Equities trading focus : Profile : Ralston Roberts : Instinet

April 27, 2020

Ralston Roberts, CEO of Instinet explains the firm’s enduring success over 50 years and plans for its future growth.

What has been the impact of Covid-19?

No one would have predicted the “Black Swan” that is Covid-19. We take this pandemic incredibly seriously and have had to establish enhanced operational policies and strategies to protect our employees and manage the risks it poses to our clients and our business. Our hearts go out to the people who have been suffering, and have lost loved ones and friends to this disease.

From a marketplace perspective, it has obviously had a dramatic effect. The volatility is challenging for our clients, and causes dramatic spikes in message traffic and order activity, which has caused some participants to experience technology outages and slowness. Scale, redundancy and capacity are greatly challenged in such markets – and we all must maintain rigour and an ‘all hands-on deck’ approach – but in a much more virtual way – to ensure reliability and operational efficiency.

When we look back on this period, we will have learned a lot about the value of dispersed, seamless technology and digital working environments, and the importance of the protection of our most valuable asset – our people. Moments like this serve to remind us all of what matters most.

Since the financial crisis, there has been a raft of a regulations on both sides of the Atlantic. Which rules do you think have had the most impact in changing the industry? What have been the opportunities and challenges?

In Europe, it’s hard to over-estimate the impact of changing regulations over the last twelve years. MiFID and MiFID II not only radically changed how research and broker execution is procured and analysed, they also completely reshaped how liquidity flows, and shifted regulated accountability for “best execution” from the broker side to the investment manager side. So, the entire trading life cycle has changed: idea formation, trade routing decisions, counterparty interactions, trading costs, and execution analysis have all been impacted.

In the Americas, similar regulatory themes have been in play but they have been implemented slightly differently. The US Securities Exchange Commission’s “Concept Release,” the sweeping Dodd Frank reforms, circuit breakers, and the various Reg ATS-N and CAT changes have likewise looked at virtually every corner of the trading life cycle. As with MiFID/MiFID II, the high-level goals revolve around transparency, fair access, and mitigating systemic risks.

The opportunities inherent in these changes have heightened the focus on and appreciation of execution quality, which is a good thing for the end investor. They have increased the use of electronic trading strategies and platforms, which in turn have increased efficiency and lowered trading costs.

The challenges are that idea formation and the way that fundamental investment ideas are generated have changed. This has impacted how the buyside delivers investment performance to their end clients, as well as how the sellside adds value and are evaluated by their asset manager clients. Finding available liquidity has also been an increasing challenge, which has only compounded the ongoing difficulty of uncovering alpha.

We’ve seen changes to how securities are traded over the course of the day, as well, with enormous volumes concentrating at the close. That has changed the way strategies work and has exacerbated the search for quality liquidity.

What reverberations has MiFID II or any other European regulations had in the US?

The biggest investment management firms are global. It’s difficult to operate with disparate processes and relationships for global firms, so most of the largest asset managers have adopted MiFID II-compliant policies and approaches on a global basis. So, we’ve seen similar pressures on research unbundling, commission rate compression, order routing transparency, and an increase in the use of data-driven execution analysis to better understand and demonstrate best execution.

The environment has become more challenging for agency brokers with analysts noting that latencies are getting shorter, data is more ubiquitous, and markets have become more electronic. How do you see the model evolving to meet all these challenges?

What we think we’re seeing with regard to the agency broker space, is that global scale is critical, and that the client execution-centric model has become highly attractive to larger firms looking to maintain meaningful, data-driven performance that will earn them a significant rotation with the biggest buyside firms. The recent market structure changes, along with broker consolidations and acquisitions, suggest that agency execution is not only the way that regulation is headed but is also increasingly demanded from clients.

In pre-crisis periods, trading relationships were cemented by multiple touch points across “origination” and distribution – including financing and capital provision, access to issuers, and research. But the rules around risk and capital reserves have changed how risk is provided. The issuer calendar has radically changed, and as we’ve said – the procurement and perceived value of research has been altered.

Today, trading relationships are evolving an increasing focus on explicit execution quality – which is the wheelhouse of an agency broker. We will see more use of automation, more demand for efficient liquidity aggregation, a higher consumption of execution quality consulting and highly personalised customisations of workflow solutions that drive efficiencies and lower costs across the trading life cycle.

Despite technology being key, what changes have organisations had to make to their culture and structures? What skillsets are required today?

Everyone has had to become more fluent in “data”. It was always the lifeblood of the trading markets, but now the explosion of a wide variety of sources of data, our ability to process it, and in the ways to use machine learning, deep learning, and AI mean that all participants must be able to integrate quantitative processes throughout their workflows. Most firms are becoming more “fintech”.

That means skillsets in quantitative analytics and advanced coding are massively important for securities professionals today and tomorrow. But we should not forget that we are all financial professionals first – we’re fintech and not simply “tech” for a reason. As great as AI can be, it is not inherently creative. Human ingenuity and industry will still be the source of ideas. Machines do not form loyal relationships based on intuition or nuanced understanding of a clients’ preferences. So, finding that balance between technology fluency, quant skills, market insights and client service will be the key to success.

From an Instinet perspective, the firm was one of the first disrupters over 50 years ago, but how can the company ensure it will be here in another 50 years? How do you stay ahead of the competition?

That’s exactly the question that keeps me on my toes, and rightly enough. No one would care what we did fifty years ago if we didn’t continue to be relevant. Fortunately, we have.

Instinet has worked very hard over the decades to foster and support a culture that values unconventional problem-solving and a willingness to challenge the status quo. And we’ve always sought to embrace – rather than resist – emerging technology. But in my opinion, the real thing that keeps Instinet at the forefront of change is our deep and abiding connection to our clients. We don’t run around being innovators for innovation’s sake. That would be the classic “solution in search of a problem” – and who has time for that? We create new things because we are trying to solve real problems that face our clients now or that we know will face them in the future. Our people are encouraged to ask “what if we did x rather than y”, “what would happen if we automated a or b?” or “what can we do to improve this or that?”

That way we’re not chasing the competition, we’re sprinting toward new ways to enhance our clients’ performance across every part of the trading life cycle.

What changes have you made since you took over the helm?

I’ve brought in a new Chief Technology Officer and we’ve restructured our IT organisation across more Agile development philosophies. We’ve embraced the Cloud. We’ve invested in our quantitative teams and have grown our electronic execution business. We launched Foreign Exchange trading via our Newport FX offering. Last fall, we launched our successful BlockCross offering in EMEA, and earlier this quarter we went live with Paxos settlement service, utilising blockchain technology.

How do you plan to develop BlockCross in Europe?

As a well-known liquidity aggregator in Europe, the team looked to build on our current presence by providing clients with the ability to seek conditional block liquidity in an anonymous way. The launch of BlockCross for European securities has enabled us to leverage our existing client relationships and strong integration with buy side trading platforms to deliver incremental, outsized crossing opportunities for clients across the globe.

This first phase of our rollout was about enabling clients to seek block liquidity in European or US securities, using Conditional order types and/or blotter integration. The model allows clients to look for outsized liquidity opportunities, while minimising risks of information leakage. Our next expansion of the BlockCross offering will be for Canadian securities, pending regulatory approvals. And we continue to expand our capabilities in conditional order management overall. This is all part of our ongoing commitment to providing astute liquidity aggregation to our clients around the globe.

What are your plans for blockchain given the recent news that you and Credit Suisse were the first two to firms to go live on Paxos?

Blockchain is obviously a fascinating technological innovation that promises to increase efficiency and deliver long-term cost benefits. We were very pleased to add this Paxos launch among Instinet’s long list of “firsts”. This is a significant digital transformation to a part of the trading life cycle that doesn’t always get enough attention – yet has a significant impact on the net cost of trading.

We will continue to work together with Credit Suisse and Paxos to further build out and refine this new solution. The next phase of growth in that space will happen as more and more firms connect.

Looking ahead over the next year or so, in general where do you see the greatest opportunities and challenges aside from Covid-19?

We’re excited about what greater use of the cloud can do for our scale, processing power and advanced quantitative capabilities. Block-sized liquidity will continue to be highly prized by our clients, so we will continue to expand our offering in liquidity aggregation and novel crossing opportunities. Execution quality analysis and our rapidly expanding consultative offerings will be an exciting space to watch. We’re continuing to expand our footprint for providing automation that is highly personalised at the client level, that applies our multi-colocation and machine learning technology.

