Buyside profile : Laurent Albert : Natixis

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April 10, 2016

A WINDOW OF OPPORTUNITY.

Laurent Albert, global head of trading at Natixis Asset Management Finance, explains how regulation is opening new avenues of business.

Can you please explain what NAM Finance is and when it was created?

We were created in 2009 to service the internal clients of Groupe BPCE, which is the second largest banking group in France and parent of Natixis, the corporate, investment and financial services group. We cover all asset classes such as equities, fixed income and derivatives but also developed a securities lending business.

What impact do you think MiFID II will have on the industry?

We see MiFID II as having a huge ‘big bang’ effect particularly in fixed income. Historically, many of the portfolio managers in this asset class focused on road shows, external meetings and trading but did not have to prove best execution. This will now change, and like equities, there will be much more focus on execution capabilities. This will not be that easy because it is happening at a time when liquidity in fixed income assets such as investment grade or corporate bonds is difficult to access. Banks are not as active participants because of the tighter leverage capital ratios under Basel III.

I also think, as in equities, there will be greater emphasis on transparency, transaction cost analysis (TCA) as well as the cost of different services in fixed income. This will lead to an unbundling of advisory services from execution. Banks will begin to rationalise their services due to cost pressures because it will become more difficult to deliver the same advice at the same level. However, we see MiFID, as well as other regulations, as a great opportunity for us to expand our business outside of BPCE.

Can you please explain why?

At the moment, we service the internal clients of BPCE but in the fourth quarter of last year we had conversations with a number of small to medium sized asset managers. Fixed income requires totally different infrastructure, IT and processes and it will be expensive for these clients to build their own systems for accessing liquidity, producing reports and building tools for transaction cost analysis. The analysis for TCA has to be more granular because there are no benchmarks in fixed income. We have built the models and can offer a wide range of services such as access to global markets, advisory and execution as well as TCA and reporting to meet the new regulations.

Focusing on electronic trading, can you tell me the driver behind TradeCross, which was launched last year by TradingScreen and a group of 15 European, long-only asset managers including Natixis?

TradeCross offers another way for the buyside to access liquidity. There have been a number of initiatives in this space just as we have seen in equities. One of the differences is that TradeCross helps address the problems many larger asset managers have with size and market impact. Firms can anonymously trade blocks but still keep their sellside relationships and STP (straight through processing) solutions which are very important. The platform has the capacity to link with internal order management systems and provides much wider global coverage than some other venues. It includes a huge part of the credit universe ranging from investment grade, emerging markets, high yield, government and supranational bonds. We believe TradeCross will be successful if it can capture around 10% to 15% of these global markets.

How do you see these electronic trading platforms developing?

I think they will develop along the same lines as electronic trading in equities. It took time, but in 2010 we saw brokers using direct market access and algos. Today, they account for around 80% of equity transactions. I don’t think we will see the end though of the classic request for quote system, but I do think dealing desks will choose two to three solutions. One of the biggest challenges is to ensure that you get the right price because there is no benchmark. Also, although I think these developments will make markets more efficient and improve liquidity, to date there is no actual proof that this is the case. I am sure that will change in the future.

What impact do you think Brexit will have on trading in London?

I personally think it will have a negative impact in the markets because liquidity is already difficult due to the Basel III capital ratios. Overall they are 3% but in the UK they are higher at 4%. If the public decided to leave the European Union, then the government could decide to apply this higher rate to non-domestic financial institutions. If that is the case, then I think we will see firms leave London and the market that will be most impacted will be repo, which is one of the main drivers of liquidity.

Looking ahead what do you see as your biggest challenges?

To be honest, I think all the challenges are down to regulation. For us it is to optimise the new environment and offer clients an integrated offering to help them meet the new requirements.

Biography:

Laurent Albert started his career in 1997 with CIAL (Strasbourg) in a treasury role covering cash, swaps and repo products. He moved two years later to ETC/Pollak to work as a broker for the government bond market. In 2001 he joined IXIS Asset Management, which merged with Natixis Asset Management in 2007. He joined as a broker and then became responsible for all fixed income at NAM. In 2009, Albert became global head of trading at Natixis Asset Management Finance, which includes equity, fixed income and securities lending.

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Equities trading focus : Alternative indexation : Lynn Strongin-Dodds

By

Ian Rycott

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April 10, 2016

WHAT’S IN A NAME?

The concept of alternative indexation is not new but the number of monikers sprouting under the label can present a confusing picture. Lynn Strongin Dodds looks at why the concept has become so popular.

Mention the words smart beta, which Tower Watson coined in the early 2000s, and the reactions widely range. While many providers bristle at the term, preferring alternative indexation or style and factor investing, others embrace the label which for better or worse has become the marketing moniker. Regardless of the terminology, all agree that these non-market cap strategies are becoming an integral part of the investment fabric.

“There is a lot of confusion with the names and this can create misunderstandings,” says Guillaume Dupin, head of absolute return strategies at La Française Global Investment Solutions. “The most important thing to remember about smart beta is that it does remain beta; and thus, the predominant factor that investors are exposed to remains the primary factor (the equity market factor). Smart beta is however a good alternative to common indexes, all weighted by market capitalisation, selecting stocks using different criteria like for example ‘value’ or ‘low volatility’.”

The idea is not new and can be traced back to over thirty years ago when renowned credit economist Bill Sharpe, along with other notable industry participants, demonstrated that the benefits of active management could be replicated using a simple rules-based approach. The methodology was further enhanced by using the Arbitrage Pricing Theorem (APT), which broadens beta from a single market measure to include a selection of factors, the classic ones being style (growth and value), capitalisation (large, mid, small), and momentum (persistence among ‘winners’).

Fast forward to today and the list of factors has expanded, although the three most common frameworks include low volatility strategies, which promise to reduce total risk (as measured by standard deviation) of the index by carefully selecting less risky stocks as well as fundamental, which focuses on measures including sales revenue, cash-flow, dividends, and stock buy-backs. Equal weighting, the simplest form of index construction, also has a strong following in that it is a simpler method that averages an entire universe.

The credit crunch catalyst

It is not surprising that these strategies took off in the wake of the financial crisis but the cracks in market cap investing were evident in the frothy Japanese markets of the 1980s as well as the technology sector at the turn of the century. These benchmarks were tilted towards large cap stocks, plus they had concentration risk which meant that when those bubbles burst, investors took significant hits.

“The discussions about alternative weighted indexes are not new but they have come to the fore over the past few years,” says Ian Webster, chief of staff at Axioma, a risk-management and portfolio-construction solutions provider. “The attention was not just on the poor performance of traditional benchmarks but also on the skills of active managers who charge high fees. Asset owners realised that they were not getting value for their money because many of the strategies they were buying were in effect closet index trackers that were producing passive returns.”

Smart beta, on the other hand, aims to offer the best of both worlds – diversification, enhanced yield, uncorrelated stocks and downside protection. As interest rates have languished, assets under management have soared from $103bn in 2008 to $616bn in 2015, according to figures from data provider Morningstar. A separate study from FTSE Russell last year, which canvassed 214 asset owners across the globe, also showed that there were geographical differences. Europeans are leading the charge with 79% of asset owners having evaluated smart beta compared to 61% of their North American counterparts.

