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Out With The Old, In With The New

Roger McAvoy, Regional Sales Director – Institutional eFX Sales, Asia, 360T Trading Networks examines ongoing transparency initiatives in FX trading.
Q3_15_Roger McAvoyThere are many reasons why the call for greater transparency in FX execution, pricing and quote management practices are coming under review. Remarkably, this has accelerated only in the recent past, particularly as a result of public scrutiny and media attention. This centred around prominent court cases in the United States where public pension funds sued their custodians for uncompetitive FX pricing practices going back to 2009, and won (see Global Custodian). Since then, the media has regularly reported on a range of issues on FX pricing practice by certain banks, including the widely-used WM/R 4PM fix. This has accelerated the push by asset owners and regulators to demand improvements.
Asset managers are taking a closer look at their “best execution” policies to ensure their own guidelines for FX execution and counterparty management are well defined. Many firms are also taking greater control of FX execution centrally as a way to tighten their own fiduciary duty to their clients, and to reduce reliance on past practices such as “auto FX”, the use of standing instructions, chat messaging, and single-bank non-competitive pricing.
Most recently, the Bank of England, along with the HM Treasury and the UK Financial Conduct Authority have laid out a body of work known as the Fair and Effective Markets Review Final Report, which covers the FICC market microstructure, structural issues and standards that will be discussed and debated throughout 2015. This will result almost certainly in further changes to FX market “best practices”.
The new era of FX trading
Much like the equity markets of recent past, the OTC FX and FX derivative markets are undergoing rapid change in the way liquidity gets sourced, priced and distributed. As a result, the buy-side trading desk now faces greater choice in technology, analytics, and liquidity provision than what past practice or past providers have been willing or able to deliver. And with that, comes the need to measure if that choice is the right one, given the pre-trade decision support tools data, analytics, and execution options available. And, before making a change, the buy-side needs to know how the new regime is better, not just different. Access to the right analytics is fundamental to exploring the alternatives.
In equities, there was a convergence of best practice that resulted in greater adoption of algorithmic trading, direct market access (DMA), and a shift from single-broker execution management systems (EMS) into the next generation of solutions. These included greater broker-neutral EMS, OMS and transaction cost analysis (TCA) capabilities. The role financial technology providers have played in electronic trading has expanded greatly over the years. This has resulted in greater buy-side control of execution, and, at the same time also more responsibility on asset managers to make the right choice of solution providers that truly support their interests and those of their clients.
In FX, more asset managers are taking a closer look at the trading technology and the depth and breadth of the data and analytics available from their counterparties and solution providers in order to better understand and control the cost of execution. Some will take it a step further, seeking openly to drive operational alpha and trading alpha to improve performance for their clients. Meanwhile the willingness of bank counterparties and their ability to absorb clients’ risk as principal is changing, and the shift to an agency-only model will make the use of technology to manage more pools of liquidity even more relevant to the buy-side trader.
The days of “processing” FX trades as “part of the exhaust” of the underlying equity and fixed income exposures, or to reduce operational-risk at the expense of cost management, are changing. It is evident asset managers are taking more control across asset classes and they need a richer set of data to monitor counterparty behaviour and pricing – not only to minimise explicit and implicit trade costs, but also to achieve and document best execution as a part of their fiduciary responsibility to their clients! This is especially important in the OTC FX markets where price formation is mostly bilateral, based on credit, relationship, or the discretion of a sales trader given the client and market information at hand.
Independence and buy-side focus
Asset managers have long-embraced the value of using broker- and bank-neutral technology and relationships to aggregate pricing, execution methods, and the ability to compare transaction costs in a non-conflicted manner to protect their clients’ interest. In FX, this is also a major reason why the use of multi-dealer trading technology has gained favour.
In today’s ecosystem, asset managers need to think about which technology providers are incentivised to assist the buy-side dealing desk reach below the surface to get a true picture of pricing, price latency, and executable quotes across trade size and tenors, for example. While many service providers may be able to talk about what they can do for G10 currencies, or simple FX Spot, most international asset managers will require access to liquidity across G10, emerging markets, forwards, swaps, and more exotic currencies, including NDFs, and the ability to get auto-pricing on block trades.
