The Evolution Of The Regulator’s Role

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April 29, 2016

With Victoria Pinnington, Senior Vice-President, Market Regulation & Policy, Investment Industry Regulatory Organization of Canada (IIROC)
Capital markets have undergone significant and unprecedented change in recent years. As a result, regulators and market participants alike have been grappling with challenges and opportunities associated with a proliferation of new products and players, segmentation and fragmentation of markets and the sheer speed of trading across all asset classes.
This pace of change in our markets has made it imperative that IIROC, as the national self-regulator responsible for the oversight of all investment dealers and their trading activity in Canadian debt and equity securities, continues to evolve in its role and keep pace to ensure surveillance of the markets remains current and effective.
Analysis and consultation
IIROC plays a unique and central role in the Canadian regulatory framework based on our mandate to conduct surveillance of all Canadian equity markets, including exchanges and Alternative Trading Systems, both lit or dark, and all Canadian debt trading. We continually invest in and leverage technology to effectively monitor this fast-paced and quickly changing environment.
An important way to keep current about the markets we regulate is to study the regulatory data we receive to understand markets’ changing dynamics, emerging trends, participants and their activity. Another important way is encouraging discussion with the industry which gives us the opportunity to step back and examine the wider question of how our markets are evolving and consider the views and needs of diverse stakeholders.
An example is IIROC’s approach to addressing issues related to the growth of High Frequency Trading (HFT). IIROC commissioned and published five academic papers on HFT and its effect on Canadian markets, examining:

High frequency market making to large institutional trades
Role of HFT in market integration/market fragmentation
HFT within the context of both the impact of change to short selling rules and dark trading rules introduced in 2012
Liquidity provision and market making by HFT

To gain industry insights on our comprehensive study, IIROC co-hosted a public forum at which the academics discussed their findings and engaged in a robust dialogue with interested stakeholders.
While the results showed that there were no concerns that warranted regulatory action at this time beyond measures already implemented by IIROC, (the implementation of the Electronic Trading Rules, requirements for third-party electronic access to marketplaces and guidance on manipulative and deceptive practices), it demonstrates the importance of IIROC taking a data-driven and consultative approach.
Recognising the value of the data to a broader constituency, we are working to implement a data sharing strategy, so that data gathered and maintained as a public good is shared, with appropriate controls, with regulators and other industry stakeholders.
The importance of regulatory partnership
Another element to managing the challenges is collaborating with our regulatory partners. The more effective our partnership and coordination, the better we can carry out our shared responsibilities to protect markets and protect investors.
An example of this is our recent work with the Bank of Canada and the Canadian Securities Administrators (CSA) to improve the timeliness and comprehensiveness of regulatory oversight of Canada’s debt markets.
Trading in debt now dwarfs trading in equity, but although greatly important to Canada’s economic growth and financial stability, the debt market has been relatively opaque to regulators and investors.
We and our partners at the Bank of Canada and the CSA recognised that robust regulatory supervision and oversight of the debt markets are critical to enhancing market integrity and investor confidence. Last November, we began collecting information on all the debt security trades done by the dealers we regulate. As a result, IIROC is better positioned to monitor and enforce compliance with investor protection and market integrity rules in a cost-effective way, consistent with the equity market surveillance we already conduct across Canada.
The CSA is also working with IIROC to enhance dark market oversight and provide greater transparency to this growing and significant asset class. Under the CSA proposal currently out for comment, IIROC will become the transparency agent or “information processor” for the Canadian corporate debt market. In this role, IIROC will publicly disseminate trade information providing transparency that will facilitate more informed decision-making by all market participants.
Conclusion
The knowledge gained through our investments in IIROC’s surveillance, oversight and analytical work is especially important at a time when the environment is increasingly challenging securities regulators, the investment industry and all market participants.
Going forward, we’ll continue to use and share valuable data, count on insights from our stakeholders and collaborate with our regulatory partners as we manage the challenges and explore the opportunities that come with an evolving market structure.
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Cross Border Regulation