In addition, 68% of the European respondents with over $10bn in AUM already have a smart beta allocation, way ahead of the seemingly paltry 27% of their similarly sized North American peers. However, North American firms are looking to narrow the gap with a further 30% of asset owners noting that they are either currently evaluating smart beta or intend to do so in the next eighteen months. As for allocation, overall, 55% had allotted a tenth or more of their equity portfolio to these strategies, up from 38% a year earlier.

No breathing room

As seen with other trending investment themes, popularity can bring its own set of problems and smart beta is no exception. Some strategies are becoming dangerously overcrowded which could lead to disappointing returns. Moreover, others are becoming overcomplicated and lines are being blurred with traditional active management. These dangers have recently been highlighted by Rob Arnott, a pioneer in the field and chairman and chief executive of Research Affiliates, the US company that launched some of the world’s first smart beta indices in 2005.

In a recent paper, Arnott argues that smart beta’s growing fame could also be its downfall. “One of the biggest problems with today’s products is that many are performance chasers and make the mistake of forecasting the future by extrapolating the past,” he says. “Investors need to be careful because these excess returns may not be sustainable in the future. Indeed our evidence suggests that mean reversion could wreak havoc in the world of smart beta.”

This may explain why the multi-factor theme has taken hold. “We found a trend in our study which showed that among asset owners with an existing smart beta allocation, over 70% are using two or more strategies,” says Gareth Parker, senior director for index research at FTSE Russell, which has $140bn of assets under management linked to its smart beta products.

“There is a growing recognition that by combining two factors you can enhance returns and reduce risk. Which factors are combined will depend on the investor’s objectives. If for example, diversification is one of your main objectives, then you will probably not choose to mix growth and momentum, because they are highly correlated. Yield and low volatility would work better,” he adds.

Two years ago, FTSE Russell launched its Global Diversified Factor Index Series, developed in partnership with J.P. Morgan Asset Management to serve as underlyings for its own US ETF product suite, while last year MSCI rolled out its own version – the Diversified Multi-Factor (DMF) index family that combines four well-established equity factors – value, momentum, size, and quality – with a weighting strategy designed to keep volatility in line with the underlying benchmarks.

French firm Edhec Risk Institute, which has around $8bn tracking its strategies, blends four stock selection factors (volatility, valuation, size and momentum) with five smart beta diversification strategies. These comprise an equal as well as an efficient volatility weighting plus a diversified multi-strategy approach that allocates stock weighting based on the average of these five separate methodologies.

“Investors who rely on single factor exposure take the risk of the likelihood of the underlying factor underperforming over short periods,” says Felix Goltz, director of research at ERI Scientific Beta. “Multi-factor investing improves diversification, avoids concentration to one given factor and generates better risk adjusted returns.”

Bryon Lake, head of Invesco PowerShares EMEA, whose parent company is the fourth largest ETF provider globally with $98bn of AUM as of December 2015, and the first to market with smart beta ETFs, believes the key is to identify factors that work well together. “It is important not to overcomplicate the conversation because one of the problems seen with quantitative managers is that they can over-engineer a product. The other challenge is smart beta is growing very rapidly and in some cases faster than clients can on-board. We believe our job is to cut out the noise and provide tools that will help them build better portfolios.”

Although diversification is important, David Schofield, president of INTECH’s London-based international division, believes that the particular factor that is followed is more a source of risk, and less important for return generation than the regularly rebalancing of the portfolio. In essence this means a sophisticated ‘buy low, sell high’ methodology with the potential to capture the volatility in stocks in the form of an excess return over the benchmark but with less risk. The process also has specific risk controls that help minimise tracking error.

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Regulation & compliance : MiFID II : Dan Barnes

By

Ian Rycott

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April 10, 2016

MIFID II: TIME TO ADJUST.

The delay to MiFID II’s implementation will make the delivery of operational changes more viable, but uncertainty will prevent firms taking action. Dan Barnes reports.

Many bankers and traders express concern about the revision of MiFID II. Some of those concerns are allayed by the delay to its implementation, pushing it back to January 2018. That creates more time to adapt to the changes as planned but firms may still find it difficult to meet the new deadline.

Pan-European regulatory body the European Securities and Markets Authority (ESMA) reported to the European Commission (EC), the European Union’s executive body in February 2016 that “neither competent authorities, nor market participants, would have the necessary systems ready by 3 January 2017.”

Andrew Bowley, head of Regulatory Response & Market Structure Strategy at sellside firm Nomura, says, “It is complex, so regulators do need time to get their heads round it, and the delay helps them as much as it helps us.”

The extension was not a surprise, having been forewarned by ESMA’s chief executive in November 2016. It took four months to become official. It was welcome, but the excruciatingly slow process of official confirmation was symptomatic of the bureaucratic mechanism.

The global head of fixed income trading for one of the world’s largest asset managers says, “The rules have been delayed at the EU level; we may not have clarity on those until April at the earliest. This will include details on topics such as pre-trade transparency and reporting requirements.”

The checklist

Anthony Kirby, director for Regulatory Reform and Risk Management at consultancy EY has set up a regulatory confidence score card to help clients identify the areas of MiFID II that they could proceed with on a relatively ‘no regrets’ basis.

“We look at MiFID II in terms of five areas of governance, of investment protection, of markets, of reporting and then finally third country,” he says. “In terms of areas like governance, certain governance, review of compliance, remuneration complaints, compliance controls – with the exception of remuneration which is affected by other issues – are relatively well defined. So we are expecting firms to be reasonably up to speed in those areas.”

However he says in areas like investment protection there are some important issues around target market assessment, treatment of inducement and treatment of research as well as best execution for non-equities.

The buyside head of trading says, “A large number of the rules that may be most impactful on our business – the investor protection requirements – will also be subject to national rule-making. It appears that national ‘transposition’ may be significantly delayed. Even with the delay, the timing will be challenging given the scale of changes.”

For example, buyside firms will have to provide clients with the costs and charges they pay in a simple manner, with a clear aggregate figure. In a 2015 piece of research, Oliver Wyman found that “more than 70% [of asset managers] do not yet have a developed value-for-money framework in place (that is a clear articulation, available to investors, of how they have delivered value for money).”

Clearly a problem

By exposing costs and charges the directive, and its accompanying regulation MiFIR, will potentially create competitive pressure, squeezing margins. Increasing transparency around market activity will make the investment and trading decisions that firms are making clear to the rest of the market. Consequently businesses are likely to use dark trading venues where possible, or to trade less. In fixed income, the introduction of post-trade transparency in the US between 2002 and 2006 led to a decrease in pricing dispersion but a drop off in trading activity for some categories of bonds, particularly high yield.

A 2013 academic study, ‘The Effects of Mandatory Transparency in Financial Market Design: Evidence from the Corporate Bond Market’ found the largest decrease in daily price standard deviation, was 24.7%, and the largest decrease in trading activity was 41.3%, occurring for a band of securities that consisted primarily of high yield bonds. Under MiFID II this will be compounded by pre-trade transparency requirements.

