On Best-Ex

January 25, 2017

By Sacha Fellica, Global Product Manager, Trading Products, Bloomberg L.P.

When embarking on projects needed to achieve MiFID II compliance, it is important to focus on the positive outcomes that these efforts will bring to regulated firms. For example, when tackling compliance to the MiFID II Best-Ex regime, a firm should take this as an opportunity to deeply embed TCA (transaction cost analysis) in their main business process by covering the whole lifecycle of a trade. A potential solution could be the creation of a feedback loop that links the TCA Review and Evaluation process with the strategy and algo selection and the execution management of an order. The solution should have multi-asset coverage and should allow the firm to test their order execution policy by analysing order execution performance through different angles and using different benchmarks. By taking such an approach, a firm would not only achieve compliance to the BestEx requirements but also improve their core business process.

On MAR
When looking at MAR (market abuse regulation) compliance specifically for investment recommendations, it is clear that the new recommendations are heavily impacting the way that recos are issued and used. A likely consequence is the electronification of recommendations and a drop in the number issued (could there be an increase in quality as a side effect?). When looking at solutions to comply with MAR for Investment Recommendations, it would make sense to implement a move to electronic templates that are easy to complete and to attach to all relevant electronic distribution channels. The templates would have hooks to the related disclosures and recommendations history. As new recommendations are issued, these are captured and integrated in the firm’s surveillance systems in order to create a onestop-shop Enterprise Surveillance System. The goal should be to incorporate both the Best-Ex and MAR processes into a single system which is in turn tightly integrated with the regulated firm’s OMS (order management system).

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Conversations And Computers: The Modern Regulator’s Toolkit

GlobalTrading

January 18, 2017

With Greg Yanco, Senior Executive Leader, Market Supervision, and Nathan Bourne, Senior Manager, Market Conduct Team, Australian Securities and Investment Commission

Political uncertainty, algorithmic errors and cyber-attacks can all destabilise a market, but the Australian Securities and Investment Commission (ASIC) believes it has the framework and technology to handle the challenges as they come.

Threats to stability
Recent volatility brought on by political events illustrates how we always want to make sure the industry is prepared to manage volatility. The unexpected Brexit referendum result is a good example, as successful planning by all within the industry meant the subsequent volatility was well managed. Disruptive threats are common, whether a political event, an economic shock, a terrorist attack or even war. ASIC’s role is to help market participants coordinate and communicate effectively with their counterparties in the trading systems.

Working with the Australian Stock Exchange and the Reserve Bank of Australia, we oversee the clearing house for equities, set capital requirements for non-bank financial institutions and monitor the businesses they are in to ensure they manage their risks appropriately.

We are also keen to make sure that firms have the right security layers in place to adjust their intraday risk exposures and reduce positions as needed. We speak to participants about their ability to adjust their risk exposure quickly or in an automated fashion, and Brexit was a good test case, because everyone knew it was coming and the systems worked well. However, the real test is the one people do not expect.

Cyber security
Beyond economic and financial threats, we are reviewing the potential impact of cyber incidents on the financial markets ecosystem, and in particular, critical markets infrastructure providers and participants.

ASIC expects the regulated markets to remain the gatekeepers and strongly encourages them to consider their cyber resilience as a key part of their enterprise risk management obligations. We have published two reports on cyber: firstly, the cyber resilience health-check report (Rep429) which is aimed at raising awareness among our regulated stakeholder population, and highlights the obligations on businesses to effectively manage cyber risks as part of the business risk management processes. Secondly, ASIC published a report (Rep468) on the cyber resilience of the two major Australian market operators, and shared in this report a number of cyber health management governance and “Good Practices” recommendations for businesses to consider in order to improve their resilience. These Good Practices are drawn from wider engagement with investment banks operating in Australia following a self-assessment process conducted by ASIC.

System account hacking occurs intermittently, but we have detected these attacks early on through our market surveillance systems and ensured they were unprofitable.

ASIC has also established an emerging risk committee to examine events in other parts of the world. We, along with other regulators, recognise the risk of a cyber security incident has increased, both in terms of frequency and impact.

Cyber resilience is a high priority for ASIC, and we have developed a strategy that aims to advance awareness and understanding of the cyber threat landscape, and introduced mechanisms for improving resilience across our regulated entities. In particular, our focus in 2017 will be to work with our population of mid- and lower-tier firms to assess their cyber resilience profile through a process of self-assessment. These firms can be more susceptible to cyber threats if they are not able to access appropriate cyber security skills and put in place adequate risk mitigation plans.

Culture and conduct
As a markets and conduct regulator, ASIC sees organisational culture as a significant driver of conduct within firms. Good governance is one of the core elements of a positive organisational culture.

We are incorporating more cultural indicators into our risk-based supervision and will use our surveillance findings to better understand how culture is driving conduct among those we regulate. ASIC is also looking out for cultural indicators that suggest we should take a “deeper dive” into issues concerning poor conduct, for instance, when policies are not aligned with what employees say or do, or there is a lack of action when things go wrong. An example of what ASIC might look for during our surveillance work is how responsive senior management or the Board is when a control team raises an issue for consideration: is the issue taken seriously and dealt with, or is it ignored?

We think that there are a number of key indicators of a healthy culture. These include the tone set from the top, such as core values, which are cascaded to the rest of the organisation, and translated into business practices. These need to be backed up by a true sense of accountability, effective communication and challenge processes, appropriate rewards for staff and strong governance and controls.

We are currently completing a survey of market participants and investment banks on conduct risk and will be providing feedback to individual firms involved in the survey. It examines how regulated entities are actually reflecting the firm’s values in their internal policies, business practices and governance structures. The next step will be to validate those processes through reviews of documentation and interviews.

There is a wide spectrum of firms in our regulated population – from the very small to global institutions. Some of the larger firms have multiple regulators working with them on the same issues, and they have well-structured teams, processes and escalation channels to deal with conduct issues. However, in some cases we have seen evidence where glossy presentations to regulators have not translated into traction at an operational level, that is, to the business practices of staff on a day-to-day basis.

Technology and market cleanliness
ASIC received additional funding for a new surveillance system that enabled us to build on our real-time surveillance to do deeper data analysis. ASIC can now perform analytical work equivalent to that done by other top international regulators and academia. Our recent market cleanliness work is a good example of this, which allowes us to measure the efficiency and integrity of different segments of our market as well as isolate suspicious trading. With improved time series data we will have a better idea of how results evolve, conduct further analysis and accumulate intelligence.

