Trading : Surveillance tools : Frances Faulds

November 9, 2015

READING BETWEEN THE LINES.

Frances Faulds looks at what tools are being developed to help investment banks monitor client flow and avoid market instability.

The combination of regulatory drivers and greater operational accountability under the European Market Infrastructure Regulation (EMIR) is making front office traders adopt a more proactive approach to their surveillance obligations. Gathering and processing the information though is no easy task.

“The original thoughts of the G-20 are now becoming a global set of standards,” says Alex Foster, financial markets industry practice lead & head of insurance, BT Global Services. “They all have a commonality of collecting, searching, analysing and then interrogating data and those interactions that create the trade to meet those regulatory requirements.”

While market surveillance is the responsibility of the execution venue, there is still a responsibility for organisations to record and review their trading activities in terms of operational accountability. Michael Cooper, CTO, BT Radianz Services at BT, adds that firms are now looking at how they anticipate and respond in the event of an activity that exposes them.

He notes, “Firms need the ability to review activities and detect anomalies so they are looking at all aspects of specific market compliance and are building surveillance across all aspects of trading, in close to real-time, especially around voice and collaborative activities, in a pre-trade landscape.”

For Foster, the biggest change emanating from the recent trading scandals is the expectation of the time needed to access the information. The demands are more complicated than ever and there is a greater time pressure. She says, “Banks and brokers have to be able to supply information and data that proves that their traders are complying with all regulations, across all forms of communication, across millions of transactions, almost immediately to the regulator, usually within 48 hours after an investigation is instigated.

This need for storage and order – to be able recover, retrieve, replay and restore trades – is one of the biggest changes that has hit the industry. We have spent a lot of time working with firms to enable them to quickly analyse and store data, with the correct indexing.”

The MiFID challenge

Foster believes that the storage and indexing requirements will become further complicated under MiFID II in January 2017, with clause 45 and annexes 10,11 and 26, regarding the recording of transactions and how they need to be recreated across 82 different fields.

In readiness, firms are increasing investment in tools that enable them to better record, monitor and store data for up to five years, under MiFID, which is longer than the EMIR requirement. “They need to bring all of this data together and analyse it. They need to have the ability to visualise all this disparate data and make sense of it,” adds Foster.

BT Assure Analytics is a visualisation tool that has artificial intelligence in-built. It fine-tunes the analytics that firms have in increasingly complex and fast markets, which continues to fragment as more execution venues continue to come to market. “This is making the obligations, in near to real-time more difficult. Firms need to focus on this in an increasingly forensic manner,” adds Cooper.

While electronic trading is continuing to rise, needing to capture voice broking, and where advice is given, further complicates surveillance. Foster says BT examined the requirements for the dealer board of the future, which would need to include mobile devices alongside the data storage requirements, as part of the cloud infrastructure that can include Edge devices along with all the other applications.

Technology alone cannot fix the problem, according to Foster. Alongside the increased use of surveillance tools, there is very big push for integrity and trust to come back to the market and there is an interesting intersection between technology meeting regulatory requirements, and at the same time, the expectation of morality and ethics playing a bigger role.

For Stefan Hendrickx, founder and executive director at Ancoa, the new regulatory environment is pushing for the extended use of surveillance tools both horizontally, across different asset classes, and vertically, further up the organisation.

He says that surveillance tools to date have tended to be mainly developed for the back office, and focused on cash equities and equity options. This has been extended to fixed income, commodities, FX products, and most recently, benchmarks. The front office is also getting a lot more responsibility for surveillance, to the point that the head of trading can be held personally liable for trading misconduct in the bank.

This has changed the type of surveillance products being developed as the front office wants more specific compliance and legal tools. Although banks have tried to build these in-house, they are now looking to build the business-specific logic for their own trading environment, according to Hendrickx. “The greater challenges are where instruments are very illiquid and there is not a clear reference price.”

All eyes on the trader

The new regulations are also prompting a greater focus on making sense of trading behaviour. This includes the behaviour analysis of individual traders and building in alerts that detect abnormalities on an individual basis, rather than abnormalities versus the average of the market. “Historically, market surveillance has simply compared a trader’s activity to the average trading behaviour in the market,” says Hendrickx. “Now we are profiling the individual trader and looking for changes in their typical trading behaviour. This is a big change in surveillance.”

Automation is used as much as possible, and the surveillance tools are calibrated by feeding historical data into the system. Back testing, in order to ‘train’ the system is automated, once the firm’s parameters are defined. Hendrickx says: “There is an element of adaptivity in the system, so it evolves with the typical market volumes going up or down, where it will consider relative parameters versus historical, recent history or broader history, and minimises the need for manual intervention in order to keep the running of the surveillance function manageable.”

Regulatory requirements are that a number of scenarios have to be checked, such as insider trading, front-running, spoofing, layering, pre-arranged trades and various types of collusion with more being added to the list as the market moves towards best execution. According to Hendrickx, these are described by the different regulators, but there is an element of interpretation, and some regulators, like Germany, take more of a rules-based approach than others, which rely on a more descriptive approach, such as the UK, to give a broader catchment.

While there are specific European Securities and Markets Authority (ESMA) guidelines for regulated markets, such as the need to reconstruct a trade and have an audit trail, the alerts are less clearly defined. For example, what exactly insider trading or front-running might look like is open to interpretation so each bank has to establish the exact logic they want to cover and what parameters they want calibrated into the surveillance system, which Hendrickx says can then be done without having to change the system itself.

FX benchmarking is the newest addition to surveillance monitoring, following recent events. As with other asset classes, it is not just about having the surveillance tools in place, but also having the right procedures and people in place to submit the benchmarks in the relevant incidences.

Another challenge is the need in the future to have a single system that covers all the asset classes and not just a sub-set as multi asset class trading continues to grow. “The single surveillance system not only needs to cover the different asset classes but also the different communication channels, and not just proprietary transactions,” says Hendrickx. “Historically, there has often been segregation between the monitoring of electronic communications and the monitoring of proprietary transactions. By bringing these together, and overlaying them, new pattern types can be identified.”