Achieving real transparency
In FX, how you look at the cost of execution relative to your eligible liquidity pool is more relevant than looking at the broad market “indicative” rates or synthetically-generated benchmarks of liquidity pools you can’t trade into.
Interestingly, in October 2014 TradeTech FX Survey reported that 56% of respondents stated that both equity and fixed income trading costs were as important as FX trading costs. At the same time, 56% also felt that TCA was the most important technology to improve execution in FX. However, while TCA may be clearer cut for equities, there are far greater challenges in attaining a meaningful result in FX given that price formation and benchmarks are less transparent and not as clear cut. To paraphrase, in FX, “a price is not a price is not a price!”
Having access to all of your own data, measuring price and spread according to currency pair and volume, speed, execution method, effect of blocking and netting, and effect of restrictions on fund counterparties are all factors that need to be measured – not just capturing the mid-price at point of execution.
Finding the right partner to make the strategic shift
The pace of change in the FX markets will continue to accelerate. On the one hand, this will be driven in part by regulators, and on the other, banks will adapt to optimise their capabilities and balance sheets to provide liquidity and their own technology and other services to capture client order flow in a more profitable manner. To navigate in this new world, asset managers need to consider how far and how deep their current technology providers are able and willing to go: engaging with those that deliver transparency and buy-side focus as an independent provider has its benefits.
Bottom line: the FX markets offer their own unique practices relative to equities and fixed income. The buy-side dealing desks that are considering a strategic shift from the practices of the past to new standards of the future, may benefit from taking a closer look at newer technology providers in the asset management space who have a track record for delivering price transparency, facilitating broader and more consistent price competition, and driving open collaboration. Those that do may find themselves better informed with a more powerful lens to navigate the future.
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A More Efficient Stack

Michel Balter, CSO of CameronTec outlines the questions to ask and rules to follow when optimising a bank’s trading architecture.
Q3_15_P42_Michel BalterRecently, we sat down with 30 of our biggest sell-side clients to discuss their trading architecture, pain points, lessons learned from recent years, their concerns for the future and what they are doing to improve their businesses today.
Inefficient architecture is the most common issue we heard about. After buying any technology required to close a deal during the boom years, combined with layers of acquisition and geographic expansion, different systems were not only siloed by asset class, but duplicated across regions and business lines.
Beyond these legacy issues, policies within banks were also responsible. Consider the degree of freedom within teams to determine their FIX infrastructure for example. Large banks never have one FIX provider. This freedom was tolerated because the technology could be on-boarded quickly, but now there are inefficiencies in the architecture. This is a real problem when it comes to basic functions, such as monitoring, efficiently on-boarding clients and testing systems.
Migrations are also a challenge for inefficient systems. The more solutions a firm has, the more migrations it will have. In a chain of 20 solutions, migrating one may require changes to 15 others, which creates potential headaches assuring quality. Addressing these problems takes time, which used to be solved by hiring people but firms can no longer afford that.
Large banks with reduced headcount often focus on day-to-day operations, and the time required to update systems to comply with regulatory changes is exponential as the number of systems increases. Some banks have exited businesses because the cost of maintaining compliant infrastructure is prohibitive.
We have also seen a power shift within banks. The power used to be with IT, but now it is more with
the business after the financial crisis. Banks are spending less, so everything is validated by the business. More and more, IT is sponsored by the business, and the business makes the ultimate decision.
Untangling your system
We advise banks to go through an infrastructure assessment to find their inefficiencies. A common issue our clients identified was that different teams are writing code without notifying other teams. When staff leave the company and a new person takes over the attitude is often ‘if it works, I do not have the time to change it’, because there is no documentation.
The most important decision is to simplify. Best practice in this area is about creating business rules for the entire flow: documentation to ensure the process can be taken care of if someone is not there; making infrastructure easily configurable rather than writing custom rules. Trading desks should shift from writing rules, which hide business intelligence, to customizing via in-built functions.