We are also exploring machine learning of natural language and pattern recognition. We are talking to colleagues in other markets about the tools they are building and what they are finding. ASIC first identified latency arbitrage in dark pools 18 months ago, and two other markets have seen the same issue and they might learn something and share it with us. We are a flexible regulator with diverse ways to cut through market activities and more efficiently spot abuse.

In response, we hope the industry takes these capabilities seriously. Most brokers have surveillance over their own activities, so we ask brokers and trading venues to report suspicious activity. When we identify a negative trend or direction, we can bring it to their attention to get them to alter their behaviour. When another problem arises we want the flexibility to respond accordingly.

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The Convergence Of Multi-Asset Trading

GlobalTrading

January 18, 2017

By Vincent Burzynski, Executive Vice President, Electronic Trading at FIS and Jonas Lindqvist, Business Expert, Product Management, Front Arena at FIS

Several forces are inducing investment firms and brokerages to conflate their securities trading functions. The convergence is taking place not only through their adoption of multi-asset trading platforms, but also with a broadening of the skills-set expected of their staff.

The primary impetus comes from the buy-side. Institutional investors are promoting multi-asset portfolios, offering clients greater diversification and often the ability to combine incremental yield in a low interest environment with earnings growth potential. Easy access to analytical tools, research data and performance measurement techniques facilitate the decision and allocation processes.

At the same time, money managers face escalating costs to meet regulatory requirements, which include documenting audit-trails and performing other administrative tasks for each sell-side and vendor relationship. Hence, there is an incentive to reduce the number of market counterparties and consolidate dealing platforms into as few as possible without raising operational risks.

This demand puts pressure on the selected sell-side firms to provide more services, which in turn encourages them to consolidate trade functions within a centralised hub. In many cases, it is also consistent with a shift already underway among brokerages and investment banks.

The sell-side is struggling with its own cost pressures caused by lower share trading volumes and dealing margins as well as from compliance implementation. Equity turnover has fallen well below pre-2008 global financial crisis levels (as much as 45% less) while G4 government bond issuance is six times higher.

Liquidity in both asset classes has declined, as tighter capital requirements and restrictions on proprietary positions constrain market makers from holding shares or bonds on their books for any lengthy period. The effect is to reduce their ability to act as all-weather liquidity providers in addition to their role as intermediaries.

Shifting bond trading practices
At the same time, MiFID II is pushing for greater transparency in over-the-counter (OTC) trading, the usual method for fixed income instruments. The sell-side is responding by creating systems and deploying tools that replicate or are similar to those used in their equity business, while retaining workflows needed for their asset classes. In addition, there is regulatory pressure to trade bonds on formal trading venues, so the rationale for conflating asset trading platforms, especially if the buy-side promotes more multi-asset funds, is becoming even more compelling. The sell-side achieves economies of scale and a more streamlined (and perhaps more manageable) operational model. On the other hand, risk monitoring can be more complex because previously discrete risk silos for different asset classes are aggregated at one source.

For example, the Singapore Exchange recently announced an initiative to trade bonds on its AsiaEx bond platform. The Monetary Authority of Singapore (MAS) is planning to introduce the 5% Rule, which imposes limits on what can be traded by retail investors and that they must have at least five percent of the value of outstanding stocks as collateral with the broker at the end of the day. So before trading any asset, it is necessary for the broker to assess and calculate, in real time, what a customer owns across its entire portfolio. Valuing (and then reassessing its risk profile post-trade) a portfolio containing a mixture of asset classes (bonds, equities, derivatives, alternatives and so on) is significantly more complicated than a fund containing only bonds.

In fact, multi-asset investing has gained traction quite rapidly in Asia. The institutional fund management industry and also the retail investor base is younger than in Europe and North America, so it is less bound by a legacy of siloed trading. Moreover, the private banking or wealth management sector is comparatively more prominent in Asia, and its affluent clients have tended to take a multi-asset approach.

So, it is important to remember that regulatory requirements are not in themselves the driver towards multi-asset trading. Instead, they make it advantageous for an increasing number of market participants to adopt common platforms for different asset classes in order to reduce costs and streamline operations – as the technology becomes available.

Generalist and specialist functions
Other imperatives follow the adoption of multi-asset platform. Both buy- and sell-sides need to construct single multi-asset order management systems (OMS) to accommodate the process through from pre-trade to execution to post-trade across asset classes at any time. Yet, the mechanics of trading a bond or a stock, for example, are different so the idiosyncrasies must be built into the systems. In effect, a unified whole must contain specialised parts.

Particularly at sell-side firms, a similar structure is needed for its professional staff composition. Salespeople are increasingly required to service their buy-side clients on diverse asset classes, but those clients might also value the expertise of a specialist, whether in a security-type, a sector or a country. A multi-asset trader might need to approach a specialist market maker directly to ensure best execution, rather than just place the order through an automated channel.

However, the generalist salesperson is the first and most important point of contact and might be expected to direct or execute trade orders in a multitude of different asset classes and jurisdictions. This subjects them to greater strain and closer scrutiny: keeping on top of so much data and so many markets is challenging and the risk of errors is amplified. Rigorous systems should be in place to maximise the ability of the generalist to provide best service while minimising errors.

Clearly, lower trading volumes and reduced dealing margins are forcing brokerages and other sellside financial firms to focus on cost-savings. The biggest expense for most is their headcount.

Yet, staff cuts are taking place at the same time as the buy-side, whose margins are also being squeezed, is demanding more sophisticated services, better value for money and a level of automation that is compatible with their own trading styles.

Paradoxically, of course, it is the adoption of greater automation and multi-asset dealing (and OMS) systems that provides hope for both sell- and buysides. The application of technologies can obviate high staffing levels, cut costs and help restore margins. It is also likely that standard rules and conventions, similar to the FIX Protocols that formalised earlier electronic trading practices, will evolve for multi-asset trading.

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Profile : Alfred Eskandar : Portware

Ian Rycott

January 12, 2017

ARTIFICIALLY INTELLIGENT EXECUTION.

Alfred Eskandar, CEO at Portware, a FactSet Company, discusses the pressures to enhance the trading desk and how investment processes are impacting the development and integration of execution management systems.