Ahead of the effects on market activity firms also need to establish how they will comply with the massive increase in the number of reportable financial instruments and a significant increase in the number and the types of transactions that need to be reported. Building a reporting system is complex, particularly for firms and instruments which were not subject to the regime.

“Most people are in the same position; there are a lot of questions being asked about this regulation,” says Bowley. “Fixed income is tough, but it’s even tougher when you get into the space around derivatives. How you do your reporting, your understanding with your systematic internaliser booking workflows, and market data workflows all drive off the back of how you classify and group derivatives. As that is not defined the industry is missing the starting point. With cash fixed income you have a product to define.”

The rules have clear economic ramifications for the sellside. Its best execution obligations and unbundling of the research and trading will compress the execution commissions that are payable as research is paid for separately. The requirements for storing of data including quote data were described as “gargantuan” by one sell-side head of FX trading and there is a cost associated with capturing and storing that information.

Speaking on condition of anonymity he said, “On the positive side everybody is as honest as they will ever be, which can’t be a bad thing. But on the negative side you have a lot of unintended consequences. In order to continue in what we are doing we need to drive efficiencies to ensure that we are able to meet these challenges.”

Getting ripped

Of course, no firm is keen to put off the process of getting compliant. James Baugh, head of Pan-European Sales and Marketing at London Stock Exchange says, “Whilst the regulatory implementation is getting pushed out to 2018 clients still want to get this ready as soon as is practicable.”

For what can be done today to prepare, a lot depends on the interlinking parts of the rules and the capacity of firms to identify quick wins. That is a limited range says the buyside head of trading, because a significant amount of the details will be decided at the national level, and there will likely be differing approaches across the EU Member States.

“For example, approaches to inducements, dealing commissions and product governance (e.g. the target market), could lead to fragmentation,” he says. “This will pose further challenges because of the need for firms to implement inconsistently and to take decisions on their economic model over a short timeframe.”

Even with the delay there is the possibility that systems may not be ready by the start date, given the complexity involved in transaction reporting,

Kirby says “I think there is a huge ask around trying to get all these different systems ready to receive two and a half times as many fields as was needed under MiFID I.”

For market practitioners the challenge is multiplied – failure to comply would carry economic impact, as would making the wrong decision about setting up reporting systems.

“To deliver a programme and run it as a project is extremely difficult at this point with so much uncertainty,” says Bowley. “Firms want to get moving but there is very little they can do. They need to keep a momentum even if there is a delay, but in many areas there isn’t a starting point.”

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Post-trade : T2S progress report : Mary Bogan

By

Ian Rycott

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April 10, 2016

A ROCKY START.

Getting T2S off the ground hasn’t been easy. Mary Bogan explains the latest challenges and opportunities.

Conceived in the wake of the financial crisis, Target2Securitites (T2S), the EU project designed to cut the cost, risk and red tape of settling domestic and cross-border transactions in Europe, finally got off the starting blocks last summer. A few early faltering steps aside, the project hit cruise mode surprisingly quickly.

However, no sooner had the champagne corks left the bottle than the project was back on old form. With the announcement that two key players, Euroclear and Clearstream, are to join the system significantly later than planned, the latest delay has ratcheted up the battle for commercial survival a notch, and left some wondering where the post-trade market is heading.

“The EC is pushing the industry on a journey towards an integrated, harmonised and consolidated land,” says Axel Pierron, managing director of financial consultancy Opimas. “But this journey could be like Christopher Columbus’ expedition to discover a western route to India and China. We will eventually land on new territory. But it will be different from the one envisioned on our departure.”

The objectives

Built and operated by the ECB, T2S is an attempt to create a single, centralised securities settlement platform in Europe. In tandem with the regulatory initiative Central Securities Depositories Regulation (CSDR), it aims to harmonise the confusing myriad of national rules and post-trade practices applying to settlement in Europe and leverage the platform’s economies of scale to reduce settlement costs. As cash and collateral can be pooled across T2S markets and the platform settles in central bank, rather than commercial bank, money, it also promises to optimise liquidity and collateral management for banks as well as increase settlement safety and efficiency.

To date, 23 central securities depositories (CSDs) from 21 countries have signed up to join T2S. Following recent delays, these will be on-boarded in five, rather than four, migration waves ending September 2017.

Last June, Greece, Malta, Romania and Switzerland became the first CSDs to go live on the T2S platform. It was only at the end of August though, when Italy’s Monte Titoli joined (having missed the original launch date due to testing issues), that the system was really challenged.

“Moving from the old to the new T2S settlement platform was a delicate and complex operation,” says Alessandro Zignani, Head of Post Trade Business Development at LSEG. “During the T2S migration weekend, we transferred in the region of 250,000 lines of stock, 50,000 ISIN and 90,000 settlement instructions.”

Getting clients up to speed with changes needed to Standard Settlement Instructions (SSIs) and linking static data were the main issues encountered. Overall though, the launch was problem-free.

“At the end of the weekend, we’d hit our deadline for migration from the old to new environment six hours ahead of schedule. On day one, there were a few minor teething issues but we were back to a 98%-99% settlement rate in just a few days,” says Zignani.

Six months on and Monte Titoli says clients are benefiting from a robust platform and working functionalities that are reducing their funding needs.

“With one euro of funding, you can settle up to five or six euros worth of securities,” says Zignani. “The cash required to settle funding activity is kept to a minimum with T2S.”

BNP Paribas confirms that T2S is producing bottom-line benefits. “It’s already looking good,” says Alan Cameron, head of relationship management. “The collateral and liquidity efficiencies, heralded as key benefits to T2S users, are starting to materialise and the amount of collateral we require has fallen in line with our expectations.”

For Monte Titoli itself, the bottom-line benefits are of a different kind. “We want to be a major European player and first-wave entry into T2S is helping us build a pipeline. International clients who, historically, had a relationship with Monte Titoli through a custodian bank now want to open a direct account to benefit from T2S. This year we expect two major international custodians to open a direct account – a strong signal that our strategy is working.”

Meanwhile EuroCCP’s decision to become the first and, as yet, only CCP to connect directly to T2S, is also showing promising signs.

“We’ve seen a big improvement in settlement efficiency since launch,” says Diana Chan, chief executive of EuroCCP. “Being a DCP to T2S gives us special recognition as a CCP that we do not get in all markets and access to some useful new features. In particular, prioritisation of CCP trades and the auto-partialling feature, which optimises the securities available for onward deliveries, coupled with the hold and release function now widely used by agent banks, are the reasons why we think our settlement rate is now near perfect. We’ve seen the overnight positions stuck in our account reduced to almost nothing.”

While first experiences of T2S seem generally positive, the delayed entry of big hitters Euroclear and Clearstream into the system (to give more time for testing) has undoubtedly disappointed and tempered market optimism. T2S is a volume-dependent business. The CSDs in migration waves one and two together account for just 20% of overall volumes. When Euroclear ESES joins in September 2016 and Clearstream connects in February 2017, waves three and four will make up a layer representing another 65%.