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April 29, 2016

Edited excerpts from a speech by Ashley Alder, Chief Executive Officer, SFC
Cross-border regulation
IOSCO has been considering how it can address these issues at a global level. First, the basic problem is fairly straightforward. This is that the application of local rules to cross-border financial business which affects national interests can lead to conflicts where one internationally active firm is subject to different conflicting rules. This can ‘Balkanise’ markets and lead to a broader drag on cost-effective financing for growth. And of course the most discussed example is derivatives, where talks are still eating up a large amount of time in the EU, the US and elsewhere. Now the G20 in its 2013 Moscow and St Petersburg communiques introduced a new idea called “deference”. This was meant to solve cross-border conflicts in the derivatives world. This formula was repeated in April of this year in another G20 communique from Washington. The idea is basically a reference to substituted compliance or EU style recognition. But in reality the G20 formula begs a lot of tricky questions. It provides that jurisdictions can defer to another “when justified by the quality of respective regulations and enforcement regimes”, but only if these lead to “essentially identical outcomes” and so long as the rules are “non-discriminatory”. It also says that we all must also have “due respect to home country regulation”. This is asking a lot. And these questions are largely the same as those which IOSCO’s Task Force on Cross-Border Regulation wrestled with for over two years. Now the end result of our Task Force’s work is that we have a very detailed toolkit for regulators to refer to when looking at cross-border financial activity and the specific factors to take into account when using it. And we also decided to hardwire cross-border considerations such as timing mismatches into all of IOSCO’s standard-setting work.
But the Task Force also concluded that “IOSCO should engage more with the G20 and FSB to raise greater awareness of the key issues and challenges faced by IOSCO members on cross-border regulation, including the need for more refined thinking on the concept of deference”. Now what are these issues and challenges? First, we need to understand that national securities regulators are firmly bound by their domestic laws, national interests and national policy objectives when acting on a cross-border basis.
Second, the real authority of international standard setters such as IOSCO is inevitably weak because it isn’t based on binding treaty obligations, and as a result, global standards do not trump local law. In fact, global standards are rarely even referred to directly in securities legislation. And if they aren’t, it’s hard for national regulators to take them into account if local law already deals with an issue.
Third, peer pressure to apply international standards on a uniform basis can be effective, but this is far harder in securities markets compared to other regulatory regimes as there is far more diversity and complexity of firms, investors, products, infrastructure and exchange platforms.
Fourth, regulators sometimes act protectively if they think that recognition of a foreign regime could cause domestic business to move overseas. In other words, even if differences in rules don’t increase systemic risk or compromise investor protection, if they still imply a difference in the cost of doing business, regulators will react in their national interests.
Fifth, recognition or deference becomes harder when the countries involved are at different stages of development, as is the case in Asia. And finally, there is often a basic reluctance to outsource regulation when a failure could end up with blame heaped at the door of the domestic regulator.
So we are a long way from the ambition expressed by global firms that any proposed markets regulation that could have a significant cross-border effect must first be decided on as an international standard, before being transplanted uniformly into local law. However, there is light at the end of the tunnel. Our IOSCO report recognises that in reality, regulators have put in an enormous effort trying to overcome hurdles where it matters, normally through bilateral negotiations of different types of recognition or deference agreements supported by MOUs. We have seen how the CFTC and the Securities and Exchange Commission have both progressed their approach to recognition through substituted compliance – a big change when compared to the hard line taken a while ago. And it seems that international standards are referred to as a measure of equivalence in new EU legislation about benchmarks. And occasionally, discussions have been multilateral, a good example being an ad hoc group of regulators from major markets that meet to discuss derivatives – called the OTC Derivatives Regulators Group (ODRG). Our IOSCO Task Force therefore concluded that the general direction of travel is fairly clear. “The emphasis is towards more engagement via recognition to solve cross-border overlaps, gaps and inconsistencies through a combination of more granular international standards implemented at a jurisdictional level, and an increasing emphasis on determining when it may be appropriate to recognise foreign laws and regulations as a sufficient substitute or equivalent for domestic laws and regulations”.
To conclude, we are still dealing with the fact that participants in global markets are regulated by national regulators, and perfect harmonisation and total convergence of regulatory standards are unlikely. And a global rulebook is an unattainable ideal. But the outlook is far brighter than a few months ago, and I am hopeful that further progress will be made as we start to deal with Europe on the international reach of its benchmark legislation.
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Natural Innovation: A Theory Of Innovation For Larger Firms In Financial Markets

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April 25, 2016

Financial markets are awash with innovation – new fintech funding stories make the headlines every day. As a result, many of the established players have been forced to sit up, listen and worry about how they might suddenly get ‘uber-ised’ by some upstart coming straight out of left field. This had led many to create innovation labs, incubators, startup committees and other bureaucratic paraphernalia to try and beat the fintech challengers at their own game. But the odds in the fintech stakes seem to favour the little guys. After all, they come armed with nimble business models and are unencumbered by legacy technology, clients or process. But is that really the case?
In this paper Steve Grob looks at how larger firms can, and are, shifting the odds back in their own favour with a different approach; one that borrows ideas and thinking from the most creative, innovative process of all time.
The ultimate innovator
The most effective form of innovation can be seen all around us, every day. Charles Darwin taught us that any random mutation that favours a particular species’ survival is automatically selected and makes it through to the next round of evolution.
This extraordinarily simple, yet powerful, construct has led to an unimaginable variety of species that can solve almost any problem, often in the most simple and elegant manner.
Nature, then, when powered by natural selection, is the ultimate innovator.
Mother Nature cheats, though, because she gets to bet on every option and the currency which she uses to place those bets, time, is in unlimited supply. Nevertheless, some of the deeper principles and implications of natural selection are allowing the more forward thinking firms to turn the tables on their smaller competitors.
Before we look at this in more detail, let’s first explore the challenges involved in successful innovation and how, at first glance, the odds really do seem stacked in favour of the smaller players.
The rules for winning in innovation
Most innovation focuses on either emerging or growth categories. The difference between the two is that an emerging category is still seeking universal acceptance of its legitimacy (e.g. Blockchain), whilst a growth category, already acknowledged as a legitimate space, has nowhere near reached mass adoption (e.g. derivatives post-trade automation). Both are typified by the fact that there is no leader that dominates the supply in that particular category and so the race is on. The winner gets to exert pricing power in their chosen category, whilst the losers will become increasingly marginalised or even forced to move to less profitable terrains. This leads to a struggle of almost primeval technical and commercial savagery. It is played by two rules that are summed up well by Geoffrey A. Moore in Escape Velocity‘.