How would you characterise the trading environment over the last 18 months?

From a trader’s perspective it’s been filled with regulatory challenges, political uncertainty and anxiety. We saw the impact of the Brexit vote, the US election was really a circus, and traders are still wrapping their heads around MiFID II. So traders in the US and Europe were really dealt a tough hand to play.

What sort of technologies are you putting R&D into right now?

In 2012 we made an acquisition and bought machine learning capabilities into the EMS; there is constant investment in that process. By adding A.I. capabilities, we have created the “Thinking” EMS. In our latest version of Portware Enterprise (v6.4) every single order on the blotter will have been analysed, vetted and comes to the trader with a recommended trading strategy, a recommended trade horizon, and a recommended algo type selection, enabling the trader to apply their skill more effectively by leveraging A.I. capabilities. It is essentially making the bionic trading desk.

FX has been the fastest growing asset class for us. We are in one of the biggest phases for Portware in terms of client onboarding for FX, with a combination of new super-large, global, multi-asset and super-complex, heavily automated accounts executing through Portware.

What is the goal of the bionic trading desk?

The key part is helping traders have faster, more informed conversations or make faster, more informed decisions. That’s the responsibility of a trading platform. We are not here to decide how you do your business. We are here to help recommend and help make what you want to do faster, easier and more accurate.

How does that tally with the pressure on the asset management community right now?

An active manager needs performance first and foremost, so that includes everything that the active manager does to outperform, to win more mandates and to raise assets under management. As a result we have seen firms, certainly in the last four years, go through rigorous cost cutting. It has created demand for efficiency, greater usage of technology and more scale.

We have spent a lot of time and money in building information and analytical tools to drive that process. The counterpart to that is regulatory reporting. It’s one of the most valuable things that we’ve built. For clients to be MiFID compliant today and have the comfort of being able to demonstrate best execution capabilities by asset class on demand is enormous.

How do those two demands balance out?

It’s a tough balancing act – because institutions do need to invest in both areas. The trend that we see is that institutions will skew their technology spend towards performance enhancement tools once they feel comfortable enough that they have achieved meaningful efficiencies in their trading operations.

Do you see the value that the EMS provides is recognised, based on those characteristics?

The problem with the EMS space in general is that the majority of them are free. So how do you value something that is free? As we are not a broker sponsored system, we have no trading capabilities in-house. We live or die by the quality of our software and our customer service for large multi-asset clients by being transparent and professional. Our entire business has to live up to a very high standard.

There are politics around connectivity and trading platforms, is that being addressed?

We have arguably the most flexible and open API in the industry, and in fact that’s one of the reasons why we get selected. We are truly an open and collaborative platform and work just as easily with client’s proprietary systems, as well as third parties.

Vendors shouldn’t limit our customers from getting access to third party systems. There are certainly closed systems out there who do have those obstacles, and I think the world and the markets are changing too much too fast for anyone to prevent clients from chasing opportunities that they would otherwise want.

In terms of other technologies such as transaction cost analysis tools, how does an EMS support that wider ecosystem?

A good EMS speaks to many systems in an organisation – not just the OMS. When Portware gets called an EMS, there is so much more behind it. There are middle office elements, there are back office elements, there is portfolio management driven work. Customers see more than a trading platform. They are essentially plugging in other parts of their company, from risk models, to alpha models, to proprietary systems. We don’t put any constraints on what they can do.

As a platform provider what trends are you identifying on the increasingly mature buyside trading desks?

Reporting and monitoring capabilities have been the most requested client proprietary services in the last 18 months. It’s telling us that our clients’ business is under a microscope and they need help in proving and demonstrating best practices to their stakeholders. Reporting is almost a justification of why you invest with a particular asset manager.

What is the top challenge you face in the FX business?

Once you get the connectivity in place then you are done, to a certain extent, because a multi-dealer electronic FX platform is a hub. The biggest challenge was getting all quote streams in place, connecting dealers in emerging markets, and so on, but that’s behind us. Now we find challenges in dealing with some of the market centres that have front ends they don’t want to see replaced. I get it, I understand their competitive stance, and it is one of our top challenges in FX today.

Does equities have any of the same challenges?

No, those barriers were torn down a while ago. Equities have been fully electronic for some time now as that market structure has been transformed over the past 15 years. Many innovations flourished: Block crossing via blotter scrapes, electronic auction systems, ECNs, exchanges, so the next area of differentiation will be A.I. tools. A.I. will pave the path to squeeze out excess performance in an efficient market.

Fixed income is perhaps the most challenged asset class, what is the number one challenge there?

It’s a really big asset class with an enormous number of issues. It’s very difficult to find a single electronic solution that can solve all the nuances of so many OTC instruments. We see the EMS playing a huge role in aggregating the different workflows for each instrument and with increased trade automation as the market structure for fixed income evolves. The next challenge is getting all the participants in the ecosystem to accept ‘co-opetition’.

We’ll eventually get there the same way we overcame it with FX, and that is by reaching a critical mass of client demand. You can’t stand in the way of innovation forever, ultimately innovation will win and right now there are technical advancements that are not utilised because of policies. Remove the policies, enjoy the advancement.

How will A.I. be implemented in equities and when do you expect it to get rolled out across other instruments?

We have A.I. capabilities for other asset classes, the goal is to extend what we have proven to work in US equities across the globe, to introduce it, incrementally, into other asset classes. I like to have the first iteration of something be very successful, then learn from it, and make the second iteration even better. We are not going to try to apply it to everything all at once. We are just going to find a beachhead and demonstrate to clients that it is equally as successful here in the next asset class as it was in equities, and the next, and so on.

Biography:

Appointed CEO of Portware, LLC., in 2012, Alfred Eskandar leads one of the financial industry’s leading developers of broker-neutral, automated trading solutions for global equities, futures, options and FX. In 2013, Alfred was named as one of the prestigious Institutional Investor Trading Tech 40, a global ranking of the most prominent innovators and managers in capital markets.

Prior to Portware (recently acquired by FactSet Research Systems Inc.), Alfred ran the US trading business for Liquidnet, where he was an executive team member and founding employee. During his 11 year tenure he held multiple leadership roles and led the acquisition of Miletus Trading, LLC, a leading quantitative and program trading broker-dealer, serving as president and chief executive officer during its integration.