There is also a lot of activity happening in the outsourced technology space. A “software as a service” platform has grown dramatically in a highly “organic” way, and is going to continue to be a priority in the next twelve months.

There are other macro and micro trends in play in our industry, such as the soft trend of “active to passive” and the continuing implications of regulatory changes, but none that have been as sobering as this threat to human health and safety.

Biography: Ralston Roberts was named the global CEO of Instinet in 2018. Previously, he was with Goldman Sachs, where he served since 2015, most recently as co-head of Execution Services and co-head of Electronic Trading for EMEA. Prior to Goldman, he was Chief Operations Officer of SunGard’s brokerage business, and as Senior Vice President of Product Management. Before SunGard, Roberts was Chief Technology Officer at Wells Fargo Securities. He holds a BA in Business Economics and Geography from the University of California at Santa Barbara.

©BestExecution 2020

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Equities trading focus : Profile : Anne Giviskos : Euronext

Ian Rycott

April 27, 2020

Anne Giviskos, Chief Risk and Compliance Officer at Euronext talks about how compliance has been transformed in the post 2008 world and the lessons that can be applied to coping with Covid-19.

Will the MiFID review have any impact on market infrastructure?

There are key topics in review. The first is on the market data side regarding reasonable commercial basis and related disclosures. The second relates to the discussion on consolidated tape in Europe. The other issues we are keeping our eyes on are the share trading obligation as well as the pre-trade transparency waivers. At the moment there are certain grey areas because of Brexit and the issues of equivalency between the European Union and UK. Establishing a level playing field on the tick size regime was an important evolution post MiFID II, so that systematic internalisers and exchanges apply the same rules.

What regulation in general over the past ten years has had the most impact?

We have always had internal processes, oversight and monitoring in place to ensure that we are compliant with regulations. However, MIFID II had the most far-reaching impact and required a large change programme including adapting our trading system, including market data and building in controls. The additional reporting, and the volume of data required to meet the various regulatory technical standards was a significant undertaking, not just for Euronext but for the industry as a whole.

And what about other regulations?

The General Data Protection Regulation and EU Benchmark Regulations (BMR) have also had an impact from an industry perspective. (The latter aims to improve governance and controls over the benchmark process, including the quality of input data and methodologies used by benchmark administrators). The BMR requires additional reporting. Euronext’s blue-chip indices are considered significant within the definition of the regulation, and we have a strong franchise of other indices (over 500), particularly in the ESG space. Euronext has deep experience in governance, creation and related maintenance of benchmarks. We have a benchmark oversight committee in place that I chair.

Given the regulatory landscape, the compliance function has changed enormously over the years – how has it changed in a market infrastructure context?

The focus for us has been on end-to-end processes and it has also meant having the right people in place. We have supplemented our teams with people who have specific knowledge of the regulation and have dedicated interlocuters who liaise with the regulators. We work closely with the regulators during implementation in order to have real-time feedback and clarity on their expectations. Euronext also has unique access to a college of regulators, which helps to streamline communications concerning the implementation of different regulations and also provides a central forum where we can have discussions and input.

There are several new developments at Euronext in terms of new markets such as Ireland and Norway as well technology and services such as Optiq? How does that impact risk and compliance functions?

Last year, Euronext announced its new three-year strategic plan to continue to diversify the business through organic and inorganic growth. We have demonstrated our ability to expand in 2018 and 2019 related to acquisitions of Dublin and Oslo Bors respectively.

A key component of these migrations is moving to our proprietary trading platform Optiq, which launched updated platforms for market data, cash equities and derivatives, and completed in November 2019. The result is that Euronext cash and derivatives markets are now operating on one platform, which from a compliance perspective means that we have a consistent level of control and centralised processes within one model. Optiq has demonstrated its robust nature throughout the unprecedented high volume/volatility environment we are experiencing as a result of the Covid-19 crisis, again supporting our compliance with related regulations, keeping the markets open and managing risk in peak periods, including effective circuit breakers.

We also acquired 66% of Nord Pool (the second largest power market in Europe) and are also looking to expand Euronext FX into other products and geographies, including Singapore.

There are so many solutions on the marketplace to facilitate compliance, what are the challenges in integrating them?

There are a significant number of regtech solutions regarding risk, compliance and control on the market. One of the questions we ask is how can we leverage the tools in the market to optimise our efficiency and add value. For compliance, market abuse and post-trade analysis are critical. We are exploring things such as artificial intelligence and how we can use technology to support and build more efficient and effective outcomes. In addition, we leverage InsiderLog to monitor compliance from an issuer perspective. It has helped to streamline the process. It is important to remember that technology is an enabler and will not solve all the problems, but if it is leveraged in the right way then it can facilitate analysis, improve data quality and provide us with a better end-to-end processing. Our team is critical in this approach. You can’t fully automate experience.

In terms of choosing the right solutions, we are pragmatic and look for a fit into our organisation. We are growing so we also want technology that will grow with us. Security is critical and we have to ensure that the right cyber and information security framework is in place before we make a selection. We have deep internal experience and consult experts as needed who help us choose the right tools.

There is a lot of emphasis on the value that machines can add. What about people?

Administration can be a burdensome task and technology frees people to add the value. For example, with post-trade analysis, we can focus on the meaningful cases. It enables the team to better support in preventing market abuse, and to have more time to be proactive with stakeholders and plan for the future.

Looking ahead what do you think are the biggest challenges as well as opportunities?

Covid-19, while a challenging moment, should be leveraged as an opportunity. We have led the organisation from a risk and business continuity perspective to date, and we have learned about ourselves, our organisation and the environment around us. We will all be different after this, change is happening. We will seize the moment to adapt and become stronger.

From a compliance perspective we will continue to integrate the acquisitions we have made. One of the good things is that the implementation of multiple significant regulations has given us different perspectives on how we can think and improve our compliance programme.

Biography: Anne Giviskos is the Chief Risk and Compliance Officer at Euronext NV with teams in Europe and the US. She is a member of the Oslo Bors VPS Board and Interbolsa Board, both Euronext subsidiaries, the Chair of the Euronext Benchmark Oversight Committee and member of the Risk Committee of LCH SA. Giviskos has over 20 years of experience in financial services and technology including nearly 15 years at NYSE/NYSE Euronext/ Euronext. She began her career at PricewaterhouseCoopers in the assurance function. She graduated from the University of Michigan with a Bachelor of General Studies, with a focus on psychology and business.

©BestExecution 2020

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Trading : Data standardisation : Heather McKenzie

Ian Rycott

April 27, 2020

SOLVING THE DATA CONUNDRUM.

Heather McKenzie looks at the challenges and initiatives hoping to overcome the data standardisation hurdles.

Although data standardisation is high on the financial services agenda, there are still several unresolved legacy issues with risk management implications. Market participants have been summoning the industry to join forces and develop effective solutions but progress has been slow.

In fact, in May 2018, JP Morgan Chase issued a call for action, urging the financial services industry, global regulators and other stakeholders, to collaboratively build on their progress toward achieving a data standardisation framework that addresses current deficiencies and allows innovative new technologies. “Establishing and implementing a common global language for financial instruments and transactions will create efficiency, reduce costs and result in the improved usability of financial data to create valuable information and manage systemic risk,” according to the US-based bank.

It added that establishing and implementing a common global language for financial instruments and transactions, that is universal across all institutions, will result in “unambiguous meaning, consistent formats, and improved usability of the data to create valuable information”. Moreover, consistent use of such standards in regulatory reporting requirements across the globe would significantly improve the ability of the public sector to understand and identify the build-up of risk across multiple jurisdictions and across complex global financial processes.

The bank also notes that “global data standards also lead to efficiency, saving time and reducing costs that firms and regulators would otherwise expend manually collecting, reconciling, and consolidating data, and will lay the groundwork for the future use of evolving technologies and innovative approaches to data management.”

The 2008 data crisis

JPM’s edict came a decade after the financial crash, an event which kick-started a number of standardisation initiatives including the development of the legal entity identifier (LEI). The fallout of 2008 made regulators realise that they could not easily identify the parties to financial transactions across markets, products and regions. Lehman Brothers’ insolvency, for example, resulted in more than 75 separate bankruptcy proceedings. When it collapsed, the group was party to more than 900,000 derivatives contracts.

