Derivatives trading focus : Market electrification : Anna Pajor

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October 10, 2016

DERIVING PROFITS FROM ELECTRONIFICATION.

By Anna Pajor, Principal Consultant, GreySpark Partners.

The traditional OTC derivatives market is shrinking as widespread market regulation has rapidly transformed the normal trading environment. OTC derivatives are now increasingly traded digitally, and the remainder of non-electronic trades will be transformed into standardised contracts to be traded, en large, electronically. The ongoing regulatory activities will require multiple short- and long-term changes, such as the updating of client-facing tools, which may appear daunting to market participants. Despite its many short-term challenges, electronification, which is a consequence of those regulations, will ultimately create beneficial opportunities for market participants.

The term ‘derivatives’ covers a broad spectrum of instruments, from standardised, exchange-traded futures and options (F&O) to structured, complex OTC derivatives. Over 90% of listed F&O are currently traded electronically, with execution and clearing functions completed through exchanges. There are currently two main options to access listed F&O liquidity: single-bank platforms in the form of white-label solutions and FIX connections. Screen trading of listed F&O contracts is preferable when the relevant trades require extra discretion, while firms utilising high-frequency trading (HFT) and automated trading systems favour FIX exchange connections. In contrast, complex OTC derivatives are mostly traded non-electronically yet some elements of pricing negotiation can be completed via a single-bank platform. However, due to the bespoke nature of the most complex OTC instruments, it is easier to capture all the nuances and details of their contracts during ‘voice’ transactions, rather than through standardised trading platform interactions.

The ongoing wave of global and regional regulatory initiatives has forced OTC derivatives to standardise and move onto trading platforms. Regulations including Basel III, Fundamental Review of the Trading Book (FRTB), the Dodd-Frank Act, and the European Market Infrastructure Regulation (EMIR) have subjected non-centrally cleared contracts to higher capital requirements with the expectation that the increased standardisation of contracts will not only lead to healthier operational processes and greater liquidity, but also better price formation, exposure calculation, and risk management. However, the higher levels of complexity and risk associated with relevant instruments makes them more expensive to trade. Compliance has therefore transformed multiple bespoke OTC contracts into a more expensive hedging tool than a standardised set of exchange-traded derivatives could provide. In some cases, these contracts are too expensive to justify the hedging activity itself. As a result, the overall derivatives market is shrinking. Recent data from the Bank for International Settlement verifies this observation, as figures indicate that the volumes of exchange-traded derivatives are not increasing in a similar manner to the drop in OTC activity.

The standardisation of OTC derivatives is enabling electronification, indicating that OTC derivatives are likely to follow the same path to electronic trading as other instruments. As the share of trading done via digital channels rather than by voice trading is consistently increasing across all products, asset classes have been following the same evolutionary path towards electronification, albeit at different speeds. First, as the number of electronically traded derivatives increases, commissions and margins are compressed, driving buyside participation and further investment in e-commerce. ‘Voice’ traded, marginally electronic trading is typically characterised by low volumes of large-size, large-margin tickets. Here, banks and broker-dealers are still attempting to build consumer demand by focusing on research, pre-trade functionality, and analytics. Specifically, banks start offering the instrument through single-bank platforms to support servicing clients. As a result, the number of tickets increases, but the notional amount of each ticket remains rather large, therefore preserving margins. While the volumes traded are rapidly increasing, ticket sizes and margins are dropping proportionally. Only the largest tickets are dealt with by voice, and multi-dealer platforms take an increased share of the price discovery and execution flows. As electronification progresses, the market moves into a ‘utility model,’ where the focus shifts to the industrialisation of processes, cost optimisation, and efficiency. Electronic trading becomes the primary means of execution through a combination of exchanges, open platforms, and dark pools. During this final stage, the primary focus is on client relationships, with banks and broker-dealers competing fiercely for customer ‘mind share’ by trying to offer differentiated and value-added propositions.

There are still challenges facing the electronification of complex OTC derivatives. The following three factors will delay, and in some cases, even prevent the full electronification of complex derivatives:

Complexity of the instruments – the challenge to codify the most complex structured products may be greater than the benefit from electronification of trading. Each product has different parameters and variety in how it was structured, and even the best attempts at standardisation cannot capture its full complexity.
Legal T&C – bespoke derivatives typically require oversight and advice from the legal team to ensure consistency of the terms and compliance with relevant rules around servicing clients and trading derivatives.
Pricing, discretion, and negotiations – firms typically have the ability to choose and moderate pricing models, levels of risk, and levels of margin for each product. Many banks will want to maintain their discretion by keeping the decision-making process manual rather than automated for complex, ‘premium’ instruments.

Organisations must also prepare for all potential consequences of the new rules surrounding OTC derivatives. While many of the most immediately visible changes and consequences appear to be negative in nature, organisations must keep in mind the long-term positive re-orientation of systemic risk the rules will bring about. Indeed, emerging electronification will usher in the following opportunities for all types of market participants:

For the Buyside – With the increasing availability of electronic trading for complex derivatives, the buyside will gain better visibility on the pricing of those instruments. With supportive electronic tools for price discovery and price and risk modelling, the time to find an optimal structured product can be shorter than in ‘voice’ negotiation.
For the Sellside – Electronification provides the sellside the opportunity to improve access to clients, attract new ones, and streamline the servicing of all clients.
For Trading Venues – With the standardisation of contracts, execution will increasingly move towards the organised venues. To benefit from this change, venues need to ensure that mechanisms are in-place to make additional instruments available to trade, whenever need requires them.
For Technology Vendors – With any form of electronification, vendors receive the opportunity to provide tools for client and market connectivity and execution management. Additionally, in the case of derivative instruments, vendors can provide tools for pricing and risk modelling. Therefore, the market size for tools supporting trading of all derivatives should grow beyond USD 1bn within the next ten years, from USD 450m in 2014. This new market for specialist trading tools will become highly attractive for existing providers of trading tools since the market is already saturated with tools for cash equities and listed derivatives trading tools.

While ongoing regulation of OTC derivatives poses myriad challenges to market participants, it is important to keep the long-term opportunities in sight. Market participants stand to benefit greatly from the resulting electronification – addressing the short- and long-term challenges in a transparent and efficient manner will help them do so quickly.

©BestExecution 2016

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Derivatives trading focus : Collateral management : Jason Ang

By

Ian Rycott

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October 10, 2016

A SPANNER IN THE WORKS?

The EU Commission’s decision to delay the implementation of collateral rules for OTC swaps has prompted fears that the global introduction of the new regulation could be hampered. Jason Ang, Senior Product Manager, SmartStream, considers these concerns and looks at how sophisticated collateral management technology can help financial institutions comply with the incoming rules.

Global regulation – the US Dodd Frank Act and Europe Market Infrastructure Regulation (EMIR) – has pushed much of the swaps market through clearing houses. Nevertheless, a considerable amount of swaps trading is still done privately and, according to estimates by the Bank for International Settlements, the OTC derivative market may total some $493 trillion. Regulators are keen to mitigate the risks relating to the uncleared swaps market and have therefore sought to impose controls. This year sees the introduction of the BCBS-IOSCO rules, which will oblige institutions trading in OTC swaps to post both initial and variation margin. Initial margin requirements are set to come into force in September 2016, with the rules on variation margin commencing in March 2017.

June 2016 saw the EU Commission throw a spanner in the works, with the announcement that it would delay to December the introduction of the new collateral rules. As a result, compliance for EU banks will only begin in the middle of next year. The Commission’s decision has led to worries over regulatory arbitrage and fears that US and Asian banks will be put at a competitive disadvantage to their counterparts in Europe. There are concerns too, that piecemeal implementation of the new rules could hamper global adoption.