A study by Deutsche Börse in 2014 forecast that T2S would cost in the region of E1bn to roll out and produce costs savings for brokers and custodians of between E30-70m a year. But recent delays, says Clearstream, have made cost savings harder to realise than previously thought. Ongoing delays and onerous regulatory changes were also thought to be the main reason why BNY Mellon put its new CSD project on hold last year.

Finding new markets to add more volume will be key to T2S success. “We always knew we’d need more markets in the system to realise the full potential of efficiency savings,” says Cameron. “Initial discussions are already being held to bring in the Eurobond and funds markets. The UK and Switzerland will probably want to see more progress before joining. But now the project has jumped cleanly over the first fence, and if we can get France and Germany safely on board, there will be a good case to be made.”

Hopes that T2S will dramatically streamline the European post-trade market are also less sanguine

“T2S will bring some necessary improvements to European post-trade infrastructure but I doubt T2S and CSDR will be sufficient to drive down settlement costs significantly or launch a wave of consolidation in Europe,” says Pierron at Opimas. “In a region where 80% of settlement business is already concentrated in the hands of just two CSDs, there will be few opportunities for a reduction in market infrastructure providers.”

The barrier is partly one of logistics and prudence. “Merging CSDs is more complicated than most people imagine,” says Tony Freeman executive director industry relations at DTCC. “Also there is a strong argument to say that each country needs a CSD as part of its financial architecture. I think we’ll see more co-operation and technology-sharing to cut costs but many will retain independence.”

Another factor is basic economics. “In just the same way that, after MiFID, we saw firms cherry-picking their equity trading, we’ll see the big players in post-trade cherry-picking the most profitable issuance business,” says Pierron. “Local CSDs could become marginalised if they don’t act but they won’t disappear. I don’t see Euroclear or Clearstream trying to capture the issuance business of Romania, for example.”

In addition, the new ecosystem could bring new opportunities for smaller CSDs. Building on existing strong relationships with issuers, they could offer extra services and financing to plug the gap left by banks’ retreat from the SME sector. There could also be opportunities to innovate by, for example, leveraging their knowledge of issuance practice and regulatory requirements to develop new blockchain technology contracts.

“I expect some efficiency gains thanks to T2S,” says Pierron, “but the benefits won’t be evenly shared across all EU countries and numerous discrepancies will remain. The emergence of a European equivalent to DTCC is unlikely to happen anytime soon.”

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Data management : Cyber-security : Chris Hall

By

Ian Rycott

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April 10, 2016

LEARNING ON THE JOB?

Cyber-security is one of the hottest topics right now but views differ on its future. Chris Hall looks at the debate.

One of the many disturbing factoids bandied about in discussions about cyber-security is that it typically takes an organisation eight months to even realise it has been attacked. The implication being that you’ve been burgled before you know it and the perpetrators have long since made their escape. Such paranoia-inducing statistics are, of course, best guesses. However, they also reflect the ever-growing sophistication and diversity of cyber-attacks.

Alongside well-known email-based ‘phishing’ scams (“Dear account holder…”) and distributed denial of service (DDoS) attacks designed to bring websites and web-based services to a halt, cyber-intruders are targeting customer and transaction data as well as other digitised assets, with the potential to damage the victim’s reputation and its balance sheet.

Juniper Research recently predicted the global cost of data breaches would quadruple by 2019 to $2.1tn, while Gartner expects IT security spending to increase from $75bn last year to $170bn by 2020.

In particular, the growing incidence of advanced persistent threats (APTs) – which may collect, delete or destroy data over a period of months – is causing alarm. Eight months or not, lengthy detection rates are causing firms in the financial markets and beyond to explore new ways of identifying and tackling rogue elements that have sneaked through the layers of cyber-protection erected in recent years.

Many believe a signification contribution can be made by tools that monitor and analyse information flows, teaching themselves to recognise and respond to particular patterns as they process massive quantities of data. Whether you call it cognitive computing, big data analytics, machine-learning algorithms or artificial intelligence (AI), this is an area of significant growth in cyber-security.

According to Russell Stern, CEO of specialist solutions provider Solarflare, RSA Conference 2016 – a 40,000-plus information security event held in early March in San Francisco – was abuzz with firms plying software that can detect cyber-threats in close to real time. “A lot of firms are looking to detect breaches earlier and remediate them faster using AI. But potential customers may struggle to identify their ideal provider in such a crowded market,” he says.

Greater intelligence

The logic for these claims is well-established. Just as the algorithms that recommend books or films on Amazon or Netflix become more accurate the more data they can analyse on an individual’s reading or viewing preferences, so AI-based cyber-security tools increase the speed with which they can spot a rogue IP address or unusual traffic upsurge over time. Rather than taking eight months to detect a cyber-attack, a machine-learning algorithm could isolate and shut down a system within minutes or hours of suspicious behaviour being identified.

In addition, such tools should not endlessly spew out false positives because – like the human brain – they can be trained to search for more evidence if necessary, learning how to react from ‘experience’. Moreover, the recent explosion in demand for big data analysis across multiple industries means many tools are already highly sophisticated, while the facilities required to store, transport and analyse huge quantities of data are widely available, and increasingly affordable.

As well as detecting cyber-attacks, it is claimed machine-learning tools also have a role in quickly determining how systems were infiltrated, what damage was done and when they are safe to bring back online.

Some observers believe AI-based solution vendors still have much to learn about cyber-security, while others suggest they must take their place alongside the existing armoury of weapons ranged against cyber-criminals, rather than replacing them. This is true in the securities markets, where threats are many and the stakes high. Compared with other industries, the sector is a challenging and appealing target.

It is high-profile and highly regulated, populated by sophisticated firms holding extremely valuable assets. Most of its data flows and digital assets are extremely well protected and highly structured. While most transactions are between trusted counterparts, it’s not always possible to check every communication or credential – even in these days of ‘know your customer’s customer’ – meaning the securities trading value chain is only as strong as its weakest link. In short, the securities market is tough, but tempting, whether your aim is to damage confidence in the system or an individual institution, to make financial gain through theft or ransom of client data, or industrial espionage.

“Retail banking is an easier target than securities trading, not least because of the comparative complexity of monetising the proceeds, but on the other hand, you only have to win once to win big,” says Richard Benham, professor in residence, UK National Cyber Skills Centre.

Cyber-security threats evolve over time as perpetrators become more sophisticated, often by information sharing, while organisations within the securities markets are subject to different types of attack. For example, a survey conducted by World Federation of Exchanges and the International Organisation of Securities Commissions (IOSCO) in 2013 found DDoS was the most common form of attack, with no exchange operators reporting attempted financial theft.

However, Stern, whose firm initially specialised in low-latency trading technology, and now provides platforms that accelerate, monitor and secure network data, says DDoS attacks are a secondary priority to ensuring firms have full control of access to platforms and devices in the workplace. “AI has a key role, but cyber-attackers can always find a way round any software-based solution; firms need to implement layers of defence to protect themselves, including both hardware and software,” he says.

