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MiFID II Boosts TCA

By
Shanny Basar
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Nearly all, 95%, of institutional trading desks in Europe are using transaction cost analysis but further progress is needed in fixed income and foreign exchange.

Consultancy Greenwich Associates said in a report, State of Transaction Cost Analysis 2019, that TCA is most embedded in Europe amongst  95% of  institutional trading desks, up from the 75% two years ago.

Richard Johnson, principal in Greenwich’s market structure and technology practice, focusing on equities and financial technology, said in the report: “This rapid uptake is undoubtedly due to MiFID II.”

The MiFID II regulations went live in Europe at the start of last year and extended best execution policies to new asset classes, including fixed income for the first time. In addition the transparency and reporting requirements of the regulation has led to an increase in electronic trading, which requires execution analytics. Greenwich added that as trading desks are increasingly global and firms tend to standardize processes across regions, the impact of MiFID II is likely to spread across to North America.

“For the buy side, TCA was once seen as a “tick-the-box” exercise but has become a differentiator, with many large buy-side trading desks now employing dedicated TCA professionals to help them eke out cost savings and improve performance for their institutional clients,” added Johnson.

However the use of TCA remains much higher in equities at 95% of trading desks in Europe. In contrast it is a lower 63% in foreign exchange and just 37% in fixed income.

Greenwich continued that global FX markets are highly electronic and so lend themselves more naturally to TCA. However, the lack of a consolidated tape can make it difficult to compare trade performance with every other trade in the market.

“In addition, spot FX is not explicitly covered by the MiFID II best execution obligations, so the regulatory tailwind is not as strong,” said the report. There is also no single benchmark price in the bond markets.

Richard Johnson, Greenwich Associates

“Nevertheless, the benefits that TCA can provide – including cost measurement, trade optimization and best execution compliance – will lead to a steady increase in TCA use in these asset classes,” added Johnson. “We expect TCA in FX and fixed income to grow over time, as the products mature and mindsets adapt.”

However, a survey last month from Liquidnet University found that more than half, 56%, of asset managers have seen no improvements in in fixed income TCA despite more data being reported under MiFID II.

Rebecca Healey, head of EMEA market structure and strategy at Liquidnet, wrote in the report that the buy side still finds it hard to find the data needed to enhance the execution decision-making process.

Rebecca Healey, Liquidnet

“Widespread industry frustration remains at the perceived lack of data quality available from Approved Publication Arrangements (APAs) today, alongside the challenges in interpreting best execution reports,” she said. “Participants complain of incomplete and inaccurate data, unnecessary complexity in terms of different fields to be reported and a lack of industry standardisation leading to the need to allocate valuable resources to clean up datasets before they can be used to derive real value.”

Fund managers need to invest in technology to manage increase amounts of data and the trading desk will need to learn new skills. Three quarters of respondents said collating accurate data is the priority to validate successful implementation of their best execution policy.

“Traders must be more IT aware and data driven in their approach, utilising available technology to feed analysis back into the pre-trade selection process,” said Healey.

Asset Managers Seek Data ‘Quick Wins’ as Performance Fears Persist

By
John DAtona
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The results of Linedata’s ninth Global Asset Management Survey reveal a desire to capitalize on quick wins from data analytics and digitization to protect investment and operational performance against the potential for further market dislocation.

After the implementation of MiFID II and GDPR, asset managers were looking forward to a period of relative calm where they could focus on longer-term innovation projects, including digital transformation technologies. Concerns of a continued market downturn are now forcing them to change direction and firms are reacting to the potential for more disruption. This survey underscores how navigating this paradigm is a new normal for asset managers worldwide.

“Asset managers were struck by a tumultuous end to last year that has led them to rapidly refocus on the critical initiatives that can boost operational efficiencies and alpha generation in 2019. In this environment, doing more with one of their greatest untapped assets – their data – is essential” said Gary Brackenridge, Global Head of R&D and North America Asset Management at Linedata. “We expect to see more developments in this area as well as a rise in outsourcing, which can not only facilitate advanced data analysis, but enable managers to focus on delivering investment performance and exceptional client service to retain and attract assets” he added.

Key findings of the 2019 survey include:

Maintaining investment performance is the biggest business challenge (34%): the concerns are a stark contrast to last year, when the top challenge was adapting to new regulation (44%) and maintaining investment performance ranked fourth. This year, attracting new client assets (33%) and sustaining operational efficiency (33%) come second and third.

Trading and other front office technology and data management are top areas of IT spending: doing more with data is seen as particularly important to investment performance and nearly a quarter of asset managers (23%) believe improvements to investment strategy decision making is the biggest data analytics opportunity.

Hype around robo-advisers and blockchain dies down: 7% of respondents see robo-advisers as the biggest disruptor to the asset management industry over the next five years, down from 22% in 2018. 12% see blockchain as the biggest disruptor, falling from 16% in 2018.

Asset managers prioritize data and nearer-term digitization projects: longer-term structural transformations are a lower priority over quicker wins with data and automation. This is supported by the significant progress managers have made with cloud adoption over the past two years; adoption for non-core systems, such as email, has grown from 29% in 2017 to 49% in 2019 and CRM systems from 22% to 38% over the same period.

Passive is dominant, but many firms are not able to benefit: ETFs are the products managers most expect to see growth in this year (cited by 36% of managers). However, only 9% plan to launch mainly passive products, versus 41% who plan to launch mainly active funds. This suggests that the dominance of ETF market leaders continues and managers should focus on what they see as their top differentiating factor – their reputation and client trust (24%) – to stand out.

Asset Allocation Model Usage Can Aid Advisors

By
John DAtona
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Business and growth concept.

Global research and consulting firm Cerulli Associates has identified more than 150,000 advisors (representing $5.8 trillion in total client assets) who could benefit from embracing model portfolios provided by their broker/dealer, custodian, or a third party.

