we talk about the settlement discipline regime and the impact of penalties and mandatory buy-ins, there is a carrot and stick approach here.
The stick hits you with penalties, with buy-ins on top of that. The carrot encourages businesses to settle as much as possible in advance, using STP and best practices, and allows for as many partial settlements as possible.
We’re focusing our efforts now for operational readiness for some of these messaging flows and designs.
Bogan: The issue with partial settlements is how do I know it’s happened, and will it be consistent across all the CSDs? Who do I chase for information? I want there to be certainty around what I think is a failed trade, and to have direct communication of when a trade has partially settled because it minimizes the risk overall.
Another issue is penalties and the thresholds we can used to claim back penalties from other counterparties. It’s likely that lots of small pots of money will accrue and may be lost if they cannot be claimed back on a transactional basis. How is that going to work in practice? That needs to be looked at.
Duggan: To reduce the impact of fines and penalties, looking at it front-to-back is key: the trade booking, referential data, people’s stock loan collateral and inventory management processes.
Regardless of any further delay, firms have already focused people and budgets so they should continue that journey. More and more people are looking for long-term cloud and digital solutions with a single, central view of their fails management because, ultimately, CSDR is part of a global fails management process and not standalone.
What they need is a solution that offers real-time workflow and SWIFT messaging updates, buy-in workflow and claims management, the ability to calculate penalties on a real time basis, use mark to market risk prioritization in their day-to-day work, and have real-time flexible dashboards that offer predictive analysis on what’s going to fail, what’s failed historically, where is the biggest risk. And not just from a trade level but from a net settlement position too.
That gets them to 50%, where they can look after themselves internally and demonstrate compliance, but it’s market interoperability and collaboration that gets you the extra mile. You can only resolve if you’re able to deal with your counterparty, your market participant, your custodian, or your outsourced provider.
Strongin Dodds: Is it front and middle offices that need to take the most responsibility for collaboration? Can client portals help with the resolution of disputes?
Image used with the kind permission of Taskize
Slavin: The diagram (above) summarises the areas firms need to consider when looking at CSDR settlement efficiency and new obligations for penalty processing and buy-ins [bottom row]. Business decisions on internal solutions must also consider how to collaborate with clients, counterparties, or service providers to make sure that all parties are kept informed during the resolution of the failed trade or any subsequent buy-in.
In today’s audience poll, 17% believe the process will be fully automated, but we know some organizations are not SWIFT enabled or have such low volumes they can’t justify the investment required to take the new SWIFT messaging. Importantly, SWIFT doesn’t support some of the notifications required. We need alternative platforms able to support the human to human interaction.
Organisations need collaboration and specific inter-company workflows should guide participants through the process so they meet their obligations. This will be second nature for businesses with high volumes, but for those with low volumes, or who are fully manual, they need to do the right thing in the right sequence. Each organization must pick the capabilities they need and integrate them with their own internal capabilities which relies on platforms having open architecture.
Everything has got to work together, whether it’s internal (below the coloured line in Fig. 1) or with other 3rd party systems.
Duggan: With the model that people have nowadays spanning many systems, many countries, different outsource providers, e-mail isn’t going to be optimal. When it comes to issue resolution, the actual generation of the query needs to be automated. Any communication then needs to be populated with the core information that’s required and then sent out to the relevant parties to be resolved by the appropriate person in the in the market. And I think that’s key.
There’s going to be a lot of disputes, a lot of questions from the front offices. You’ll need a centralized audit trail of data and communications, one that shows the timings of everything that happened on that transaction so you can demonstrate compliance to the regulator, to your internal auditor, but more importantly to your client or to your business.
Strongin Dodds: What is the sequencing of events and approach for buy-ins? What is the downstream impact for the buyside and how will panel members handle cash compensations?
Bogan: First, you have to know you’re going to get fails, then you have to be able to discern what type of fail it is. Then you have to chase it and that’s the point around collaboration. We’re going to have to be a lot more succinct in dealing with our counterparties around why a fail isn’t getting to a resolution a lot quicker. Once your ISD plus four has come up, you have to think about the buying agent. Then there’s the question of pre-notification. So, you’ve made the decision to buy, do you have to tell the person?