Monitoring network flow for suspicious abnormalities is an established part of cyber-security, but machine-learning algorithms need to know what they’re looking for when searching through the digital haystack for a potentially malicious needle, notes Allan Russell, senior vice president of strategy at analytics solutions provider SAS. “Machine-learning tools can sift through the data at great speed, but they will only find what they’re programmed to look for, for example deviations from normal data patterns that suggest a device is part of a botnet,” he says. As such, they are typically flagging up potential problems for humans to act upon, rather than automatically responding to the threat themselves.

And although data storage and analysis costs have declined, Russell points out that some firms only capture low-level network data to save on costs, which means it has to be enriched – for example with IP addresses – before it can be meaningfully analysed.

The questions

Many remain highly sceptical. Anthon Chuvakin, a research vice president in Gartner’s security and risk management group, blogged last year that the rush to deploy machine-learning algorithms to bolster cyber-security is highly risky because today’s tools apply non-deterministic logic, i.e. they are not guaranteed to deliver the same result from a given starting condition. “Do we want a security guard that shoots people based on random criteria, such as those he ‘dislikes based on past experiences’, rather than using a whitelist (let them pass) and a blacklist (shoot them!)?” he asked. Others also worry about the imbalance between positive and negative cyber-attack data samples for AI tools to learn from.

But the growing nature of the threat requires action. A February 2015 IDC whitepaper asserted that the prevalence of APTs demands a new, pro-active response from government and industry, including the use of “predictive and behavioural tools” to detect threats, understand attacks and execute appropriate enterprise-wide responses.

Sharing Stern’s concerns about the hackability of all software tools, IOSCO senior economist Rohini Tendulkar backs the multi-layered, consistent vigilance outlined in the IOSCO-Committee on Payments and Market Infrastructures recent consultative report*. “100% security is an illusion,” she says. “If you assume machine-learning algorithms will detect all threats, you could risk letting response and recovery falter. Cyber-security is never complete.”

*Guidance on cyber-resilience for financial market infrastructures. CPMI-IOSCO. November 2015.

©BestExecution 2016[divider_to_top]

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FIX EMEA Conference 2016 : Key findings

By

Ian Rycott

-

April 10, 2016

FIX EMEA CONFERENCE 2016.

Tim Healy, Global Marketing and Communications Manager, FIX Trading Community.

On 3rd March 2016, the FIX Trading Community held its 8th annual EMEA Conference at its spiritual home, Old Billingsgate in the City of London. By numbers, the day was a huge success – a record of close to 900 delegates from 22 countries spanning Asia, Europe, Africa, and the Americas, featuring 40 high quality speakers, 40 sponsors, 16 sessions. The numbers only tell part of the story though.

Renowned as Europe’s largest one-day trading event, the conference brings together market participants to discuss and debate current trends in the industry. The true success of the event is down to the work of the members and FIX staff to ensure the topics are relevant, and a high level of integrity is maintained throughout some potentially contentious subjects.

The overarching theme at the event was one of collaboration. Whether it was regulatory, cybersecurity, post-trade workflow or blockchain the message from the podium to the audience was clear – collaboration and co-operation can only be of benefit to the industry.

The buyside form an extremely valuable part of the work done by the FIX Trading Community. After the keynote speeches, the opening session, hosted by Dr Robert Barnes, Co-Chair EMEA Regional Committee, FIX Trading Community, and CEO, Turquoise, gave an update on the work that has been done by the EMEA Investment Management Committee and a ‘handing over the reins’ to the three new co-chairs. The continued drive and enthusiasm of this group is very evident, and there is a real desire to push forward with the initiatives on IPOs and Execution Venue Analysis. Earlier, Maria Netley, Co-Chair EMEA Regional Committee, FIX Trading Community, presented tokens of appreciation to the inaugural chairmen that had served for 3 years.

For the first time at the event, the audience were invited to give their opinion using vote pads. With nearly a quarter of the audience make-up being buyside (see Fig. 1), it was extremely interesting to get their views on a number of different topics. The regulatory environment continues to dominate the agenda for most people. 47% of the audience said that “Everything to do with MiFID II” would be of most concern for 2016 (see Fig. 2), whilst 41% said their cost profile has changed due to an increased regulatory spend.

The Best Execution session hosted by Rebecca Healey, Co-Chair EMEA Regulatory Subcommittee, FIX Trading Community, CEO & Co-Founder, Incisus Capital Partners, was extremely well attended. Results from the audience vote indicated that the majority of respondents did not have a sufficient quantitative component to meet the upcoming requirements under MiFID II (see Fig. 3). It was noted during the discussion that there is a need for improved processes to deliver good outcomes for the end clients. Key to this improved process will be clean data. This is perceived to be a major issue by the market as 48% of the audience thought that the greatest challenge in providing best execution for fixed income is obtaining sufficient and accurate data to create a statistical dataset.

The issue of accessing liquidity isn’t a new one, however the increased collaboration between the venues and exchanges, buyside and sellside is worthy of note. The anticipated regulatory changes are expected to lead to more block trading in 2018, the majority of the audience noted. A number of order book innovations have appeared in Europe and the audience expressed a clear preference for one of these as market participants partner with each other to ensure a more efficient market structure (see Fig. 4).

The session on Unbundling showed that the growth of commission sharing agreements (CSA) has not translated to a growth in Independent Research Providers (IRP) as of yet (see Fig. 5).

The audience was split on how they see this changing in 2016, but there was a clear need for firms to address unbundling research costs in FICC with 74% of the audience saying they had not yet started this process.

Reporting to the regulators is deemed to be everyone’s responsibility. There will be a huge transformation over this with the changes in regulation over the next two years. The panel session on this topic looked at transaction reporting, personal data reporting within regulatory reporting, suspicious transaction and order reports, and instrument identifiers for regulatory reporting. There was consensus in the audience, and a call to action to ensure that they can use the FIX Protocol for their transaction reporting.

OTC Derivatives face a sea-change as MiFID II forces a new trading model involving electronic platforms and greater pre- and post-trade transparency. As the panel agreed, there is no escape from MiFID II. The relative complexity of OTC derivatives was noted as the need for unique product identifiers given the electronification of the marketplace.

FIX has had a profound impact in the post-trade workflow over the past number of years, particularly in the equities space. The post-trade panel session discussed new initiatives to broaden the asset class coverage whilst also recognising there are still inefficiencies in the entire post-trade infrastructure. There is scope to include the custodians in these discussions as the working group push the initiatives forward.

The cybersecurity panel discussion showed the value of collaboration within the FIX Trading Community. Work has been initiated and is being undertaken to develop best practices with cybersecurity being seen by many regulators as the single greatest threat to the financial markets. Cyber-threat is multi-dimensional and the means by which adversaries are able to disrupt environments is clearly growing. The panel agreed that through collaboration, sharing of knowledge, application of best practice and enabling communications between internal security practitioners, business partners and counterparties the threat can be addressed.

The final session of the day concerned blockchain, a new topic for the conference. Much discussed and much hyped, but still a relatively unknown subject for many of the audience. 40% replied “what is blockchain?” when asked where their firm stood with regard to blockchain (see Fig. 6). For FIX, as for many of the other initiatives discussed on the day, collaboration will be a key factor going forward.