Must be present to win (you have to be in the race to win, regardless, which leads to the codicil rule of ‘go ugly early’); and
Best offer carries the day (which is fundamentally a deployment strategy that vows not to lose the deals, regardless)

These two rules, however, are hard to follow for many large firms which, by nature of their success, operate to almost opposite principles:

Brand reputation is vital (which leads to a “it will be done when it’s ready” approach); and
Maximise customer revenues (i.e. “we’ve earned the right to maximise our returns from our hard won and well cared for customers”)

Small firms have the advantage here as they are able to develop and deploy product faster (ofter this may be no more than just advanced prototypes) and then iterate and improve upon them on site. Also, customers tend to be more forgiving of their smaller, new suppliers than they are of their established partners from whom they expect every shipment to work first time, every time.
Smaller firms have greater flexibility commercially, too, as they operate from smaller cost bases and are prepared to fight – almost literally – as if their lives depended upon it. Conversely, selling into emerging or growth categories does not come easily to established firms. Their account managers are naturally more focussed on maximising each customer relationship over the long term. Smaller companies simply don’t care about this because if they cannot win in the here and now, nothing else matters.
Faced with these conundrums, the natural reaction of many large firms is to try and play better or harder at the rules. Unfortunately, this is completely the wrong thing to do.
The first knee-jerk reaction is to go and acquire small innovative firms and so capital markets are littered with stories of small, highly innovative firms that have been acquired by larger ones. But the results have generally been disappointing as the small firm’s great technology often gets swamped by the daily operating and commercial rules of the acquiring firm. Almost by magic the innovation, alternative thinking and dynamism gets sucked out of these firms overnight and all that is left is disgruntlement on both sides.
Innovation committees, incubators and labs are another approach, but these can suffer a similar fate too. As soon as an idea is conceived and brought into ‘real world’ operating conditions, it is all too easily strangled by the bureaucracy, rules, process and generally diminished risk appetite that is essential to keep the established business lines operating well. New ideas are simply not mature enough to fight for scarce resources against established business lines that, by definition, have learnt to play the corporate game effectively.
A third approach is to set up separate investment business to provide finance to new firms. Whilst this can work well, it indicates a corporate shift into venture capital which is a domain that operates with a very different risk/reward dynamic that may not fit well with the higher corporate goals of the organisation.
The solution for larger firms, then, lies in playing by entirely different rules. Rules that favour scale and that can amplify the natural advantages of the big guys.
Natural innovation
Pretty much all industries have to operate within a set of regulations that are aimed at ensuring the proper functioning of the underlying market. Nowhere is this truer than in finance which operates within one of most convoluted and changing regulatory environments. This is compounded by the fact that, despite being a globally intertwined business, it has multiple regulatory bodies opining on market structure and participants’ behaviour.
The governing principles of natural selection

Winning in a fintech emerging or growth category is a particularly daunting prospect, then, and it is this fact that enables large firms to leverage Darwinian principles of natural selection to their advantage. Key to this is adopting a principle of self-directed evolution which allows firms to increase their chances of being successfully innovative.

Technological Integration

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GlobalTrading

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April 23, 2016

With Rob Keller, CFA, Executive Managing Director, Product Management and Development, Eze Software Group
In the investment technology space, we have seen considerable interest in technology integration over the past several years. Investment firms are looking to reduce the number of vendors and correspondingly the number of applications on their desktops. They are looking to engage one or two trusted technology partners to help them solve their current and future technology-related needs. The ultimate aim would be for a firm to have just one partner as their sole support to help them with the needs of their growing technological complexity.
Many investment companies are stretching the limits of what standard protocols, such as FIX and Swift, can do for them. The use of standard protocols has helped to integrate the investment lifecycle and allow data to flow between systems, but it can only get you so far. If you want a more fluid workflow between products, standard protocol can have its limitations, specifically where one product workflow ends and another product begins. You are still forced to swivel back and forth between two applications with two distinct workflows.
To address these limitations, a number of technology firms are striving to provide solutions across the investment life cycle by creating a seamless workflow via one platform. One of the critical components is owning the source code itself. Some firms have achieved this and are able to provide a tightly integrated workflow to their clients. The ultimate goal is to provide this integration via a common platform and to have a common product team that can work together on delivery and strategy.
The drivers of integration
What exactly drives the integration of technology varies between investment firms. For firms with heavy compliance business requirements, it is often the compliance team driving workflows that can affect the trading desk. We are seeing this frequently, where compliance is being further integrated into the trading workflow in order to identify concerns much earlier in the investment life cycle. At other firms, it might be the head of a trading desk who is trying to lower the total cost of ownership and consolidate the number of systems providing advanced trading functionality across the various desktops. A further example might be the CTO of a firm, looking across their entire technology stack and trying to simplify and reduce the number of vendors that they have to manage.
One common theme across all investment firms is the desire to lower overall costs, both explicit and implicit. When a firm is paying for multiple providers the explicit costs increase. At the same time, inefficient workflows implicitly cost firms on incurred slippage or market impact.
From a regulatory standpoint, it is clear that firms really need a single trusted view of their orders and positions. They can no longer have disparate desks that do not integrate until end of day reporting. This is where the term “IBOR” has arisen from; firms have had disparate systems that are specific to a particular workflow but have no centralised place to actually look at their overall portfolio.
For additional regulatory purposes, it is necessary to have a real-time holistic view across the entire book of investments to run accurate real-time exposure, counterparty exposure, and ownership disclosure requirements that various jurisdictions require at this point. That holistic view is very important to us. If we look back to the implicit costs, the further upstream in the investment process firms can catch one of these violations the better.
Challenges
There are a number of factors that can pose challenges for investment firms when it comes to integrating technology platforms with other third-party systems. Firms have legacy platforms that they are trying to integrate using standard protocol. It’s difficult to create a truly unified workflow by stitching together disparate third-party systems that do not share the same source code.
Additionally, separate systems often have incongruent data structures. Trying to synchronise different data structures across systems in real time can be very difficult. Companies that own all the source code can sync data structures and provide a more cohesive system. Now that we own the source code across systems, we can actually deliver that sophisticated workflow. Furthermore, the additional complexity and desire for more flexible workflows is going to mean that it will continue to become more difficult for financial firms to stitch together third-party systems through APIs and standard protocols.
A challenge for technology firms is that some are reluctant to integrate with competitors. As firms integrate capabilities, they are surrendering some of the best parts of their technology. Without these distinct parts, they can lose their competitive differentiation.
For those technology firms that have integrated themselves and own all the necessary source code, they can deliver this streamlined workflow with some further along this development path than others.
Finding solutions
Advanced EMS and OMS integration is one area that our client base has expressed a need for. What we have done is given our users the ability to benefit from the advanced trading tools available in our EMS, while also taking advantage of important OMS features such as fully integrated compliance, position-checking, and automated allocations.
Historically, an order would be created in the OMS where it would automatically run through position-checking, robust allocation processing, and then compliance. It would then be staged into an advanced trading tool such as an EMS. At this point, the workflow in one system has ended and the order moves into an entirely separate system. If the order needs adjusting outside of that very standard workflow, you have to swivel from the EMS back to the OMS to make that adjustment.
With our EMS/OMS integration, our clients can now work exclusively inside the EMS but leverage all the robust position-checking and compliance tools available in the OMS. In essence, we are matching up the best of both worlds. If the compliance officer is driving the decisions, they will want to ensure that compliance is a seamless part of the new trading workflow.
Since we have the same shared source code and development cycles, we are able to provide our clients a fully integrated seamless solution.
The future
We will continue to see firms building platforms and acquiring products and services across the investment life cycle to ultimately develop a single, seamlessly integrated system. As we develop our platform, we will continue to innovate and add value to our existing solutions so we can continue to differentiate ourselves from our competitors. With increased regulatory pressures affecting all parts of the investment lifecycle, it is becoming harder for investment firms to stitch together the data required to meet these regulatory requirements. Having an integrated solution with centralized data will put investment firms in a better position.
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Measuring The Impact Of Mutual Funds On Bonds