Recognizing the challenges facing advisors in proficiently running client portfolios and in ceding discretion, Cerulli used advisors’ current portfolio construction preferences in combination with the resources and capabilities across myriad practices to create a sizing of the realistic opportunities available to asset allocation model providers.

Cerulli believes that practices lacking dedicated investment personnel present significant opportunity to strategists and home-office consultants who seek to expand model distribution and adoption. As with so many advisors, though, the advisors in this cohort may resist adopting models because they want to own the entire investment process, trading off potential gains in client acquisition for complete ownership of portfolio construction.

“Based on our findings, we believe that in excess of 150,000 advisors would be better served if they were to increase their reliance on model allocations, rather than keeping these responsibilities in their practices. Those fully immersed in portfolio construction may need to shift their business model to focus on financial planning and business development,” states Scott Smith, director at Cerulli Associates.

For asset managers, taking on the role of an allocation provider offers an unparalleled opportunity to maintain their relevance. Instead of allowing their products to become commoditized ingredients used by advisors, managers are increasingly embracing the role as developers of recipes that feature their proprietary strategies as key ingredients. Still, these asset allocation models will require consistent efforts to generate returns that may be difficult to calculate.

Cerulli’s new report, U.S. Asset Allocation Model Portfolios 2018, assists a variety of stakeholders in the asset allocation model segment to assess their own current position and develop strategic goals and plans to achieve them. For more about the findings of the report, visit here.

Institutional Crypto Three Years Away

By
Rob Daly
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Data analyzing in exchange stock market: the candle chars on display. Analytics price change cryptocurrency BTC to USD (Bitcoin / US Dollar), the most popular pair in the world. Big Bitcoin logo.

Wall Street broad acceptance of token-based assets as collateral is approximately three years away, according to Don Wilson, founder and CEO of DRW Trading.

“I’ve talked with people who run clearinghouses about this very question,” he said during a fireside chat at the Synchronize 2019 conference.

In the meantime, there is a lot that needs to be accomplished between now and then.

The most significant gating factor for institutional adoption is the dearth of the necessary tools asset managers need to manage and execute token-based transactions. Once firms have access to the new tools, it should whet their appetite, according to Wilson.

“The opportunity for entrepreneurs is to think about how we go from where we are now to where we can imagine and what needs to be built to accomplish it,” he said. “There is all sort of opportunities in terms of plumbing that fits these things together.”

One example, he cited was the recent decision by Digital Asset, which Wilson co-founded, to open source its DAML smart contract language.

“The work that Digital Asset is doing to put DAML on top of not just private blockchains but also public blockchains is a great example of the direction that companies in this space should be thinking about going to enable the wider spread adoption to these tools,” said Wilson.

Once institutional investors have access to the new toolkits, they will be able to use token-based assets to diversify client holdings, as a representation of real-world assets like real estate, and improve their efficiency via smart contracts.

“I believe all of them will happen, but it is going to take a long time,” he said.

Wilson expects that companies that already have extensive customer usage will be critical for widespread adoption of token-based assets.

“They will roll out wallets and crypto-tokens to their client base, which would simulate a lot of use,” he said. “And I think that will take place in the next year.”

OpenFin Reaches Critical Mass

By
Shanny Basar
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Adam Toms, chief executive of OpenFin Europe, said the technology has become the standard operating system across capital markets as it is being used across nearly 200,000 desktops in 1,500 banks and buy-side firms.

Adam Toms, OpenFin

Toms told Markets Media: “We have reached critical mass as the default operating system. There has been a shift to OpenFin being viewed as more like an industry utility.”

The OpenFin desktop operating system is similar to the Android or iOS operating platform for mobile phones but was launched to provide standardisation across capital markets desktops so that the industry can deploy new applications more quickly and they will be interoperable.

“OpenFin is on nearly 200,000 desktops across 1,500 unique firms, including 13 of the 15 largest investment banks, across a number of different areas,” added Toms.

He continued that desktop numbers are expected to increase as OpenFin has a number of significant projects launching with clients this year.

OpenFin will further increase its penetration on the buy side as FlexTrade, which provides execution and order management trading systems for asset managers, announced a partnership with the firm this month.

FlexTrade said traders will be able to seamlessly integrate third-party vendor applications deployed on the OpenFin operating system into their workflows while benefiting from full interoperability. In addition, FlexTrade will be able to roll out new desktop applications to its clients more quickly as they will use a common language.

Andy Mahoney, head of sales at FlexTrade UK, said in a statement: “FlexTRADER has operated an open architecture model for many years, ensuring traders have the data and workflows they need right at their fingertips. Connecting with the interoperability bus from OpenFin allows FlexTRADER users to both source normalized data, and control other applications from within the trader’s day-to-day workflow without information leakage.”

Mahoney continued that this saves users from unnecessary mouse clicks or context switches, which frees up their time to work on the more important tasks.

Toms added: “FlexTrade is used by the largest asset managers and the partnership shows that they are aware of the need for an interoperable, contextually aware desktop for the buy side.”

Compliance and operations

OpenFin initially gained traction on front office desktops but last year it partnered with risk technology provider Numerix so the operating system began to be used in middle and back offices. This month Irisium, KRM22’s market surveillance application, deployed on OpenFin’s operating system.

“We started in the front office but now have use cases in compliance and operations,” added Toms. “Irisium was the first compliance vendor to join OpenFin.”

Irisium will be able to easily share and receive information from other independent and permissioned desktop apps as they will be interoperable on the OpenFin operating system.

Saeed Patel, director of product strategy at KRM22, said in a statement: “Making Irisium available through the OpenFin framework will allow us to efficiently deliver continuous service enhancements to end users without large overheads. Our customers including banks, brokers and asset managers, will benefit from the enhanced user experience with the strong security they require.”