The event is put together by the industry for the industry. The working groups and committees that make up the FIX Trading Community seek to educate, collaborate and ultimately address the numerous challenges that are happening in the marketplace.

We invite you to find out more – www.fixtradingcommunity.org.

©BestExecution 2016[divider_to_top]

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The impact of regulation : Viewpoint : MiFID II/MiFIR : Silvano Stagni

By

Ian Rycott

-

April 10, 2016

REGULATORY REPORTING, DATA AND THE IMPORTANCE OF A HOLISTIC VIEW.

Silvano Stagni, global head of research at IT consultancy, Hatstand.

Data is one of the most important aspects of the Markets in Financial Instruments Directive/Regulation (MiFID II/MiFIR). Making sure the right data is in the right place at the right time is one of the major challenges when the MiFID Review regulations are implemented. This becomes evident when working towards putting into practice the reporting requirements.

The timetable for regulatory change in the next two years is hectic as demonstrated by four examples of the ‘financial trading’ regulations, all with reporting requirements:

MAD II/MAR (Market Abuse Directive/Regulation) will come into force on July 3rd, 2016 with the exception of the part that is dependent on the MiFID Review. That section will be implemented from January 3rd, 2018.
EMIR (European Market Infrastructure Regulation) changes to reporting to transaction repositories will take effect in the Spring of 2017.
SFTR (Securities Financing Transactions Regulation) is currently under discussion and consultation but it is likely that it will come into operation in 2018.
The MiFID II/MiFIR deferred implementation date is now January 3rd, 2018 (subject to confirmation by the European Parliament).

Unfortunately, there is not much coherence across ‘financial trading’ regulations. Trading and post-trading regulations (MiFID and EMIR) have different goals and have been examined by different teams. Although a Transaction Repository (TR) can be licenced as an Authorised Reporting Mechanism (ARM) under MiFID, reporting to repository under EMIR (both the current and the future version) and transaction reporting under MiFID II/MiFIR are inconsistent.

There are no plans to introduce consistency. If an investment firm chooses to report to the regulator using a TR as an ARM, they will still have to prepare two reports rather than one as the two have major differences between them. We still do not know what ‘reporting Securities Financing Transactions to Repositories’ will look like as at the time of writing this article, the technical standards have not yet been published. In any case a SFTR repository and an EMIR repository will very likely be different because the logic behind the content is different.

If things are so different, why does it make sense to look at all the reporting requirements together?

Change is expensive, time consuming and risky. Reviewing it once is more efficient.
These regulations are all concerned with reporting trades in financial instruments. All the data comes from the same environment. It makes sense to figure out what information needs to be captured and when, so that all changes to processes and procedures concerned with data capture can take place once.
There are some differences in static data and identifiers. It is important to look at them together to secure the most efficient result. MiFID transaction reporting identifies instruments with ISIN code but pure OTC products (most likely a one-off instrument) may not have one. An AII code may be used to report transactions in Financial Instruments that do not have an ISIN code under EMIR. Most reporting regulations include one or more taxonomies to identify the characteristics of the instrument being traded. These taxonomies may not be in common, but looking at them within the same project will help to avoid making unnecessary changes to static data and identifiers.
It is easier to look at the rules in a co-ordinated fashion. Both EMIR and MiFID use similar rules to define who the seller is, and who the buyer is, in transactions that do not have a real seller or a real buyer (for instance a foreign currency swap).
There are dependencies. MiFID transaction reporting flags a transaction subject to SFTR rules and the trader code included in the report will then be used under MAD II/MAR when there is a pattern of suspicious transactions.

This common approach is described in Figure 1.

A common implementation strategy would allow any synergy or similarity between reports to be taken into account and their implementation planned according to a common timeline across all regulations. Each report would then be prepared separately.

At the last FIX Protocol EMEA Trade Conference, over 70% of the delegates surveyed listed reporting as the major concern in the implementation of regulatory change. A holistic view across regulations will maximise what is common, make the most of any possible synergy, co-ordinate any change to the data structure, and simplify the actual preparation of the report.

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The impact of regulation : Viewpoint : Post-trade reporting : Jason Waight

By

Ian Rycott

-

April 10, 2016

CLARIFYING MIFID II.

Jason Waight, Head of Regulatory Affairs & Business Management at MarketAxess Europe and Trax, explains how the new post-trade reporting requirements will affect the buyside.

The delay to MiFID II could well provide the industry with the breathing space needed to avoid some of the issues encountered with EMIR, where a last minute rush to put in place suitable reporting arrangements caused real challenges for many industry participants. Learning from that experience, a key question is to what extent buyside firms will seek to rely on their brokers to meet the trade and transaction reporting obligations they will incur under MiFIR. Under MiFIR it will no longer be possible for buyside firms to benefit from an exemption from the obligation to report¹ altogether. EMIR has taught us that the buyside’s reliance on the sellside will only be achievable through a more formal outsourcing arrangement together with the attendant compliance requirements associated with the outsourcing of a regulatory obligation. We consider below the implications for both trade reporting (real time publication of price and quantity) and transaction reporting (market surveillance reporting to Regulators on a T+1 basis) on buyside firms.

Trade reporting/post-trade transparency

Not to be confused with the T+1 transaction reporting obligation to national regulators (discussed below), this is the post trade real time trade reporting/publication requirement. It is well understood that MiFID II expands the scope of this obligation beyond the existing MiFID requirements currently applicable to equities to include fixed income, derivatives and commodities. Perhaps less well understood are the implications upon who has the obligation to report and whether or not it may be avoided, delegated or outsourced.

Today under MiFID I (for equities only), buyside firms typically agree that the responsibility for satisfying the post-trade publication requirements shall be assumed by their broker. Effectively, this removes the obligation from the buyside to take any further action. This is possible because currently MiFID I expressly allows the parties to a transaction to agree upon whom the responsibility should fall, and thus all the obligations that flow with that responsibility are avoided.

MiFID II is subtly different. There will no longer be any express permission for firms to agree between themselves who will be responsible for satisfying the publication obligation. Instead, the rules state that the seller is responsible for making the report, unless the buyer is a Systematic Internaliser (SI) for that class of instruments. So, when selling to a broker who is not an SI, or to a broker who is not a MiFIR firm (for example, a Swiss or US dealer) or an unauthorised firm, the buyside firm will incur the obligation to report, which must still be satisfied in some way. The parties are of course always free to delegate the performance of this activity by way of an outsourcing agreement, but any such agreement does not exempt the buyside entity from either the obligation to report in the first place, or the liability for failures.

This means that the buyside may need to have more systems and controls around the arrangements including a written agreement, and systems to verify and monitor the act of reporting². Outsourcing agreements of this nature are likely to have a different commercial structure to the current informal arrangements under MiFID I, and it would be prudent for buyside firms who are provided such services without charges, or on a soft-dollar basis to get comfortable with such arrangements from a compliance perspective, having regard to the increased stringency of rules around incentives and transparency.

Furthermore, trade reporting can only be satisfied through an authorised Approved Publication Arrangement (APA), regardless if the selling firm is a buy- or sellside entity. Trax is planning on registering as an APA and also working in close collaboration with the industry to develop unique tools for SI determination. Figure 1 explains the trade reporting obligation for buyside firms.