The Financial Stability Board (FSB) and G20 finance ministers and central bank governors advocated the development of a universal LEI which would be applicable to any legal entity that engaged in financial transactions.

The LEI is a 20-character, alpha-numeric code that contains information about an entity’s ownership structure and thus answers the questions of ‘who is who’ and ‘who owns whom’. The publicly available LEI data pool can be regarded as a global directory, which greatly enhances transparency in the global marketplace. In June 2014, the Global Legal Entity Identifier Foundation (GLEIF), a not-for-profit organisation, was created to support the implementation and use of the LEI.

Speaking at a financial industry event hosted by the GLEIF in Amsterdam in February 2020, Klaas Knot, president of De Nederlandsche Bank, said since the introduction of LEIs, more than 1.5 million entities in over 200 countries have registered for an identifier. “The LEI has seen widespread adoption in several financial markets most notably in the over-the-counter derivatives markets. It is also used increasingly in the issuance of debt and equity securities in jurisdictions. In other areas, the uptake of the LEI is less widespread, and the Financial Stability Board (FSB) continues to monitor this progress.”

Knot said the LEI had led to improvements in the quality of data analysis, opening up possibilities for research and data aggregation. The identifier had also improved the accuracy of data reporting and was now being used in international stress tests. These benefits are available not only to regulators, but also to the wider financial industry, he added.

“[The LEI] is invaluable in helping to understand interconnectedness. It has improved our understanding of the build-up of risk across multiple jurisdictions,” he said.

Knot referred to a peer review conducted by the FSB in 2019, that issued four recommendations to support broader use of the LEI. conducted a peer review last year to assess the current adoption and use of the LEI. It came up with four sets of recommendations to support the broader use of the LEI. These are:

Mandatory use of LEIs for the identification of legal entities in data reported to trade repositories (this is already being pursued in Europe for derivatives data and from April will be required for securities financing transactions).
The FSB to explore the potential role of LEIs in other financial activities.
Standard-setting bodies and international organisations to review ways to further embed or improve references to the LEI in their work.
The LEI Regulatory Oversight Committee and the Global LEI Foundation to improve the LEI business model to lower the cost and administrative burden for entities.

Knot concluded: “I am convinced the use of the LEI will expand in the coming years. Beyond securities and derivatives trade reporting, and into other sectors. Because in a globally operating financial world it is clear we need global standards.”

Expanding the LEI reach

The requirement for LEIs as a means of identifying counterparties that are legal entities in MiFID II transaction reporting ensured uptake of the standard. The upcoming Securities Financing Transactions Regulation (SFTR) also requires the use of LEIs.

In its February 2020 Global LEI Data Quality Report, the GLEIF stated that the highest number of LEI issuers had achieved expected or excellent data quality since November 2017. The LEI data quality score assesses 11 criteria: accessibility, accuracy, completeness, comprehensiveness, consistency, currency, integrity, provenance, representation, uniqueness and validity.

While the number of LEI records with parent relationships increased, the number of failing checks related to relationship data remained stable. The ‘business card information’ available with the LEI reference data – the name of a legal entity and its registered address – is referred to as level 1 data. It answers the question ‘who is who?’. In addition, the LEI data pool includes level 2 data – ‘who owns whom’? Legal entities that have or acquire an LEI report their ‘direct accounting consolidating parent’ as well as their ‘ultimate accounting consolidating parent’.

“LEIs have worked well, despite some parts of the industry being sceptical at the start,” says Harry Chopra, chief client officer of US-based risk analytics and data company AxiomSL. “The only remaining challenge is that when an entity goes out of business, its LEI is not switched off. There’s a bit of work to do there.”

While the creation of standards is one very complex and time-consuming thing, ensuring they are adopted and complied in a coherent manner is another. Once data is consistent, says Val Wotton, managing director of product development and strategy, derivatives at DTCC, firms can leverage it beyond trade reporting.

“We have seen this in credit derivatives with the development of the Trade Information Warehouse. The industry drove standardisation of the underlying product, which is important for timely and accurate confirmation, settlement and reporting.”

Some standards initiatives have faltered because the industry has “bitten off more than it could chew,” according to Linda Coffman, executive vice-president Reference Data Utility (RDU) at SmartStream. The adoption and use of standards, particularly for firms with legacy systems, is costly. She believes that while regulation is a major driver of standards initiatives, regulators around the world should collaborate on standards to ensure consistency for global firms.

Alexander Dorfmann, senior product manager, Financial Information, SIX, says the data universe is “highly fragmented”, which means data in the market is not readily available for end users or systems. He points up that even if data is made available at no cost, the preparation and use of data is costly and is operationally intensive. “Sometimes the conversation is about making data available free of charge. But that doesn’t do the trick – we need to have standards, both functional and technical, for the data to lower the costs associated with it.”

Organisations such as SIX, DTCC and SmartStream via the RDU focus on shielding clients from the lack of data standards. SIX, for example, has built a platform that takes in the data in all of its different formats, normalises it and makes it available to users in the technical format of their choice.

“Our aim is to offer our clients platform that enables them to decide what type of data they want for their best execution reports,” says Dorfmann.

©BestExecution 2020

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Regulation & compliance : CSDR : Gill Wadsworth

Ian Rycott

April 27, 2020

GETTING CSDR BUY-IN.

Gill Wadsworth explains why regulators decided to delay the CSDR and the questions that still need to be addressed.

For the financial organisations swimming through a sea of regulation, the news that the European authorities were delaying the impending stricter clearing and settlement regime was a huge relief.

The Central Securities Depository Regulation (CSDR) – designed to iron out failings in the settlements process – has been postponed until February 2021 from this September, giving something of a reprieve to those institutions who were up in arms over some of the more complex regulations. It impacts a wide range of market participants (CSDs, CCPs, trading venues, investment firms, credit institutions) and authorities, and will require significant IT system changes, market testing and adjustments to legal arrangements between the parties concerned.

The proposed system of mandatory buy-ins – where those selling securities are forced to make good a failed transaction – has been such a thorn in so many participants’ sides that they resorted to sending angry letters to the European Securities and Markets Authority (ESMA) demanding a rethink of its plans. In fact, in January the buy and sellsides joined forces, with two major industry bodies – the International Capital Markets Association (ICMA) and Investment Association – to voice their concerns to the European Commission’s executive vice-president, Valdis Dombrovskis.

The joint letter stated: “Our members are concerned that the buy-in provisions specified in the CSDR, while well-intentioned, will prove to be unduly harmful to the functioning, liquidity, and stability of the EU’s bond markets.”

ICMA says the CSDR buy-in provisions differ legally, structurally, and economically from existing contractual buy-in remedies used in the non-cleared bond markets.

“These significant differences undermine the effectiveness of EU CSDR mandatory buy-ins as a bond market settlement risk mitigant,” the organisation says. “In stark contrast, these provisions are specified in such a manner that they are widely expected to serve to increase market risks markedly, both for liquidity providers and investors. In turn, this could have unintentional detrimental consequences for issuers raising capital in the EU’s bond markets.”

The fallout

Among these unintended consequences are increased costs and liquidity risks for investors, and the concern that market participants pass the penalties and cost of buy-ins onto end users. In addition, ICMA argues investors will be ‘forced to reflect the increased risks associated with securities lending, either in their pricing or by lowering their propensity to lend certain securities or asset classes’.

Fortunately, the authorities agree that more needs to be done to ensure any mandatory buy-ins do not inadvertently scupper the markets, and thus create more trouble than they resolve.

In a report published in February, ESMA outlined its reasons for the delay. The regulator stated: “Having regard to additional time needed due to new developments mentioned by stakeholders and reflected in this report, such as the envisaged go live date of the penalty mechanism jointly established by CSDs that use a common settlement infrastructure, the estimated time needed for the IT system changes, the development of ISO messages, market testing and adjustments to legal arrangements between the parties concerned, ESMA considers it to be appropriate to provide for more time before the start of the application of the new settlement discipline requirements under the RTS on settlement discipline.”

What matters now, according to market participants, is that there is a sensible and active debate about the best way to proceed. Although ESMA notes there is no need for a formal open consultation and that it will recommend practical alternatives directly to the European Commission, there are clearly open channels of dialogue between the authorities and affected stakeholders.