But is the EU Commission’s decision really such a cause for concern? Importantly, both the US and Japan have a final set of rules around which banks can shape their compliance programmes and it seems reasonable to assume that Europe will ensure its regulations are as similar as possible to those applied in the US and Asia. After all, if the EU took a ‘left turn’ at this late stage it would undermine the efforts of regulators – which have involved years of negotiations between national financial authorities – to co-ordinate the oversight of the swaps market on an international basis.

Stalling in Europe appears, however, to be causing some other regulatory authorities to hesitate. August 22nd saw the Australian Prudential Regulation Authority (APRA) defer the commencement date for CPS 226 margining and risk mitigation requirements to beyond September 1st. APRA cited delays in implementation in other major derivative markets, adding that it would release “in due course” the final version of CPS 226.

So how do those subject to the incoming regulation view these delays? Recent conversations with SmartStream clients preparing for the introduction of the new rules indicate that major traders in OTC swaps have made up their minds to adopt a most stringent adherence approach: firms are making sure that they are ready to meet the toughest regulatory standards and are implementing operations procedures as if arbitrage opportunities did not exist. That is not to say, however, that all arbitrage opportunities will go unexploited – it may be left up to individual trading desks to determine if they wish to do so or not.

While there will be a delay in Europe and Australia, there is no doubt that financial authorities mean business and that the new collateral rules are here to stay. Initially, only the largest traders in uncleared swaps will be affected but compliance for other firms will be introduced in a series of phases, finishing in 2020. Smaller financial institutions, if active in this market, will therefore have to turn their attention to managing the increased volumes of collateral agreements, as well as the added layer of complexity, that the new rules will surely introduce.

Automation can offer a useful way forward in this respect. Developing the type of technology required can be daunting and for many firms carrying out such work is simply too operationally challenging. They may, instead, choose to implement technology developed by a third party.

For those considering implementing a vendor-designed application on their own premises, a couple of points are worth bearing in mind. Firstly, a system is only as good as those who designed it and industry experts must be involved in the development process. Secondly, turning to a vendor with a significant market share can be beneficial as a provider with access to a large number of participants will be able to establish market consensus in the way regulations are implemented.

The optimum type of system – whether developed by a third party or designed by in-house experts – will be one that is comprehensive and capable of encompassing the collateral management process from end to end. It must be able to apply regulations accurately yet possess flexibility, ensuring that compliance is carried out correctly while allowing the user to fine tune execution details. Flexibility also enables a financial institution to cope with any ambiguity that may exist, for example, where regulation has yet to be fully finalised.

The question of communication and connectivity is just as important. How well is a system able to connect, for example, to external vendors or to communicate using industry standards?

Does a system offer collateral optimisation capabilities? Collateral optimisation technology allows assets to be gathered together to form a consolidated inventory against which margin calls can be viewed and appropriate collateral selected. This ensures the most efficient use of all available collateral – an important tool in financial institutions’ efforts to keep costs down.

Our collateral management technology has been designed with these factors in mind. It applies regulations robustly while giving users flexibility as to how they manage the detail of execution, and has also been developed with a strong focus on connectivity and communication. One of the company’s strengths is its excellent relationships with other vendors, and its ability to communicate with them.

Importantly, all SmartStream technology is capable of mutualisation and can be scaled up to form the basis of a utility. An organisation can therefore install our technology to meet its own needs and also to serve those of its clients. The SmartStream collateral management platform in use at a Tier 1 US Bank is one such example. The application, which forms the backbone of the bank’s collateral management service, supports a client portal through which users are able to view their exposures and collateral positions, generate reports and make collateral decisions.

Finally, it is worth bearing in mind that financial institutions taking the route described above can not only support their clients by offering access to sophisticated technology – which smaller entities might not otherwise be able to take advantage of – but potentially also create a new income stream to bolster their own revenues.

©BestExecution 2016

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Profile : Bill Stenning : Societe Generale CIB

By

Ian Rycott

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October 10, 2016

REBUILDING MARKET INFRASTRUCTURE.

Bill Stenning, managing director of clearing, regulatory and strategic affairs at Societe Generale Corporate and Investment Banking explains how regulation is changing the intricate plumbing and how the bank is responding.

What further changes do you see under MiFID on sellside, buyside and market infrastructure?

In general MiFID II will drive fundamental changes to market infrastructure for non-equity products. They will be driven by a move towards electronic trading but as always with these things the devil will be in the detail. Although we have a good idea of the direction of travel, there are still gaps that need to be filled and we are waiting for clarification on a wide range of issues. For example, as yet we do not have any International Securities Identification Numbers (ISINSs). These identifiers, although widely used for securities, were not originally designed for derivatives, so finalising how this should be implemented is a big challenge for the industry. It also means that it is difficult to know how to build some parts of the market infrastructure and in-house technology to meet some of these new requirements.

What about with the European Market Infrastructure Regulation, which is already being implemented?

It is a phased approach, but in June the clearing obligation came in for Category 1 (clearing members) for G4 currencies and that will be expanded to other currencies and products in time. We have also done a great deal of work already with trade reporting and repositories. The next step is to enhance the quality of the data.

One of the biggest challenges facing the buyside will be the introduction of new rules requiring initial margin for uncleared swaps. In September, this came into force in the US for the largest swap dealers, with gross exposures of more than $3tn, as well as Canada and Japan, impacting 20 global firms. However, Europe has delayed implementation until 2017. The rules are still being defined and need to be formally agreed.

There have been several issues tied to the systematic importance of central counterparties. How do you see this evolving?

The attention has increased on a CCP’s resilience, recovery and resolution. The Financial Stability Board (FSB) in August reiterated their intention to prioritise this for the remainder of this year while The International Swaps and Derivatives Association (ISDA) also set out its proposed recovery and continuity framework. However, while effective resolution and recovery tools are designed to resolve a bad situation, the best solution is to avoid the bad situation in the first place. Therefore we must also want to ensure that the resilience part is not overlooked. This means a greater focus on membership quality, adequate resources and that the incentives across all participants are aligned so that CCPs have a strong first line of defence so that any shocks can be avoided.

What are your main concerns with the Basel III leverage ratio rules and how do you think this will impact client clearing?

The rules make it quite expensive and difficult for clearing members because they have to guarantee the performance of their clients to the CCP. Clearing members are also not able to net cash initial margin against total exposure and, instead, have to add it in the leverage ratio calculations. It is counterintuitive in that the more clearing members protect themselves the more expensive it becomes.

This has resulted in a general decline in the number of futures commission merchants (FCMs) offering clearing and those staying in the business are looking at the capacity they are willing to make available. I am not entirely sure that means less competition for a given account, but it has reduced the quantity of services to the market as a whole. FCMs may only focus on the most attractive types of clients which could undermine some of the key philosophies that underpin the design of the CCPs. CCPs need a diversified group of brokers with diversified positions to mutualise the risks and support all market participants. The industry is still debating the issue and making their viewpoints known to the regulators.

What impact do you see Brexit having on London as a hub for derivatives trading?

It is difficult to say because Article 50 has not been invoked and it will depend on the terms set in the negotiations. Passporting or equivalency is certainly a key topic and there will be a great deal of debate regarding these two issues. For Societe Generale, we believe we are well placed and able to handle whatever the outcome as we are organised around two hubs – one in London and the other in Paris.

How has SG responded to the new world regulatory order? What changes has the firm made?

As a general point, we are now more focused on the most effective use of scarce resources including the balance sheet, leverage and short and long term funding. We are also beginning to see a trend of clients becoming more sophisticated in their understanding of how their business impacts the balance sheet of broker dealers and I think this will continue.