Before that Alfred served as the head of business development for the operations, trading and technology division of Thompson Financial’s Investment Marketing Group. He holds a BBA in Finance and Economics from Baruch College.

©BestExecution 2017

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FX trading focus : Profile : James Wood-Collins

Ian Rycott

January 12, 2017

THE GREAT DIVIDE.

James Wood-Collins, CEO Record Currency Management discusses divergent money polices and other themes going into 2017.

What have been the major trends this year that have impacted FX market volumes and structures?

I would put them in three categories – macro fundamentals, market structure and participants, and regulation. One of the biggest macro trends, which is also impacting other securities markets, has been the expectation of divergent monetary policy between the US and Europe. We have had many false dawns, starting three years ago with the taper tantrum and then last year which resulted in only one Fed rate rise. Expectations at the start of this year of further tightening went unfulfilled, although we are now back on track as the Fed has made a move in December. The ECB is still pursuing a different strategy in terms of looser monetary policy and low interest rates while the jury is out with the Bank of England.

A further level of rate divergence is seen in the breakdown of covered interest parity, where interest rates implied by FX forward trading should be consistent with market interest rates, so that there are no arbitrage opportunities between the two. The relationship first broke down during the banking crisis in 2008 and the disconnect has continued to grow over the last few years. This favours some investors at the expense of others – so for example UK investors can pay anywhere between 20 and 60 basis points more to hedge US dollars than interbank rates suggest, whereas US investors get the corresponding benefit.

It is important that investors understand this relationship because although it could work in their favour, it can also make it more expensive when having to hedge foreign assets.

What about market structure?

This is mainly related to the spot market which has seen an increase in the number of non-bank liquidity providers. In the past, it was the banks that were the main market makers but tighter capital and leverage regulation has had an impact on their balance sheet and ability to participate. At the same time technology has opened the door to many non-bank market makers, as alternative providers of liquidity. One of the perceptions is that these non-traditional players are not as committed to providing liquidity as the banks were, although many would contest this.

I thought the FX market was among the most liquid?

The currency market continues to be tremendously liquid and enormously transactionally efficient – average daily market volume in excess of $5 trillion dwarfs all equity and bond markets. As a result, trading costs are very low and on almost all occasions liquidity is very high, meaning very large transactions can be executed without impacting the market. However, perhaps on one day in a hundred or even one in a thousand, the market hits an air pocket of liquidity. This has been attributed to market fragmentation, although there is a growing differentiation between long term non-traditional providers and the more opportunistic short term firms who will quickly turn the tap on and off.

In this current environment, then how are investors approaching FX – as a hedging tool or an alpha generator or both? What type of solutions are they looking for in both?

In this low interest rate environment investors are open to both sets of objectives. The increased frequency of event risks in FX and volatility has made investors more sensitive to currency risk management and hedging. However, there is also a growing interest in return seeking strategies. We think that there are opportunities in both developed and emerging markets and that it is important to build a multi strategy portfolio that has a low correlation between strategies as well as against other asset classes.

What are the challenges and opportunities in the light of regulation?

If you look at the market as a whole, one of the biggest issues is the lack of harmonisation between different jurisdictions. The European Market Infrastructure Regulation is different from Dodd Frank which differs from the Canadian and Swiss regulation. It is a significant compliance and operational challenge if you have multiple clients in many locations trading with multiple counterparties, also in different locations.

For example, in the US, FX forwards and swaps are exempt from regulation whereas in Europe they are treated as OTC derivatives and are exempt from initial margin but subject to variation margin – regardless of the size of the counterparty. It is effective for swaps from March 2017 and forwards in 2018, and we have gone on record questioning how necessary variation margin is for forwards. We are working with all of our affected clients on developing practical solutions on how they can set aside cash and liquid assets as margin without it being an operational burden and drag on performance.

The other big piece of regulation the industry is focusing on is the FX Global Code which not only covers market ethics, information sharing, execution costs (including mark-up), trade confirmation, and settlement but also risk management as well as the specifics of dealing with issues related to execution. This will have a significant impact in the way banks interact with clients.

What about MiFID and the challenges of proving best execution in FX?

MiFID II, which is effective from January 2018, is further down the list of challenges because these other bigger regulatory changes come in first. However, it is certainly relevant to all European Union domiciled firms and we have a compliance project where verifying best execution is a big area of focus. We have always had the resources, incentives and alignments to deliver best execution but one of the biggest challenges across the industry is to verify that because of the lack of a central exchange.

What impact do you think Brexit will have and how should investors position themselves?

We have started to plan how best to serve our EU clients from outside the EU even though the passporting issue – probably one of the biggest negotiating chips – has not been resolved. We can’t, however, wait for politicians to finish the negotiations but have instead started to look at alternative plans.

Looking ahead, which I appreciate is always difficult, what type of trading conditions do you foresee? Will the volatility continue?

I don’t think we see any end to event-driven volatility, given both the changes in market structure and participants, and the forward calendar of events, in particular elections in Europe. Thinking more about margining, we’re also wondering whether the market will start to distinguish between trades being conducted on credit lines and those where collateral is used, unlike at present.

Biography: James Wood-Collins joined Record in August 2008 as a senior member of the Client Team, and was appointed chief executive officer in October 2010. He was previously at JP Morgan Cazenove, where he was a managing director advising financial institutions on M&A, IPOs and related corporate finance transactions, including the December 2007 IPO of Record plc. Wood-Collins chairs Record’s executive committee and is a member of its investment committee.

©BestExecution 2017

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FX trading focus : Profile : Jon Vollemaere

Ian Rycott

January 12, 2017

EMFX IN THE SPOTLIGHT.

Jon Vollemaere, CEO and founder of R5FX explains why he is shining the electronic light onto emerging market currencies.

What is the background to R5FX?

A few years ago I was approached by two banks who were being asked by their clients to make emerging market (EM) currencies available on their e-FX platforms. The problem for the banks was that there was no reliable emerging market price feed on which to base their prices, and their traders highlighted all the problems with emerging market FX – a lack of liquidity, a small number of traders and an opaque market, which was the result of the market mainly being voice traded. From these meetings R5 was born.