Jennifer Hanes, division executive, securities finance & processing for capital markets & credit at FIS, says: “There is time between September and February for us to look at this. Market participants are discussing this amongst themselves and through industry associations and with ESMA. It is more than likely there will be a culture of recognition and then the challenge is to come up with practical alternatives.”

ICMA asks that cash fines for failed settlements are ‘implemented as early as practicable’ while a detailed market impact analysis is implemented covering the potential effects of mandatory buy-ins across all asset classes, especially the least liquid segments of the European capital markets. “Given the potential consequences of the buy-in regime, a robust market impact assessment is viewed as a critical consideration in informing the design and calibration of any buy-in framework, if it is to be effective,” according to the trade group.

Sensible measures

As the industry awaits the outcome of ESMA’s deep dive into mandatory buy-ins, there are practical steps participants can take in ensuring they are ready for whatever the final regime holds. Camille McKelvey, head of post trade straight through processing business development at MarketAxess, says businesses will need to bring in additional resources to manage the settlement process, specifically to identify where fails occur and be able to track and report that process.

“There is a lot of work that needs to take place and while some of this is already happening, much of it will require a certain amount of support. Getting settlement agreed as close to point of trade as soon as possible is the key thing and new teams will be created to support this,” she adds.

Meanwhile Daniel Carpenter, head of regulation at Meritsoft, says aligning with the CSDR requirements is complex, especially for buyside firms running multiple asset classes across numerous regions covering several systems.

He notes that organisations will need to put in a single fail management system if they are to be able to keep up. “Most custodians and brokerages are being proactive and aiming for a consolidated fail management system,” Carpenter says. adding that while firms may want to use one system, since there are multiple clearing houses with which they must interact, harmonising into any single process is a challenge.

Although postponed, the CSDR regime will come into force, and it needs to if there is to be confidence in the industry at this fundamental level. However, the delay looks like it will ensure the regulations do not come with a damaging set of unintended consequences which serve to undermine investors confidence and leave the whole regime proving counterproductive.

Stakeholders seem confident that the issues surrounding buy-ins will be resolved adequately but there is an awful lot to do before February. “I think that CSDR will achieve what it is meant to do but that will come down to an agreement between the regulators and industry that doesn’t result in a massive disruption to market,” says Hanes. “Right now, what is on the table is disruptive and there is consensus that [CSDR regulation] will impact liquidity.”

Ultimately the settlements industry already has the tools and the will to get this robust regime in place. As McKelvey says: “Improving settlements is a good thing. The electronification is there and we have the tools to improve all these issues. We should be leveraging them and [CSDR] will move us towards that.”

What matters now is that the industry continues to keep the momentum going while authorities lend a sympathetic ear to the concerns from those on the front line. And – global health crises aside – CSDR could yet serve its purpose.

©BestExecution 2020

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Fintech : AI & machine learning : Jannah Patchay

Ian Rycott

April 27, 2020

THE ART OF DELEGATING TO TECHNOLOGY.

Jannah Patchay gets behind the jargon and looks at how new technology is impacting the trading and investment world.

Artificial intelligence (AI) and machine learning (ML) are perhaps two of the most misunderstood and misused terms in the modern lexicon. These technologies may be slowly revolutionising the way in which trading venues and participants operate but the death of the sales-client relationship or an increasingly disconnected market landscape, are largely unfounded.

At the moment, the technologies are mainly targeted at data management and insights. Although often labelled as separate functions, ML is in fact but one application of AI, in which computers are programmed with algorithms that enable them to learn and adapt, and are given vast amounts of data on which to ‘train’. It is typically used to collate vast amounts of market data, determine market behaviour and train algorithms to recognise patterns of behaviour. Trades are then executed based on their assessment of current market conditions.

AI, on the other hand, is an umbrella term. It is a wide-ranging concept involving the ability of computers to execute tasks and make decisions in a way that exhibits characteristics of learning and intelligence, as opposed to algorithmically pre-defined programming logic.

Different solutions with a twist

Not surprisingly, there are many different products on the market. For example, Tyler Capital, a proprietary trading firm and liquidity provider has rolled out trading system OpusOpus, a dedicated and highly specialised ML-based application. The aim, according to Chris Donnan, Tyler Capital’s CTO, is “the systematic application of machine learning to the global financial markets, with our priority being to operate a process that can consistently create safe, scalable, repeatable, reliable goal-directed adaptive systems that operate in many environments.”

Tyler Capital operates at one, highly automated end of the spectrum, that deploys ML in sales and trading environments. However, there is another, potentially much larger group of market participants who think that the technology’s key benefits lie in its ability to reinforce sales-client relationships, and to improve the firms’ offerings to their clients.

For example, at NatWest Markets, the investment banking arm of RBS Group, Matt Harvey, Head of Fixed Income Digital Sales and Client Execution Platforms, is working to improve the customer experience through increasing use of automation, digitisation and data-driven solutions. Harvey cites the enhanced data capture requirements of MiFID II, and the increased overheads this brought to the sales-trader workflow, as instrumental drivers towards greater digitisation of the fixed income desktop.

The firm’s Scout bot, built on the Symphony platform, enables salespeople to focus on the provision of higher-value conversations, information and services to clients. “The objective of the Scout bot is not to replace the human interaction between the client and the salesperson, but rather to augment it in a way that enables good data capture both for ML and for regulatory compliance requirements around how voice negotiations need to be handled for NatWest Markets and our clients, both now and as market structure continues to evolve,” says Harvey

He adds that “by presenting more data to our salespeople, we can also create a virtuous circle: you get people to engage more with patterns of client behaviour or particular aspects of the client and that creates better service.”

It’s not just traditional investment banks who see AI/ML as a means to enrich the customer experience and building stronger relationships. AiX is an AI-driven matching engine, built to act as a broker for institutional OTC traders in both cryptocurrencies and traditional asset classes. It automates pre- and post-trade data capture, handles multi-party negotiations, performs pre-trade credit checks, and passes trade details electronically to the settlement agency or clearing house.

The engine combines natural language processing (NLP), ML and cognitive reasoning technology to create a chat-bot, similar in concept to NatWest Market’s Scout, but with an additional execution capability.

Priyanka Jain, Business Development Executive at AiX, says that “AI/ML-based technology solutions are setting new standards for efficiency, accuracy, and regulatory best practice, not only in digital assets but also across all financial markets. I believe they will be welcomed by the front office, as this is their chance to re-skill and up-skill – to focus on more intelligent and high-value tasks like strategy, and leave the menial tasks to the technology.”

Further along the spectrum, there are firms focusing on using AI/ML to supplement human knowledge and to facilitate decision-making. For example, Liquidnet, an agency broker, acquired, OTAS, a trading analytics provider that uses customisable alerts highlighting opportunities, exceptions, and risks in global stock markets, delivered to clients in real-time and in plain English.

“So much work has been done already by the systematic and quant funds to really squeeze the lemon dry on data that impacts price. And that’s always been a speed race,” says Vicky Sanders, Global Head of Investment Analytics at Liquidnet. “We’re not in that race. We’re looking at how to best support the fundamental active investment community with data-led intelligence and insights. Investment decision makers typically apply a mosaic approach to investing and they will take many different data inputs, synthesise them and make their decision.”

She adds that “our focus for exception alerting relies on questions such as, are we targeting factors that might influence price? Are we targeting factors that might influence KPIs (key performance indicators) and fundamentals of a company?”

Forging ties

As to other solutions IPC, a communications and networking solutions firm for the financial markets community, has collaborated with GreenKey Technologies, a provider of voice software with integrated speech recognition to develop a range of cloud-deployed products based on AI/ML technology. The aim is to boost the sales-client experience and internal sales-trader workflow.

Their new workflow tools employ ML and NLP to convert a user’s voice quotes and trades into a streaming transcript as it unfolds in real time, which can then be deployed to populate blotters and order books. The technology also enables seamless integration of conversations across multiple channels including voice and chat. Other functionality parses quotes and trades alongside conversational raw text, creating a real-time internal price data feed. This allows firms to easily scan and determine the most current state of multiple conversations for faster trading against more up-to-date data.

“Even though it’s early days, ML advances are already allowing trading desks to realise faster execution, more efficient communications, and streamlined settlement and reporting processes right now, today,“ says Tim Carmody, Chief Technology Officer at IPC. “There are soft-dollar ROI (return on investment ) advantages with efficiency gains from real-time speech-to-text transcriptions, and capture of in-stream orders and quotes, and the ability to free up a workforce from repetitive dual-keying functions.