Cloud services

Toms said there is a big focus in the industry on managing screen real estate. He added: “A generational shift is happening on what is possible on the desktop.”

For example, in February the firm launched OpenFin Cloud Services allowing market participants to launch their own private app store and workspace management solution out of the box, eliminating the need for clients to set up their own bespoke development project. Users can choose from internal and third-party apps curated for their organisation.

Nick Kolba, chief product officer at OpenFin, said in a statement: “We don’t mix being a platform provider with being a content creator. We provide the technology, but it’s not Our app store; it’s Your app store. You decide what’s in your store, you set your branding, you decide who has access to what.”

The OpenFin app store incorporates FDC3 App Directory standards allowing all applications to be automatically discoverable and form part of the user’s workflow. The Financial Desktop Connectivity and Collaboration Consortium (FDC3) was founded by OpenFin in 2017 in collaboration with major industry participants to enable universal connectivity and standards across all desktop applications.

“FCD3 was ratified as a standard two weeks ago and its use will save the industry tens of millions of dollars,” added Toms. “Facilitating the inception of the standard and contributing it to an open source foundation was the right thing to do.”

Last year OpenFin contributed the FCD3 initiative to the Fintech Open Source Foundation. FINOS is an independent nonprofit organization promoting open standards and open source in financial services.

Buyside Profile : Supurna VedBrat : BlackRock

By
Ian Rycott
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FINGER ON THE PULSE.

Supurna VedBrat, Global Head of Trading at BlackRock explains to Lynn Strongin Dodds why staying current, flexible and dynamic is crucial in today’s ever-changing global marketplace.

Supurna VedBrat is Global Head of Trading, BlackRock and a member of BlackRock’s Trading and Liquidity Strategy Executive Committee, Global Operating Committee as well as the Human Capital Committee.

Previously, she was BlackRock’s Deputy Head of Trading. Prior to joining BlackRock, she consulted for the firm she founded, Strategic Solutions Consulting Corp., and held various positions at Bank of America, ING Barings in London and Lehman Brothers in New York. She started her career as a software engineer with IBM at their research centre in New York.

Externally VedBrat sits on the CFTC Technology Advisory Committee (TAC) and the CFTC Global Markets Advisory Committee (GMAC). She has a Computer Science degree from Rutgers University, US, and a Mathematics (Hons) degree from Delhi University, India.

 

What have been the fundamental changes in the post MiFID II world?

From a buyside perspective, we look at MiFID II from two different angles. The first is from a liquidity standpoint and how it is changing the liquidity pools around us. It is still too early to tell, but we have not seen a material change in terms of the availability of sellside liquidity. Over the last few years we have increased the trading flow that we do electronically, which has also expanded the list of counterparties providing us liquidity through electronic platforms. The other angle is from the dual sided reporting requirement, which has been a big lift from an infrastructure perspective for all buyside firms. Prior to MiFID II, you were able to delegate reporting to one side or the other.

 

What is the impact of unbundling? Have you adopted a global approach?

We already had a model where the portfolio managers were responsible for investment strategy and alpha generation, while the traders were responsible for execution. We have a central trading desk with a global footprint, which allows us to trade in the region or time zone that offers us the best liquidity, and that translates into competitive pricing for our clients. It is necessary to have a consistent global approach which may have an overlay of regional elements or requirements. In addition, a robust best execution methodology with proper oversight has always been part of the BlackRock DNA, which means we did not have to materially change our best execution practices to meet MiFID II requirements. Most of our execution policies and procedures were already aligned with the regulatory requirements.

 

I have read that over the past two years, BlackRock has created a more dynamic team structure and trading strategy. What skillsets does the trader of today need?

Advances in technology and data science are influencing trading and investment decision making. Trade execution today requires efficient ways to aggregate fragmented liquidity and the knowledge on how to use algos and analytics combined with time sensitivity of pricing. From an organisational structure standpoint we look to create a more dynamic structure by rotating traders among asset classes so that they can become specialists in more than one asset class. In the past, traders tended to specialise in a narrow and deep sector of an asset class. But today there is a need to be more flexible and agile to respond to changing market conditions and client needs. This has resulted in better trading capacity management at the firm level and a career path where traders gain broader experience. It also helps satisfy employees’ desire to keep learning and growing their skill base.

Financial markets have become much more electronic, and the modern trader needs to have the savvy to be able to keep reinventing themselves to stay ahead of the market curve. To trade today, you need to have a strong understanding of how the market works, a good calibration of where liquidity resides and the expertise to use transaction cost analysis. In fact, this is more critical today than five to ten years ago because the luxury to call three to four brokers and have them move the risk is no longer available.

 

In general, how has BlackRock leveraged technology in the trading process?

Technology is constantly evolving and trading must evolve as well to keep up with the changes. It means being proactive and adopting a much more holistic approach, including considering whether we need to redefine our trading strategies or use new methods to trade. In the past few years there has been a proliferation of data, particularly in markets that were previously less transparent like fixed income. At the same time, the use of algos and artificial intelligence has increased, enabling us to compute using a larger set of attributes in a shorter time frame.

We have always used data as part of our trading research efforts, but advancements in computing power and technology have enabled us to look at performance in greater detail. For example, we have a feedback loop where our trading research team provides insights on how we can adjust trading to improve performance. Put simply, technology and data has made our decision-making smarter.

 

How has the changing dynamics altered the relationship between the buy and sellside?

Our sellside counterparties are very important and are essential providers of liquidity for us. These relationships are indispensable to trading complex transactions, minimising information leakage or providing the buyside with a suite of algorithms. That being said, the style with which the buyside and sellside interacts has changed. In the past we would trade many of the liquid instruments via voice with the sellside and now we trade these instruments via their algos. Trading by voice today is now limited to large risk transfers or trading in less liquid instruments.