[divider_line]©BestExecution 2015

[divider_to_top]

News review : Equities

Ian Rycott

November 9, 2015

BATS PAYS FOR ETF LISTINGS.

BATS Global Markets is hoping to grab a bigger share of the exchange traded fund pie with the launch of BATS ETF Marketplace, which will pay ETF providers as much as $400,000 a year to list on its trading platform. Payments will vary depending on average daily volume.

Traditionally, ETF providers have paid between $5,000 and $55,000 a year to list on a stock exchange. BATS previously offered firms the option to list on its exchange for free. Besides the monetary incentive, the firm is also changing the way it rewards market makers for continuously offering to buy or sell ETFs, a move it said will help reduce volatility.

BATS entered the ETF listing business in January 2012 with the launch of the iShares MSCI Norway Capped ETF followed by several other single-country offerings including the iShares MSCI Denmark Capped ET, iShares MSCI Canada Small Cap Index Fund and the iShares MSCI Finland Capped ETF.

CEO Chris Concannon, who joined BATS in 2014 from high-frequency trading firm Virtu, has earmarked ETFs as a major focus. In April, the Kansas-based company hired one of the New York Stock Exchange’s top ETF executives, Laura Morrison, followed by the recent addition of Rob Marrocco, another ETF specialist from the NYSE, and more recently ICE.

BATS is currently the top US exchange for ETF trading volume, handling around 45% of trading of ETFs on exchanges and roughly 27% of overall trading of ETFs on exchanges and private venues. In addition, the firm adopted a favourable ETF market-making programme, which provides incentives to market makers that put up their own capital to aid in tighter bid-ask spreads to promote liquidity and more efficient ETF trades.

However, BATS still has a long way to go to catch up with its rivals in listings. Out of the 1,411 US-domiciled ETFs at the end of 2014, the BATS’ website showed 33 exchange traded products listed on its exchange. The Intercontinental Exchange’s NYSE unit has the lion’s share at over 1,000 ETFs, with the remainder held by Nasdaq.

ETFs have come under greater scrutiny in the wake of the problems on August 24 when prices of ETFs moved far out of sync compared with those of the underlying holdings. They experienced dramatic price swings and an unusually high number of trading halts in a week which saw the Dow Jones Industrial Average plummet by 1,000 points over fears of an economic slowdown in China. Exchanges, market makers and ETF sponsor firms are in discussions over rules that would help prevent similar problems from happening.

[divider_line]©BestExecution 2015

[divider_to_top]

News review : Derivatives

Ian Rycott

November 9, 2015

LCH.CLEARNET SETS A DATE FOR CROSS MARGINING SERVICE.

LCH.Clearnet, the world’s largest clearer of interest rate swaps, is preparing to launch its long-anticipated cross-margining service in early 2016 to coincide with the start of mandatory clearing of interest-rate derivatives in Europe.

LCH announced plans in March to provide the service via SwapClear, its interest rate clearing subsidiary, but the recent statement specified the timeframe. Cross-margining enables correlated over-the-counter (OTC) and listed derivatives trades to be offset against each another to reduce collateral requirements.

Under the offering, market participants using SwapClear and LCH.Clearnet’s listed rates services, will be able to maximise their margin offsets between the two instruments. There is expected to be strong demand for cross-margining services once central clearing for standardised derivative contracts comes into force for the first time in April 2016, under the European Market Infrastructure Regulation (EMIR).

Daniel Maguire, global head of SwapClear and Listed Rates, LCH.Clearnet has said that the business will be a “transformational initiative for the interest rate derivatives market. SwapClear is uniquely positioned to efficiently aggregate, clear and portfolio-margin interest rate derivatives from multiple venues across multiple products. Portfolio margining across both OTC and listed interest rate derivatives, on a fully open access basis, will give our members and their clients execution venue choice and access to our deep global pool of liquidity.”

Currently, users of LCH are required to hold collateral for interest rate products in two different pools: collateral for OTC swaps trades is held with its SwapClear subsidiary, while margin for listed rates products is held within a separate pool.

The change has important implications for Nasdaq’s NLX, which launched six fixed income futures products – all cleared by LCH – in 2013. One of NLX’s core propositions is the ability to offer greater efficiency, both by clearing long and short-dated contracts together and by offsetting those positions with OTC contracts cleared through SwapClear.

Until now, collateral for NLX’s products has been held separately from the collateral held in the SwapClear pool. LCH’s cross-margining initiative means NLX positions can be netted against OTC positions cleared through SwapClear potentially reducing costs. According to Charlotte Crosswell, NLX’s CEO, “Portfolio margining has huge potential to deliver real cost savings to the market and we look forward to playing a key role in that story.”

Clearing is expected to be one of the key battlegrounds in the new EMIR regime and the move by LCH.Clearnet will put it in direct competition with Eurex Clearing, which launched a similar “cross-margining” service last year. The Deutsche Boerse-owned clearinghouse said that firms could save as much as 70% in collateral costs.

News review : Fixed income

Ian Rycott

November 9, 2015

LIQUIDNET DEBUTS FIXED INCOME PLATFORM.

Liquidnet, the institutional block trading network that made its name in trading equities, has launched its Fixed Income dark pool that facilitates direct, peer-to-peer trading of corporate bonds among asset managers in the US, Canada and Europe.

Liquidnet said that it has enrolled more than 120 asset managers, representing a sizable pool of liquidity and portion of assets under management for high yield and investment grade bonds in the US. The trading network enables execution for US and European corporate bonds (high yield and investment grade), emerging market corporate bonds, and European convertible bonds.

The platform has been built with input from Liquidnet’s network of asset managers and leverages its experience in the equities space. Similar to Liquidnet’s equities solution, the Fixed Income dark pool will provide the option for those corporate bond traders utilising an order management system (OMS) to easily have their orders swept into the pool with minimal changes to existing workflow.