And then you have to worry about the execution and then the instruction. There are so many different elements in the chain that need to be worked on, and these can not only be different for each firm but different depending on how you interact with your counterparties.
Coyle: There’s also the question of who is at fault if the transaction has reached a buy-in. Who takes responsibility for additional buy-in charges? If there are price differentials, then there’s already a discussion – depending on which way the price goes – would that end up in a kind of claim process or will it be settled as part of that overall charges approach?
It’s complicated.
Johnson: As it stands, there is only one buy-in agent and if you look at it purely from an onboarding perspective, we’ve got about 3,000 buyside firms across Europe that need access to an agent. They need to onboard at a fund level – and they could be managing upwards of 200 to 300 portfolios. There are probably just not enough man hours to do that.
Who owns the buy-in process? Is it middle or back office? Is it price discovery, do firm’s view it from that angle or is it just a way to get the trades settled in the middle office?
I totally agree with Alex about the need for real-time data. If the front office is going to be initiating the buy-ins to the agent, they’re going to need to know exactly what and when to buy-in. If all they see is the fully executed position of the failed trade, they don’t see what’s been partialled, and without that information they could buy-in too many bonds or too many shares and that can obviously lead to liquidity funding issues and all sorts of operational issues.
Audience Poll
A live poll conducted during the webinar.
Strongin Dodds: What are your final thoughts on the CSDR delays?
Coyle: We know where the delays will impact operations in terms of flows and processes. Look at building out the project designs and then naturally reach into the connection points, whether upstream or downstream, and talk about those flows. Those data connection points and those communication channels are going to be key in terms of being ready.
Slavin: Everybody seems to understand the delay does not mean ‘stop working’’. The focus should be less on how to manage penalties and buy-ins as there is now more time for the regulation to evolve. However, the settlement efficiency projects should continue at pace.
Duggan: People recognise they must interoperate and collaborate, and the pandemic has reaffirmed this. There is also a recognition that the legacy architecture that most people have isn’t the full solution that can get them to where they need to be to mitigate and reduce the impact of the regulation. Having a single workflow in a centralized place which can give you real time updates and interoperate with the market is going to be key.
Bogan: The whole industry has got to change and work with this. If it’s not standardized and it’s not general best practice, then you’re going to have divergence of thought on how something can be done. Firms must have their houses in order and understand what’s going to go wrong in order to limit the impact of CSDR.
Johnson: It comes down to accurate data, for example making sure that SSIs are in the correct formats and in the correct place. Automation or creating no-touch workflows will reduce problems and failures. For the buyside, it’s about onboarding into buy-in agents and understanding who owns the buy-in process and whether they can handle the volume of buy-ins that will potentially come their way.
Audience Poll
A live poll conducted during the webinar.
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The European Banking Authority (EBA) launched an industry consultation to identify the main barriers and risks of deploying RegTech and potential ways to support its uptake across the European Union.
The EBA is inviting all relevant stakeholders, such as financial institutions and information and communication technology (ICT)) third party providers, to share their views and experience on the use of RegTech solutions, on a best effort basis.
The EBA said that feedback from financial institutions and ICT third party providers is essential to better gauge the extent and the impact of RegTech for regulatory, compliance and reporting requirements by regulated institutions.
The survey will focus on mapping and understanding the existing solutions as well as assessing the key challenges of the offerings.
The regulatory agency has prepared two separate questionnaires – one for the financial institutions and the other for ICT third party providers.
Both are composed of a general part, aimed at collecting an aggregate information on all types of RegTech solutions in use, and a more detailed part, which will have a closer look at individual offerings in four specific areas. These include anti money-laundering /combating the financing of terrorism (AML/CFT), creditworthiness assessment and compliance with security requirements, and standards (information security, cybersecurity, payment services). Last not least is supervisory reporting
After the review of the responses, the EBA may further investigate areas of RegTech via follow-up interviews with financial institutions and ICT third party providers.
The EBA expects to report to be published in the first half of 2021.
Since the global financial crisis, RegTech has disrupted the regulatory landscape by providing a host of technologically advanced solutions to meet the ever-increasing demands of compliance within the financial industry. They incorporate a wide range of digital tools from machine learning to natural language processing, blockchain and artificial intelligence.