It is important to work with a partner that provides more than software solutions. A flexible partner should empower banks with best practice and readymade templates so the client can progress to the next level on their own. It is a bad sign when your provider says, ‘you only need to rely on us’. That is not a serious position.
Ultimately, efficiency is about the architecture. The first recommendation is to decouple the front office, market layer and the backbone layer, from any subsystems. There will always be disparate subsystems, but if client connectivity is coupled to a vendor platform, a firm may lose the connectivity via the vendor. As banks consider their regulatory and risk management requirements, decoupling allows a concentrated view across clients and each of their connections.
Asking the right questions
The first questions large brokerages should ask themselves are what are my inefficiencies and how can I better manage them. The reality often is that firms may not know what issues they have. Firms should ask their partners to tell them about their inefficiencies as well as the different approaches to addressing them. The solutions vary widely depending on how quickly a firm is ready, willing and able to implement change.
Another question brokers should ask is what are my peers doing and how has it worked. These provide invaluable insights that would otherwise be difficult to obtain.
In my experience, most firms plan about three years out. They need to plan farther to think what are the challenges of tomorrow and how can they best serve their clients today. Bear in mind, IT staff have two clients: the internal business owners and the external clients, each of whom have very different needs.
Building an architecture that is scalable will allow a broker to meet clients’ needs today and position the firm as a leader of innovative high value services which increases competitiveness.
Take back your stack
Here are four steps to take back your stack.
#1 No shortcuts.
Brokers must assess their existing flows and then translate those existing flows into better processes and architecture to improve efficiency. This process has no shortcuts. If you don’t go into the details of the flows, from the end point at the client connectivity level to the trading and the back office integration, valuable business knowledge may be overlooked.
#2 Integrating business logic into flows.
If business logic is well-integrated, it will greatly increase the effectiveness of risk controls. Many systems employ strong risk solutions, but apply them at the wrong end of the cycle. Order modification after the risk check often does not pass through the risk check again, which may result in a failure. The client can do something they are not allowed to getting both client and broker in trouble with the regulator. Designing business logic into the architecture is very important.
#3 Know your business.
As an external provider we are required to understand our client’s business, and so should the bank’s IT team. It is wrong, when improving efficiency is to only have the IT team in the room. Efficiency is achieved through infrastructure but it begins with knowledge of the clients’ needs, which usually sits with the business and the on-boarding team. The on-boarding team knows what type of business the client wants to do, what testing they have implemented, which type of orders they prefer, etc. Improving architecture should involve the business and IT as well as processes like risk and compliance.
Banks should not underestimate the number of people involved. Occasionally, we see a situation where management wants to do something and fears that the IT will block it, so they drive the change with minimal disclosure. That will not work. The best way to get to an honest solution is to include everyone in the process.
#4 Automate processes.
How can firms best improve efficiency? The most effective answer is the automation of processes and controls. Among our clients, about 70% perform manual FIX testing and 30% use automated testing. The most efficient testing system is a continuous testing service.
The on-boarding process has much that can still be automated. The solution most banks use is a certification utility, which can be locally deployed or accessed via a hosted solution with on-demand testing. The reality is that on-boarding is about much more than just certifying a client’s system.
A number of our clients are automating the creation of business rules specific to each client. In the certification process they test the rule in the broker UAT environment and automatically transfer it into the client’s production environment.
After speaking with many clients and leading brokers, the best way to for banks improve efficiency is to optimize the architecture itself. Only then will they be in a position to go after the next business goal and capture the next wave of growth.
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How Prepared Are You?

With Lisa Toth, Head of US Risk, Compliance and Regulation, Hatstand
Q3_15_Lisa TothThere has been a lot in the press over the last year on not IF you will experience a cyber-related event but WHEN. With this in mind, every firm should have a clear understanding of their cybersecurity preparedness not only to external threats, but also to internal ones. A sound cybersecurity program should cover governance, asset definition, communication protocols, incident management, employee training, resource assignment and accountability, current threat awareness (internal and external), control deployment and disaster recovery/business continuity.