In June, the firm successfully integrated seven OMS operators that support direct connectivity as well as striking a partnership with Interactive Data for continuous evaluated pricing to aid in pre-trade transparency and more efficient best execution analysis. In addition to new features, Liquidnet has also expanded its Fixed Income team and expertise with the recent high-profile appointment of Chris Dennis, formerly of BlackRock, as head of US Fixed Income Sales.

“The corporate bond market is desperate for innovation and improved efficiencies, and we’re starting to see several new trading platforms emerge,” according to Kevin McPartland, head of research for market structure and technology at Greenwich Associates. “Greenwich Associates research found that 80% of investors find it extremely difficult to execute large block trades; as such, platforms that can help ease that burden while not causing a shift in the trader’s workflow is a necessary part of the path forward.”

Seth Merrin, founder and CEO of Liquidnet also noted that, “the fixed income market has been woefully underserved by technology and, as concerns about a liquidity crunch continue to rise, it needs a transformation. With close to 15 years of experience connecting asset managers around the world to solve the unique challenges of institutional equities trading, Liquidnet is uniquely positioned to provide a more efficient trading solution and experience that delivers a critical mass of natural liquidity that minimises information leakage and maximises best execution.”

A recent survey of buyside firms-comprising $12.15 trillion in assets under management – conducted by our sister publication, fixed income magazine, The DESK – showed that 58% percent of buyside respondents indicated that they were planning to move to Liquidnet for their fixed income trading.

[divider_line]©BestExecution 2015

[divider_to_top]

News review : Regulation and compliance

Ian Rycott

November 9, 2015

THE FINER POINTS OF MIFID TECHNICAL STANDARDS.

After months of intense lobbying and debate, the European Securities and Markets Authority (ESMA) published the MiFID II technical standards for new transparency requirements for bonds, position limits on commodity trading positions and open-access provisions for derivatives clearing houses. However, absent from the list was the controversial unbundling of research and execution commissions which will be published in November (see p38).

Starting with best execution, MiFID II will require that trading venues, systematic internalisers (SIs) that match client trades away from an exchange, market makers and other liquidity providers publish their figures on their execution quality for all financial instruments. However, only trading venues and SIs will have to publish information on instruments subject to trading obligations. This will cover costs, daily pricing and the likelihood and speed of execution. The information will have to be published free-of-charge four times a year, within three months of each quarter end.

On the fixed income front, ESMA has adopted the ‘instrument-by-instrument approach’, or IBIA, to determine which bonds should be classified as liquid, and therefore subject to stricter transparency requirements. The method measures liquidity on individual bonds and reviews thresholds as they trade. According to Steven Maijoor, chairman of ESMA, based on current data, around 4% of European bonds – or 2,000 instruments – would fall under these new transparency requirements. The watchdog ruled against a ‘class of financial instruments approach’, or COFIA, which would classify bonds into various groups and set thresholds accordingly.

As for dark pools, ESMA held firm on its position much to the chagrin of market participants. Starting in 2017, the amount of trading in a stock that can take place in a single dark pool will be limited to 4%, while across all European dark pools it will be confined to 8% on a rolling 12-month basis. ESMA will only require venues to provide data for the past 15 days and will provide free data on its website.

The regulator also decided to introduce caps – or position limits – on trading firms in certain commodity derivatives to reduce speculative activity. It will employ two measures – the ‘market share’ test which looks at whether a company’s speculative trading in commodity derivatives is high in relation to overall trading in the EU market and the ‘main business’ test which measures a company’s speculative trading in commodity derivatives as a percentage of its total commodities derivatives trading.

As to open access to clearing, firms trading on exchanges will be allowed access to a central counterparty (CCP) unless that CCP is not licensed to clear the financial instrument being traded and would not be able, despite “reasonable efforts”, to obtain an authorisation extension. MiFID II will also require exchanges and other trading venues to price their data on a “reasonable commercial basis”. To this end, exchanges will have to unbundle the provision of market data to help reduce costs while trading venues should disaggregate data by asset class, country of issue, the currency in which an instrument is traded and according to whether data comes from scheduled daily auctions or from continuous trading.

[divider_line]©BestExecution 2015

[divider_to_top]

Regional focus : UK : Louise Rowland

Ian Rycott

November 9, 2015

BREXIT: FACING THE UNKNOWN.

Louise Rowland presents all sides to the arguments.

Business as usual … or the Long Goodbye? No one knows which way the European Union referendum will go. Or even, right now, the date it will take place. Within an increasingly febrile climate of rumours and hyperbole, the only certainty is that the battle over Brexit will be bruising.

The Prime Minister is deep into his campaign to negotiate changes in the UK’s EU membership terms. Meanwhile, the question vexing the City is ‘what would a UK withdrawal mean for London as the region’s leading financial hub?’

The country may be fairly evenly split, but within the financial services sector, it’s a very different story. Estimates say a 70/30 majority would prefer the UK to stay in, with investment banks leading the charge.

In, out, out, in

It would be madness to walk away from a single market of 500 million people in 28 countries, say supporters of the status quo. The EU is the largest consumer of UK exports of financial services, and around two thirds of the EU’s net exports in financial services come from the UK. Some 250 foreign banks are based in the capital.

Post-Brexit, they argue, the UK would no longer have passporting rights to the single market and London would be unable to offer the full range of financial services. It could then face a realignment where it loses out to other business-hungry financial hubs such as Paris or Frankfurt, Singapore, Hong Kong or New York. Some foreign institutions with large UK operations such as Deutsche Bank have already threatened to move their headquarters out of London if the country leaves.

The UK also needs to be able to influence relevant EU legislation, they add. Pull out, and you lose voting and veto rights plus EU legislators might well make it harder for UK financial firms to do business unless they have a physical base on the Continent. In addition to complying with EU rules, the UK would also have to deal with its own regulatory regime. There has even been speculation that credit ratings agencies would downgrade the country if it goes it alone.