He adds that there is “also hard-dollar ROI in trading and compliance, where NLP can directly improve the bottom line through transaction cost analysis, cost-avoidance for fees and penalties, and surveillance in general.”

©BestExecution 2020

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Equities trading focus : Overview : Dan Barnes

Ian Rycott

April 27, 2020

SHAKY TRADING, TRADERS UNSHAKEN.

Market resilience has been good, even as market returns have been tested. Dan Barnes assesses the current coronavirus state of affairs.

The multiple impacts of coronavirus (COVID-19) isolation policy, a price war over oil, central bank and government reactions has triggered enormous equity market moves and challenging conditions for traders.

John Lonski, chief economist at Moody’s Capital Markets Research, wrote on 19 March, “From the perspective of the US equity market, COVID-19 is the worst natural disaster ever.” For example, US equity markets saw the S&P 500 index drop 30% when it hit a 52-week low of 2,380.94 pts on 16 March 2020, down from a 52-week high of 3,393.52 pts on 19 February 2020. The FTSE 100 hit 4,898.79 pts on 16 March down 36% from its July 2019 highs, and other indices saw similar crashes (see Fig 1).

That has a corresponding impact on asset managers; UBS analyst Michael Werner, in a note dated 10 March, observed that equity market volatility is typically correlated with outflows for buyside firms. As markets sell off and asset managers liquidate positions to give cash to clients, Werner highlighted how this might impact listed fund managers.

“We find that Amundi and DWS are most immune to a 20% equity market decline in terms of the negative impact to their total AUMs (4-6%), given their high exposure to fixed income and multi-asset products,” he wrote. “At the other end, Schroders and Jupiter, which have high exposure to equity AUMs, will see the greatest impact to their AUM bases (8-15%), based on our analysis.”

On the frontline, traders are working hard to minimise the effect that any absence of liquidity or trading fragmentation has on clients’ investments, even in the face of significant outflows and inflows. They face a tough challenge on several fronts.

Home schooling

The first challenge is the operational risk of market access. When travel into offices in major cities has been banned, this requires back-up systems and trading from home.

“Our [buyside] traders have been remotely trading at full-capacity, as have the sell side, in some cases for the last two or three weeks,” says Paul Squires, head of EMEA equity trading and Henley fixed interest at Invesco. “Market volumes are significantly higher than average but we can absorb it. It’s fair to say larger asset managers have become really well equipped in their capacity and structure – even in these particularly challenging circumstances.”

Remote trading has its challenges. Many traders have had to order in extra screens to give them the view of the market they get in the office. Home broadband has improved significantly in capacity but is more susceptible to disruption than institutional trading infrastructure. However, the use of cloud-based trading systems does reduce the impact of traders moving location.

Equally, the markets themselves are under strain with capacity issues. In equities and futures, aggregate market volumes are high; the London Stock Exchange has reported a 23% increase in trading on its main market for February; anecdotally European equity volumes are said to be up by 30% in aggregate over March.

“In Europe exchanges have been working pretty well, handling this increased capacity day-in, day-out,” says Anish Puaar, market structure analyst for Europe at Rosenblatt Securities.” Although in the US there have been concerns about circuit breakers, that has been a debate around their design, not around their functioning which has been as intended.”

Australia has seen volumes driven so high by high-frequency trading (HFT) firms that the Australian Securities and Investments Commission stepped in to limit the number of trades being conducted by specific firms. The Philippines is an outlier in that it has closed its national exchange.

“[A] real positive we have had is market stability,” says Squires. “These are exceptional moves that we have had, in some cases triggering circuit breakers, but the markets are still open and we’ve had a very minor amount of intervention, such as temporary short-selling bans. So, I would have to say that financial markets have been pretty robust throughout.”

Puaar adds, “ If we compare that to 2009 when there were significant outages at some European exchanges, it is a testament to the technology investments that have been made over the last decade.”

Sound knowledge

The next risk is in the trading itself. With most of the buyside managing outflows, the directional nature of liquidity needs to be overcome, and the volatility of pricing has to be handled. Where liquidity is shallow it makes larger trades harder to execute, or at least more expensive.

“Spreads have blown out 50% in German and UK stocks when you look at the depth of the market, not just the touch prices,” says Mark Montgomery, head of Strategy and Business Development big XYT. “Therefore, liquidity is costing people more. Average trade size in March is down around 10-20% against the previous month.”

Matthew McLoughlin, head of trading at LionTrust, says, “We have not encountered too many issues with liquidity at this stage as large-cap equity volumes have increased dramatically, but we are yet to be fully tested across the entire market cap spectrum.”

The large market moves mean dealers are more cautious about pricing, and so spreads can be wider earlier in the day, tightening up as high-frequency trading (HFT) firms engage and brokers become more confident.

Those banks still willing to offer a risk trade to buyside clients – by taking on a whole position which they must then trade out of – are reducing in number, with buyside firms reporting fill rates for risk trades dropping by between 50% and 75%, in some cases falling to 10%. Dealers are also pulling away from other facilitated trading services such as pairs trading.

At the same time, buyside traders need to focus on getting the price their portfolio managers are aiming for, rather than risk being wrong-footed. “There is less willingness to rest orders in dark pools; as you might expect when prices are moving around a lot you may want certainty of execution over potential price improvement,” notes Puaar.

The sunny uplands of lit markets

Prior to the recent triggers of the sell-off, market regulators in Europe were reviewing infrastructure and trading rules in order to assess any weaknesses. The European Commission (EC) issued a white paper to review MiFID II, including the delivery of a consolidated tape of price data for both equity and non-equity markets.

“Having a single tape of record would definitely be of benefit,” says Chris Jackson, head of execution and quantitative services EMEA for Liquidnet. “There is value in post trade, and the market has found ways to deliver that. But in terms of reconstructing a tape day-by-day from multiple sources, that is much more difficult to achieve if there is no mandate.”

The European and Securities and Markets Authority (ESMA) had also begun a consultation into equity market transparency, which could have serious consequences for the use of dark pools, notably under the systematic internaliser (SI) regime. This allows sellside firms to supply risk pricing to clients without pre-trade transparency on the price. The consultation argues for removing SIs as eligible execution venues under MiFID II’s share trading obligation, and removing the use of waivers for dark trading, based upon the use of reference price or negotiated trading.

Buyside traders have voiced concern about the removal of these as they could impact their ability to minimise market impact by trading in the dark, using the large in scale (LIS) threshold.

“Institutional asset managers are of the view that maintaining the reference price waiver (RPW) and negotiated trading waiver (NTW) … provides an important function in protecting institutional order flow from adverse information leakage,” wrote Rebecca Healey, global head of Markets Strategy & Insight at Liquidnet. “Even large cap household names such as Telefonica and Daimler Chrysler would need to trade 113 and 83 times the average lit order size to reach the pre-trade transparency protection of LIS thresholds.”

The consultation deadline has reportedly been pushed back and traders are using industry groups to voice their concerns.

Montgomery notes that recent data indicates the fear of dark trading may be overplayed, in terms of its impact, as trading fragmentation today has been moving away from risk trading and unlit order books. “For all the concerns of the regulators on the side of the exchanges, volume is going back towards the lit order books in times of crisis because it is the only place where there is certainty of trades,” he says.

©BestExecution 2020

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ESG investing: Lynn Strongin Dodds

Ian Rycott

April 27, 2020

Finding the ESG common ground.

Lynn Strongin Dodds explores the difficulties in analysing and integrating ESG issues into qualitative and quantitative research.

Although the incorporation of environmental, social and governance (ESG) factors into financial research was gaining momentum, Covid-19 is expected to accelerate the pace. ESG funds have outperformed many of their mainstream peers during the market downturn although the lack of standardisation, uniform definitions and quality data will continue to pose challenges.

Numbers crunched by Schroders showed that during the market crashes throughout the latter part of March – when more countries including the UK went into lockdown – the MSCI ESG Leaders indices outperformed their mainstream counterparts in most geographies, albeit modestly in several instances. The UK was the most striking example with the FTSE 100 ESG Leaders index returning -27.3% year-to-date compared to -33.7% for the FTSE 100 index. The MSCI ESG Leaders indices target companies that have the highest ESG rated performance in each sector of the parent index.