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April 23, 2016

Shane Worner, Senior Economist, IOSCO examines the impact of asset management flows on bond market liquidity.
In the wake of the crisis of 2008, many economies implemented accommodative monetary policies to help alleviate some of the worst effects of the fallout. These accommodative monetary policies have increased the liquidity of primary market corporate bond issuances, driving down interest rates and ultimately lowering the cost of borrowing associated with corporate bonds.
However, with the US Federal Reserve signalling the normalisation of interest rates, there is continuing concern that the secondary market liquidity has failed to keep up with primary market liquidity and is prone to evaporation. Also in doubt is whether the changing structure of the secondary market will stand up in a stressed scenario. Given their importance to corporate bond markets, the driving factors behind these concerns deserve a closer look.
Secondary bond market measures
There are a number of traditional measures of secondary market liquidity including: trading volume; bond turnover ratio; dealer inventories of corporate bonds; the bid-ask spread and price impact; and data on trade size. However, many are telling an inconsistent story. Trading volumes in secondary markets have been increasing (see Figure 2), while the bond turnover ratio (BTR), on the face of it, shows secondary market liquidity declining (See Figure 3). However, the BTR is biased by a skewed denominator effect. The BTR captures secondary market turnover as a proportion of primary issuances. With record primary issuances, the data highlights that in fact it’s not a question of “less secondary market activity”, but rather of higher primary issuances that have outpaced trading.
Additionally, the decline since 2008 in dealer bank bond inventories has been citied as another indication that secondary market liquidity and the functioning of corporate bond markets have declined. Figures 4 and 5 highlight large declines in net positions since 2008. However, it is not clear from this data what proportion were corporate bond holdings. In an IOSCO research department report, Corporate Bonds: A Global Perspective, ¹ the authors also noted that the data on net positions pre-2013 include other types of corporate credit, such as asset and mortgage backed securities, whose issuance declined rapidly after the onset of the crisis and as new regulations were introduced. This trend mirrored a similar decline in dealer net positions.
Economic theory would dictate that any unusual developments in secondary market liquidity should flow through to the price of executing a transaction. The bid-ask spread is such a measure, but Figure 6 shows the bid-ask spread has in fact decreased since 2008.
The age of asset management
Against this backdrop, assets under management in the funds industry have grown since the crisis of 2008.
Although growth has broadly been across all fund assets classes, in an environment of low interest rates and yield search, many illiquid asset classes, such as emerging market debt and high yield bond funds, have seen increases in assets under management, while offering daily redemption facilities. Consequently, concerns relating to potential systemic risks associated with the activities of asset managers in less liquid asset classes have been at the fore of financial stability discussions in recent years.²
The concern primarily centres on how the activities of funds will interact with potentially less liquid bond markets. In an environment of rising interest rates, bonds fund performance would suffer, due to capital losses. In response, and perceiving some so-called “first mover advantage”, unit holders will try to redeem, en masse, potentially forcing funds to liquidate their holdings in illiquid markets, amplifying price falls and thereby creating a price decline spiral. This is just one of many other plausible scenarios. Data indicates, though, that bond mutual funds generally experience greater net inflows than outflows and, as the ICI has pointed out, redemptions tend to be quite sticky, especially for retail investors.