Groundless scare-mongering, counters the ‘out’ camp, largely comprised of hedge funds keen to shirk the costly, time-wasting shackles of EU regulation and to develop closer ties with the US and Asia Pacific. London’s global clout as a financial hub would protect its pre-eminence and foreign banks would continue to maintain a major presence here. After all, they point out, the UK’s refusal to join the eurozone didn’t harm London’s standing. If anything, the EU would lose out if it refused to do meaningful business with a liberated UK.

Multiple choice

There may only be two options available on the ballot paper, but things couldn’t be less black and white. TheCityUK, a membership body representing the UK financial services and professional services industries, published a report in 2014 outlining eight possible post-referendum scenarios – five for ‘out’ and three for ‘in’. These cover the full spectrum from continued, ever deeper membership to options such as the UK joining the European Economic Area (EEA) and/ or European Free Trade Association (EFTA) Also on the list are the undertaking of bilateral agreements as well as relying on its membership of the World Trade Organisation (WTO) as a basis for trade with the EU.

Some point to the looser ties Switzerland and Norway have with Europe as evidence that there is life outside the EU. Others insist that any similar renegotiations by the UK would be costly, tortuous and could take years to achieve.

Markets recoil from uncertainty and senior industry figures warn that some international banks have already put investment in the UK on hold while the country decides its future. “London’s balloon is deflating slowly,” says one senior investment banker. “All the uncertainty we currently face is like Usain Bolt running with a lump of lead on his back.”

Shadow over London

“The prospect of Brexit is undoubtedly casting a pall over London’s predominance as a financial centre,” agrees Christian Lee, who leads the clearing, risk and regulatory team at Catalyst, a consultancy firm. “There’s a problem with inward investment, because people are thinking more short term than long term and City companies themselves are therefore operating sub-optimally.”

The trend for ‘banker bashing’ is only exacerbating things, he adds, citing the introduction of super-taxes and hefty regulatory fines. “That’s a big deterrent, particularly when you compare London with Singapore and Hong Kong. The UK needs to be far more financial-services friendly.”

Others are less concerned in the short term. “Brexit would not be like Grexit, it would be a slower, more contained and managed event,” says PJ Di Giammarino, CEO of independent think-tank JWG. “From a regulatory perspective, any change in the EU is all about planning for the ‘unknowns’ that will affect the rule books. There are many known Brexit scenarios, but new ones could emerge, including the market changes caused by MiFID II in the run-up to 2017.”

He adds that “firms need to understand all their regulatory deltas and the potential risks inherent in them in order to take a risk-based approach to mitigating their impact. If Brexit did happen, it would not take place overnight. With tens of thousands of pages of regulatory change to digest for next year, I don’t think people have any time to jump up and down about the potential impact of a longer term possibility.”

Being prepared

Are most firms working on a Plan PB – Post Brexit? It’s concentrating minds, says Mark Holland, partner at business transformation consultancy Holley Holland. “What is good is that firms are actively shining a light on how their organisation works in order to be prepared for all scenarios. They’re taking a holistic view, looking at data and their business architecture, where their operations are based and so on. Previously those activities have been put on the ‘too difficult’ pile, but there are so many possible permutations post-Brexit that the best an organisation can do is to be aware.”

As the battle over Brexit heats up, even the most pro-Europe firms agree that there is a clear need for a stronger financial services framework within the bloc, including sufficient protections for non-eurozone countries to avoid a two-speed Europe. Reform is definitely high up the agenda.

Mark Hemsley, CEO of pan-European equities trading venue BATS Chi-X, is convinced that the UK’s interests are best served not only by staying in the EU, but by committing itself wholeheartedly to the project. “In the future, I think we need to be more actively involved in EU and its workings, with more senior people batting for us in Europe. We need to end the uncertainty for the UK so that we can say ‘this is it for many years to come’. It’s a difficult line to play – not only to be in, but to play an even deeper part – but we’re a large economy and have an impactful financial services business. We are a very positive presence in Europe.”

Winning outcome

Simon Lewis, CEO of Association for Financial Markets in Europe (AFME), points to the Capital Markets Union, a flagship project now being developed by the European Commission, as a powerful example of what the UK stands to gain by staying within the EU. “The introduction of the Capital Markets Union would be a win-win situation for the UK. All EU countries are in favour of it, but the country that would benefit the most from its creation would be the UK. It’s one of the many reasons why AFME is so supportive of the UK remaining part of a single integrated market in financial services.”

How will the landscape look five years from now? For referendum, read ‘neverendum’, quips one banker. Whichever way the vote goes, this will be a step-by-step process with many twists and turns ahead.

Ignore all the alarmist chatter, one consultant advises. “There’s a lot of brinkmanship going on but London is not going to wake up one day cut off from Europe. It’s been the centre of financial trading for ever. We’ve got the language, time zone, infrastructure and a legal system that’s the envy of the world. Any changes would definitely be very gradual.”

[divider_line]©BestExecution 2015

[divider_to_top]

Post-trade : Collateral management : Maha Khan Phillips

Ian Rycott

November 9, 2015

COLLATERAL CRUNCH.

Industry participants are coming up with new ways to deal with margin requirements, but regulation has yet to bite, writes Maha Khan Phillips.

According to global consultancy Capco, there is an estimated shortfall of $1.2tn of collateral needed to meet new margin requirements. This is nothing new though. Industry participants have known for some years that the great squeeze was coming. Some firms are more prepared than others however, with a few still lagging behind, according to industry pundits.

“We’ve been talking about this for so long, that people are wondering if we overstated the problem,” says Ted Leveroni, executive director of strategy and buyside relations at DTCC. “The answer is no. We’ve had really good foresight. We looked at the number of regulations that will be implemented and anticipated that there will be a collateral squeeze.”