Research by Bank of America Merrill Lynch also found that the top 20% of ESG-ranked stocks outperformed the US market by over five percentage points during the recent sell-off. This was not just down to a sector bias – ESG stocks are less likely to be in energy sector, and more likely to be consumer staples/healthcare – but persists on a sector-adjusted basis.

Hurdles to overcome

As a result, there is greater demand for detailed ESG research, but one of the biggest stumbling blocks to ESG analysis is, unlike financial information, corporates may volunteer but are not required to report on most types of ESG activity. Even if they do disclose their activities, there are different ways to report. Take the auto industry. As Ian Love, head of SEI Investment’s Institutional group for EMEA and Asia points out, “car companies could get high marks for their electric car ambitions, but recent studies show that battery production and electricity provision can be carbon intensive in nature and it could take roughly 150,000 kilometres of use before these cars effectively lower emissions.”

These issues help explain the results in the report by NMG Consulting and sponsored by Franklin Templeton which confirmed the lack of acceptable policy frameworks and reliable data hampered the buyside from integrating ESG research into their portfolios.

“There are fund managers that have built fairly substantive proprietary structures and models, but in general, there is a lack of common standards and reporting metrics which hampers the ability to compare metrics and measures across companies,” says Gill Lofts, EMEIA sustainable finance leader at EY. “This leads to discrepancies and variations across the industry. “However, ESG is moving up the priority list and the focus is increasingly about mandatory reporting that not only points out the risks, but also flags how companies can create sustainable businesses and long-term value.”

Third party providers

Currently, the major conduit for information is from external data vendors and ratings agencies although industry experts advise caution. “The high reliance of investment managers on aggregated ESG scores from third-party vendors is both surprising and disconcerting given that correlations are low, transparency on backfilled, corrected, and extrapolated data is poor,” according to Dr Tom Steffen, a quantitative researcher at Osmosis Investment Management. He adds that several of the data points are also generated by qualitative and subjective means which makes analysis difficult.

Mark McDivitt, head of ESG for State Street’s investment servicing businesses, also points to a study from the Massachusetts Institute of Technology – “Aggregate Confusion: The Divergence of ESG Ratings,” which looked at the parallels between five prominent ESG rating agencies – KLD, Sustainalytics, Video-Eiris, Asset4, and RobecoSAM. On average they were 0.61 compared to 0.99 of the credit ratings from Moody’s and Standard & Poor’s. “The result is that although there are several people in the space, no one has perfectly nailed it,” he adds. “However, I think the definitions will continue to evolve as the data gets better.”

Vanessa Bingle, Alpha FMC’s co-manager of its ESG proposition also believes that, “the lack of quality data and disclosure is a red herring but should not be used as an excuse for not moving forward. The data can be imperfect in other areas of investment research and yet investment decisions get made. What we are seeing is that instead of solely having specialist ESG teams, ESG training for all analysts is beginning to emerge and be thoroughly embedded into the investment decision process. This is because they are looking at these issues in all of their investments and not just specialist funds.”

Forging their own ESG paths

Not surprisingly, it is the larger fund managers as well as the ESG buyside stalwarts who are farthest along the curve. This is reflected in the NMC study which found that the more urbane investors integrated ESG into 91% of their equity portfolios while those at the medium and lower end of the sophistication spectrum incorporate ESG into 69% and 41% of their respective equity portfolios.

In general, most of the veterans in the field use third party data as a starting point, but they have also developed their own models and methods. Although the metrics may differ, there is a mutual focus on the financial material impact ESG issues have on a company bottom line, revenue growth, margins and risk. They, of course, vary according to sector, supply chain management, environmental policy, worker health and safety, and corporate governance are common measures.

“Materiality has become increasingly important but everyone has their own way of incorporating ESG into financial models,” says Archie Beeching, director of responsible investing at Muzinich & Co, which is developing a heat map highlighting the most material factors for every sector. “For select best-in-class strategies we do apply thresholds and companies have to meet certain scores and we feel it’s important to be clear about the thresholds that you set. The important thing is you need to do your homework on ESG. You will always need external data providers but you have to do your own ESG analysis and integration. It is by no means perfect but it is a journey that all fund managers need to take.”

Some managers like PanAgora Asset Management, though, have their own proprietary quantitative models that help identify ESG friendly companies that can also deliver alpha. “We would look at measures such as cost of capital to see which areas have a lower and higher cost of capital,” says Mike Chen, director of portfolio management, adding that ESG-rated companies tend to have less exposures to systematic and company-specific risk factors, which can lead to a lower cost of capital. “We would also look at how a manager is being compensated – is it direct ownership or stock options – and the behaviour of the company’s stock.”

Technology, of course, is also playing an important role. Fund managers such as State Street have developed their own ESG scoring system and leveraged artificial intelligence, machine learning and natural language processing to create a more comprehensive picture. “For example, you can look at a company report and it will tell you that they are doing great on ESG issues,” says McDivitt. “However, we are leveraging AI to look at social media and see what people are saying about the company. Are their employees happy or are they really making improvements on the environment side?”

While the buyside navigate their way through the ESG landscape, industry and trade groups have launched their own plethora of initiatives to help guide them. On the international stage, they include the International Integrated Reporting Council (IIRC), Global Reporting Initiative (GRI); the Climate Disclosure Standards Board and the Task Force on Climate-related Financial Disclosures.

Nationally, the US has its Sustainability Accounting Standards Board (SASB) while regionally there is the European Union’s recently agreed taxonomy on sustainable investing – which has been called the world’s first regulatory benchmark for green financial products. It may only cover a small part of the investment universe – the environment – but market participants see it as a step in the right direction.

In the UK, the Investment Association has introduced an industry-wide definition on responsible and ESG investing in an attempt to create a common language for advisers, fund managers and consumers based on a consultation with more than 40 investment management firms representing £5trn of assets. it defines and explains the terms “Stewardship”, “ESG Integration”, “Exclusion”, “Sustainability Focus” and “Impact Investing”.

Looking ahead, Nadia Humphreys, a business strategist for sustainable business and finance at Bloomberg believes that the industry is in a transitional period but that there is more pressure on fund managers to look more closely at the material impact of ESG issues. “There needs to be greater transparency and disclosure,” she says. “Investors should kick the tyres, ask more questions and dig more deeply into the methodology that their fund managers are using for their investment decisions.”

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Equities trading focus : ETF RFQ model : Massimiliano Raposio

Ian Rycott

April 27, 2020

THE ON-EXCHANGE ETF RFQ MODEL.

What’s in it for institutional investors, asks Massimiliano Raposio, Market Hub, Banca IMI.

In this article we review the ETF RFQ execution model, as promoted and managed by the primary exchanges, and assess whether it provides an attractive solution for institutional investors. We also ask where the model sits in the industry in comparison with risk pricing and the RFQ services promoted by the major electronic trading platforms and venues? In addition, can on-exchange ETF RFQs become increasingly relevant for the needs of institutional investors?

This examination is by no means systematic, as it is based primarily on the characteristics of the ETF RFQ service offered by the Italian exchange, Borsa Italiana. As a member of the exchange, Banca IMI’s Market Hub, has provided access for its clients since its December 2016 launch.

Background

Exchange Traded Funds (ETFs) now account for a substantial chunk of buyside investments with studies showing ownership levels by the asset management industry at between 30% to 40% of total assets.

When selecting a liquidity provider for ETFs, price competitiveness is regarded as the most influential factor for buyside institutions globally. This is also supported by MiFID II which emphasises the importance of the price discovery process.

Consequently for the buyside, RFQ processes have established themselves as the benchmark model for executing and as an alternative to seeking a risk pricing execution from an individual liquidity provider. The RFQ model which consists of a competitive auction process among counterparties, is typically conducted on institutional marketplaces, and through widely available electronic platforms, such as Bloomberg and Tradeweb.

In fact, the liquidity available on ETF instruments quoted on listed markets is inadequate to meet increased buyside requirement to trade immediately and with limited market impact. Some exchanges have addressed this trend by developing RFQ electronic platforms as part of their offering to complement the scarce liquidity available on their continuous trading segments.

Borsa Italiana was an early adopter, launching RFQs on ETFs at the end of 2016. The ETF RFQ order process has subsequently been enhanced with a number of tailor-made parameters, which aim to mirror those available through the electronic platforms. In parallel, the number of liquidity providers has increased.