Regulation was also starting to have a major impact on FX. Whilst not all areas are required to be regulated, there is a growing movement towards making FX markets more transparent. E-commerce helps with this, making prices available to a wider audience, so R5 is pushing against an open door, as we are a regulated marketplace in a growing list of jurisdictions.

R5 is Emerging Market FX (EMFX) only. We went live in October last year and since then we have been busy adding currencies and clients. It’s still early days but volumes are going up strongly quarter on quarter. The aim is to be the marketplace for eNDF (electronic non-deliverable forwards) and EM trading whilst extending our central credit model (which enables OTC, exchange and onshore traded flows to be supported in one marketplace). In doing this we can open access to more participants and help to grow EM volumes.

R5 saw a need to create new liquidity to support the growth of EMFX, not just republishing prices from other venues. By supporting prices from OTC and exchange trading as well as on and offshore access we bring genuine new liquidity to EMFX. All counterparties have access to best price and they can choose where to net, settle and clear.

What regulation has had the most impact and how have markets changed?

MiFID and BCBS 270 (the Basel III Leverage Ratio framework and disclosure requirements) are the two main regulations that are impacting EMFX. Central credit helps clients address the demands of these regulations and there is a growing interest in central counterparty trading. We have built our platform to support clients who want to trade and clear in this manner.

Regulation has made trading FX more expensive, increasing the costs associated with credit and risk. As a result banks are less willing to warehouse risk. Some of the larger banks used to chase flow, believing that more volume led to increased trading profits. Due to the increased costs there is now a move to focus mainly on key customers. This has allowed the regional banks to reclaim some market share from the bigger players.

We recognise that the market is changing. Particularly in emerging markets, where regulation is sometimes onerous, and it’s worth noting that the NDF market was created to get around regulation.

The exchanges are positioning themselves as a regulated alternative on which to trade FX. Even though FX is not mandated to clear, businesses are reviewing their entire trading activities to comply with global regulation, and as part of this process some are also looking at moving FX onto exchange.

BCBS 270 presents the CCPs with an opportunity as long they can achieve the desired levels of compression and multilateral netting. But I don’t think CCPs will ever dominate FX. Instead the industry is moving towards a hybrid model which takes the best of OTC and exchange trading. With a centralised credit model you can combine liquidity for a peer to peer marketplace, with liquidity derived from arb opportunities and relationship-based pricing in one spot.

What has been the impact on FX volumes?

Volumes have flattened. The headline is that the BIS (Bank for International Settlements) reported a drop in volume to USD5.1tn a day (down 5.5%). This is mainly the spot market, down 19%, and of that mainly G10 currencies. Another trend is the growth of Asia as a trading centre, which has increased from 15% to 21% of the global market.

There is also more volatility, and it’s likely to remain that way. With market makers streamlining their relationships, less warehousing of risk and the automated / algorithmic nature of the market, price movements are more volatile and faster.

Do you foresee a continued move to electronic trading and if so, what happens to OTC markets?

Yes – The OTC markets are already there at 90%+ electronic, but this reflects mainly G10 currencies. EMFX is lagging behind, which is the opportunity for R5. Traditionally this has been a more difficult and less of a commoditised market, but the market is moving in this direction. The result for EMFX will be more participants and increased volumes.

Both the OTC and exchange traded markets are likely to grow as EM becomes more electronic. That’s something you see time and time again.

What impact do you think Brexit will have?

Brexit has caused uncertainty, which in turn creates volatility. This uncertainty extends to other currencies like the euro and then also to EM.

The same question applies to Trump and whether the Fed will continue to raise interest rates?

Volatility in the USD does have an impact on EM, for example USD/MXN recorded an 11% move on election night. The US will have a very unconventional President, whose Twitter account may trigger currency moves. The Fed has raised interest rates and the US dollar will strengthen over the next 12 months, but the wider story is more political and that’s moving rates in South Africa, Turkey, India, and of course Russia.

In terms of the EM space, how difficult is it to prove best execution?

It’s very difficult to prove best execution in EMFX. That’s because there is so little data to base it on. That’s one of the reasons we started out, and R5 is planning to launch a data product in 2017 to give people the price.

How has the changing market structure impacted EM currencies and liquidity?

The changing market structure has highlighted the potential of EMFX, particularly compared to G10 which is flat lining. There are more potential profits as well as significant growth compared to G10, but EMFX can only grow if we can make the liquidity easier to find and increase access to more traders.

When we were designing R5 we conducted over 400 client meetings to discuss what we should build. The vast majority of clients who traded EMFX wanted us to build a future-looking platform to support market growth, a central credit model that enabled more counterparties to trade at best price and access to trade on both OTC and exchange prices. They also wanted us to support all-to-all trading with market transparency and the choice of whether or not to clear trades. Also, let’s not forget about China. Opening up the Renminbi market will significantly grow EMFX. I spend a great deal of time in China, working with organisations to increase access to the global FX market.

What is the best way to trade EM currencies?

With caution and understanding – these are high risk, high return pairs that are not for everyone – you need to keep your helmet on.

Against this changing background how can market participants differentiate themselves?

Manual traders who are willing to step in and make a price – if they are simply following automated traders they will lose. Also – get to know and understand Russia, China, India – they are the growth markets for FX towards 2020.

Biography:

Jon Vollemaere is an eFX entrepreneur, having worked with new financial technology since its early days. He is the Founder and CEO of R5, a new primary market which offers centralised credit for eNDF’s and Spot EM pairs and focuses on the growing FX activity in markets such as China, India, Russia, Brazil, Indonesia and Korea.

Jon’s experience of working in early stage financial technology organisations includes executing the first trades of Reuters D22, being part of the launch team at Currenex, and developing retail FX trading in Europe for FXCM and Barclays. He also co-founded and globally built the low latency trading network, FXecosystem, as well as the FX trading community, LetstalkFX.

Jon is a regular speaker at conferences and acts as an advisor to a number of early stage FinTech firms, a mentor at Level39 and a founding member of the Emerging Capital Markets Taskforce which reports to The Financial Services Trade and Investment Board (FSTIB).

©BestExecution 2017

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FX trading focus : Overview : Gill Wadsworth

Ian Rycott

January 12, 2017

A YEAR IN THE LIFE OF FX.

Gill Wadsworth looks at how FX has ridden the political waves.