Transaction reporting

The obligation to report full transaction details to the regulator within T+1 (not a publication requirement) shall also increase in scope pursuant to MiFID II. Currently, under MiFID I, many buyside firms rely on an express exemption from the obligation to transaction report (known as the ‘portfolio manager’s exemption’), which principally applies to portfolio managers operating a discretionary fund.³ The mechanics of the portfolio manager’s exemption are not well understood. In particular, the exemption operates to relieve the investment firm of the obligation to make a transaction report, but it does not mean that the broker has made a report on their behalf. Critically, the broker does not make two separate transaction reports, and only satisfies its own obligation in respect of itself. Under this exemption, the buyside are relieved of the obligation to report if they have ‘reasonable grounds’ to be satisfied that the broker will make a transaction report to the regulator. In order to have ‘reasonable grounds’, FCA guidance⁴ is no more onerous than an annual confirmation that the broker continues to be a MiFID firm.

MiFID II requires instead that a buyside firm may rely on its broker to make a separate report on its behalf (in addition to the broker’s own report) through a transmission of order arrangement. Even if sellside brokers are willing to perform this as a delegated service, the key difficulty will be completing this report from the perspective of the buyside. The information required to complete a transaction report under MiFID II is considerably broader than under MiFID I – the number of reporting fields expands from 26 to 65 and includes personal data regarding the investment committee that approved the transaction needs to be identified, as do the details of any underlying client. If buyside firms wish to avoid the obligation to transaction report, they must become comfortable with sending this type of detailed information about their clients to their brokers, in addition to the execution instructions in order to enable the broker to complete transaction reports on their behalf. In addition to the outsourcing obligations discussed above, it may also complicate the considerable challenge the buyside faces in complying with the new best execution and compliance requirements. For example, if you choose to trade with a broker who offers to transaction report on your behalf over one that does not, how can you be sure that the reporting broker is offering the best price? Lastly, the buyside must take steps to ensure that no transactions fall through the cracks and are reported (for example when trading with a non MiFID and/or non EEA broker).

For their part, sellside brokers will have to consider whether they are prepared to offer a delegated reporting service and whether the prohibitions on inducements force them to charge for providing it.

Faced with the prospect of sending multiple, potentially reluctant, brokers extra information to supplement their initial order, many buyside firms are opting to report to regulators directly via an Approved Reporting Mechanism (ARM), such as Trax. This enables them to have a single process for transaction reporting and potentially benefit from longer operational deadlines in meeting the T+1 timing requirement. Reporting via an ARM also facilitates transactions executed via a Non-EEA broker, ensuring complete compliance with the MiFID II transaction reporting obligation.

Industry readiness

It seems highly likely that different firms will reach varying conclusions, based on the size and complexity of their businesses, as to how they comply with the MiFID II trade and transaction reporting requirements. The key issue is really to raise industry awareness of the forthcoming requirements to avoid, or at least minimise, a chaotic rush to the finish line when MiFID II is implemented.

Footnotes:

Strictly speaking it is not an exemption but an opportunity to rely on a third party report
The rules relating to outsourcing by FCA regulated firms are covered in the FCA Handbook under SYSC 8
[Consolidation of orders from various funds across multiple jurisdictions in a central dealing desk which includes execution only authorisation, may arguably invalidate the ability to rely on this exemption].
TRUP (Transaction Reporting User Pack) 9.7.1.

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The impact of regulation : Market opinion : MiFID II delay : Daniel Simpson

By

Ian Rycott

-

April 10, 2016

THE MIFID II DELAY AND ITS CONSEQUENCES.

Daniel Simpson, head of research at JWG explains why now is not the time to procrastinate.

After months of rumour and speculation, the European Commission has finally spoken out on the delay of MiFID II, announcing a one-year extension to the implementation deadline. The new date is now 3 January 2018 but as it had been expected by many it did nothing to alleviate the collective sigh of relief from the regulators and the regulated. Both had found the original timeline extremely challenging for several varying reasons.

Although many believed the delay was inevitable in the wake of publication deadlines for both the final Regulatory Technical Standards (RTS) and the final Delegated Acts, by ESMA and the Commission respectively, in the second half of last year, the silence was deafening. As the length of time without official word grew longer and longer nerves were jangling. There was also speculation about whether the postponement would be total or partial. Some expected that only the more challenging aspects of the MiFID II framework would be delayed, creating a confusing phased implementation process.

Ultimately the decision to delay the entirety of the MiFID II regime was welcomed because it meant avoiding the kind of confusion predicted under a phased implementation.

In justifying their decision to delay, the Commission cites “the complex technical infrastructure that needs to be set up for the MiFID II package to work effectively”. Confirming that they see the issue in primarily market data terms, it goes on to state that “(ESMA) has to collect data from about 300 trading venues on about 15 million financial instruments”. The market data mentioned will be crucial in setting liquidity thresholds on an instrument by instrument basis as well as systematic internaliser (SI) thresholds and trades on trading venue classifications for instruments.

While several have seen the rationale or the delay to mean that ESMA plans to deliver some semblance of the fabled ‘golden source’ of reference data, others are not so optimistic. In this space there has long been a lack of clarity in the industry around where a golden source of various forms of reference will come from and ESMA have, to date, held back from categorically declaring their willingness to commit to providing one. Whether or not this one-year delay now gives them the breathing space to do so remains ambiguous.

Moreover, while a date set in stone brings a slice of certainty to the MiFID II process that warm, fuzzy, enlightened feeling may not last too long. Final text remains unforthcoming, and implementation teams continue to wait on both the final Delegated Acts and the final RTS. In this context, the Commission’s assurances that “This extension will not have an impact on the timeline for adoption of the ‘level II’ implementing measures under MiFID II/MiFIR” will be viewed through understandably sceptical lenses.

Whilst the stated rationale clearly makes sense; ESMA would not have been able to meet the original January 2017 deadline, it only tells half of the story. Completing all of the work required to change technology systems, policies and procedures in line with MiFID II was an impossibility for most of the industry. The workload involved to be fully prepared for 2018 is huge, particularly in the most complex areas of pre-trade transparency, the derivatives trading obligation and product governance.

The deadline will continue to look tight whilst the industry does not have certainty on the final text. Until the requirements are finalised it is very difficult to commit to the millions of pounds worth of systems changes the will be required. This is because a last minute change to the reporting fields in the RTS or record keeping specifications in the Delegated Acts could then lead to further millions worth of rework. Given that the highly technical kinds of change that we are talking about can take upwards of 18 months, not including industry wide testing, 2018 is starting to look a lot closer already.

In thinking about allocating project resources this year, it’s also worth senior management considering that, just because MiFID II has been pushed back, it doesn’t necessarily mean that other, interdependent regimes have also been postponed. And this will complicate the landscape still further. The Market Abuse Directive and Regulation (MAD/R) deadline, for example, remains July of this year and therefore the timelines for aspects of that regime that are interdependent on MiFID II, such as the identification of what is ‘traded on a trading venue’, look extremely aggressive.