As for the regulations, our response has been to work with the different businesses to assess the impact and we have also made a variety of systems upgrades to ensure we are compliant. We also have increased the number of pre-trade regulatory checks and under MiFID II we will need to ensure that we have all the data required about the trade, where clients sit and the jurisdictions they are trading in, etc.

I think one of the biggest challenges is the complexity that comes with being a global firm because there are differences between countries as well as cultural biases. For example, in the EU, both parties to a trade must report transactions whereas in the US it is only one party that must report. Overall, you have to take a good look at the new products and processes and make sure you factor in all the impacts. Then it can be broken down to bite-sized chunks and solutions can be found from a market infrastructure perspective.

I read that Societe Generale hosted the Accenture FinTech Innovation Lab with five investment banking start-ups. How are you collaborating with these firms?

We are not looking at specific game changers at this stage but are involved in a number of initiatives. There is a lot of talk about blockchain, for example, but I do not see large parts of the bank moving in that direction anytime soon. That said, there are opportunities and we are trying to get to the bottom of them. For now we see the technology building blocks as the beginning of an architectural system on which future distributed applications will be built instead of producing a specific solution today. It is also important to look at the cost benefit analysis as well as value of implementation of the technology. What we are seeing in general on the financial technology front is the automation of existing processes with an emphasis on the re-engineering of the workflow to obtain better results.

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Biography:

Bill Stenning is managing director of clearing, regulatory and strategic affairs at Societe Generale Corporate and Investment Banking. Previously he was Managing Director – Business Development at DTCC and before that COO-Trading at Sungard Trading & Risk, He was also COO at SwapsWire as well as Vice President – Business Management, The Chase Manhattan Bank and Supervisor – Product Line Accounting at Cargill Financial Markets. He started his career as an accountant at KPMG Peat Marwick before joining Cargill Financial Markets in Product Line Accounting.

©BestExecution 2016

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Industry viewpoint : Turquoise : Dr Robert Barnes

By

Ian Rycott

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October 10, 2016

THE FUTURE OF TRADING IS NOW.

By Dr Robert Barnes, CEO, Turquoise.

The catalyst for Plato Partnership ^{1, 2, 3}

Dr. Robert Barnes, CEO, Turquoise Asset managers, like AXA Investment Management^{4, 5}, BlackRock^{6, 7, 8}, Deutsche Asset Management⁹ (see page 14), Fidelity^{10, 11}, and Norges Bank Investment Management^12-17, have with increasing frequency published views about the role of exchanges in well-functioning markets and the need for innovation in electronic block trading. Their views among others, were heard at the FIX Trading Community’s 8th annual EMEA Conference in March 2016, which had nearly 900 delegates from 22 countries, comprising 23% buyside; 26% sellside; 28% vendors and 23% exchanges and others.

During an electronic vote²³, attendees were asked “What one thing concerns you most in 2016?” 47% answered: “Everything to do with MiFID II”, followed by 17%: “The search for liquidity”. While more than half the audience (51%) answered “More Block Trading” when asked, “As a result of impending regulation, what do you expect in 2018?” (see Fig 1).

The prize is a Large In Scale electronic execution channel that works. We hear the buyside asking the sellside to provide access and return meaningful execution reports; from the sellside, the request is for the buyside to send larger parent orders via the sellside. Repeatedly buyside dealers have expressed their opinion of the importance of a trusted public exchange in the trading ecosystem to be accessed by institutions or any investor, the sellside continue to play a role.

Turquoise has been listening and innovating with customers, turning these ideas into actions^{24, 25}. In fact, our Large In Scale electronic execution channel received 46% of the vote when the financial community was asked “Which order book innovations are you most using?” (See Fig. 1).

be34_turq_fig-1

The new reality – Turquoise Plato

The latest innovation comes with the recently announced partnership between Turquoise and Plato Partnership. The resultant Turquoise Plato^™ encompasses all of the Turquoise non-displayed services, including the award winning Turquoise Block Discovery^™ and Turquoise Uncross^™ – rebranded as Turquoise Plato Block Discovery^™ and Turquoise Plato Uncross^™. Turquoise Plato Block Discovery^™ matches undisclosed Block Indications that execute in Turquoise Plato Uncross^™.

Our aim is to grow Turquoise Plato^™, as more buy and sellside firms adopt and optimise workflow to deliver best results on a continuous basis. Turquoise Plato^™ key differentiator is that Turquoise Plato Block Discovery^™ is a Large In Scale electronic execution channel that has nearly two years of empirical data. This solid track record has robust reputation scoring, designed to avoid information leakage and deliver quality execution. Turquoise Plato Block Discovery™ matches undisclosed Block Indications that execute in Turquoise Plato Uncross™.^{31, 32}

Empirical data through to the end of August 2016 shows that users of Turquoise Plato Block Discovery^™ benefit from:

High firm up rates – Consistently more than 90% of order submission requests arrive in time and in full Block Indication size or larger;
Low reversion – Block Indications matched by Turquoise Plato Block Discovery^™ execute in Turquoise Plato Uncross^™. In this mechanism, after 1 second following execution the PBBO mid reference price has changed in less than 10% of occasions, as per independent analysis by LiquidMetrix; this compares well with the 50% for continuous dark pools;³³
Higher average trade size – Turquoise Plato Block Discovery^™ now averages more than E250,000 per trade, and this average is more than 25 times larger than the average E10,000 for electronic trades matched by continuous dark order books across Europe; these size results continue to grow compared to prior publication.³⁴

be34_turq_fig-2

In the intraday chart enriched by trade size (see Fig. 2), investors are trading shares of the German company, Fresenius, on multiple trading platforms including Xetra – the electronic order book of its primary listing exchange, Deutsche Boerse – and Turquoise. This illustration shows the prices and sizes of trades by investors on 7 April 2016. Turquoise trade prices are similar to those of the primary Stock Exchange, while trade sizes serve both the smallest and largest orders through its single connection for straight through processing from trading in London to settlement into Germany. Turquoise not only enables investors to access more than 35% of the order book value traded that day, but it also matched the very largest order book trades of all venues that day via its award winning electronic block trading innovation Turquoise Plato Block Discovery^™.

Record performance

Key insights are that:

Turquoise Plato^™ is growing in partnership with customers, turning ideas into actions;
Turquoise Plato^™ innovations are working consistently well: even post EU Referendum extraordinary activity,
Turquoise Plato^™ maintains its differentiated profile:

– e.g. Turquoise Plato Block Discovery^™ has ~50% activity greater than 100% Large In Scale thresholds; this compares with each of European continuous dark pools just ~1%;

– and on the 24th June, the shock day of the EU Referendum results, 75% of value traded was >100% Large In Scale.

Turquoise Plato Block Discovery^™ 2016 continues to set new records, with each month outperforming the one before, including July, August and September, each larger than June’s EU Referendum activity.

be34_turq_fig-3-update

Reliability and trust

Surveillance of Turquoise activity, including monitoring of price movements ahead of Turquoise Plato Uncross^™, is undertaken by the independent London Stock Exchange Group Surveillance team. Any suspected manipulation of Reference Price will be referred to the UK Securities Regulator, FCA.

A combination of robust automated reputational scoring, independent quantitative analysis evidencing empirical quality of the LIS trading mechanism, and an independent surveillance oversight add further to confidence in the integrity of Turquoise Plato Bock Discovery^™ for the matching of undisclosed Block Indications that execute in Turquoise Plato Uncross^™.