 

There is a lot of talk about diversity and inclusion but are firms doing enough? It is often tied to hiring more women but is progress being made across different ethnic and socio-economic groups?

At BlackRock, our hiring practice requires interviewing a diverse slate of candidates. We train our managers to value diversity of thought and experience in their teams. We also aim to make people much more aware of their unconscious biases, not only through training but also by building a culture where people feel comfortable talking about these issues. Talent management includes not only creating a career path where employees can learn new skills and advance in the organisation, but also developing their leadership skills, collaboration skills, and people management skills to name a few.

In trading, we look at the team dynamics and see what is missing, and then consider how best to fill the gaps to ensure that the team is strong. When someone leaves a role, it may be a chance to give a stretch opportunity to a high performer or to fill a skills gap in the team. Sometimes it pays to slow down the process, wait, and be much more thoughtful about what is needed.

BlackRock has also created a few customised leadership programs, such as the Emerging Leaders at BlackRock (ELAB) and the Women’s Leadership Forum (WLF), designed to help high-performers to enhance their leadership skills and advance their careers. Furthermore, the BlackRock Founders Scholarship program gives high-performing students from underrepresented communities the opportunity to learn and contribute to the firm through merit awards and a position in our summer internship program. This has helped increase the diversity of our analyst classes. We also sponsor a number of employee networks that help foster community and support for the many diverse groups that our employees identify with.

 

Looking ahead what do you see as the opportunities and challenges?

In the UK, the uncertainty around Brexit has forced firms to prepare for multiple outcomes across multiple work streams. We are also focused on China and making sure we’re prepared to trade as that market opens up. Again, it is about preparation and being able to effectively execute our plans. Lastly, I think we will see more development on the use of artificial intelligence and data science, which will impact and improve the investment and trading decision making process.

©Best Execution 2019
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Equities trading focus : Sellside focus : Natan Tiefenbrun : Bank of America Merrill Lynch

By
Ian Rycott
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Natan Tiefenbrun, BofAML

Natan Tiefenbrun, Managing Director, European Execution Services at Bank of America Merrill Lynch discusses the tools needed to succeed in the changing execution landscape.

Natan Tiefenbrun is head of Equities Execution Services for Bank of America Merrill Lynch (BofAML) in EMEA. He joined the firm in 2013 and is based in London. Prior to joining BofAML, Tiefenbrun spent four years with the London Stock Exchange Group, most recently as the Chief Executive Officer of Turquoise, a pan-European equities and equity derivative trading platform. Prior to this position, he spent two years working with a VC-funded start-up. He began his financial markets career in 1993 at Instinet, where he spent thirteen years developing and running the firm’s portfolio trading, algorithmic trading and sponsored access businesses. He holds a degree in Computing Science from the University of Edinburgh.

What difference has unbundling made to the buy & sellside relationship?

Unbundling has empowered buyside heads of trading to select brokers purely with a view to achieving “best execution”. We’ve seen this result in a trend towards buysides holding fewer (deeper) sellside trading relationships. They are focused on those able to deliver the best outcomes and deepest/most diverse liquidity.

Having to define best execution has created its own challenges; how to balance quantitative and qualitative factors; when to choose high-touch versus low-touch execution; whether to in-source or out-source responsibility for measuring execution quality; how to recognise and measure good service; how to construct robust performance and liquidity benchmarks. This is driving the need for new quantitative skills and expertise on the buyside, along with a growing appetite for data and actionable insights.

On the sellside, execution must stand on its own merits; some firms have quit the execution business entirely, while others are investing to benefit from consolidation towards the most capable players. At BofAML, areas of investment have included access to and provision of additional liquidity, enhanced cross-asset trading solutions, new infrastructure for algorithmic trading designed to perform in the new landscape, and investments in our sales trading and trading teams. We’ve also further enhanced our capabilities to evaluate different liquidity sources and trading tactics, understanding both child- and parent-level impact and performance implications and using these to optimise outcomes. These tools, data-sets, and on-going dialogue enable us to evidence to clients that best execution is being pursued and delivered.

Natan Tiefenbrun_BofAML

 

 

 

What type of services do the buyside want today – algos, TCA, analytics?

What all clients have in common is the need to focus on driving continued improvement in execution outcomes for their investors. Clients are progressively more aware of their own flow characteristics and the evolving market structure, and more sophisticated in using this understanding to inform execution decisions. We see analytics, and services that help provide and evidence structured data-driven decisions, in particular demand.

This drives us to increase customisation and specialisation of our services to suit each individual client’s needs – whether in the behaviour of algorithms or routers, in the service from a sales trader or sector trader, in the provision of liquidity, or in the execution consulting and TCA reporting. This is resource-intensive, but rewarding, as it deepens the partnership with clients and can demonstrably enhance outcomes. But we shouldn’t over-complicate things – in plenty of situations, and especially in emerging markets and for larger orders – clients want the same today as they did ten years ago – service and insight from experienced sales traders and traders, and access to the liquidity they need.

More specifically, there has been an increased reliance on data and analytics, but how is that enhancing the decision-making process? Everyone wants more data and analytics in order to evidence best execution – but most clients would admit it can be challenging to collect sufficient, good quality data to draw statistically robust conclusions. To help, we established a dedicated execution consulting team that partners with clients – sharing expertise, comparing or supplementing data, and advising on how to optimise execution further.

In algorithmic trading, some clients focus principally on measuring execution results against an agreed set of benchmarks, and give brokers discretion on how and where to execute – subject to rigorous post-trade analysis and discussion. Other clients look to standardise how and where brokers execute on their behalf – due to their own conviction and/or to make comparisons across brokers easier. Once clients have meaningful analytics, they can improve the quality of the engagement with brokers, and drive a cycle of experimentation and improvement to their algorithmic trading.