An ETF RFQ order on Borsa Italiana can be submitted for orders above €100,000 and allows interaction with 10 market makers in either ‘manual’ or automatic execution modes. Buyside traders can choose for the RFQ to be anonymous (i.e. open to all liquidity providers) or visible (i.e. selecting up to eight competing market-makers). In addition, they can access this service through any broker member of Borsa Italiana’s ETFplus platform.

The flows processed via this channel are still small compared to institutional electronic marketplaces, but they are growing in both numbers of orders and size. In February 2020, Borsa Italiana recorded 442 trades, a new historical record, with a total turnover of more than €1.1bn. The average trade size in 2020 until end of February was €2.5m per trade, which points to an increased usage by local asset managers, private banks and insurance companies. Since the beginning of 2019, more than €12bn has been traded via this functionality.

The advantages of on-exchange RFQ orders

The main selling points for the exchange RFQ functionality are central counterparty (CCP) clearing and the access through their broker via an agency model rather than by establishing a direct relationship with a liquidity provider. The RFQ order-flow on exchange is fully incorporated into the equity execution workflow, and all executions settle against the executing broker, with CCP clearing, minimised risk and no settlement relationship with the dealer against which the transaction has been completed.

The advantages of the exchange RFQ can be summarised as follows:

CCP clearing minimises settlement fails and improves efficiency as RFQ trades are automatically cleared and settled like on-book trades.
The agency model separates commission from the best execution price and at the same time channels the flow within the standard equity workflow client-to-broker (including utilising the same connection).
Anonymity (although the request can also be named).
Limitation of counterparty risk and no requirement for onboarding or assigning a limit to multiple counterparties.
Trades are made on a regulated market and reported and consolidated with the exchange volumes.

Focus on best execution

The requirement for best execution will continue to be an important driver for the development of on-exchange RFQ processes, as they become increasingly widely adopted. This can be measured in terms of size as well as pricing benefits of RFQ trading compared with centralised, top-of-book exchange-listed prize and size (BBO).

In order to analyse this point, we looked at the data made available by Borsa Italiana. In terms of trade size, the average ETF trade executed via RFQ on Borsa Italiana in 2019 amounted to 150 times the average trade size of orders executed directly on the exchange over the same period.

In terms of price, the average improvement spread over Best Bid and Offer (BBO) had ranged between 4.3bps and 8.9bps, depending on the category of ETF.

If we looked at all the trades executed in 2019, 88.2% were traded within the spread.

Conclusion

RFQ trading provides better access to liquidity, as well as more competitive and transparent pricing. This more efficient workflow also applies to on-exchange ETF RFQs and not only to the more established institutional platforms, because the workflow and the participants are comparable.

When looking at executing RFQs on-exchange instead of using the electronic platforms, which currently enjoy a bigger market share and a longer track-record in this service, there are several advantages. Given that the execution size and price is the same, institutional investors operate in a fully regulated market framework with CCP clearing which electronic platforms are only now starting to develop. In addition, they have the opportunity of integrating this service in a fully transparent agency model, available through their broker. This, in our opinion, is why they deserve the full attention of market participants.

*Details on how the service operates are available on the Borsa Italiana web-site: https://www.borsaitaliana.it/etf/rfq/rfq/rfq.en.htm

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Equities trading focus : Rapid Addition : Mike Powell

Ian Rycott

April 27, 2020

RETHINKING ‘BUY OR BUILD’.

Best-Execution speaks to Rapid Addition CEO, Mike Powell about market trends and the launch of their new trading technology platform.

Rapid Addition (RA) has been providing electronic trading technology to the market for over a decade, what have been the major trends over that period and what does the current landscape look like?

Things have come a very long way in that time. It’s certainly been a decade for growth in electronic trading, both in terms of pure volume but also in its expansion beyond equities to virtually all other asset classes.

New regulation has driven significant change to market structure since the global credit crisis too, and we’re now seeing common challenges across markets in the form of liquidity fragmentation, a heightened focus on execution quality, and pressure on revenue models.

The buyside has become increasingly sophisticated and demanding of their brokers, especially when faced with their own regulatory obligations towards performance benchmarking. So, with shrinking margins and a crowded market, sellside firms are having to work harder than ever before to differentiate themselves from their peers.

What I find interesting though, is that we are now seeing the sellside want much greater control over their electronic interface with their customers. Increasingly, it is being seen as something much more than just a connection – it has become the primary shop window for their services.

So what are the implications of all this?

Well, the first point is that the commissions associated with electronic trading are far lower than for traditional high-touch order flow, and so efficient use of technology is key to ensuring trading in specific markets, or with different customer segments, is economically viable.

But, this cannot come at the expense of reliability and performance, nor a cumbersome on-boarding process. A poor on-boarding experience can lose a customer before they even place an order. And, at a minimum, it can strain hard-won customer relationships. This is one reason why firms want to own this whole process rather than rely on third-party FIX network providers, certainly for their more strategic clients.

Of course, we’ve seen plenty of regulation in this time too. How has this affected what your clients want?

Clearly, all the post-crisis regulation, and in particular MiFID, has had a huge impact. As I mentioned, liquidity fragmentation and best execution obligations have led to massive growth in algo trading. But agility is really the key here – being able to see what is happening to flow and having the ability to quickly apply new routing logic is one feature of our platform that customers really like. Providing real-time visibility to individual orders, connectivity status, and network latency is vital too. Broker-dealers live or die by the quality of their execution and so responding to issues quickly is an essential part of maintaining, or even growing, client relationships and margins.

Another key piece of regulation relates to scalability. RTS6 states that firms must demonstrate that they can handle twice their 6-month historic peak volume, and in the current environment the bar has obviously just got significantly higher. So, the ability to handle massive throughput without performance degradation is critical.

The other emerging trend we’re seeing is the increasing number of firms implementing multi-asset electronic trading platforms. The combination of best-ex, enhanced surveillance, risk management and trade reporting requirements across all asset classes is driving many to incorporate a multi-asset approach. We therefore see firms looking for systems which can combine both order-driven and quote-driven markets into their routing algorithms. Interestingly, this also allows such firms to provide a better, more comprehensive service to their clients.

So what has RA been doing to meet this new environment?

Much of what I’ve outlined was the thinking behind the launch of our new 3.0 platform, which has been over 3 years in its design, development and roll-out. Our current platform, RA Hub, always had a reputation for high performance and reliability, but we wanted to go a step further and deliver a solution fit for the new world of electronic trading.

Naturally, speed and robustness remain at the heart of what we do, so we have incorporated proprietary FPGA (field-programmable gate array) technology into RA Platform 3.0 for firms looking for even greater levels of performance. At the same time, however, we have retained the flexibility that the core software platform provides.

We believe that we are unique in the different combinations of speed, throughput and agility that we now provide.

Another objective was to cut through the complexity of deploying and running large, global trading infrastructures. The way RA Platform 3.0 is architected, along with bespoke tools such as our Service Discovery and full integration with Git, means that managing large scale deployments across multiple datacentres, in different geographies just got far easier. As part of this, we’ve added the ability to run automated tests in a virtual environment before rolling changes into production, giving technology teams complete control over their trading infrastructure.

Another key part of our design philosophy is that, while we do all the heavy lifting in getting messages from A to B, we make it very easy for our customers to add their own unique IP onto the platform. This way, our customers get the best of buy and build, with an optimum combination of lower overall operating cost but also with the power to effectively differentiate their services.

Finally, we wanted to ensure that RA Platform 3.0 had the flexibility to support any messaging protocol and any asset class. This has had a huge benefit for our customers wishing to simplify their own infrastructure, helping them interface to any version of FIX or proprietary protocol. In short, making a single, multi-asset trading platform a reality.

You mentioned increased volumes – how do you see that playing out?

Yes, the challenge is not only volume but also volatility – ensuring that your trading infrastructure can scale to meet overall volumes and respond effectively during peaks is vital. Current market conditions are also focusing everyone’s minds on risk – not just market or counter-party risk but operational risk too. With markets moving so fast and experiencing such large swings, even a small outage can have a disproportionate effect on the bottom line and damage client or counterparty relationships. The ability to adjust risk parameters intra-day is also crucial in volatile conditions such as those that we are experiencing.

So how do you see the future?

I think what we will see is an acceleration of what was already happening. By that I mean the move to assembling trading infrastructure out of foundational components and platforms such as RA Platform 3.0. In this way, firms will shift their focus to their own differentiating IP, be that algos, routing logic, or risk parameters.