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Notes:

• Conventional order books tend to shrink trade size.^{18, 19}
• Europe also faces impending regulatory change.²⁰
• MiFID II’s ‘double volume cap’ calculations start January 2017 and will allow only order activity above Large In Scale thresholds to avoid the caps starting January 2018.^{21, 2}²
• Repeatedly Buy side dealers have expressed their opinion of the importance of a trusted public exchange in the trading ecosystem to be accessed by institutions or any investor, the Sell side continue to play a role.^{26, 27}
• The requirement for the first time is for the Buy-side, Sell-side and trading venue to collaborate in a new way. Plato Partnership entered into a Cooperation Agreement with Turquoise^{28, 29} to explore this.
• Our response is Turquoise Plato™.³⁰

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References:

[1] Stafford, Philip. “Banks and fund managers plan new European equity venue” Financial Times, December 17, 2014.
www.ft.com/content/a0274b92-8571-11e4-a06e-00144feabdc0

[2] Baker, Sophie. “Investors warming up to trading venues being created by manager groups” Pensions&Investments, February 23, 2015. www.pionline.com/article/20150223/PRINT/302239971/investors-warming-up-to-trading-venues-being-created-by-manager-groups

[3] Plato Partnership. “Formation of Plato Partnership complete” September 6, 2016. www.platopartnership.com/assets/plato-formation.pdf

[4] Laurent Lionel and Hutchison Clare. “Fund managers push for safer trading waters in dark pools.” Reuters, October 20, 2014.
www.reuters.com/article/us-dark-pools-funds-idUSKCN0I91HN20141020

[5] Stafford Philip. “Turquoise aims to lure institutions’ block trades to dark pool” Financial Times, October 20, 2014.
www.ft.com/content/88294b24-585a-11e4-b331-00144feab7de

[6] Novick Barbara, Prager Richie, de Jesus Hubert, VedBrat Supurna, Medero Joanne. “US Equity Market Structure: An Investor Perspective” BlackRock Viewpoint, April 2014. www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-us-equity-market-structure-april-2014.pdf

[7] Novick Barbara, Fisher Stephen, Parkes Martin, Mahoney Michael, Mcleod Tim, Rosenblum Alexis. “Improving Transparency” BlackRock Viewpoint, August 2016. www.blackrock.com/corporate/en-pt/literature/whitepaper/viewpoint-improving-transparency-august-2016.pdf

[8] Novick Barbara, Goldstein, Rob, Evans Phil, Perlowski John, Clement Michelle, Rosenblum Alexis. “The Role of Third Party Vendors in Asset Management” BlackRock Viewpoint, September 2016.
www.blackrock.com/corporate/en-pt/literature/whitepaper/viewpoint-role-of-third-party-vendors-asset-management-september-2016.pdf

[9] Bellaro, Mike. “Buyside Profile: Deutsche Asset Management” Best Execution, Autumn 2016, pages 14-17. https://globaltrading-lscura.dev.securedatatransit.com/?p=5731

[10] “Modern Markets: benefits and challenges” Fidelity Viewpoints, 2 February 2015.
www.fidelity.com/viewpoints/investing-ideas/modern_markets_benefits_and_challenges

[11] Barnes Robert, Finney Jonathan, Hilton James. “Finding Blocks – A Case Study – Industry Collaboration in Action” Global Trading, Q1 2016, March 2, 2016, pages 64-67.
https://fixglobal.com/home/finding-blocks-a-case-study-industry-collaboration-in-action/

[12] “Well-functioning financial markets” NBIM Discussion Note, November 2012.
www.nbim.no/globalassets/documents/dicussion-paper/2012/discussionnote_13.pdf

[13] “High Frequency Trading – An Asset Manager’s Perspective” NBIM Discussion Note, August 2013.
www.nbim.no/globalassets/documents/dicussion-paper/2013/discussionnote_1-13.pdf

[14] “Sourcing liquidity in fragmented markets” NBIM Asset Management Perspective, April 2015. www.nbim.no/contentassets/1b25761cb30e4025b627865627610dab/asset-manager-perspective_1-15.pdf

[15] Shanke Øyvind and Emrich Simon. “Trading in Dark Pools – An Asset Manager’s Perspective” Global Trading Magazine, 18 April 2015. https://fixglobal.com/home/trading-in-dark-pools-an-asset-managers-perspective/

[16] “Role of Exchanges in Well-Functioning Markets” NBIM Asset Management Perspective, August 2015. www.nbim.no/contentassets/03b3c386e08a4b59ba24bfc7d44d77e1/asset-manager-perspective-2-15.pdf

[17] Mortensen Pauli and Schanke Øyvind. “Taking the Liquidity Reins“ Best Execution, July 11, 2016
https://www.bestexecution.net/profile-pauli-mortensen-oyvind-schanke-norges-bank/

[18] Even if a large order is on one side, if the other side is a small order that can match then the result is trade size smaller than the large order; or, if the large order has a Minimum Execution Size above that of the smaller order, there is no trade.

[19] Barnes, Robert. “Dark pools and best execution” Best Execution, Summer 2015, pages 79-81. www.bestexecution.net/analysis-dark-pools-best-execution/

[20] FCA. “Firms will need to start planning for the MiFID II changes ahead of the finalisation of the EU implementing legislation and the subsequent changes that we and the PRA make to our Handbooks, and changes that HM Treasury makes to financial services legislation.” www.fca.org.uk/markets/mifid-ii

[21] European Commission. “A Directive and a Regulation extending the application date of MiFID II and MiFIR by one year have been published in the Official Journal of the European Union. The date of application will be 3 January 2018. The transposition of MiFID II into national laws has also been extended to 3 July 2017.” Updated rules for markets in financial instruments: MiFID 2, 30.06.2016. www.ec.europa.eu/finance/securities/isd/mifid2/index_en.htm

[22] Barnes, Robert. “Dark pools and best execution: Turquoise Block Discovery™” Best execution, Autumn, November 3, 2015, pages 69-73. www.bestexecution.net/analysis-dark-pools-best-execution-3/

[23] Healy, Tim. “FIX EMEA Conference 2016: Key findings” Best Execution, April 10, 2016.
www.bestexecution.net/fix-emea-conference-2016-key-findings/

[24] Barnes, Robert. “Forward thinking: Aρετη! Excellence and its pursuit through collaboration” The Trade, THE TRADE HOT 100, 22 April 2016, pages 18-19. www.thetrade-digital.com/thetrade/the_trade_hot_100?pg=18#pg18

[25] “In less than 10 years from concept in 2006, Turquoise activity has grown from nothing to more than €1 trillion value traded in 2015 and achieved industry recognition for its innovations including Turquoise Uncross™ and Turquoise Block Discovery™ designed in cooperation with Turquoise buy side and sell side customers for quality electronic trading of larger sized investments. Turquoise won the Financial News 2015 Award for Excellence in Trading and Technology for Most Innovative Trading Product/Service for Turquoise Block Discovery™” in Barnes, R. “Turquoise” The Parliamentary Review 2016 [Issue: Finance Edition], September 2016, pages 33-35. www.theparliamentaryreview.co.uk/editions/pdfs/TPR2016-Finance.pdf

[26] Laurent Lionel and Hutchison Clare. “Fund managers push for safer trading waters in dark pools.” Reuters, October 20, 2014.
www.reuters.com/article/us-dark-pools-funds-idUSKCN0I91HN20141020

[27] Cooper, James. “Disintermediation? Don’t Bank On It.” Global Trading, March 29, 2015. https://fixglobal.com/home/disintermediation-dont-bank-on-it/

[28] www.finextra.com/news/announcement.aspx?pressreleaseid=60593

[29] “Plato Partnership enters Cooperation Agreement with Turquoise“ Best Execution, September 6, 2016.
www.bestexecution.net/announcement-plato-partnership-enters-co-operation-agreement-turquoise/

[30] Turquoise Plato™ Collaboration. Innovation. Execution.
www.lseg.com/sites/default/files/content/documents/LSEG_Turquoise%20Plato_Brochure_16-09-16.pdf

[31] www.lseg.com/markets-products-and-services/our-markets/turquoise/turquoise-products-services/turquoise-midpoint-dark-book/turquoise-uncross%E2%84%A2/turquoise-block-discovery%E2%84%A2/turquoise-block-discovery%E2%84%A2-explained

[32] www.lseg.com/markets-products-and-services/our-markets/turquoise/turquoise-video-resources/how-does-turquoise-block-discovery%E2%84%A2-work

[33] LiquidMetrix Turquoise Uncross™ – Execution Quality Analysis by Dr Sabine Toulson & Dr Darren Toulson, extracts of presentation to Turquoise Buy Side round table, 13 November 2015.