We’re also seeing more clients integrate execution-related analytics into their investment processes, for example, using a better appreciation of addressable liquidity and market impact estimation to inform order-sizing, or using stock factor exposures in combination with trading cost estimates to weigh up alternative hedge construction or trade expression.

If there’s one particular area where clients are still grappling with the ‘whether or how’ to apply data and analytics, I would point to high-touch execution.

How has the trading landscape changed with the advent of new counterparties and trading protocols? Help or hindrance?

Innovation often introduces complexity – but it also creates opportunities for meaningful differentiation in areas that might have looked commoditised previously. Eventually, after a transition period, the market collectively drives the success of innovations that solve a real problem, whether by reducing costs, improving efficiency, or simplifying the search for liquidity.

If the sellside challenge is dealing with the added complexity, the challenge for the buyside is the lack of data with which to judge or measure the benefit/detriment. Quite reasonably, many clients are sceptical about change until its value is proven – but proving whether a new venue or protocol adds value is particularly complicated if you experience it indirectly via brokers.

BofAML has supported trading initiatives such as Turquoise Plato and Cboe LIS – what are the importance of these relationships?

Both have brought significant efficiency improvements and cost reductions in block trading, safely bringing together buyside parent-orders and sellside algorithmic liquidity. They’ve driven the expansion of large in scale liquidity, and have also driven lower fees from prior incumbents – to the benefit of end investors.

Plato Partnership provides a unique forum in which the buyside and sellside can work collectively to drive further innovations. It can be challenging to reach consensus, but everyone benefits from the quality of debate.

Where specifically does BofAML see opportunity to innovate and differentiate in execution?

We want to be the best, so of course we have to find opportunities everywhere. In high-touch execution, we believe the market remains rather opaque. We don’t think the buyside receive the information they need to fully grasp how sellside firms decide who to show liquidity to, or how they manage and recycle their risk inventory. And nor do clients know how their business contributes to the overall success of the broker’s franchise. We’re working with clients to change that.

In algorithmic and portfolio trading we’ve totally re-engineered our trading platforms to deliver significant improvements in our capabilities, and in our ability to improve execution performance for clients. We’re also excited about our new office and dramatically expanded footprint in Paris – relationships matter, and clients are welcoming the greater presence and engagement.

Looking ahead, what challenges and opportunities do you foresee?

I think our industry, buyside and sellside, will continue to see revenue and cost pressures. Working together, we have to find ways to become more efficient, without sacrificing the integrity or quality of the execution outcomes we deliver to investors. Partnerships with fin-techs, investments in technology/people, and improvements in statistical research methods can all contribute to enhancing the quality and efficiency of decision-making. And as clients increasingly focus on multi-asset strategies, demand will grow for more integrated and consistent cross-asset execution services.

One other small detail…, we still need to work across the industry to introduce a consolidated tape with consistent data standards and reasonable economics. In many respects Europe remains a much more expensive region to invest and execute, and market data costs would be a prime example of this.

BofAML

©Best Execution 2019
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Regulation & compliance : Impact of MiFID II : Gill Wadsworth

By
Ian Rycott
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WORK IN PROGRESS.

Gill Wadsworth assesses the highs and lows of the MiFID II implementation and the gaps needed to be filled.

Anyone who remembers the Millennium Bug will most likely do so with an amused fondness. In 1997, warnings emerged that the world’s computer systems would fall into meltdown because technology could not cope with a turn of the century date change.

As it happened, when clocks struck midnight on 1 January 2000, nothing happened. For some, the lack of technological Armageddon epitomised the typical hysteria associated with a shift to anything new. However, the reality is many millions of IT hours and a staggering amount of money were spent ensuring companies and individuals could move into the millennium without incident.

The same may well be said of MiFID II. Fifteen months have passed since what was described as ‘the single largest piece of financial legislation for a lifetime’ has passed into statute, and all still seems well. However, MiFID II is a work in progress and commentators are keen to point out that much is yet to come out in the wash.

Northern Trust_Gerald Walsh

Gerard Walsh, head of development, institutional brokerage at Northern Trust, says MiFID II’s smooth transition is to be commended, but warns of challenges ahead. “We are only 14 months into implementation, there is much more with which we must comply and comprehend,” he adds.

The most recent concern relates to open access trading which allows derivatives to be traded at one venue and cleared at another. This is a popular concession in London, but other European countries are less enamoured. If the UK is no longer a part of the EU, its voice in what should or should not be part of MiFID II seems rather diminished.

The tasks at hand

Attempting to make calls about the UK’s influence in Europe seems futile given the ongoing Brexit uncertainty. Instead the industry needs to focus on the knowns and make assessments about how MiFID will proceed with other challenges as they emerge.

Trading venues is one area that needs attention. Systematic internalisers (SIs) were among the first to demonstrate teething problems. These were accused of bringing some disparity to the system; a criticism that appears to run contrary to the directive’s core equality objective. MiFID II extended SIs’ reach to include bonds and at the same time ensure that internal trading did not undermine that done on external venues.

For more than a year, the European Securities and Markets Authority (ESMA) has been aware of misgivings about SIs’ advantages over other trading venues. Speaking in March last year, ESMA chair Stephen Majoor acknowledged that SIs were increasing market share while not being obliged to follow the same rules as other venues. For example, they are not subject to the tick size regime applicable to trading venues in the EU for equity instruments, allowing them to offer marginally better prices than other trading venues.

Majoor said: “There are concerns that the attractive environment for trading on systematic internalisers may ultimately result in changes in the market structure away from trading venues.”