This year, a £1 bet on Donald Trump winning the US Presidential elections, the UK voting to leave the European Union and football team Leicester City FC winning the English Premier League title would have netted a £4.5m fortune.

The fact that no one foresaw these events happening in 2016 reflects just how unpredictable a year it has been, and as these shocks have hit the world so the markets have responded. Currency in particular has endured a bumpy ride.

That £4.5m win before the outcome of the 23 June EU referendum would have been worth £5.29m if the plummeting pound had not lost 15% of its value by October.

In the US, dollar holders are sitting pretty as the domestic currency surged following Trump’s victory, but Mexicans and Canadians felt the full force of his election success as the peso hit a record low while the Canadian dollar fell to 73.6 cents against its US counterpart.

Anyone who was trying to predict the outcome of the EU referendum or the presidential election, could have done worse than look at what was happening in FX. Michael Metcalfe, head of global macro strategy at State Street Global Markets, points out that activity in the currency markets hinted at both a Brexit win and a Trump victory.

“The FX options market has been one of the better early warning signs for the political shocks this year,” he says. “In sterling you saw a significant skew in favour of people buying protection against currency weakness. In the US we saw something similar with people trying to buy protection against weakness in the Mexican peso.”

Yet market shocks – big as they were this year – are nothing new. Last year the Swiss National bank sent the FX markets into chaos when it unpegged the Swiss Franc from the euro, while the Chinese devaluation of the renminbi (RMB) created global upset.

Tod Van Name, global head of FX and commodity electronic trading at Bloomberg, says it is up to the players in the FX markets to be adequately equipped with appropriate technology and liquidity to bear such events. “Market shocks will not only continue to occur, but may actually increase in frequency,” he says. “Brexit, the sterling flash crash and the RMB devaluation are just a few examples of recent volatile moves that are exacerbated as liquidity diminishes. The best way to cope is to have an effective risk management strategy and access to ample liquidity.”

To prove Van Name’s point, Robbie Boukhoufane, global head of fixed income and FX trading at Schroders, says he was “reasonably impressed with market liquidity this year”, particularly after Brexit and the US presidential election.

He adds: “Our key bank relationships remain extremely important to us but in the currencies where electronification is more prominent, non-bank liquidity market makers seem to be contributing more consistently and although we do not access this liquidity bilaterally with these names we can access this liquidity when using algorithms as execution tools.”

Regulatory headwinds

Changes to regulation is another key trend for the FX market as the fallout from trading scandals persist and steps are taken to revive the sector’s damaged reputation. In May this year the Foreign Exchange Working Group of the Bank for International Settlements (BIS) revealed the first part of a global code of conduct for the FX market, and will roll out additional codes to cover electronic trading, brokers and prime brokerage in May next year.

Simultaneously, regulation which began its journey through various national and international regulators in the wake of the global financial crisis continues its slow march to statute. Dodd-Frank. MiFID II and Basel III are all yet to be fully realised, yet Van Name says the regulations still influence the systems and processes in today’s FX market.

He says: “What began with Dodd-Frank in 2009 is now moving to Europe with the introduction of MiFID II in early 2018. This will have a significant impact on the way markets are traded and how trades are reported. Furthermore, banks must also face provisions in Basel III that will have lasting impact on balance sheet requirements and ultimately the risk appetite of major market makers.”

The future for Dodd-Frank now looks uncertain, however. Trump has made no secret about his dislike for predecessor Barack Obama’s regulation and has threatened to dismantle it. Chris Matsko, head of foreign exchange trading services at Portware, says it is ‘unclear’ whether Dodd-Frank will make it through.

However, Keith Underwood, founder and CEO of Underwood FX a US-based consulting and market intelligence firm, says: “Scaling back [financial regulation] might be difficult at this point as you would be hard pressed to say the monitoring of trader transactions and communications is a negative or that it inhibits doing business.”

The technology shakeout

While nothing is certain in terms of regulatory progress under a new president, what can be guaranteed is the endless march of technology. FX has undergone notable fintech advances as players demand improved transaction cost analysis (TCA) and performance measurement.

Underwood says: “[Technology] is still about lowering the cost of doing business and increasing as much volume as possible.”

Automating the trading process remains the target for fintech companies, yet Matsko hints that some traders may resist technology unless it can be fully justified. “Technology is making the [trading] process more efficient and it is doing so in as far as the traders will allow for it.” He adds, “You have some desks that are very much attuned to allowing technology to make their processes more efficient. Others are providing certain sets of rules for execution. To the effect that the trading desk embraces [automation] they can definitely make the process more efficient.”

Matsko says some ‘old school’ traders still prefer to manually execute a trade believing that they get a better price by speaking directly with brokers. “It’s about trying to understand whether there is a true cost advantage to doing a trade one way versus the other; so trying to get better execution by trading a forward in an electronic environment versus calling my broker,” he says.

With an eye on the future, Van Name highlights algorithmic trading (algos) and blockchain technology.

Algos have been an important development in terms of reducing market impact and lowering transaction costs, something that Van Name says has benefited both developed and emerging market currencies.

However, Schroders’ Boukhoufane says he would like to see more technological advances to assist with trading emerging market currencies where liquidity is scarce: “Electronic trading is less advanced [for emerging currencies]. The exit door remains small for some emerging market currencies, which means implementation remains key when entering into positions where liquidity can evaporate in times when markets have increased volatility and momentum.” (See interview with Jon Vollemaere, p50)

Blockchain technology has also been an important trend for FX traders and Van Name argues it will continue to drive improvements and efficiencies when dealing with Bitcoin transactions. “Blockchain technology, and the operational benefits it can bring, has become a frequent and widespread conversation topic,” he adds. “Transparency, immutability, reliability and speed are factors that will drive greater collaboration and lower costs.”

2016 has been a busy and unpredictable year not just for FX but the markets in general. Next year could prove yet more unsettled as Trump beds in, Brexit’s future becomes clearer and the fate of the EU hangs in the balance. Traders will need to be on their toes and it will be down to technology to ensure they can stay focused on the difficult job in hand.

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Data management : Outsourcing : Heather McKenzie

Ian Rycott

January 12, 2017

MANY HANDS MAKE LIGHT WORK.

While data is becoming increasingly crucial for financial firms, it is generally a rather messy business: significant investment is made by buy and sellside firms in cleaning, enriching and aggregating data. Despite this expenditure, data management continues to be a thorn in the side of many firms. Heather McKenzie investigates what can be done about it.