Nandini Sukumar, chief executive officer at the WFE
Nandini Sukumar, CEO of World Federation of Exchanges talks to Lynn Strongin Dodds about vision, strategy and consensus building.
In the five years since Nandini Sukumar took over the reins of the World Federation of Exchanges (WFE) – the global industry group for exchanges and central counterparties (CCPs) – not only has it been given a revitalised sense of purpose but also a greater voice on their leading issues of the day.
“On a fundamental level, we were looking at what WFE’s purpose should be and what the challenges and opportunities were; we wanted to see how we could be more proactive in terms of co-ordinating policy, developing markets, creating harmonised standards & best practices and building on industry education efforts through research and capacity building,” says Sukumar. “One of my main objectives when I became CEO in 2015 was also to raise the WFE’s profile on behalf of our members and ensure we were as impactful as we needed to be. Our members want us to be the public face of regulated markets.”
She adds, “We wanted to bring the members together in a meaningful way, to get the different members to meet in the middle. We are a diverse membership, both large and small markets, with multiple asset classes and geographies across the exchanges and CCP landscape. They sometimes have different views and we needed to unite as an industry and find that common ground on issues.”
WFE comprises 300 market infrastructure providers – both exchanges and CCPs. Geographically, the breakdown of members is 45% in Europe, Middle East, and Africa, 35% in Asia-Pacific, and 20% in the Americas. WFE exchanges are home to nearly 53,000 listed companies, which combined have a market capitalisation of over $93 trn.
WFE’s 57 member CCPs collectively ensure that risk takers post some $1 trn (equivalent) of resources to back their positions, in the form of initial margin and default fund requirements.
Sukumar’s strategy and vision has meant that WFE is rarely out of the news. Its various working groups regularly publish detailed analysis on a wide variety of topics ranging from public policy to technology, emerging markets, market structure and sustainability. The trade group is also kept busy responding to the plethora of regulatory consultations. The more recent include the European Commission’s current review of MiFID II as well as the Financial Stability Board’s treatment of CCP equity in resolution.
WFE is also not afraid to weigh in on more contentious subjects such as short selling, which has been a hot topic during the pandemic and the ensuing lockdown period. It was banned across various European countries due to the increased market volatility and WFE published a paper assessing the academic literature on the pros and cons. The conclusion was that short selling bans not only reduce liquidity but also increase price inefficiency and hamper price discovery, which seemingly exacerbates market volatility rather than control it.
Not surprisingly, the last six months with Covid-19 raging and lockdowns implemented has been a busy yet very productive time for WFE. One of the first steps WFE took was to create a new single Covid-19 page to support and help member navigate through a volatile and uncertain time. It not only kept them abreast of the latest and news developments within but also outside the WFE.
“We wanted to provide a sense of community because everyone was working remotely,” Sukumar says. “On the research front, a lot of the work that we do is conceptual, and we publish big thematic pieces in additional to empirical analysis while with our policy work, we agree and publish those co-ordinated industry positions. But this has been an unprecedented time and we wanted to ensure that we had coordinated information to help our stakeholders understand how Covid-19 was playing out across exchanges and CCPs, and what our industry was and is doing.”
She notes that cyber-resilience rose to the top of the agenda during the crisis, but attention was also focused on the short selling bans being imposed and the debate over whether market infrastructures should be shut down. “There was talk at the time of closing them down, but we feel it’s fundamental that they remain open during the crisis because market infrastructures allow businesses to fund, investors to price assets and manage risk appropriately,” she adds.
Sukumar was well versed to become CEO of WFE, having spent 14 years learning the inner workings of market infrastructure at Bloomberg where she established its coverage of exchanges and of the UK financial services regulator. She joined WFE in 2014 as chief administrative officer before quickly taking over the helm as acting chief after Hüseyin Erkan, the former head of Turkey’s biggest bourse, retired.
“I set up the beat at Bloomberg and was very pleased to be asked if I wanted to join WFE,” she says. “I knew the organisation well and had a clear sense of the role it should play and where it should be going.”