Leveroni though says it doesn’t matter how great the squeeze is, because ultimately, it comes down to each individual firm to find an individual solution to the challenge. “Firms need to take a two pronged approach. They need to create within their own houses a centralised collateral management team and then place automation on top of that to manage their collateral in one location, so they don’t have a separate repo collateral management team and a separate futures team, and so on. If these processes are managed and optimised from a central location then efficiencies can be gained across the entire firm. Once these processes are in place, firms can begin leveraging community-based infrastructure solutions and utility providers, helping to make the lines between a firm, its counterparties and custodians and different collateral pools more efficient.”

Regulatory challenge

And efficiency is desperately needed. The Dodd-Frank Act in the US and the European Market Infrastructure Directive (EMIR) requires that all OTC derivatives be cleared through a central counterparty (CCP), and collateralised on a bi-lateral basis, with stricter rules on margin, reporting, and record-keeping. With the advent of CCP clearing, collateral requirements increase. Also the benefits of exposure netting are lost due to the fragmentation of trades between various clearers and bilateral counterparties, increasing the cost of collateral funding for the trading firms, according to Infosys.

The International Organisation of Securities Commissions (IOSCO) and the Bank of International Settlements (BIS) has also set out their own, stringent collateral requirements for OTC derivatives contracts conducted on a bilateral basis. Collateral has to be highly liquid and hold its value in times of financial stress, for example. Under Basel III, banks are required to have collateral management policies in place that will control, monitor, and report concentration risk and the reuse of collateral. Their liquidity coverage ratios require more high quality securities.

“Aside from mandatory clearing in the US, most of the drivers that we anticipate will create a collateral squeeze haven’t been implemented yet. These include mandatory clearing in Europe, as well as the global implementation of margin requirements for non-cleared derivatives which are due to come into effect in 2016. So these issues will fire up again next year,” says Leveroni.

Idle collateral

However, Capco estimates that if even just a third of existing idle collateral is mobilised, it would be sufficient to cover the expected additional margin requirements. “Our belief is that there is enough collateral to go around. But it’s being able to access that collateral, that hasn’t been leveraged properly. It means using internal models, and the more active use of things like tri-party offerings to sweep up bits of collateral,” says Samit Desai, principal consultant at Capco.

Capco estimates that the initial margin for non-centrally cleared trades will be $700bn, while the initial margin from cleared trades will be $260bn. The increase in variation margin is estimated to stand at $100bn, while the increased margin due to more stringent segregation will be $70bn. Finally, the default fund contribution will be $40bn and a $30bn increase in demand for collateral from a narrowing of eligible collateral schedules and stricter haircuts will occur.

The firm believes that multi-lateral netting and more efficient practices around clearing will considerably reduce margin requirements in CCPs, and make clearing even more economical. Positive developments include cross-product margining policies, where collateral requirements can be netted or shared amongst multiple asset classes.

Optimisation

Ultimately, all eyes are on optimisation. Mike Payne, associate partner at Delta Capita, believes that firms need to put together a holistic view of collateral, and that means more than just bringing teams together in-house. “There are three problems, you need to increase and optimise the use of collateral, you need to optimise the team, just by bringing the team together; it doesn’t give you any people efficiencies. Finally you have multiple technology solutions with high costs, and without a radical change through looking at that operating model and the technology around it, these costs and efficiencies will remain high and inefficient.”

Delta Capita points to new big data technologies that help, such as Apache Hadoop, the open source software for distributed storage and processing of very large data sets, and Apache Cassandra, a distributed database management system.

Optimisation also means centralising external managers, says John Southgate, head of derivatives product at Northern Trust. “Collateral management is about trying to be as efficient as possible in your use of collateral. Pension funds have multiple underlying managers and historically they have let those managers manage the collateral for them, and that’s inefficient because you have multiple pools of collateral. So now asset owners are taking responsibility of collateral away from their managers and are centralising it.”

Cash crisis

Other challenges also exist, that will have an impact on costs and efficiency. “We are now seeing intra-day valuations being required,” says Noel Montaigue, senior EMEA manager at trading and risk management platform OpenLink, “Without the right tools, and capabilities in-house, the cost of these functions inevitably goes up significantly. This in turn negates the historic benefits and savings of having valuations outsourced or solely supported by some sort of external third-party,”

There is also a challenge around cash requirements. “Because of the new liquidity capital ratio rules coming out of Basel III, you have many considerations about whether to keep more cash in hand. But then using securities for collateral also has an impact on post-trade considerations. IT becomes quite operationally challenging, and that’s where automation is important,” says Jan Vendel Peterson, domain manager for asset services at SimCorp.According to ISDA’s Margin Survey 2015, there has been a 6.2% drop in total collateral for non-cleared derivative transactions, down to $5.01tn. However, the total proportion of cash pledged as collateral has actually increased by 6.7% to 76.6% of the total.

“This is evidence to me that the industry has failed to optimise collateral,” says Giles Kenwright, associate partner at Delta Capita. “We’ve seen lots of inefficiencies around the use of collateral. Cash is an expensive form of collateral due to funding costs. Globally interest rates are at historic lows and as they inevitably start to rise, cash collateral will become increasingly costly.”

Northern Trust’s Southgate says that there is no room for complacency. “The timelines in Europe have been extended significantly, which has allowed some of the clients who were potentially lagging behind to catch up. There is a risk however, of leaving it too late to establish your clearing relationships and infrastructure. There are a limited number of clearing houses in Europe that will win the bulk of the clearing business, and the top tier clearing members are becoming more picky or selective about the types of clients that are on board.”

Capco’s Desai says that some firms are more prepared than others. “Many firms have already initiated programmes to enhance their models to cope with new requirements, but it is far from simple. They know what they need to do but there is no silver bullet answer that will help with all organisations, no one size fits all solutions. Technology solutions and individual process solutions must be highly configurable, because each client has a different strategy and a different need in terms of the market that they operate in.”