[34] Barnes, Robert. “Turquoise Block Discovery™ Firm Up Rates: Integrity Matters” Best Execution, February 1 2016, pages 82-84. www.bestexecution.net/industry-viewpoint-dr-robert-barnes-turquoise/

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www.tradeturquoise.com @tradeturquoise

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Announcement : Turquoise Plato

By

Ian Rycott

-

October 10, 2016

THE FUTURE OF BLOCK TRADING IS NOW.

Following the recent announcement from the not-for-profit industry group Plato Partnership of its collaboration with pan-European MTF Turquoise, Best Execution was granted an insight into its aims and aspirations.

The Plato Partnership spokespeople pictured from left to right comprised:

James Hayward, Principal, Strategic Investments, Goldman Sachs
Mike Bellaro, Plato co-Chair and Global Head of Equity Trading, Deutsche Asset Management
Nej D’jelal, Plato Co-Chair and Managing Director, Head of Electronic Equities Product, EMEA, Barclays
Robert Barnes, CEO of Turquoise

What are you announcing?

Plato Partnership is a not-for-profit industry group representing the buy- and sellside with a vision to improve market structure in Europe and reduce transaction costs. Participation in Plato enables market participants who have a desire to change markets for the better to turn ideas into action. The composition of the parties around the table at Plato makes this a truly unique proposition.

On 6 September, Plato announced that it had appointed Turquoise, a leading pan-European MTF as its preferred partner. This decision was made following an extensive selection process, with Turquoise having displayed a secure and rapid route to market, demonstrable innovation and an alignment with Plato’s guiding principles. As part of this partnership, Turquoise will rebrand its non-displayed services as Turquoise Plato™.

Turquoise Plato™ represents the first time that the buyside, the sellside and a trading venue have come together to deliver increased efficiencies in anonymous European block trading. This marks a significant milestone for the industry and will enable the most efficient and effective dark trading venue in the market.

What is Plato trying to achieve?

The Plato consortium’s key aims are to increase transparency, reduce trading costs, simplify market structure and act as a champion for end investors.

Our Market Innovator (MI3) is integral to what we are trying to achieve and will guide what future market challenges Plato will address. Academic research is central to our vision and MI3 will produce independent research – open to peer review – that will determine the ways in which the Plato community can collaborate to build a better financial ecosystem. We are inviting interested parties – both existing Plato members and beyond – to submit their ideas on where they believe we should be focusing our research via our website.

Why have so many firms become involved with Plato?

Firms have been quick to realise that the creation of an innovative organisation to improve equity markets, based on a not-for-profit ethos and value chain representation, is a truly unique proposition. There is no other forum in the market that does what Plato does. Participation in Plato enables market participants to turn ideas into action. If you are a firm and you want to be at the heart of the future of this evolution, you need to be engaged and not on the sidelines.

Are you open to other organisations joining Plato?

Yes. Plato is an overtly open and inclusive project. We want as many organisations with an interest in shaping the future of block trading and how markets fundamentally work to participate in what we are doing and bring new ideas to the table. Ultimately, we are trying to do something for the greater good of the marketplace and we invite all market participants to help us deliver this change.

Why are you launching this now?

Changes to markets, regulations and participant profiles have had a significant impact on the buyside’s experience of trading in size. Prompted by this ongoing deterioration, and in anticipation of further changes prompted by MiFID II, we believed there was a need for a consortium of market participants to come together to find a way to improve the markets of tomorrow.

What are the drivers?

We have created a simple governance structure where each voice around the table is given equal weight, which allows Plato to be both nimble and innovative. The way Plato is structured, coupled with the underlying ethos, which members have fully bought into, ensures we have created an organisation that will drive the change the market so desperately needs. The proposition is far stronger in partnership, when all parts of the value chain come together, because it focuses the market’s attention on something that is already working extremely well. From Turquoise’s perspective, the challenge is now all about scale, which this partnership will deliver, while from Plato’s perspective, this ensures that from day one there is a venue that is already working and can deliver a real impact for market participants.

Which organisations make-up Plato’s current membership?

Members include AXA Investment Managers, BlackRock, Deutsche Asset Management, Fidelity International, Franklin Templeton Investments, Norges Bank Investment Management, Union Investment, Barclays, Bank of America Merrill Lynch, Citi, Deutsche Bank, Goldman Sachs, Morgan Stanley, and UBS, and firms currently undergoing the membership process include JP Morgan.

What the buyside have said:

“This partnership between Plato Partnership and Turquoise is a hugely important development for the marketplace. Plato Partnership’s innovative response to regulatory developments represents a refreshing change, and should not be undervalued as an impetus for enabling further new and innovative thinking. The collaborative nature of the initiative; bringing together the buy and sell side, as well as utilising the established industry knowledge of Turquoise alongside Plato Partnership’s not for profit ethos, makes it a unique equities solution, and one which should soon gain strong momentum.” Paul Squires, Global Head of Trading and Securities Financing at AXA Investment Managers

“We must continue seeking to address any element of market model inefficiency and an initiative such as Turquoise Plato™ provides a solution to that problem. Well-functioning markets are essential for us and other participants to operate, and we fully support initiatives that seek to make markets work better. This partnership with Turquoise seems like a natural choice for Plato Partnership to work towards its goal of enhancing the fairness and robustness of future markets, as well as reducing complexity in the marketplace.” Øyvind Schanke, Chief Investment Officer for Asset Strategies, Norges Bank Investment Management

“Union Investment is delighted to support Plato Partnership and its partnership with Turquoise. This grouping of thought leaders coming together to solve big market structure issues of the day is a compelling proposition and represents a huge opportunity both for our clients and for the market more generally. Collaboration with an industry partner like Turquoise will offer Plato Partnership the possibility to achieve an effective route to market, and we believe that representation from all parts of the value chain makes this a promising approach, and very important for the buy-side community.” Christoph Hock, Head of Multi-Asset Trading, Union Investment

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Viewpoint : Forex Market : Louisa Kwok

By

Ian Rycott

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October 10, 2016

PRIME OF PRIME AND THE REGENERATION OF THE FOREX MARKET.

By Louisa Kwok head of Prime of Prime sales and product at ADS Securities.

Every three years, the Bank of International Settlements (BIS) produces a comprehensive survey, which reveals the volumes that are passing across the global foreign exchange markets. As the only such source of data – 1,200 institutions in 52 countries contribute – it’s considered something of a gold standard by the industry and given the changes we’ve seen in recent years – both in terms of regulation and also how the big players in this market want to interact with one another – it’s fair to say that the 2016 edition has been very much in focus.