Other highly interdependent initiatives such as Packaged Retail Investment Products (PRIIPs) with regard to product governance and Securities Financing Transactions Regulation (SFTR) with regard to transaction reporting remain fixed in the implementation window as well. This means that whilst you may have just got an extra year to get MiFID II right, resources are likely to be much tighter than expected in this window.

The FCA’s Senior Manager Regime (SMR) is another that will carry on, full steam ahead. SMR will force firms to identify senior managers within their organisations who are ultimately accountable for ensuring compliance with regimes such as MiFID II and, in this context, no-one can afford to take their foot off the gas, even though the deadline is extended.

Ultimately then the MiFID II delay has been well received by regulators and investment firms alike, but that reception has not lasted long as thought. This is because of the huge book of work that remains undone, both with regard to writing the rules and implementing them in terms of both MiFID II and much more beyond.

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Corporate statement : Expense management : SmartStream

By

Ian Rycott

-

April 10, 2016

EXPENSE MANAGEMENT.

Severine Melis-Cooper, Global Head of TLM Fees and Expense Management at SmartStream, explains how the system enables execution cost management strategies and savings realisation through accounting and invoice control.

Brokerage, Clearing and Exchange (BCE) fees are the largest, non-compensation expense for capital markets businesses. The total annual estimated spend in the BCE category across the major investment banks ranges from $12bn to $14bn. Yet, despite the size of the BCE expense category, many capital markets groups do not have the technology and processes in place to measure and optimise their BCE spend.

As a result of the gradual reduction in commission revenues and constraints in principal businesses, many investment banks are struggling with reduced profitability across asset classes. In response, over the past few years, investment banks have begun to focus intensively on managing expenses, driven both by diminishing transaction volumes and declining margins but also by a combination of regulatory constraints and higher capital requirements.

Achieving greater efficiency in this area is not without difficulty. In particular, processes and controls relating to the management of BCE costs are currently fragmented and manual. For those investment banks that have been able to reduce their BCE spend through manual analysis, the net impact has been limited and unsustainable. In order to achieve durable and sustainable savings across the entire BCE category, on an ongoing basis, as well as to realise material savings, a co-ordinated strategy is required – one which includes new processes, more automation and additional control.

There are significant challenges to be met by investment banks when trying to manage BCE expenses. Accounting control processes are fragmented and do not support the ability to post expenses in a consistent and transparent manner. As a result, the general ledger does not provide the required visibility in relation to BCE expenses across the service provider universe and business flows. The distribution of expenses is worked out using imprecise allocation methodologies and not calculated by means of equitable distribution based on usage.

Another hurdle faced by investment banks is that BCE agreements are often complex. Further, the agreements are subject to periodic change by exchanges, clearing houses and custodians. Lack of a centralised repository for these agreements makes it extremely difficult to estimate the cost of a transaction. Additionally, investment banks frequently do not have the correct internal data points or level of automation needed to accurately apply BCE agreements and to calculate fees.

The challenge faced by investment banks in relation to BCE agreements was underscored by SmartStream research, carried out with a group of 20 investment bank clients. A common theme amongst those interviewed was the complex methods brokers and exchanges utilised for calculating fees. The complicated way in which transaction fees were structured left banks without a clear idea of what they were actually being charged for, or even unsure as to whether they were being overcharged.

Leading investment banks have been partially successful at implementing process consolidation and creating efficiencies in relation to BCE expense management. This has been achieved through strategic outsourcing partnerships, supported by some level of automation in specific business areas. Investment banks, however, have not been able to build complete enterprise solutions due to the additional investment required to develop a full suite of capabilities. Another obstacle, which has prevented investment banks from realising BCE expense efficiencies is the lack of internal subject matter expertise.

Regulators have begun to scrutinise and penalise investment banks for their manual processes and lack of controls in relation to BCE expenses. Most recently, a large wealth management division of a major investment bank was fined $2.8m by FINRA. Regulators commented; “The bank lacked an adequate supervisory system to ensure that customers were billed in accordance with their contracts and disclosure documents.”

SmartStream provides well-controlled BCE services underpinned by automation. Our solution enables investment banks to manage BCE expenses strategically through data-driven decision making. TLM Fees and Expense Management is an end-to-end, automated platform that supports BCE expense management throughout its lifecycle – expense calculation and allocation, as well as accrual posting, invoice control and vendor payments.

TLM Fees and Expense Management provides a global repository of BCE expense and rate data that can be accessed by different business areas and existing financial systems. SmartStream’s technology enables BCE expenses to be allocated using complex and configurable models. Costs can be apportioned accurately to the relevant businesses, thus enabling a true assessment of business performance net of expenses. In addition, our solution enables investment banks to independently verify BCE expenses and to automate payment of third-party invoices. TLM Fees and Expense Management is deployed as a hosted on-premise service, or it can be delivered as a managed service.

TLM customers have experienced a variety of benefits. Importantly, they have been able to reduce their overall BCE expenses and ensure that all businesses are executing cost-effectively. Many customers have realised savings by identifying and recovering overbilling by service providers. In addition, the solution has enabled – and continues to support – cost-plus businesses. The solution is currently being utilised as an input to systematically measure client profitability and is also used to allocate rebates to specific businesses, on the basis of how cost-efficiently they execute. TLM’s data is harnessed by a number of firms to optimise their algorithmic trading strategies for cost-effectiveness. Finally, TLM Fees and Expense Management customers have been able to put in place improved controls in relation to accounting processes, providing transparency into BCE expense and allowing for balance sheet substation.

www.smartstream-stp.com

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A WINDOW OF OPPORTUNITY.

Laurent Albert, global head of trading at Natixis Asset Management Finance, explains how regulation is opening new avenues of business.

WHAT’S IN A NAME?

The concept of alternative indexation is not new but the number of monikers sprouting under the label can present a confusing picture. Lynn Strongin Dodds looks at why the concept has become so popular.

MIFID II: TIME TO ADJUST.

The delay to MiFID II’s implementation will make the delivery of operational changes more viable, but uncertainty will prevent firms taking action. Dan Barnes reports.

A ROCKY START.

Getting T2S off the ground hasn’t been easy. Mary Bogan explains the latest challenges and opportunities.

LEARNING ON THE JOB?

Cyber-security is one of the hottest topics right now but views differ on its future. Chris Hall looks at the debate.

FIX EMEA CONFERENCE 2016.

Tim Healy, Global Marketing and Communications Manager, FIX Trading Community.

REGULATORY REPORTING, DATA AND THE IMPORTANCE OF A HOLISTIC VIEW.

Silvano Stagni, global head of research at IT consultancy, Hatstand.

CLARIFYING MIFID II.

Jason Waight, Head of Regulatory Affairs & Business Management at MarketAxess Europe and Trax, explains how the new post-trade reporting requirements will affect the buyside.

THE MIFID II DELAY AND ITS CONSEQUENCES.

Daniel Simpson, head of research at JWG explains why now is not the time to procrastinate.

EXPENSE MANAGEMENT.

Severine Melis-Cooper, Global Head of TLM Fees and Expense Management at SmartStream, explains how the system enables execution cost management strategies and savings realisation through accounting and invoice control.

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