Sukumar relished the chance to take WFE to the next stage of development particularly in a world where markets at the time were becoming even more fragmented due to the rise of dark pools. “Often challenges are talked about in a negative sense, but I look at them as opportunities — something to be solved and not as a hurdle,” she says.
However, she stresses the importance of creating a team with diverse experience and talent. “In order to be a good manager, you have to have a vision but be realistic about what can be achieved. It is important to be a strong communicator and understand human nature and recognise the different skillsets that people bring to the workplace. You need to be able to motivate people, who are driven and inspired by different things, and bring out their best capabilities.”
Sukumar is also sharpening the focus on diversity and inclusion and was pleased that for the six-consecutive year, around 78 of its member exchanges rang opening or closing bells to celebrate International Women’s Day 2020. The event this year was to raise awareness about the business case for women’s economic empowerment, and the opportunities for the private sector to advance gender equality and sustainable development.
“I think we are making progress, but the world is not perfect, and we need to do much more,” she says. “At WFE, around 50% of my colleagues are women at any given time but I do not think, at the WFE, we need to have a specific diversity filter. The most important thing is to hire the best person for the job. Women want to be known for being the best person for the job. What we need to do is get more women to apply, get them to believe they can rise and help them rise. I am lucky in that I had very encouraging parents and very encouraging mentors at the WFE.”
In general, in terms of her own career development, Sukumar believes it is essential to “find a job that is interesting and to do it to the best of your ability. It is important to like what you do, and I am fortunate that I have an incredibly fascinating job where I can think, study, talk, debate and research market structure and how the industry works across the world. Also, I just really enjoy my members – I miss seeing them during this time of pandemic.”
Initial public offerings (IPOs) and mergers & acquisition activity were among the hardest hit in the first six months of the year due to Covid-19 while equity underwriting saw a year on year increase, according to the Association of for Financial Markets in Europe (AFME) first half report card.
The report showed that IPO issuance on European exchanges slumped 59% to €4.9 bn in the first half compared to the same time frame last year. It marked the lowest volume since 2009. This reflected global IPO activity which research from EY found slowed dramatically in April and May, with a 48% decrease by volume (97 deals) and a 67% slide in proceeds ($13.2bn) compared to April and May 2019.
Completed M&A of European companies also suffered, falling 24% to €331.2bn from €433.3bn during the same period last year. The decline was across most European regions except for Belgium. Netherlands and Luxembourg (Benelux) and Central Easter Europe. It was mainly attributed to a reduction in cross-border deals.
Again, this mirrored worldwide trends where research from law firm White & Case revealed that the total value of deals—both completed and pending—was $901.7 bn (€766.14), 53% below the same period the year before and the lowest half-yearly total since the first half in 2010. Volume, meanwhile, dropped 32% year on year, to 6,943 deals, the lowest half-yearly volume total since H1 2013.
By contrast, equity underwriting on European exchanges accumulated a total of €78.6 bn proceeds in the first half of 2020, an increase of 22% year on year from the €64.4 bn during the first six months in 2019. The London Stock Exchange and AIM led the pack with €28.3bn, followed by Euronext exchanges and Deutsche Börse with €14.5 bn and €10.9 bn, respectively.
AFME also provided an update on MiFID II dark trading caps. The European Securities Market Authority publishes a monthly list of instruments temporarily banned from dark trading at the European Union or trading venue level after their trading volumes surpass pre-determined dark trading thresholds.
The research shows that the number of instruments banned from dark trading has recently stabilised at between 300-400 suspended at the EU or trading venue level compared to the over 1,200 in Aug 2018. Revoked suspensions of previously banned instruments have become, most recently, uncommon, and infrequent.
In addition, the average weekly turnover in the form of block trades (traded above the large in scale or LIS threshold) has also steadied to a quarterly total of €82.1 bn in the second quarter from the €134.7 bn first quarter this year.
According to bigXYT data, the percentage of dark traded as LIS blocks has stood relatively unchanged during the year at 30-40%.
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The European Banking Authority (EBA) launched an industry consultation to identify the main barriers and risks of deploying RegTech and potential ways to support its uptake across the European Union.