Financial regulators and clients are data hungry – regulators want to avoid a repeat of 2007/8, while clients want more focused analysis and data to help them make better investment decisions or to report to their underlying clients. Reporting is an important element in today’s financial world and data drives this function. However, disparate data feeds, a lack of standardisation and cost pressures combine to make data management a significant challenge for many firms.

As regulators require more data and a growing number of investment firms are expanding into multiple asset or multiple geography strategies, the traditional ways of dealing with data management are no longer sufficient, according to James (JR) Lowry, head of State Street Global Exchange, EMEA. Historically, most investment management firms did data management themselves, either building their own data warehouses or buying a packaged solution that was installed in a data centre.

This has changed with an increasing number of firms hosting data in the cloud or outsourcing to specialist firms, fund administrators or custodians such as State Street. This enables data aggregation and management to be carried out on a firm’s behalf while it focuses on its core fund management business.

Variations on an outsourcing theme

The solutions that are emerging to deal with data all feature an element of outsourcing, although it is often called something else. Data utilities, for example, are a form of outsourcing whereby a company or group of companies or financial institutions combine their efforts to run certain aspects of data.

An example is SmartStream’s Reference Data Utility (RDU), which was set up in late 2015. Goldman Sachs, JP Morgan and Morgan Stanley have joined with the technology firm to develop services for instrument reference data normalisation and validation across all asset classes. The founding banks will be clients of the utility.

Peter Moss, chief executive of the RDU, says if reference data is not correct from the outset, significant breaks can occur in automation. “The initial response to this was that firms created data management teams that were focused on pulling in market data from various data vendors and pooling it. But they found there were gaps and inconsistencies and it was difficult to cross-reference different data sources,” he says.

The utility model has gained momentum because since the financial crisis, revenues have not increased and firms are looking for greater cost efficiencies. “The banks realised they were all doing the same thing with data and it didn’t make sense to duplicate these efforts,” says Moss. The benefit of a utility is that it delivers more consistent data across the industry and trade processing generally works more effectively. A utility model won’t be appropriate for all types of data, however. Moss says there are some classes of data that are proprietary and a financial institution will want to continue to be the owner of such data. The key for reference data, however, is consistency and this can best be achieved if it is done “once, and by the industry for the industry”.

For many buyside firms, there is little benefit in doing data management themselves, says Chris Pickles, an independent consultant to the securities industry. “Sellside firms have a different requirement – they will need to be involved in data management because they are creating trading instruments. But unless you are a large buyside firm that can get economies of scale, outsourcing data management is the better option.”

The amount of data, number of instruments and what is required of the data in terms of reporting, mean that any inefficiencies within a firm regarding data management will be amplified. “Any area from which a firm doesn’t derive a unique benefit could be outsourced,” says Pickles.

Keeping an open mind

For the remainder, increasing effort is made to rationalise data via open standards. To date, most firms have created their own identifiers for instruments but this is becoming untenable. The Open Symbology project is an attempt to rationalise reference data by creating a unique identifier that is free of charge and can be managed centrally. An open data standard, defined by the financial industry, it provides a solution to consistently identify financial instruments, regardless of asset class, or function being performed.

As part of the project, FIGI (Financial Instrument Global Identifier^®) is the first and only open data standard for identification of financial instruments. Under the auspices of the Object Management Group, FIGI is provided free of charge.

Lowry cautions that standardisation efforts in data management will help, but the journey will be long. “Data is messy because different firms and different parts of the same firm use different data sources. There are differences between the trading and settlement books of record. There are also differences in accounting rules in different countries. This requires some harmonisation if firms are to be able to look at data in a holistic way.”

Frederic Ponzo, a managing partner at London-based consultancy GreySpark Partners, says there is a great deal of appetite among large buyside firms to outsource instrument data management, “but without standards you cannot do it”. All a firm can do is insource using a third party to do the manual work. Smaller firms, however, can use hosted solutions that will do everything and produce good, clean golden copies of data.

The ability of firms to outsource key data management functions – where it is feasible – is not difficult, but Ponzo says, regarding the ability or willingness to outsource certain elements of data management, it is a very mixed picture.

There are ways to tackle the data challenge, says Ponzo. Firms can outsource everything and “make your problem someone else’s problem”, he says. Firms such as State Street and Blackrock are providing such services and can achieve economies of scale that other companies cannot.

Lowry says as a custodian, State Street holds a great deal of data related to its customers, and clients can trust the firm to be steward of their data assets. This trust can be extended out to other data assets as well, such as market data and third party data. “We can aggregate and transform data in a way our clients ask us to and get that back to them in a cleansed fashion. It can be a very holistic model, based on the intent of taking the hassle of data management off the hands of our clients so they can focus on other things.”

Alternatively, firms can look to use utilities, says Ponzo, which he describes as “the purest form of outsourcing, in theory”. This will also deliver economies of scale, but can be difficult to put into practice because of the nature of consortia (particularly if there are too many partners). He is also sceptical that in some cases participants in a utility will end up providing data into it and then subsequently paying for their own data.

If a utility is run for profit, or there is conflict or misalignment of the members of the consortium, a firm would be better off dealing with a sole vendor, which generally can be faster and nimbler at responding to requirements.

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FinTech : The Cloud : Louise Rowland

Ian Rycott

January 12, 2017

BLUE SKY THINKING.

Cloud computing comes into its own. Louise Rowland reports.

It may impact almost every corner of our daily lives but, until recently, uptake of cloud technology within financial services has been relatively modest. Over the past 18 months or so, that’s all started to change as growing numbers of firms finally embrace the virtual world.

A recent Cloud Security Alliance study shows that 61% of institutions across both the buyside and the sellside are already developing a cloud strategy, with hedge funds and new start-ups way ahead of the field.

“We’re witnessing a step-change transformation,” says Terry Roche, head of FinTech research at TABB Group. “At the start of the year, the light was amber, whereas it’s now moved to full green. Executive managers at the top of institutions are interested in migrating to this technology for at least some of their operations and are executing or developing a cloud-based roadmap.”

Manna from heaven

So what’s driving an often risk-averse industry to step out of its comfort zone and use cloud infrastructure and services? Top of the list has to be the dramatic cost savings offered by the cloud’s pay-as-you-go business model.