This is a multi-stage report and we’ve only had the first pass of the data released so far. It’s also fair to say that many market participants were aware that the numbers would fall some considerable way short of what had been predicted following the last survey, again heightening interest in the news. Back in 2013, the daily turnover figure for April was $5.3 trillion, up from $4 trillion in April 2010 and forecasts had initially anticipated that this growth would continue to accelerate. However, this failed to take account of a series of unforeseen events, which have collectively taken a notable toll on how the market has evolved in recent years. The April 2016 figure showed an average daily turnover of just $5.1 trillion – the market had in fact shrunk.

These events included such unrelated factors as the currency rigging scandals with the accompanying hefty fines serving to reduce activity, and investors rotating out of active and into passive funds. Extended periods of low volatility in currency markets have also served to suppress volumes as the number of arbitrage trades falls as a result, but perhaps most telling is the risk aversion we’ve seen from the prime brokers who have historically offered up so much liquidity in this market. The Swiss National Bank’s (SNB) decision to remove the EUR/CHF peg in January 2015 caught currency markets wholly off-guard and the massive spikes in volatility we saw as a result left regulators demanding a more capital-conscious approach. With many of the big players being left to reassess the risks they were willing to take, this squeeze on volumes was inevitable.

So although some of the contraction in the market size may have been dictated by shifting fundamentals, such as the realisation that in the low inflation, low interest-rate world, active managers are finding it increasingly difficult to outperform their passive rivals, and to some extent the tap – the flow of actual money to trade with – had been turned off. Two years ago there would have been 12 prime brokers willing to offer out their liquidity to a whole range of institutions seeking to trade currencies. Now there are maybe six banks willing to participate in the market like this, and the criteria regarding who they are willing to do business with has jumped higher, too.

Financial markets are however, by their very nature, efficient beasts and any gap should be arbitraged away soon enough. So it’s to this extent that primarily in the wake of the SNB event of last year, there has been some genuine evolution. There’s the increasingly popular term ‘Prime of Prime’ being used by banks and well-capitalised brokerages, as they bid to plug the gap that’s been left by the prime brokers themselves.

The prime-of-prime term perhaps still requires some tighter definition – a number of market participants are using it as shorthand for extending credit lines yet still determining what pricing is shown. So you have the liquidity, but not the ability to absolutely control who your counterparties are at execution, potentially meaning that you’re not getting the pricing or the degree of leverage that may be expected – especially if historical relationships have produced preferred pricing streams. There are however a small but growing number of institutions – including ADS Securities – who are now pushing a pure Prime of Prime solution. Once the appropriate due diligence has been completed, institutions are granted access to the Prime of Prime service and are in turn given the ability to control pricing relationships at source and the ability to direct how any trades are executed. There’s a cost for doing this but it comes with the benefit of absolute transparency and control over your liquidity.

Solutions like Prime of Prime – and especially the purest iterations where institutions still retain control over the execution – will play an instrumental role in reshaping the foreign exchange market in the years ahead, although whether we ever see a return to the growth rates posted in the early part of this decade is something that remains to be seen. On top of the shifting fundamentals that have driven the contraction since 2013, there’s also a growing role for technology to play as banks develop more advanced proprietary systems. So long as there’s no adverse pricing impact, the bigger banks will increasingly find themselves in a position to internalise the currency flows, rather than farm them out into the open market and again this will stand to erode the perceived size of the market.

Perhaps if nothing else, the BIS survey provides us with a valuable reminder that even the most established financial markets live in a state of perpetual evolution. So long as we have multiple currencies then there will always be a need for forex trading, but the size and shape of this market is as dynamic as ever. And if recent history is anything to go by, then it’s fair to suggest that many of the opportunities and threats this market will have to account for over the next three years will still be lurking well below the radar. n

Louisa Kwok is head of Prime of Prime sales and product at ADS Securities London Limited. Louisa is a well-established financial markets professional who has also spent 12 years in the prime brokerage space. She has worked at high profile firms including BNP Paribas, Morgan Stanley and JP Morgan, and has significant expertise in relationship management, technical sales and legal negotiation.

©BestExecution 2016

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Viewpoint : Trade surveillance : Nick Gordon

By

Ian Rycott

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October 10, 2016

THE “TRIPLE-A” APPROACH.

Financial firms looking to address the latest European regulatory measures requiring trade surveillance and speedy reporting of suspicious activity would do well to consider a “Triple-A” approach to the task at hand. What does that mean? A focus on Assessment, Agility and Assurance, says Nick Gordon, business development director at Certeco.

In an effort to bolster market integrity, European regulators have introduced new measures to root out unscrupulous trading behaviour. A centrepiece of their campaign is Europe’s Market Abuse Regulation (MAR), which came into effect this year and which is still being fine-tuned. Under MAR, a range of market participants will need to report any suspicious trades, orders or patterns of activity. The hitch is that many of these firms have never before had to deal with this sort of obligation. Identifying suspicious trades, building and installing the necessary technical systems and creating the organisational workflows needed to satisfy regulators throws up a welter of issues. So how can firms make sure they will make the grade?

The problem is far from straightforward. It requires advance planning, a consideration of wider organisational issues such as the relationship between compliance and the front office, and a readiness to engage with a range of firms to engineer and introduce a trade reporting system that will meet demanding requirements. One way to address all of this is what might be called a Triple-A approach. That involves breaking the problems down into three broad categories. The first is Assessment, where firms review their trading activity in order to understand the nature of what they’re dealing with. The second is Agility. This means designing, building and introducing interoperable systems that can be adjusted to meet complex or changing requirements. Finally there is Assurance. This is where the focus is on testing to make sure the solution is fit for purpose.

Assessment

In theory, firms should have a strong grasp of the business they are in. In practice, it is often not so simple. The speed, complexity and fluidity of modern trading mean that the nature of the business is constantly evolving. Yet any trade surveillance and reporting system needs to be based on the nature of the underlying business. There are no one-size-fits-all models, in part because regulators themselves have not been cut and dried about what needs to be reported.

The lack of rigid rules results in a need to think about a firm’s trading activity in terms of risk. Companies will want to ensure that the priority of any system is calibrated to focus on where the greatest risks lie. For example, one type of firm that now needs to meet MAR requirements is the interdealer broker. IDBs frequently undertake complex transactions, which in turn means risk profiling becomes fundamental.

IDBs and other firms need to think about what the regulator is asking of them and what their own business requirements are. Then they need to bring all of that together. Firms that have greater exposures to cross-market activity will have different needs from those that specialise in one market or asset class. The complexity of monitoring activity at a cross-market level is naturally much higher.

Agility

Building trade surveillance and reporting systems involves first and foremost building solutions that will generate alerts for the business. These alerts are the building block of a trade reporting process. But solutions need to be able to work within existing infrastructures and at the same time be flexible enough to change with the times.

Alerts also are only the first step in the process for meeting regulatory requirements. Once alerts have been generated, they need to be investigated for anything that might be considered suspicious. This is where the importance of Agility becomes clear. The business needs a system that can allow the alerting system to be calibrated based on back-testing. For instance, a company may find its alerting system is generating too many false positives, which can become costly.

Firms can build in protocols that allow front- or back-office staff to adjust parameters based on business or compliance requirements. Throughout the entire process, it’s important to separate business requirements from technical requirements. This can be helpful in bringing IT, legal, compliance and front office stakeholders together to achieve a solution.

Assurance

Finally, having determined requirements and designed a system, there is the question of whether the solution fits the bill. Companies also need to be able to ensure it will work 24/7. Here, it becomes a matter of more than just software and hardware. There are also issues in terms of introducing effective and efficient workflows between the back and front office.

One other major point is worth noting. Automation is vital throughout this process. The sheer amount of trades that are being monitored and the number of alerts generated require a degree of automation if a firm is to avoid devoting too much resource to the regulatory requirement. Creating a bespoke automated system can help firms maintain healthy margins while still satisfying regulations.