The Multi-Asset Revolution Part II: Risk, Centralisation and Consolidation

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April 17, 2016

By Vincent Burzynski, Executive Vice President, FIS’ Global Trading Business
As discussed in the previous issue of GlobalTrading, the question is not if but when multi-asset trading will catch on. Indeed, the move from old style to modern multi-asset trading is well underway on the sell-side. According to a recent research report from Aite Group, The shifting sands of global trading, 62 percent of sell-side desks indicate that they have already organised some trading desks on a multi-asset basis – that is, with multiple asset classes traded either on a single desk or multiple but aligned trading desks.
The risk-enabled multi-asset trading firm
Much has been written about the downsizing of traders and the hiring of compliance and risk management staff literally in their place on the trading desk. This trend is confirmed in Aite’s research. In this survey, sell-side firms also confirm the renewed attention being paid to risk management.
This is 100 percent reflected in these firms’ current risk profiles, with more and more preferring to be flat by end of day. Matched or riskless principal trading abounds. Keeping positions is on the wane, and even putting a trade on for a week is not as welcome as it once was. Given the proportion of sell-side trading that is purely customer-driven, sell-side firms’ emphasis on customer risk management is unsurprising.
Multi-prime or centralisation?
One of the major services the sell side plans on offering the buy-side is risk management and margining and collateralisation services. To that end, 79 percent of sell-side firms think that consolidating their customers’ trading into a single sell-side platform is necessary and a good idea for the buy-side.
Offering cross-asset offset across positions will help buy-side firms optimise margins and collateral and entice them to concentrate more order flow with brokers offering this type of service. But this runs counter to the multi-broker narrative. Some buy-side customers are particularly concerned about information leakage and enjoy being on the multiple platforms that multi-prime affords them. For them, consolidation onto a single sell-side platform is not the answer.
Another interesting finding in the report is that the overwhelming majority of sell-side firms surveyed – 88 percent – say they have or plan to have a centrally managed, real-time, pre- and post-trade risk management system through which they aggregate risks. Of course, a centralised risk system with aggregated risk across assets, markets and systems is critical for a complete view of risk, especially given that order books (i.e., client portfolios) are still siloed at 70 percent of respondent firms. In Aite’s interviews, however, it was less clear how many of these systems actually provide risk management across products and asset classes to the trading desk themselves, though there is sentiment in favour of more cohesive risk views there.
Reducing complexity and TCO: Is trading system consolidation the answer to all pains?
Sell-side firms’ IT infrastructures are often made up of a mass of disparate legacy systems connected by home-grown integrations. That certainly seems to be the reality for many trading firms. Indeed, the firms surveyed confirm that they have a large number of trading and risk systems. Only the smaller or most focused firms have just one or two systems in place. In follow-up interviews, few think that is sustainable.
Will that be followed up by action? Seventy-nine percent of firms indicate interest in consolidating their jumble of systems, with the plurality having the strongest interest. Perhaps we will see progress on this front, for this may be as much a practical consideration as an economic reality for sell-side firms.
In fact, Aite found that technology and execution quality have risen to the top of competitive differentiators to win and keep buy-side business. And in multiple conversations with the sell side, trading system consolidation is viewed as a major necessity by most and as an opportunity by a select few.
There are certainly significant system renovation and greenfield projects underway in the OTC derivatives world, including inside sell-side firms. That seems to be consuming the most internal technology bandwidth, at least as of 2015.
But sell-side firms do have project renovation in incumbent listed systems underway as well, and a few are taking on the heavy lifting of bringing listed and OTC together more widely in their firms. These efforts are, for now, focused far more on risk management than trading, however. Will that change in 2016?
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China’s New FX Regime An Opportunity For RMB Currency Futures Users

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April 17, 2016

By Julien Martin, Head of FIC Product Development, Hong Kong Exchanges and Clearing Limited (HKEX)
On 30 November 2015, the International Monetary Fund’s (IMF) Executive Board decided to include the Renminbi (RMB) in its Special Drawing Rights (SDR) basket, giving the RMB a 10.92% weighting. The SDR inclusion is essentially an endorsement by the IMF of the RMB internationalisation process. It puts the RMB on par with the likes of the US dollar (USD), Euro (EUR), Japanese Yen (JPY) and British Pound (GBP). The short-term impact is likely to be limited, with a 10-month delay until the new SDR weighting becomes effective on 1 October 2016. Over the longer term, however, the acceptance of the RMB as a reserve currency will trigger asset re-allocation and facilitate foreign capital inflows into China’s capital market. The market estimates that at least US$1 trillion of global reserves will switch into RMB assets following its SDR inclusion¹. Moreover, the SDR inclusion will probably push the Chinese government towards further financial reforms, including gradual removal of quota controls on cross-border investment and increasing depth and openness in China’s capital markets.

RMB internationalisation accelerated in 2015
On 11 August 2015, the People’s Bank of China (PBOC) adopted a new daily fixing framework based on the previous day’s closing rate in conjunction with supply/demand factors and movements in other currencies. On 11 December 2015, the PBOC introduced a CNY (onshore RMB) trade-weighted index, CFETS CNY TWI, published by CFETS² which covers 13 currencies³. The PBOC highlighted the index as an important and more appropriate reference for the market, as it was overly fixated on the bilateral USD/CNY rate. The move was consistent with the PBOC’s stated policy goal of maintaining the RMB exchange rate “basically stable at an adaptive and equilibrium level”. From a macro perspective, with USD on a tightening cycle, the PBOC’s action should help de-link the RMB from a strong USD.
On 4 January 2016, the PBOC extended the onshore RMB, or CNY, market’s trading hours to 11:30 pm in order to allow onshore RMB traded during London business hours under an SDR price fix, and prepare for more international hedging flows.
Liquidity in the offshore RMB (CNH) market continues to develop along with the rapidly growing RMB crossborder trades and offshore deposits. Turnover has nearly quadrupled over the last four years, and the market expects 15-20% YoY growth in the near future, according to a key industry group. Daily spot trading volumes in USD/CNH now stands at over US$25 billion, according the City of London, and a major international bank estimates daily forward and swap trading volumes stand at around US$20 billion. Both are at a comparable size if not bigger than onshore volumes. Over the longer term, demand for CNH will be supported primarily by rising levels of trade (imports and exports) in RMB, cross-border fund flows and CNH asset creation.
RMB’s two-way volatility the new normal With the RMB’s recent two-way movement, the market is beginning to accept RMB volatility as the new normal.
On 4 January 2016, the PBOC surprised the market by setting the daily reference rate for RMB below 6.5 against the USD, the lowest in more than four years. Furthermore, the 332 pips weakening in the CNY fixing on 7 January 2016 was a record single-day decline since the new fixing framework in August 2015, and it represented a five standard-deviation fall in price over the course of the past five years.