[divider_line]©BestExecution 2015

[divider_to_top]

Derivatives trading : Announcement : London Stock Exchange and Borsa Istanbul

Ian Rycott

November 9, 2015

TURKISH DERIVATIVES LAUNCH ON LONDON STOCK EXCHANGE DERIVATIVES MARKET.

Be30-LSEG-IstanbulSX-960x503

In September 2015, London Stock Exchange Derivatives Market (LSEDM) launched trading in Lira denominated futures and options on the BIST 30 Index, Turkey’s leading index. Central counterparty services on these new contracts are provided by LCH.Clearnet.

The launch follows the signing of a partnership agreement between London Stock Exchange Group and Borsa Istanbul earlier in the year, confirming closer collaboration between the two exchanges on derivatives products. This will be followed by the listing of options and futures on selected Turkish stocks. The partnership was sealed at a special signing ceremony held in London and hosted by Ahmet Davutoglu, the Turkish Prime Minister.

London Stock Exchange Derivatives Market

The agreement is an important step in the ongoing development of London Stock Exchange Derivatives Market, presenting our global client base with the unique opportunity to trade and clear Turkish futures and options in Europe. In addition it underlines the Group’s commitment to enhancing London’s position as the world’s most global capital market, whilst working with Borsa Istanbul to help boost its liquidity and appeal to global investors.

Turkey is the latest overseas market to join the Group’s leading international derivatives marketplace. The market already actively trades Russian Depositary Receipts, Index and Dividend derivatives. We also operate a linked order book model with Oslo Børs to enhance Norwegian liquidity, as well as futures and options on the FTSE 100 Index.

The goal with any new product of this type is of course to build liquidity quickly and we are actively seeking support from market making firms. That stems from our strong desire to provide both order book and trade reporting for these products from day one.

Alongside a vibrant local market, Turkish equity derivatives are traded OTC by most foreign investors. In particular, equity swaps and CFDs are still widely dealt and settled bi-laterally but regulatory changes and the implementation of Basel III will inevitably increase OTC trading costs. While CCPs have started clearing selected OTC trades, we believe that the availability of exchange-traded contracts will accelerate the convergence towards centralised clearing with substantial benefits in terms of trading and collateral costs.

The opportunity created by listing Turkish products on London Stock Exchange Derivatives Market will be to facilitate this process and provide the added benefit of efficient price discovery through a central order book. That’s in addition to the flexibility normally associated with OTC products through the availability of flex contracts.

Building Turkey’s global ambitions

As one of the most exciting emerging markets in the world, Turkey is in a key position to help shape the global economic agenda. Furthermore, with a near trillion dollar GDP, export-oriented economy, and dynamic corporations, its capital markets exhibit enormous potential. And London Stock Exchange Group is the natural trading and index partner for Borsa Istanbul as Turkish capital markets rapidly develop into a major regional financial hub, alongside the Istanbul Financial Centre initiative.

Indeed, LSEG has a long history of partnering with ambitious markets around the world, using its expertise in technology and product development to help boost the ability of fast growing economies to access the unparalleled pool of international investor capital in London.

This openness to partner with other markets is a defining characteristic of LSEG, reflecting its commitment to Open Access: partnering with other exchanges such as Borsa Istanbul as it builds on its ambition to become a major regional financial centre. Crucially, this type of partnership is built on the mutual recognition that it will enhance activity on both markets, offering an easier route for international investors.

The growth of derivatives products in emerging markets has remained strong in the last few years and activity has become more global. Increasingly, equity derivatives business is transacted cross-border and no longer dominated by domestic participants. As a result, the co-operation between exchanges in established markets and their emerging country counterparts will further develop this internationalisation, diversify the nature of market participants and facilitate a more open trading model globally.

www.lseg.com

[divider_to_top]

Derivatives trading : Algo trading : Benedict Cheng : GreySpark

Ian Rycott

November 9, 2015

RISK ASSESSMENT.

Benedict Cheng, Managing Consultant and COO Asia-Pacific at GreySpark considers the main challenges of algorithmic trading in listed derivatives.

Since the late 1980s, advances in computer processing power have created a broader sphere of capital markets trading methods that allow for an increase in process efficiencies and the expansion of trade execution methods. As a class of instruments, trading in listed derivatives is largely electronified, with algorithms used to execute 40%-50% of all transactions. With growing adoption, proper management of algorithmic trading systems and high-frequency trading (HFT) systems is becoming increasingly important for the sound functioning of markets. This management starts with an understanding of the impacts and risks associated with using these types of systems so that a proper risk management framework can be created.

Algorithmic trading of derivatives is predominantly done in the US, followed by the UK, Japan and Australia. In those markets, the algorithmic trading of listed derivatives is popular because the markets there have more depth with respect to two-way liquidity, and as such transaction costs are relatively low. There are also more market participants, making the price discovery process more efficient. Additionally, in those markets, exchanges have adopted circuit breaker safety mechanisms that give investors reassurance if something systemic goes wrong, allowing stepping in and prompt suspension of trading. Some markets, such as the Hong Kong Stock Exchange, have not adopted circuit breakers, and the stamp duty charged on listed derivatives trades remains high compared to other markets for the instruments. This means that the cost of transacting large numbers of trades over a very short period of time via algorithmic or HFT systems is not economically justifiable.

The volume of algorithmic trading activity in listed derivatives relies on the fact that many of those trades are triggered by an auto-hedger, which is a tool for speculation. For instance, sovereign wealth funds typically deploy algorithmic trading strategies via investment banks to sell down block size trades, which allow them to exit strategic investments over a period of time without disclosing their identities and without creating additional volatility in the market. This type of algorithmic trading strategy is typically used for hedging or risk management purposes. On the other hand, a hedge fund – in order to conduct risk arbitrage or generate alpha on certain assets using a relative value type of pair trading strategy – would seek better pricing and execution levels for transactions in its book of algorithmically-traded listed derivatives. This is why hedge funds use HFT systems and strategies to assist them in the price discovery process.