Next steps

Breaking down the problem into the three “A”s described above can help companies get to grips with the new regulation. But there are still business decisions that can have a huge impact on the success or failure of any new surveillance system.

Some firms may want to build their own solutions, from start to finish. These are often going to be larger international firms that already have a good deal of in-house expertise. But for a sizeable number of firms that are suddenly caught in this new regulatory web, this will not be an option. For these firms, a big question then becomes whether to outsource the requirement to a single provider or seek to mix and match problems with specific vendors. The more complex the trading profile, the more likely it will be that multiple solution providers will need to be brought in.

Whatever solution firms opt for, there is one thing worth bearing in mind. Never underestimate the scale and complexity of the challenge. The last thing a trading outfit wants to do in this day and age is to get on the wrong side of a regulator.

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Viewpoint : Unbundling : Ivy Schmerken

By

Ian Rycott

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October 10, 2016

MIFID II: THE IMPACT OF UNBUNDLING.

By Ivy Schmerken, Editorial Director at FlexTrade.

Even though the final Markets in Financial Instruments Directive (MiFID) II rules are still evolving, buy- and sellside firms in Europe are bracing for reforms that could sever the link between research payments and dealing commissions. New rules from the European Union are going to transform the way that asset managers pay for investment research and report the value of research to their end clients. The onus is on the buyside to control the research costs. For example, the buyside is required to assign a price to each piece of research and to pre-determine a research budget on an annual basis.

“In its final advice to the EC, The European Securities and Markets Authority (ESMA) recommended that the investment firm must pay for the research directly with their own funds, or pay for such research from a designated research payment account funded by specific charges to its clients,” wrote attorneys at Sidley Austin in the law firm’s May 16 update to clients.

As for the sellside, the regulatory overhaul has the potential to disrupt global research models. Rather than purchase research services with brokerage commissions, MiFID II will allow investment managers to pay for research in one of two ways. The EC’s Delegated Directive, published on April 7, states: Investment firms can fund research from their own accounts and pay from their own P&L with hard currency. Alternatively they can set up a so-called Research Payment Account (RPA), a new concept where the RPA must be funded with a specific research charge to the client. The asset manager must create a research budget for the year ahead.

CSAs: Are they allowed?

One of the unanswered questions has been the fate of Commission Sharing Arrangements (CSAs), a type of research payment mechanism that allows the buyside to allocate commissions to brokers and independent providers, while they are trading through execution-only brokers. CSAs are widely used in Europe and the US.

There was a leak of MiFID’s Delegated Acts in December 2015 which was, “encouraging because it suggested that there was an opening for commissions to be used as a currency for research,” said Chris Tiscornia, president and CEO of Westminster Research, a provider of research and commission management services.

Experts are of the opinion that buyside firms will have a choice of utilising existing CSAs, with the client’s permission, to fund the RPAs.

Will RPAs add complexity?

Brad Bailey, research director at Celent’s Securities & Investments practice, said, “The CSA became the tool for paying brokers and how you allocated [commissions] to the brokers, but the RPA is a much more complicated tool. You can’t just manage the process of paying other brokers. You have to value the research as well as manage the clients.” With the RPA, the buyside must predetermine the research budget and have a means of managing the dollar allocation to brokers.

“The end result could be potentially higher costs or greater complexity and access not to the same research,” Bailey cautioned.

Will asset management raise their fees?

“The largest asset managers will most likely pay for research out of their own pockets”, said Andrew Upward, head of market structure at Weeden & Co, an institutional broker in Greenwich, Connecticut. MiFID II also allows investment managers to raise their fees to recoup the cost of their research budget.

If firms are charging 50 basis points, and tell clients the fee is increasing by a handful of basis points, clients could go elsewhere, cautioned Upward. He contends that managers won’t be able to raise fees; asset managers will end up “eating” the higher costs. But it’s likely that if investment firms decide to pay out of pocket, buyside firms will become more selective about purchasing research.While larger asset managers have the scale to absorb the research costs without raising their fees, market participants have raised concerns about the impact of such rules on smaller asset managers.

Furthermore, the buyside values corporate access – a service to the buyside where the sellside sets up meetings with management teams and also offers invitations to conferences. With these changes it’s possible that the price of corporate access could actually go up.

The devil is in the details

Upon request, investment managers are required to provide clients with the budgeted amount of research, a summary of providers paid, services consumed, amounts paid, benefits received and totals spent in comparison to the budget. At the outset, they must tell the client what their overall research budget will be for the year.

Part of the ongoing debate is over whether the reporting to clients has to be at the strategy, portfolio, or account level. “The more granular the reporting becomes, the more cumbersome and costly it tends to be,” said Tiscornia, who adds that there is a concern that some managers will “throw their hands up” and decide to pay with their own funds.

On the upside

Despite some of the operational costs and complexity entailed with transitioning to RPAs, MiFID II is going to give investors more visibility into their research costs. “It mandates transparency for any fund that wants to use client’s assets to pay for research. Ultimately that’s better for the end client and is a good thing,” maintains Upward.

Since MiFID is a directive and not a regulation, there can be differences in the interpretation by national regulators. Some US fund managers with European sub-managers or affiliates could conceivably have to comply with varying regulations on usage of dealing commissions.

Some US investment firms are said to be looking at adopting a global standard for dealing with research payments rather than cope with multiple rules. Instead of having to comply with different standards and multiple modes of operation, large investment firms may decide to simply adopt the tougher European standard.

Fixed Income

European regulators are said to be speaking with the industry on how it intends to unbundle fixed income research. How the final rules will shake out remains to be seen. As with all regulations, there will be unintended consequences from MiFID II’s revamp of research payments. What can be said with certainty is that regulators want to see a real separation of research payments from the volume and value of trading. n

This article is an abstract from a full-length white paper also entitled, “MiFID II: The Impact of Unbundling” by Ivy Schmerken. A copy may be downloaded at www.flextrade.com/unbundling.

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Viewpoint : Market Abuse Regulation : Lars-Ivar Sellberg

By

Ian Rycott

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October 10, 2016

JUMPING THROUGH HOOPS.

Best Execution spoke to Lars-Ivar Sellberg, Executive Chairman of market surveillance solutions provider, Scila about the challenges implementing the Market Abuse Regulation [MAR].

What was the buyside’s level of preparedness for implementing MAR?

In my view, many buyside participants were taken by surprise by MAR, especially the obligation to implement an automated trade surveillance procedure. In their defence, it would seem a bit extreme to deploy a full-scale surveillance system for an investment firm that only trades a few times a day. The problem is that the term “proportionate” used in MAR is too vaguely defined. While the regulator may have had a good reason not to be too specific when formulating regulatory text, in this case details would not have gone amiss.

Many of the firms we have spoken to over the last year do not even execute trades themselves, which means they don’t have any experience in deploying IT solutions such as surveillance. Based on our conversations with the buyside, both pre and post MAR, surveillance vendors need to develop a scalable solution that works for all market participants, regardless of size, technical preparedness and financial strength.

Did firms have systems in place or did they have to start from scratch?

It differs greatly depending on the type of firm, asset class or market segment. MTFs are generally well prepared, since surveillance is a core part of their trading infrastructure and a necessity for market confidence. Large investment banks and brokers also have a history of using surveillance, although it is usually deployed T+1 (i.e. not real-time) and uses multiple systems spread across asset classes. For this category of firms, the challenge is to consolidate the various systems and conduct cross-product/asset class monitoring as per the requirements in MAR.