Trading Small Caps: Communication Is Key

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April 17, 2016

With Daphne Chang, Dealer, Acorn Capital
While liquidity is important for all traders, it is crucial for small cap traders. Portfolio managers regularly demand positions of at least 5% of a company’s holdings, so finding and executing block trades is always the priority.
Clear communications and close coordination with our PMs is critical to understanding stock valuations and how target weights for the fund are to be established. To have efficient communication, we have regular research meetings with our portfolio managers and analysts to discuss about our portfolio. Apart from the research meetings, we have developed our internal research system for the portfolio managers to upload their research reports or notes at anywhere and anytime. Once their reports or notes are uploaded in the system, the trading desk will receive the notification emails and can quickly pick up the revaluation from the PMs in order to take proper action in the market.
In this space, the trading desk’s activities cannot simply be limited to mechanically executing trades. We need to be up to speed in all aspects of the market, whether monitoring the actions and movements of brokers, IOI, turnover changes, and changes in substantial holders.
Armed with this knowledge, our desk has far better opportunities to secure blocks at preferred prices at the right time.
Managing relationships
Developing sound relationships with local brokers is important, particularly those who specialise in small caps. Well maintained broker relationships keep the trading desk abreast of underlying trading activity, potential placements and other corporate opportunities. We give high rankings for the brokers who can provide good small cap flow, deep knowledge about the small cap market, and good effort on delivering the block trades.
In situations where there is high liquidity, our adoption of algo trading strategies has helped us optimize our execution of trades enabling a lower profile in executing larger positions which might create undesired uncertainty in the market. Empowering dealers to act independently is important in the small cap space because market conditions often require nimble and effective responses. Naturally, PM’s will make the buy-sell decision but how the order is executed must be the province of the trading desk. This is where traders must be au fait with how PM’s have arrived at their valuations and the underlying investment case with catalyst expectations. These provide the desk with guidance for an acceptable price when seeking liquidity. In addition, our dealers can see each other’s trades at our own trading screen and are all aware of the valuation/target weights of each single trade. By sharing all the information together and working as a team, the trading desk can maximise the performance.
By the same token, the communication must go both ways with the PM. For example, unusual price movements and flows must be fed back to the PMs regardless of their buy-sell decision or the progress of the execution.
Technology
Technology can often have a limited application in small cap dealing. Transaction cost analysis can be of limited use in providing information to analyse trades. The methodology for valuing a trader’s performance is generally not a matter of whether the trader can secure a block above the VWAP price or below the VWAP with 60 days to complete the target position, for example. Performance is generally a function of how efficiently the trader can execute the PM’s decision and achieve the desired portfolio position.
Adopting our algo strategy has allowed us to better exploit liquid conditions, but traditional knowledge and relationships are still far and away the most important resources for traders in small caps.
What sets us apart, I believe, is the strength of our Portfolio Managers in research and analysis. The fact is, market research for small cap stocks is often very limited and the brokers covering these companies can be very thin on the ground. There are often no research reports from external sources available, which means the quality of our own research needs to be world class.
So, the performance of a trader is directly related to the performance of the PMs and the quality of their communications. In this way, our trading desk’s knowledge has been bolstered by regular research meetings where we discuss all manner of topics ranging from broker movements to market flows.
Traders who have relied mainly on technology for executing their trades may find adjusting to the small cap space challenging initially if lacking the fundamental experience and knowledge derived from such close relationships.
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Sellside profile : Michael Horan & Scott Coey : Pershing

By

Ian Rycott

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April 10, 2016

OVERCOMING REGULATORY HURDLES.

Michael Horan, Head of Trading and Scott Coey, Managing Director & Head of Broker Dealer Services EMEA at Pershing, a BNY Mellon company explain the ongoing impact of legislation and the operating models needed to respond.

There has been a trend to integrate the different dealing desks, why has Pershing decided not to?

Michael Horan: We are a multi-asset class dealing desk – equities, fixed income and FX – but we have dedicated teams trading all three. The reason is that integrating the desks can lead to ‘juniorisation’ meaning you have traders who can work across a range of asset classes but are masters of none. We like to have experts in their field and for us the most important thing is to offer a multi-trading offering. The other issue is that at the moment there are no order management systems (OMS) that can trade all three together. For example, we use Bloomberg for fixed income, Realtick for equities and Dean for FX.

What regulations have had the most impact on the industry and Pershing?

Michael Horan: The Market Abuse Regulation (MAR), which is coming up imminently, is having an impact on our trading services business because it is turning a directive into regulation which means everyone has to implement it. There are a lot of firms running around making sure they are ready. We have already implemented Liquidmetrix surveillance systems that spot nefarious activities such as layering, spoofing, reference price manipulation etc.

MiFID II is another key regulation that will impact both our trading and post-trade services. The industry may have breathed a sigh of relief because of the delay until 2018 but firms should start preparing now even if there is more time. From a trading perspective, there is a small difference in MiFID II in the wording of best execution. It has changed from firms being obliged to take ‘all reasonable steps’ to achieve the best possible results for their clients under MiFID I to being required to take ‘all sufficient steps.’ This will catch out firms who do not do enough to prove and monitor best execution, but again we are well prepared.