At this point ESMA proposed that SI quotes adhere to the same tick size requirements imposed across the board.

More than nine months after ESMA’s response, the International Capital Market Association’s (ICMA) fourth quarterly report – published in 2018 – revealed buyside and sellside do not think there has been any improvement in price transparency, or that liquidity has increased. In effect, MiFID II has not resulted in a level playing field between trading venues.

One ICMA member told the association: “It is more the case of the opposite [of a level playing field]. The SI regime has made some smaller players re-consider business due to implementation costs.”

SIs and the buyside

Brian Charlick-CGIThe MiFID II SI regime is also accused of making life more difficult for the buyside. “SIs were supposed to make it easier for the buyside to trade, but people are concerned about the complexity of the market,” says Brian Charlick, principal consultant at CGI “There are so many layers that it is hard to say who can do what, and where they can do it. It is more confusing and there is more for everyone to watch and monitor.”

Christian Voigt-ION

However, some commentators are positive about the SI regime. Christian Voigt, senior regulatory adviser at ION Markets, describes this SI inequality as ‘minor’, and remains confident that SIs are a valuable part of European trading. “Systematic internalisers have undergone significant enhancements due to MiFID II,” he says “As those changes are settling in, minor issues such as tick size are emerging and require some fine tuning. Overall, it is positive that regulators updated the SI regime allowing the formation of compliant alternative liquidity pools servicing the buyside.”

Voigt says it is important that the industry remains positive about SIs since they allow the buyside to interact directly with liquidity providers in a fully regulated and transparent manner. “It is crucial for the buyside to have access to a large and diverse selection of liquidity pools,” he adds. “Systematic internalisers are a vital part of such an ecosystem”.

While much of the focus has been on the SI regime, other trading venues are also making noise post MiFID II. Periodic auctions in particular have proved a success. “Trading venues embracing regulator change were able to attract new business and generate growth,” says Voigt. “A good example is the periodic auction, which quickly captured a considerable market share and established itself as a meaningful source of liquidity.”

However, like SIs, periodic auctions may see the MiFID II goalposts move after ESMA released a call for evidence on periodic auctions in November last year. Since MiFID is all about improving transparency, trading volumes conducted through dark pools are subject to the double volume cap (DVC). The regulator is concerned that frequent batch trading on periodic auctions are being used to ‘circumvent DVCs’ and as such wants to close any perceived loopholes.

Ben Springett-Jefferies

ESMA is also exploring the introduction of consolidated tape – which would bring greater clarity around all trades, whether at SIs or periodic auctions. Ben Springett, head of European electronic and program trading at Jefferies, says “Despite its broader objective of increasing transparency, MiFID II failed to deliver a consolidated tape. A combination of this gap and varying interpretations of regulation around trades eligible to be reported as SI, has not brought the desired clarity.”

Charlick though is confident that periodic auctions will not lose their shine. “The auctions are working well,” he says. “There are going to be minor problems with it which is to be expected as they’re brand new. I still think they will be one of the triumphs of MiFID II.”

Jason Waight-MarketAxess

While ESMA revisits the rules, commentators predict likely consolidation among trading venues as providers struggle to keep pace with MiFID II’s requirements. Jason Waight, head of regulatory affairs at MarketAxess, says alongside this trend, it may be harder for new players to join. “The cost of operating under MiFID II has increased and that raises the barriers to entry. [MiFID II] does not make it impossible to become a trading venue, but it may be harder.”

Consolidation may be accelerated by what Walsh argues is specialism among trading venues. He likens the market to food retail, comparing the big investment banks to the likes of Tesco and Sainsbury’s. He argues that the big players offer access to broad markets at lower prices. Alternatively, Walsh compares smaller trading venues with artisan food shops or farmers markets, offering specialist deals at higher prices.

“That specialism is solidifying in a concrete way under MiFID II, which means execution is delivered by certain venues to certain clients,” Walsh says.

Whether this proves to be a positive outcome, remains to be seen.

The lack of chaos post MiFID II is – as with the Millennium Bug – testament to how much work was completed before deadline day. The challenge now is keeping up with glitches and hitches that arise post implementation date. There is still more to come from this monumental piece of legislation.

©Best Execution 2019
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Fintech : Blockchain technology : Dan Barnes

By
Ian Rycott
-

BLOCKCHAIN: WHAT THE INDUSTRY DID NEXT.

Without an industry consensus on distributed ledger technology, internal developments are the future. Dan Barnes reports.

In February 2019, JP Morgan launched a digital coin that represented fiat currency, to facilitate the exchange of value between institutional accounts. The JPM Coin uses blockchain-based technology to allow instant transfer of payments. In January 2019, HSBC reported to have settled more than three million FX transactions and 150,000 payments worth $250bn using its own distributed ledger technology (DLT) over the previous year.

DLT has been proven tested and shown as useful infrastructure in both delivery vs payment (DvP) or payment vs payment (PvP) spaces by major financial institutions. However, this value is eradicated from the promise it initially offered, promising to remove post-trade processing from transactions, along with associated costs.

Blockchain, the DLT underpinning bitcoin transactions, was conceived as a way to avoid payments being made using non-existent or fake currency. Bitcoin can only be transferred if the shared database / ledger that has recorded its transactions confirms it is legitimately owned, based on previous transfers.

In making that check pre-trade, the system moves the settlement process to the point of trade, where using other models it is run one or two days (T+1 / T+2) after the trade is agreed. Fundamental to the T+1/T+2 structure is the need for an investor to communicate the request to sell via a broker at a given point in time, which can be affected immediately, while the process of transferring securities from a custodian account requires a more formal set of checks. This prevents brokers trading client assets in order to prevent fraud. When trading across borders Nostro accounts are needed, with a bank parking money with another entity overseas, to act as a buffer against transaction problems.