Challenges and risks

The leading risk associated with algorithmically trading listed derivatives is often not the trading system, but adverse market conditions that represent extreme conditions that, in all likelihood, the algorithm being utilised was not tested for.

Broadly, there are two categories of fundamental risks for market participants using algorithmic trading systems for any asset class, which are: the sensitivity of systems, and feedback loops. As the sensitivity or aggressiveness of an algorithm increases, especially in the case of HFT, so does the overall risk of market instability. Trading algorithms are non-linear in their processing of market information to generate trades. This means that, with listed derivatives, small differences in the input of data into an algorithmic system can produce large differences in the outcomes that system can potentially create. If a system becomes hypersensitive or overly aggressive, then even small events can have noticeable results. Also, the faster the trading system, the faster adverse changes can appear. Even if these adverse changes have a short-term negative effect, recovery of lost system functionality can take a disproportionately long time, especially if those negative events accumulate rapidly.

In HFT, malfunctioning algorithms can combine with market conditions to generate feedback loops. HFT algorithms typically trade and hold small positions for a short time, and they use market reactions to determine when to place the next order. If the HFT algorithm fails to process feedback from previous trades properly, then it can create a negative loop of miscalculated trades.

Additionally, the main risk of algorithmic trading in derivatives is the ability to have controls monitoring risk exposures intra-day wherein the unintended accumulation of a large position in equity futures, for example, could result in a trading firm undertaking excessive risk before end-of-day risk processes take effect. Meanwhile, technology failures, exceptional or unanticipated market conditions or even the unexpected failure of the algorithm during the day may prompt the firm to take on significantly more overnight risk. The 2012 Knight Capital algorithmic trading malfunction was caused by an order routing system running an algorithm to execute orders in accordance to specific signals. One of the criticisms around algorithmic trading is the lack of sufficient testing; however, regulators globally are working on numerous proposals designed to strengthen algorithmic trading risks and controls.

Another challenge in algorithmic trading is related to the need for available liquidity. When there is a lack of two-way markets, it will be difficult to find an accurate mid-point price between the bid and offer of a trade. Even if there is ample liquidity, there are also issues surrounding latency with respect to market data such as the time lapse between direct execution and consolidated securities industry pricing or pricing from market data providers such as Bloomberg and Thomson Reuters. Meanwhile, technology efficiency and speed in assessing, transmitting, normalising and computing a mid-point price for a trade in any instrument also influences the ability of a trading venue to generate the best bid/offer for a listed derivative and to develop a precise mid-point and affix that to a matched trade.

HFT is closely associated with the effectiveness of dark pools when liquidity levels in lit markets are low, leading to a greater tendency to transact listed derivatives trades with resting orders at off-market prices in dark pools rather than at best-bid-offer prices. Consequently, there will be a higher rate of suboptimal fills when dark pools are unable to price trades accurately.

More importantly, if a trade execution system uses prices as a priority rather than taking into account the amount of available liquidity, then the dark pool venue will not be deemed as efficient by an algorithm and will make HFT less attractive or impractical to function as expected.

Overcoming challenges

With reference to what can be done in mitigating algorithmic trading risks, risk controls should play a big role with respect to the robustness of both inbound and outbound risk firewalls as the key risk management gatekeeper. Controls around order completeness are keeping pace with the technological complexity and trading speeds of new algorithms, and they can be used to reduce the risk that an erroneous or destabilising order will reach the markets. More importantly, risk controls should also take into account the governance and oversight of risk-taking activities so that they can be aligned to the firm’s risk appetite framework and consistently applied.

GreySpark Partners observes that the level of awareness for adopting sound risk controls is high among Tier I and Tier II banks. However, with the lower-tier regional or local banks, the level of awareness would have been lower. Smaller banks want to compete with the big boys. They may want to improve latency by moving some of the risk controls to post-trade. That way they are hoping to remain competitive from an execution speed point of view. Alternatively, some smaller banks are not yet operating at the same level of sophistication as their Tier I or Tier II competitors with respect to their risk controls environment. As a result, there may be gaps in the overall picture of market-wide risk control mechanisms for listed derivatives trading.

Regulations are expected to prompt banks to invest more into further enhancing the robustness of existing risk controls frameworks. More flash crash incidents will definitely expedite this process. However, the effectiveness of the management of risk around algorithmic trading in every organisation is a function of organisational culture, the availability of resources to improve controls, the sophistication of regulations, requirements from trading venues and supporting vendor offerings.

[divider_to_top]

Derivatives trading : Andrew Willis : SGCIB

Ian Rycott

November 9, 2015

SEEING THE BIGGER PICTURE.

Andrew Willis, Head of Exchange Traded Derivatives execution, Global Execution Services at Societe Generale, spoke to Best Execution about the challenges and opportunities of incorporating derivatives into a truly cross-asset trading operation.

Trading cross-asset class and breaking down the silos is not a totally new phenomenon. How long has SGCIB been trading cross-asset class, what are the drivers behind this trend and what has been the impact of regulation?

Societe Generale has always been agile in reacting to changing client needs and the evolving market place, and in common with many other large global banks, has historically offered various cross asset solutions to its clients. The integration of Newedge into Societe Generale’s Global Markets division and creation of Prime Services brought an opportunity to develop the cross asset model and improve co-ordination, centralising agency cross-asset execution.

It’s a dynamic industry that without doubt is getting smarter, maturing and adapting to new markets, access, products, and different investment appetites, with an increasing focus on risk management whilst searching for alpha. This is true across the investment process, from decisions on asset allocation through to execution, where implementation alpha can be captured or lost.

This, along with changes in regulation, has resulted in renewed focus in technology, from cross-asset order management through to advancing execution tools, with improved risk controls as products and markets become more (electronically) accessible. This has in turn lead to greater centralised governance; controls and risk management need to align as processes across asset class begin to harmonise, specifically within the agency model.