The markets that traditionally had the most underdeveloped trade surveillance are energy, foreign exchange and fixed income. While some participants have taken this very seriously in the past, few have deployed automated trade surveillance systems to monitor their markets prior to MAR. This is partly due to the fact that many technology vendors have focused on equities and exchange-traded products.

In fact many firms that we have met over the last couple of years are tired of being shown surveillance systems monitoring on-exchange or order book trading. Consequently we have spent a lot of time and effort to develop functionality around these areas, including request-for-quote/auction based support and specialised energy markets monitoring.

What are the key elements for implementing a surveillance system?

Implementing a trade surveillance system typically involves resources from IT, compliance and trading. It often involves a mix of people who have not worked together before, so it’s important to have a project manager who fully understands all of these areas. Having a grasp of your own data is a key factor to a successful implementation, especially if you are trading multiple asset classes and the data is spread out across different source systems.

Integrating this data into one centralised trade surveillance solution can be beneficial for both compliance and surveillance. We also encourage our clients to use the trade surveillance system for other purposes, such as business analysis, studying market behaviours, etc. There is a wealth of consolidated data generated that can be effectively leveraged.

And finally – compliance, legal and trading need to adopt a risk-based approach to trade surveillance and apply suitable monitoring algos – or alerts – to comply with both regulation and market rules. If you have direct market access or sponsored access, it’s also important to remember that exchanges and marketplaces can issue fines for market abuse, so it’s not only a matter of complying with MAR.

What were some of the biggest technical challenges of implementation?

From my experience working with both trading and surveillance systems, key challenges include the process of outputting all relevant data from separate source systems and implementing effective testing procedures. Since regulation now requires firms to monitor all orders irrespective of asset class, they need to ensure all data is processed in a centralised trade surveillance solution. That makes testing a crucial part of the implementation process. In the end you need to be confident that your source systems are pushing all data through the trade surveillance platform. While many tech-savvy firms in the financial industry have experience in testing, others do not. We recently partnered with test and change management specialists Certeco to provide an alternative to using internal resources for implementing a trade surveillance system.

How are firms meeting the new rules for monitoring the different asset classes?

Generally I think firms are doing very well. It gives them the opportunity to have a comprehensive view of their trading operations, which traditionally has been quite challenging for firms such as inter-dealer brokers. We are working with two of the largest firms, and it has been a rewarding challenge for both sides to consolidate data from five to ten source systems into one centralised solution for cross-asset class monitoring.

What is the most effective way to monitor instruments from different source systems?

In a perfect world, different source systems are perfectly in sync. In reality, however, this is not the case. The most effective way to monitor instruments that are linked together but reside in different source systems, is to base synchronisation on source timestamps and allow for non-precise and less granular time stamps.

As a vendor, we need to adapt to the client’s infrastructure. Many vendors rely on industry standard connectivity such as FIX, but we know from countless examples in the past that clients can rarely provide all the data from different source systems in the same format. Therefore, our surveillance system needs to be flexible enough to cater with a wide range of formats. To this date we have built adaptors for over 100 different protocols and file formats.

Against this backdrop, what lessons can US markets learn from MAR?

When introducing new regulations for trade surveillance and prevention of market abuse, the regulator needs to be precise enough in order to avoid putting an unnecessary burden on market participants interpreting the rules. This represents a real cost for firms, and we now see this being a problem for the buyside, in Europe especially.

However, the regulation should be flexible enough to cover new abusive behaviours and changes in market structure. Take spoofing or layering, if you look at some of the actual cases from regulators and marketplaces in Europe and the US, the definitions differ.

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Viewpoint : CSDR : Camille McKelvey

By

Ian Rycott

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October 10, 2016

COULD CSDR BE THE STRAW THAT BREAKS THE CAMEL’S BACK?

By Camille McKelvey, Head of Match Strategy for Trax.

Amongst the plethora of acronyms denoting new regulations (MiFID II, SFTR, APA et al), CSDR is another one of the many that you will hear, and you may not realise it now, but it has the potential to arguably have the biggest impact of all. The Central Securities Depository Regulation (CSDR) was designed to improve securities settlement in Europe. Settlement has historically been one of those things that just ‘happens’ in the back office. In theory exchanging some securities for some cash on a given day seems simple, but in practice is not always as easy as one would imagine. Regulation is driving change in the way that organisations are looking at their front to back processes and an efficient mechanism for settling trades is an absolute pre-requisite. In 2018, under CSDR, all failed trades will have an associated fine, and a subsequent mandatory buy-in, in the event of ongoing failure to deliver.

The industry has already experienced the first wave of CSDR; in October 2014 the European markets moved from a T+3 to T+2 settlement cycle, and our US counterparts are set to follow the trend of moving to T+2 by Q3 2017. The impact of T+2 in Europe was felt globally, across both the buy- and sellside, as will the implementation of CSDR in 2018. Unlike other regulations whereby compliance is predicated on location, this will impact any party who is settling trades in Europe. The differentiator between CSDR in 2018 and the move to T+2, is not only the on-going cost associated with the fines and buy-ins but also the challenge to efficiently manage this operationally.

So how does this all work in practice, and who bears the cost of this next wave of CSDR? If we take just one aspect of the penalties, for any trade which is not settled on the intended settlement date (generally T+2 in Europe), there will be a fine. This won’t always be for the party who actually fails to deliver, but can also be for the last party to match the trade at the depository. This means that firms must place more importance on their middle office teams of matching trades in near real-time, within 15 minutes of execution through automated systems in order to minimise these fines.

Settlement rates, although in the 90% range, are not nearly at the level that the regulation dictates. The European Central Securities Depositories Association (ECSDA) estimated that based on current fail rates the fines will cost the industry E2.2 billion per annum (see box), and in this current climate this is an additional cost that the industry cannot afford. Although some fails are truly unavoidable, the majority of these issues can be mitigated through the implementation of robust trade date processes to confirm trades. We have seen this happen in the equity markets where many processes are automated and fail rates are extremely low, and these same changes need to take place in fixed income.

Firms should now be proactively thinking about how they can mitigate the risk that this regulation can bring whether financial or reputational. To be only reactive will put even more pressure on an already lean operations infrastructure and should be avoided. Using a real-time trade date matching platform such as Trax gives users a view of outstanding trades and can define what action is required in order to get all trades fully agreed on trade date. Operational processes need to change imminently in order to avoid serious P&L hits to the front office. Although it is true to say that the industry is managing a lot of regulatory change, the clock to 2018 is ticking, and the longer the industry keeps its manual and inefficient processes the bigger the challenge will be to overcome. n

Camille McKelvey is the Head of Match Strategy for Trax, joining in May 2014 to develop the firm’s post-trade matching product offering. Prior to this, McKelvey was Senior Vice President at Citigroup Global Markets from 2011 to 2014, where she oversaw outsourced operations and managed process re-engineering. McKelvey previously worked in cash and repo market operations at Morgan Stanley and Barclays Capital. McKelvey studied Russian & French at University College London.

CSD late settlement fees

According to November 2014 data, the accumulated gross late settlement penalties to be collected by the 17 CSDs would have amounted to over E183 million or around E9 million a day. Assuming that the month of November is representative, this translates into yearly gross late settlement penalties of close to E2.2 billion.

While the two ICSDs hold the largest share of late settlement fines to be collected (75%), the difference is less striking than for buy-ins. Excluding the two ICSDs, the remaining CSDs would on average still each account for more than E3 million per month. Among these CSDs, figures range between very close to 0 and E15 million per month, and only 5 CSDs would have collected less than E100,000 worth of penalties.

Source: Comments on the upcoming CSDR technical standards and technical advice on settlement discipline, ECSDA,19 February 2015.

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