Whether in the local settlement process or trading overseas, there is still risk and uncertainty in a transaction until settlement is completed. Removing that risk frees up any capital needed to hedge against it. The straightforward advantages of DLT are clear, which raises the question of why the technology is not more widely adopted.

Hugh McMillen-Instimatch

“Using a layer of DLT you could basically do away with the Nostro accounts,” says Hugh McMillen, founder and chief innovation officer at Instimatch. “There is the equivalent of US$5 trillion sitting parked around the world in various accounts just to facilitate cross border payments. The cost savings that could be facilitated by DLT are huge, it alters the whole settlement costs. The fact that you can pledge securities and margin them properly, without actual physical settlements from one CSD to another.”

Still not standard

To reduce the post-trade costs implicit within trading, banks will need to replace the existing settlement infrastructure with a newer version that they can all connect to. To use a DLT-based model they must agree the technology that will underpin it.

Jerry Norton-CGI

“The technology can work, so delays are not about technical challenges, there are several other factors at work, and chief amongst these is standards,” says Jerry Norton, head of strategy for CGI’s UK financial services business. “Without a de facto or de jour standard, you are creating a closed circuit.”

However, many banks are engaged with multiple consortia, which are effectively creating rival standards. In doing so the banks are sustaining rivalry in the hope that one will emerge as a victor, instead of choosing a model.

Where infrastructure is developing DLT, that could create a de facto standard. For example, The Australian Stock Exchange (ASX) is using Digital Asset DLT to replace its settlement systems. The US Depository Trust and Clearing Corporation announced the results of research into DLT provided by Digital Asset (DA platform) and R3 (Corda platform) in November 2018 which showed that entire trading day’s equity trading volume at peak rates, which equated to 115,000,000 daily trades, or 6,300 trades per second for five continuous hours, could be run on either platform.

Yet multiple infrastructures running on various DLTs would simply replicate the existing model of connectivity that trading firms have with settlement platforms today. A lack of interoperability between them would not reduce costs for the settlement banks, but may for the infrastructure provider itself. As infrastructure does not typically face competition, and therefore price pressure, the extent to which savings would be passed on is unclear. Banks and trading firms would still be left with the challenge of how to move data or instructions from one DLT mechanism to another.

Darryl Twiggs_SmartStream

Dr Darryl Twiggs, SmartStream says, “If they are developed to handle different parts of the trade lifecycle, the challenge is, what if I need to get off one network for trading and onto another network, which handles corporate actions for example?”

The big consortia, which had initially promised to create standards through consensus, have seen declines in support. R3 has lost Goldman Sachs, JP Morgan, Santander, Morgan Stanley, and National Australian Bank as members. Digital Asset saw chief executive Blythe Masters exit in December 2018 and has since seen James Powell, chief information and technology office of engineering leave, along with a number of regional staff. However, that should not be read as sentiment for the whole market argues Michele Curtoni, vice president in State Street’s Digital Product Development and DLT team.

“What happens with any one consortium is not a strong indicator of progress,” he says. “Some might have had membership or licencing issues that they were not happy about, but blockchain is really about the creation of networks.”

If a consortium does not prove to be the answer, there are moves afoot to deliver a technical standard via other routes; work is ongoing with the ISO/TC 307 committee, which is developing commonality around taxonomy, interoperability and governance, the latter also being a major stumbling block.

Who’s the boss

The need for a shared ledger between peers creates a demand for governance over the intellectual property and processes within the mechanism. While a consortium can provide a structure to support that, at least some departures have been triggered precisely by ownership debates.

“We need blockchain to have a completely new governance structure so that in the transaction flow, I don’t see the data from somebody else,” notes Curtoni. “I have to make sure the data governance layer has been built in a way that I can be 100% confident I am not breaching any data policies.”

That need for control and protection feeds into the selection process for systems. McMillen notes that Instimatch chose to work with R3 technology because it made compliance with the European Union’s General Data Protection Regulation (GDPR) more straightforward. His firm is working with a major bank to support cross border money market engagement, noting that at present some 45% of money market activity is purely domestic.

Central banks are looking at the potential to provide a possible point of origin for digital token or currencies, and several have been working on proofs of concept to issue risk-free fiat currency via DLT.“The utility settlement project seems to be approximately two years away, involving central banks and systemic banks,” says McMillen.

Consequently, at present, projects like those of HSBC and JP Morgan are proving more likely to deliver in the shorter term.

Mike Tae-Broadridge

“One of the things I do think that global banks or global institutions can deliver around the world is intrabank settlements so I am bullish on that,” says Mike Tae, head of strategy and M&A at Broadridge. “I think that’s a real possibility. There are questions that need to be answered around the legality of digitised assets on the blockchain, but that is more straightforward when it’s inside of the company.”

©Best Execution 2019
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Data management : GDPR : Heather McKenzie

By
Ian Rycott
-

INTO THE LIGHT.

Heather McKenzie assesses the impact of GDPR to date and the work that is still required to get up to speed.

It has been nine months since the European Union’s General Data Protection Regulation (GDPR) came into effect and many would say it’s too early to judge its success. However, the Facebook Cambridge Analytica scandal has reminded organisations of what is at stake in preserving and protecting personal data.

Vera Jourova-EC

According to European Commissioner for Justice, Consumers and Gender Equality, Vera Jourová speaking at the Computers, Privacy and Data Protection conference in Brussels in January, while the GDPR had been initially criticised, it has been “finally embraced” and understood. Data breaches and mishandling scandals “remind us of what is at stake – from preserving our most intimate sphere to protecting the functioning of our democracies and ensuring the sustainability of our increasingly data-driven economy”. She added that GDPR is a “tool for businesses to try to regain the lost trust. And I do not see any offers of a better response”.