Firms will also need to become better at segmenting and understanding the profitability of their clients, creating differing levels of service to meet specific client needs and budgets. This will result in accelerated adoption of cloud for trading with less latency sensitive counterparties. RA Platform 3.0 performs equally well whether deployed on-premise or in the cloud, so we can support these emerging deployment strategies across all types of trading firms.

We see our mission at Rapid Addition is to change how firms view the traditional dichotomy between buy or build, helping our customers achieve the optimum combination of resiliency, latency, control and cost effectiveness.

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Equities trading focus : Market continuity : Christian Reuss

Ian Rycott

April 27, 2020

MAINTAINING OPEN MARKETS IN TIMES OF UNCERTAINTY.

Christian Reuss, CFA, Head Cash Markets Swiss Stock Exchange, Member of the Management Committee, Securities & Exchanges, SIX.

In March 2020, the Covid-19 crisis caused unprecedented market turmoil. In such extraordinary times, functioning capital markets play a critical role in maintaining global economic stability. The Swiss Stock Exchange, just like many other exchanges globally, continues to ensure fair and orderly trading, enabling investors to adjust and implement their investment decisions seamlessly.

The Covid-19 pandemic has resulted in almost unprecedented uncertainty across economies and led to increased volatility in the global financial markets. As such it has tested the operational resiliency of a number of systemically important financial infrastructures. Significant turmoil in financial markets can destabilise the financial system and, as a result, the economy as a whole. It is crucial that markets function seamlessly in such times: Open markets allow for fair and orderly price formation so that investors can react to the uncertainty they face. If central market infrastructure was not operating it would lead to the already increased levels of uncertainty and cause more damage as investors would not be able to react to the events, could not accurately assesses the values of assets they hold and would be prevented from adjusting their portfolios to accommodate events as they unfold. This has an impact on the majority of our population who have investments in their pensions and savings which would suffer as a result. The main focus of SIX is to ensure a functioning market infrastructure – including the Swiss Stock Exchange – to help the market and the investors who rely on it to weather the storm.

Time to take a breather without stopping the entire market

Switzerland is known for its high quality, stability, and trustworthiness. This also sets the bar for our financial market and its infrastructure: SIX was always at the forefront of technological evolution being the first exchange in the world to switch from floor trading to electronic trading almost 25 years ago. Subsequently we have constantly invested in our systems and infrastructure as well as upgraded the Nasdaq X-stream INET platform we employ. So today we operate not only one of the most technologically advanced, but also one of the most stable stock exchanges in the world.

As a result, we are prepared for extreme market conditions and possess all of the necessary tools to support and protect market participants and investors. We have withstood extraordinary situations in the past from the financial crisis in 2008 to the impact of de-pegging of the Swiss Franc from the Euro in January 2015 which both led to unprecedented volumes. Our rule book allows for well-established methods to address high market volatility. Circuit breakers on individual stocks levels result in trading halts and volatility auctions to limit uncontrolled and excessive price movement. So without interfering with the entire market we can give traders the opportunity to re-assess the situation for a single stock. This does not suggest we prevent price movement altogether. In addition, our active market control and surveillance team monitors every single trade and takes action if activity does not conform with market price bands.

All of this is underpinned by robust technology. The events which unfolded in March 2020 are precisely the reason why our systems are calibrated towards peaks and not averages. As a result, our system capacity has been coping very well with the large volumes and velocity of trading. Capacity usage was at its peak in the low double digits of our system’s threshold and we have had no outages or system issues. This applies not just to our listing and trading businesses, but also to our best in class post-trade systems.

Open markets to best weather the storm

We didn’t just keep the Swiss Stock Exchange open because we technically could, we did it because we deemed it crucial to support the market in coping with the crisis situation and enabling investors to operate. Although there have been voices that advocated for shutting down markets, such suggestions seem counter-intuitive and could even exacerbate the crisis further. The Philippines Stock Exchange in Manila – to name a current example – closed for 2 days and when it reopened, stock prices were down by around 30%. Closing markets would not remove the underlying cause of the uncertainty and volatility. It would only remove transparency around asset valuations and for investors the important ability to act which results in these effects multiplying when markets re-open.

We are consequently also of the opinion that price formation should not be interfered with to allow unbiased valuations to be reflected in them. We already prohibit so called “naked short-selling” – in the sense of selling with no ability to settle the contract if the seller is neither in possession of the security nor able to borrow it – on our market and our market controls suspend trading if there are significant price movements intraday. We oppose blanket short selling-bans since they can have a negative impact on real-time price formation. Finally, we believe it is important to the orderly functioning of markets that investors can adapt to changing economic views in a timely manner – including mechanisms such as short-selling – to smooth the economic impact of price adjustments.

Listings in times of uncertainty

High volatility and declining asset valuations in March changed the prior benevolent environment for capital raising activities such as IPOs almost overnight. While European IPO activity in January and February 2020 was significantly up in terms of transaction volume – if not in numbers – compared to 2019, activity in March has slowed down materially, both in Europe and globally. In Switzerland, at this point, only already publicly announced spin-offs with distribution-in-kind to existing shareholders currently confirmed their intended time plan – subject to required approvals and to market conditions.

With regard to investment products, however, we have observed a significant upswing in issuances of structured products: More than 10,000 instruments were listed in March – an all-time record – as issuers updated their portfolios to new market levels. Looking beyond the exchange but not beyond the infrastructure that SIX provides to the financial centre, over 220,000 newly listed structured products were uploaded via our CONNEXOR service in March – another all-time high. On the ETF side, 21 new instruments were listed and Credit Suisse – on 16 March, in the middle of the storm – returned to being an ETF issuer on our exchange. So not only trading remained open, issuers also actively updated their investment products portfolio to provide investors with a wide choice of financial instruments to react to the market turbulences and to position themselves according to their market view.

Volatility boosts trading volumes to unprecedented levels

Uncertainty drives volatility and volatility drives turnover; a spike of uncertainty leads to a spike in volatility which leads to spike in turnover. To give a reference point: an implied volatility of 16% indicates that a stock is moving 1% per trading day. In mid-March, volatility as measured by the VSMI spiked to more than 70% – many times over the average of the past (albeit historically less volatile) years and a multiple of the “Rule of 16”. The increased volatility reflects the uncertainty facing stock markets and has led to massive reductions in asset values. As indicated above, this led to very high trading volumes – and unlike “Jordan Day” in January 2015, when the Swiss National Bank unpegged the Swiss franc from the Euro, this volatility persisted for several trading days rather than just being confined to a single day. As result, we’ve seen several new records being established in March 2020, both in terms of trading turnover – up +80.9% on the previous month at CHF 293.0 billion –, and in terms of trades – increasing by +127.7% to a total of 17,399,685. These new all-time highs surpassed the previous ones by 61.3% and 127.7% respectively, established in January 2015 and February 2020.

This sort of trading environment normally results in wider spreads and available liquidity being tilted to one side. On the Swiss Stock Exchange our spreads did widen in March, aligned with our peers who also saw similar trends. However, the relative spread changes were at the lower end of the spectrum when compared to our European stock exchange peers. A reason for this positive outcome is that our committed liquidity providers delivered during such difficult periods. So despite the high levels of uncertainty, trading remained fair and orderly. This is why we favour open markets which allow for informed price formation to best weather the storm in the markets.

A “certain price improvement” despite high volatility

A highly volatile trading environment usually leads to market participants opting for certainty of execution as opposed to seeking price improvements – a traditional dilemma. Our non-displayed liquidity pool SwissAtMid breaks with that tradition. Thanks to its unique sweep functionality, the service allows users to achieve both – certainty of execution and price improvements – at the same time.

In the second half of March, turnover in SwissAtMid exceeded CHF 1 billion in 11 out of the 15 trading days and yielded price improvements of more than CHF 8 million for market participants during this volatile period.

Trading in uncertain times

March 2020 was – in many ways – an extraordinary month and it is impossible to predict what the near future will bring. On the positive side it showed that European financial market infrastructure providers can be relied upon in times of crisis. SIX continues to operate a fair and orderly trading environment to support the market. Despite the current levels of uncertainty, volatility and record volumes our systems remain stable and offer investors a compelling environment with robust spreads and prices and a strong price formation process: The Swiss Stock Exchange is open and supports market participants and investors to best cope with the current uncertainty in the markets.

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