What impact do you think unbundling will have on research?

Michael Horan: There is a view that it will have a negative impact but I think broker dealers that are nimble enough will be able to adjust and it will give them an opportunity to diversify their offering. For example, they could specialise in certain areas such as Asia or mining. However, they will have to restructure the way research is paid for. The common response is that they already have commission sharing arrangements in place, but the whole point of MiFID II is to change the reliance on execution. They have to not only separate the payment but also offer a better price for the research.

We might also see wealth management funds set up their own research function instead of relying on the broker dealer because their end client will not want to pay for it.

Scott Coey: I think one of the unintended consequences of research unbundling is that broker firms that cover stocks below the FTSE 250 may choose to no longer cover them, because the revenue they receive for providing research is a prime driver for covering these stocks.

What impact do you think MiFID II and other regulations have had on fixed income markets?

Michael Horan: One of the challenges is market conditions in that issuance is rising, because of the interest rate environment and monetary policy by the different central banks, while liquidity is going down. This is because investment banks are no longer as active in the market due to capital controls under Basel III. Although the push to on-platform trading is designed to attract more players and facilitate the search for liquidity, the buyside’s buy and hold strategy will have an impact on liquidity, despite the greater activity in issuance.

What about the caps on dark pools?

Michael Horan: I think it will be a greater challenge for the stock exchanges, MTFs and investment banks that have dark pools. I think the lit markets will absorb these trades. However, LSE wrote a paper that stated 99 out of the FTSE 100 stocks would be banned from dark trading because they are using the reference price waiver or negotiated price which are subject to the caps.

How are broker dealers changing their business models and what are the challenges?

Scott Coey: The cost of compliance is one of the greatest challenges. A study by Oliver Wyman – The State of the Financial Services Industry, published last year – shows that this cost will increase by 50% per employee. The result is that banks are looking more closely at their operations to see where they can differentiate themselves and add value. Outside of research and origination, there is really nothing else that gives them a unique selling point. Trading, clearing and settlement and asset servicing have become too commoditised and they want to move away from these huge fixed costs.

Is this a trend with larger banks as well as small to medium sized institutions?

Scott Coey: It has been an evolution but over the past couple years we have seen the larger broker dealers look at outsourcing because of the stricter capital requirements under Basel III. They are not meeting their hurdle rates in terms of return on investment and they realise they are spread too thin across their offerings. They are taking the decision to go back to their core offerings and also to have areas of specialisation.

Michael Horan: The other driver is that different divisions now have to stand alone, on their own two feet, and cannot be subsidised. This is also driving banks to outsource different parts of their business.

What type of solutions are Pershing providing clients to cope with all these changes?

Scott Coey: Our aim is to help our clients make better decisions and we see ourselves more as a partner working together rather than a supplier. We offer front, middle and back office solutions across the full trading lifecycle including execution, clearing and settlement, pre- and post-trade analysis, reporting and custody. It provides our clients with economies of scale as well as flexibility to adapt to market changes.

Biographies:

Scott Coey is Managing Director and EMEA Head of Broker-Dealer Services at Pershing. Previously, he was a principle consultant at Detica, managing investment and private banking projects in London, Geneva and New York, as well as serving as a spokesperson on industry developments such as MiFID and exchange consolidation. Coey also worked at The London Stock Exchange, where he held a number of senior strategic business development and project management roles, and ran the European Institutional Relationship Management team.

Michael Horan is Director and Head of Trading Services of Pershing Limited, with overall management responsibility for the firm’s global equity and foreign exchange trading desks. Prior to joining the firm, he was Head of the Foreign Exchange desk at FLG Group, providing execution-only FX services for both private and corporate clients. He also spent five years with Instinet and before that was a trader at Tullet & Tokyo and ABN AMRO Hoare Govett.

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Technology : The rise of the utilities : Louise Rowland

By

Ian Rycott

-

April 10, 2016

LET’S GET TOGETHER: UTILITIES COME OF AGE.

Louise Rowland explains why mutualised solutions are becoming part of the landscape.

Incredible, but true. Unlike the rancour defining the EU debate, the finance industry is currently enjoying an unprecedented outbreak of consensus. Firms on all sides are entering into mutualised solutions with their competitors. What’s driving this appetite for unanimity? And where will it all lead?

You don’t have to delve very far to explain the utilities’ moment in the sun. Post 2009, the industry is facing not only squeezed margins and reduced revenues, but also phenomenal cost pressures on all sides. A recent survey commissioned by DTCC found that in post-trade processing alone, the industry spends as much as $100 bn annually, yet only 5% is managed by industry-owned market utilities. Billions of dollars are being wasted on redundant and duplicative processes that, in most cases, provide no competitive or economic advantage. The same is true for the reference data industry, which some estimate could be saving $3-4 billion annually through shared solutions.

However, costly, wasteful processes are just the half of it. The industry is also dealing with an onslaught of new regulations concerning transparency and reporting requirements, with the arrival of MiFID II, European Market Infrastructure Regulation (EMIR), Basel III and Dodd-Frank. The development costs involved are completely beyond the reach of many firms.

“The cost model of the financial services industry has become unsustainable, largely because of the cost of compliance with regulatory fiats,” agrees Terry Roche, TABB. “Firms are spending billions in investment in data transparency and unification, compliance and risk management along with reporting and fines.”

Industry efforts to rationalise haven’t made enough of a difference. “People have already downsized and outsourced and automated as much as they can,” he adds. “The only choice now to achieve further costs reduction is restructuring. There is opportunity for significant take-up of utilities. It has become difficult to make the argument internally against utility of commoditised tasks, if the only argument is protection of internal processes and systems.”