Cambridge Analytica had acquired and used personal data about Facebook users from an external researcher who had told Facebook he was collecting it for academic purposes

The compliance headache

If GDPR is now a fact of life, it is one for which compliance has involved a great deal of work at financial institutions. Aoife Harney, senior regulatory consultant at software company Fenergo, says the regulation “required a huge amount of preparatory work from organisations in scope”. The scope included non-European organisations as GDPR assigned extra-territorial obligations on many firms. These included establishment – whether an organisation was deemed to be established in the EU – or if an organisation offers goods or services or monitors the activities of data subjects within the Union.

Aoife Harney-Fenergo

Harney says there are “common threads” that will run through any organisation’s approach to GDPR compliance that may help when preparing for data protection and privacy requirements in other jurisdictions. “Approaches will depend on the nature, scale and complexity of the business, and the quantity and sensitivity of data they process, among other factors. But all organisations should take a ‘privacy by design and default’ approach to data protection,” she adds.

The GDPR requires organisations to put in place appropriate technical and organisational measures to implement the data protection principles and safeguard individual rights. This is privacy by design or ‘data protection by design and by default’. The UK’s Information Commissioner’s Office (ICO) states in essence, this means firms must integrate or ‘bake in’ data protection to processing activities and business practices, from the design stage right through the lifecycle.

According to the ICO, “Data protection by design is about considering data protection and privacy issues upfront in everything you do. It can help you ensure that you comply with the GDPR’s fundamental principles and requirements, and forms part of the focus on accountability.”

Steven Martin, associate director at consultancy CapCo, says previously, privacy by design was “largely only for the elite, large institutions. It was adhered to when new systems or products were being developed and built in from the start. GDPR has made it necessary for all organisations to consider privacy by design and make sure they embedded it in all their products and services.”

Among the specific techniques that have been employed, organisations are looking at how data flows across their networks in transit and at rest and are applying tighter security measures to this, including encryption, he says.

“Encryption can be an easy win for an institution. Linked to this idea is pseudonymisation – where data is protected by a separately held key. This means users can un-encrypt it and bring it back into a personal data form.”

Philip Greaves-Protiviti

A key difference in how GDPR is approached will be who leads the programme, says Philip Greaves, a director and GDPR lead at consultancy Protiviti. “Is it a legal and compliance task or operations/IT led? If the legal and compliance team leads it, the focus is often top-down policies, privacy notices, contracts, etc. If operations/IT, the focus will be on IT systems compliance, information security controls, etc.”

Some organisations, says Greaves, have passed responsibility for GDPR on to an information security chief, although there is much in the Regulation that is not directly related to information security. “It is important to have a balanced approach, bringing in capabilities from privacy, legal, marketing, human resources, IT, information security and customer services.”

Martin says one of the first moves regarding GDPR compliance that many firms made – particularly if they were in the public sector, or an organisation that deals with large volumes of data or sensitive data – was to decide whether or not they needed to appoint a data protection officer. This got people thinking about GDPR compliance, he adds.

Drawing parallels

In terms of data management, there were parallels between GDPR and other EU regulations such as MiFID, says Greaves. His colleague, Stuart Campbell, a director and market infrastructure lead at Protiviti, says managing data is a common feature in much of regulatory change, whether it is MiFID II or GDPR. “An issue for buyside firms to tackle is the way data is outsourced to service providers such as transfer agents. How to control the transfer of data and how to map it is very important. For those firms that use a cloud services provider, the issue is even more complex, including ensuring control over who accesses the data within the organisation and for what purpose. Risk profiles can change; hence training has to be very specific and up to date.”

Stuart Campbell-Protiviti

Firms always knew there would be a data challenge with GDPR but also MiFID II, he adds. “Many took the view with MiFID II that they would get over the line and go back and make it more efficient later on. This is especially true for the quality of transaction reporting which is heavily dependent on the quality of data.”

Campbell says reporting was always expected to be patchy to begin, but the UK’s Financial Conduct Authority expected it to improve after time. “The FCA is also getting firmer with organisations, insisting that issues are ironed out. It’s in the regulators’ interest to ensure financial institutions have the right processes in order to deliver accurate, timely and complete information to them.”

The Data Protection Directive meant that each EU Member State had data protection requirements in place before GDPR, so many organisations in scope already had to comply with the data requirements of their respective national regulators, says Harney. “Those organisations would have already had a good foundation in place on which to build GDPR-compliant policies and controls.”

She adds that GDPR has had a “butterfly effect” around the world as national authorities and governments outside of the EU are now clamouring to ensure their data protection laws meet the high global standards set by GDPR. This allows these jurisdictions to apply for white-listed status or allows for greater ease when arranging cross-border data transfers. “There is a great deal of work under way in the US, Asia Pacific, Africa and in South America, where similar principles to GDPR are being implemented, although there will be some deviations – including controversial data localisation rules,” she says.

Martin says some countries have decided that if the GDPR is “good for the EU, then it is good for us”. Brazil, for example, is implementing a new data protection regime that will come into effect in February 2020. It is a cut-down version of GDPR, he says, and recognises the cross-border transfer of data and is aimed at protecting Brazilians’ data wherever it is. “Like many regulators, those in Brazil are recognising that they need to protect their citizens’ data in the global environment – not just within their borders,” he adds.

Thailand also recently announced a new data protection law based on GDPR and protection of their citizen’s data in cross-border processing. This is likely to be effective from mid-2020.

Jourová adds: “When we look around the world, from Asia to Latin America, we see that a growing number of countries are adopting new privacy laws that are inspired by our European law. People around the world want to see their privacy protected. Consumers want their data to be safe. In turn, businesses recognise that strong privacy protections give them a competitive advantage as confidence in their services increases.”

©Best Execution 2019
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