The electronification of access and various market microstructures has therefore brought many synergies across asset classes, both in terms of tools and costs. And it will continue…, but this also brings significant challenges, for example managing the skills curve, applicable to both buyside dealing desks and sellside service providers.

Regulation of course remains a major catalyst, if not the most significant, and will continue to drive change in market microstructure, transparency and liquidity, and therefore the access to trade and execute. But the “big bang” events, with technology and an evolving controls focus, are now becoming more manageable, albeit increasingly costly.

What impact will MiFID II have on this trend?

MiFID II will undoubtedly accelerate what we’ve already seen, including new controls frameworks with both implicit and explicit measurements. I believe there will be growing focus on cross-asset best execution, which is already well underway, with renewed transparency and further microstructure changes a certainty. As we witnessed with the first EU parliament legislation (MiFID), new product providers and technology will have to respond. We are already starting to see this with GMEX and ERIS for example, and Societe Generale’s cross asset Prime Services and Execution services are already well positioned to respond.

In the derivatives space, what lessons can be learnt from the cash equity markets in terms of transaction cost analysis (TCA) as well as trading? Are you seeing a greater demand for execution tools?

We are indeed seeing a greater demand for cross-asset execution tools and I see that trend continuing in the agency service model. Fragmentation changed the cash equity market place and the industry had to adapt quickly, triggering the rapid development of new technology. The importance of TCA promptly grew alongside, as navigating new venues and utilising increasingly intelligent tools required greater, more detailed monitoring.

Execution and TCA now go hand in hand and we offer both Cash Equity and Futures TCA services. We’ve seen increasing TCA requests from clients executing listed derivatives and expect this theme to continue into other asset classes as the market microstructure evolves. Electronification and the importance of execution as a source of investment alpha will drive this trend.

How are algorithms being used in the derivatives space?

The use of algorithms in the listed derivatives space depends on a number of variables: the underlying asset class, market microstructure, client type and the investment objectives. It’s an interesting challenge trying to meet differing needs, whether building more sophistication on top of current strategies or engaging in relatively new products or styles. Historically many of the service offerings have been leveraged from legacy cash equity modelling, simple time weighted or POV (percentage of volume) strategies. However the full integration of Newedge into Societe Generale has created a unique opportunity, with bespoke asset-focused algorithms dedicated to cash equity and listed derivatives, complementing and enhancing our existing portfolio of global strategies. We have seen increasing focus on specific asset class microstructure and, as a result, a rise in customisation requests that have previously been commonplace across cash equity. We are already well into our investment programme, listening to our client requirements and providing specific solutions whilst preparing for increasing cross-asset electronification.

How is the integration of Newedge and SocGen progressing and what type of products can clients expect?

Prime Services is now a fully integrated business line within Societe Generale’s Corporate and Investment Banking’s capital markets.

Further to developing our existing cross-asset prime brokerage and clearing model, Global Execution Services provides innovative execution solutions across global cash equity and listed derivatives.

We have unrivalled access to 125+ global markets and exchange venues, with a single order and execution management platform, operating a 24/6 ‘follow the sun’ global coverage model.

Algorithms and engineering are in our DNA: our Algorithmic Execution group is a global team of cross-asset quant traders and developers that sit within Global Execution Services. The focus is to continue developing an already established platform with cross-asset execution a key focus for the bank, supporting Prime Services and preparing for the evolving market environment.

Retaining pre-eminence in the changing world of prime brokerage and execution, Societe Generale has already made investments in GMEX and ERIS.

[divider_to_top]

1...568569570...673 Page 569 of 673

.cls-8{fill:#fff;stroke-width:0px;}

READING BETWEEN THE LINES.

Frances Faulds looks at what tools are being developed to help investment banks monitor client flow and avoid market instability.

BATS PAYS FOR ETF LISTINGS.

BATS Global Markets is hoping to grab a bigger share of the exchange traded fund pie with the launch of BATS ETF Marketplace, which will pay ETF providers as much as $400,000 a year to list on its trading platform. Payments will vary depending on average daily volume.

LCH.CLEARNET SETS A DATE FOR CROSS MARGINING SERVICE.

LCH.Clearnet, the world’s largest clearer of interest rate swaps, is preparing to launch its long-anticipated cross-margining service in early 2016 to coincide with the start of mandatory clearing of interest-rate derivatives in Europe.

LIQUIDNET DEBUTS FIXED INCOME PLATFORM.

Liquidnet, the institutional block trading network that made its name in trading equities, has launched its Fixed Income dark pool that facilitates direct, peer-to-peer trading of corporate bonds among asset managers in the US, Canada and Europe.

THE FINER POINTS OF MIFID TECHNICAL STANDARDS.

BREXIT: FACING THE UNKNOWN.

Louise Rowland presents all sides to the arguments.

COLLATERAL CRUNCH.

Industry participants are coming up with new ways to deal with margin requirements, but regulation has yet to bite, writes Maha Khan Phillips.

TURKISH DERIVATIVES LAUNCH ON LONDON STOCK EXCHANGE DERIVATIVES MARKET.

In September 2015, London Stock Exchange Derivatives Market (LSEDM) launched trading in Lira denominated futures and options on the BIST 30 Index, Turkey’s leading index. Central counterparty services on these new contracts are provided by LCH.Clearnet.

RISK ASSESSMENT.

Benedict Cheng, Managing Consultant and COO Asia-Pacific at GreySpark considers the main challenges of algorithmic trading in listed derivatives.

SEEING THE BIGGER PICTURE.

Andrew Willis, Head of Exchange Traded Derivatives execution, Global Execution Services at Societe Generale, spoke to Best Execution about the challenges and opportunities of incorporating derivatives into a truly cross-asset trading operation.

.cls-8{fill:#fff;stroke-width:0px;}