The move from capex to opex – (capital expenditure to operational expenditure) from running costly legacy systems in-house to outsourcing front or back-office activities to an external infrastructure and set of application services – promises to deliver savings of anything up to 40% over five years.

That’s music to the ears of an industry battling squeezed margins, weak revenues, costly regulatory requirements and a wave of fleet-footed new competitors.

“People don’t want to spend £100k on building an IT infrastructure on their premises, if they can spend £2k a month buying services as they need them,” says one market participant.

“Very true,” says Iain Buchanan, CTO of quantitative asset manager Piquant Technologies, which harnesses AI to perform its market research. “The cost-model works for us, because we do a lot of ‘bursts’ on the cloud, carrying out calculations using a large number of machines for short periods of time. If you’re a large bank and have your machines on all the time, the costs issue is perhaps less clear-cut, whereas firms with small teams keep everything lean and don’t need to run as much hardware.”

Fitter and faster

The performance of the cloud has also improved, making it increasingly tempting for firms looking to enhance their own efficiency.

“It was mostly about cost savings at first, but now firms are also attracted by the room for innovation, testing out core new business ideas, and the faster time to market, helping them differentiate their business,” says Chirag Shah, senior financial technology executive at Sapient Global Markets. “Every time there’s a new initiative, people are starting to say ‘is this a good use case for the cloud?’ For many firms, it’s now their first choice – a forethought, rather than the afterthought it was two or three years ago.”

The cloud’s speed and elasticity are key, stresses Gordon McArthur, CEO of Beeks Financial Cloud, a low-latency cloud service provider. “In the past, if a London-based fund wanted to trade in Chicago, they would first have had to put space, hardware, racks and plumbing in place, which could have taken four months to achieve. With cloud computing, that can happen in a day.”

It can also boost competitiveness, says Christian Schiebl, EVP, Corona Business Unit at SmartStream. “Banks recognise there is no value-add in continuing with many back-office tasks internally and are now outsourcing them to the cloud, to concentrate on their core business. They should have been doing this a long time ago, but the typical European bank is still very slow and conservative. It will be more natural for the next generation of managers.”

The other buzz is around the test space of new products and services – long a costly environment to build and run, says Darren Craig, managing associate partner, European financial services at IBM Security.

“Nowadays, a new ‘test & dev’ environment can be up and running in a fraction of the time compared to what organisations have been used to. These environments can be created, taken down or expanded within minutes and provided at a very low cost without large capital expenditures and long procurement cycles.”

What kind of cloud?

A lively debate is raging around the best type of cloud provision for financial services: the public cloud, through providers such as Amazon Web Services, Google Cloud Platform or Microsoft Azure; a dedicated private cloud delivered through a proprietary architecture, available only to trusted users; or the hybrid version, blending aspects of both the public and private clouds – which for many observers, is the most likely way forward.

Data sensitivity and intrinsic caution have led many banks to prefer the private cloud option, but others argue that the public offering makes more commercial sense, as well as providing far greater elasticity.

Louis Lovas, director of solutions at OneMarketData, believes the industry will continue to use a mix of cloud models. “Whereas public clouds focus on computing power, storage and memory, the private cloud has many benefits which are very product specific. It is an impractical scenario to think everything will be on the public cloud. The evolution will be a hybrid mix, inclusive of the local infrastructure. No one will completely divorce from that because of internal corporate policies that centre on security and regulatory compliance.”

Safe and sound

Security issues are, of course, at the heart of cloud debate. High profile cyber-attacks such as the recent hacks of Twitter, PayPal and Tesco Bank – and the Democrats during the US Election – certainly don’t help.

Some see an inherent conflict between the open source computing and networks on which cloud architecture is built and the security risk for firms handling highly sensitive client data. Others warn that cyber security technologies are too focused on after-the-fact analysis rather than on prevention and that significant investment is needed in intrusive technology.

Overall, however, the consensus is that, while cyber crime will remain a fact of life, the industry has made great strides in developing preventative technology. Furthermore, they add, the public cloud is likely to be safer than a private platform, as only the Amazons and Googles have the resources and economies of scale to maintain state-of-the-art cyber expertise. Even the CIA uses cloud technology for some of its operations.

Firms need to their homework, advises Ryan Rubin, UK managing director and European lead in the technology consulting security & privacy practice at Protiviti. “Companies need to choose appropriate Cloud partners to ensure they can manage the business risks. They also need to apply measures such as additional encryption and security controls or choose service providers in specific constituencies to manage data privacy risks. Establishing accountabilities and responsibilities between client and cloud provider is critical to ensure there are no gaps in oversight or governance.”

Some companies are more cloud savvy than others, points out Ralph Achkar, strategic alliances director, Colt Capital Markets. “People need to know some technology and why they should choose one cloud provider over another in terms of price and performance. The model generally won’t rest on one single provider but on competing offers to keep vendors on their toes.” Cloud experience should be an end-to-end experience including strong, reliable connectivity. “The road to the house needs to be safe, as well as the house itself, to prevent security beaches.”

The sky’s the limit

Pockets of resistance remain – typically amongst risk and compliance teams, IT departments unwilling to cede control or within Tier 1 banks still needing to run down large legacy infrastructures. The most demanding and latency-sensitive workloads are likely to stay on private clouds for now, with core trading infrastructure probably the last area to migrate across.

But with regulators such as the FCA giving cloud technology the go-ahead – provided stringent safeguards are in place, reflecting the rigorous oversight firms must apply to their own activities – it’s clear the only way is up.

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ARTIFICIALLY INTELLIGENT EXECUTION.

Alfred Eskandar, CEO at Portware, a FactSet Company, discusses the pressures to enhance the trading desk and how investment processes are impacting the development and integration of execution management systems.

THE GREAT DIVIDE.

James Wood-Collins, CEO Record Currency Management discusses divergent money polices and other themes going into 2017.

EMFX IN THE SPOTLIGHT.

Jon Vollemaere, CEO and founder of R5FX explains why he is shining the electronic light onto emerging market currencies.

A YEAR IN THE LIFE OF FX.

Gill Wadsworth looks at how FX has ridden the political waves.

MANY HANDS MAKE LIGHT WORK.

BLUE SKY THINKING.

Cloud computing comes into its own. Louise Rowland reports.

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