Lightening the load

Few market participants would disagree. The opportunity to share costs, radically boost efficiency in the back and middle office and focus on core activities is too good to pass by. Hence the marked rise in the number of utilities coming on stream, not only in the collateral space – for settlement, margin hub, uncleared derivatives, portfolio reconciliation, tri-party repos and end-to-end solutions for the OTC derivative trade lifecycle – but also for reference data management KYC.

Collaborations aren’t completely new, of course. But the level of activity taking place reflects a profound shift of mindset within the industry.

There are two principal types of utility: at-cost or not-for-profit solutions and for-profit set-ups. The former is owned and managed by its participants, the latter run as a commercial exercise.

An at-cost, or ‘pure’, utility has the industry’s best interests at heart, says, Stefan Naumann, Director of Sapient Global Markets, which helped build the European Datawarehouse, set up to collect, store and distribute standardised ABS loan level data, in order to boost market transparency.

“It makes a difference whether a utility is set up as an at-cost operation or a for-profit platform. It’s part of the DNA of a pure utility to work as a public service, to be more competitive and so gain acceptance within the market. The visibility of the fee structure is very important to participants, as is service reliability.”

For-profit utilities would no doubt counter that they enjoy greater flexibility and freedom of movement when it comes to value added-services.

Striking the balance

In either case, success is not a foregone conclusion. There have been several casualties along the way, often due to a faulty business model not achieving a critical mass of members – or to a lack of the necessary expertise in governance.

The latter is crucial, stresses Marc-Robert Nicoud, CEO of Clearstream International, which founded the Liquidity Alliance, a partnership of market infrastructures to provide common and sustainable collateral management solutions.

“People underestimate the challenge of day-to-day governance and its significant costs. All participants need to feel involved, they want their voice to matter. The utilities management has to drive things forward, but also needs the expertise necessary to navigate a community and to keep everyone on board, as well as the capability to make major investment decisions. The regulators aren’t letting anyone off the hook, even if they’ve outsourced their processes.”

Others also cite efficiency, scaleability, flexibility in terms of on-boarding costs and ease of implementation as crucial ingredients.

Take your partners

Listening to the views of the industry when building the utility is key, says Ted Leveroni, Chief Commercial Officer, DTCC-Euroclear GlobalCollateral Ltd, a new collateral processing infrastructure.

“Over the last 18 months, we’ve been engaging leading firms to get their input as to how our platform could be developed further. There has been an overwhelming sense of agreement around the table, with the majority agreeing that such a collateral settlement messaging solution would make sense. That input has led to the emergence of new developments on our roadmap and the evolution of the product.”

It’s a similar story at SmartStream Reference Data Utility (RDU), another new arrival looking to make a big splash in the market. A joint venture set up by J.P. Morgan, Goldman Sachs, Morgan Stanley and SmartStream, the mission is to drive through cost-savings and greater efficiency over the whole life-cycle of a trade.

Joseph Turso, VP Product Management, SmartStream RDU says the utility has been well received so far. “We’ve done extensive R&D over the past five years and run stringent testing. The backing of banks of this stature encourages others to come on board. Once you have six or seven major participants, that’s the tipping point and it spreads out to their counterparties. It’s an exponential uptake, rather than a domino effect. People need an assurance that you will provide what it says on the tin, but if a bank has the cleanest data, others will want to use it.”

Here to stay

Is the utilities landscape becoming too crowded? No, say most observers: some even argue the take-up has so far been very low.

“Let a hundred flowers bloom,” says Diana Chan, CEO of EuroCCP. “Competing utilities providing different services and user benefits are a good thing for the market, because competition creates dynamic efficiency. There’s bound to be consolidation eventually – that’s the lifecycle of business. Streamlining will come when the capacity of the competing utilities far exceeds demand. Provided there is a level playing field, consolidation should lead to a few robust competitors with economies of scale that continue to innovate.”

If community-based solutions are here to stay, many not-for profit infrastructures are likely to broaden their offerings from their basic commodities services to become even more competitive. Some participants expect the landscape to eventually coalesce around two or three big players, complemented by a number of niche for-profit specialists. The risk of a monopolistic situation developing, where one or two utilities dictate the fee structure, is unlikely, however.

Free-flowing future

Technology is at the heart of things, says Sassan Danesh, Managing Partner at Etrading Software, which runs Neptune, a new not-for-profit open standards network utility for pre-trade indications in bond markets.

“Standardisation will deliver significant benefits, with open source technology creating a far nimbler, more flexible and agile environment. Connectivity is increasingly seen as a basic service amenable to the utility model. I am optimistic that in five years, we’ll have an integrated marketplace with data flowing freely, enabling end-users to capture the value of that.”

That’s a win-win situation, says Matthew Stauffer, CEO of Clarient, a utility run by DTCC and several leading financial institutions, to simplify client data and document management.

“Ultimately, we believe that having one comprehensive source of client reference data and documentation, including KYC data, will be the best approach for the industry. I am very optimistic about the value utilities bring to financial markets. They allow firms to take advantage of increased efficiency and enhanced control over data collection and validation processes while focusing on the core functions of their businesses that add value. By using solutions, like Clarient, which are user-owned and governed, any future enhancements that are made are prioritised based on client needs and not on commercial interests, which further translates into benefits for users.”

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OVERCOMING REGULATORY HURDLES.

Michael Horan, Head of Trading and Scott Coey, Managing Director & Head of Broker Dealer Services EMEA at Pershing, a BNY Mellon company explain the ongoing impact of legislation and the operating models needed to respond.

LET’S GET TOGETHER: UTILITIES COME OF AGE.

Louise Rowland explains why mutualised solutions are becoming part of the landscape.

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