Early in January 2015 the Securities and Exchange Commission (SEC) released guidance on their expectations for cybersecurity programs for registered advisors and funds, identifying what they would be looking at during their 2015 exam reviews. In May, the SEC further recommended that investment companies and advisers consider assessments of their cybersecurity controls, strategy and procedures. This theme from the regulators has been picked up globally, encouraging firms to take a more proactive view of their risks; benchmarking where they stand today and put in place a plan to close any identified gaps in their current cyber defence practices. This benchmarking process should not be a one-off exercise but rather a continuous, periodic process, to show key stakeholders that each firm is taking their cybersecurity risk management responsibilities seriously and being able to evidence this through comparing their progress against their baseline assessment.
In terms of resources, there are a few assessment tools and frameworks that can assist in this process, as well as consulting firms that are well versed in running these assessments. The building blocks commonly used by the financial industry are provided by the National Institute of Standards and Technology (NIST) Cybersecurity Framework, the Council on Cybersecurity (CCS) Critical Security Controls and, just released in June, the Federal Financial Institutions Examination Council (FFIEC) Cybersecurity Assessment model.
The value of the assessments is to give management a very clear picture of the key assets that need to be protected as well as identifying where the firm is most vulnerable in regard to these same assets. Firms can then use this knowledge to plan and make provision for the right balance of defensive controls versus the cost of implementation, supplemented by policies and procedures.
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Cyber Security And FIX: A Time For Focus

A panel discussion, with Marcus Prendergast, CISO, ITG; Michael Cooper, CTO Radianz, BT; Tim Healy, Global Marketing and Communications, FIX Trading Community; Tom Jordan, President, Jordan & Jordan.
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Why cyber security, why now?
Michael: I’ll just focus on three things very quickly. I think one point I’d make is that as a group, we have focused on security in the context of the FIX protocol for some time, it’s not necessarily something that is new. It is just the latest iteration with regard to considering security in a FIX protocol context. Two, I think the landscape and the attention on security makes it a prudent time to review the security of the protocol, even in the absence of any direct threat. And I think increasingly, all of us have been touched by security or have to consider it in the context to which we operate, especially as time goes on.
Marcus: Just to build on that, I’d say we’re focusing on being proactive and trying to stay ahead of any new potential major attacks on the markets.
Why embed this process within FIX and the FIX Trading Community?
Marcus: The firms themselves have been focusing on their own information security and investing in that very heavily over the past 5-7 years, and we are realising that we have a couple of points of commonality. FIX isn’t the only element but it is a major common mechanism of exchange and as such it needs to be evaluated and assessed for security. The challenge is that it doesn’t just extend to the edge of a firm, the edge of a network, it extends downstream. So now we’re having a conversation looking at how firms have invested in their information security together with how they secure what they are sending downstream, and what is being accepted coming upstream. FIX seems to be a good common point. FIX is the common core protocol used across the industry and now we’re trying to have a conversation on how we secure that as a group.
Tom: I think the reason why FIX is important is because it is the language of trading. The industry cannot run without FIX, and while it used to be principally for equities, FIX is now applicable across the entire trading process and across multiple asset classes. We do a lot of work in post-trade, we use FIX going into the clearance and settlement process and those roles are expanding all the time. FIX is so integral to the capital markets that we have to be proactive because all of us are so dependent upon the use of FIX.
Michael: As an additional point, this is absolutely not the only place to look at security. We have to examine security in a holistic manner. However, the FIX Trading Community is responsible for the protocol. It has a responsibility to look at security, and by building this working group we are taking that responsibility seriously. It’s highly appropriate and the right thing to do. If you look across the industry, this is one of a number of times to review how we operate as an industry in the context of changing environmental backgrounds.
This is a global issue and the ability of the FIX Trading Community to respond on a global basis is a strong and compelling point. There is definitely an invitation for everyone to be engaged in this initiative. It does affect everyone and we will welcome everyone’s input into it.
Tim: Within FIX we do have the entire industry represented. We’ve got vendors, brokers of all types and sizes, exchanges, the buy-side etc. We have constituents of the whole investment process involved within the membership and getting involved in a working group is the next stage to that.
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Marcus: I think it shows our commitment long-term to the protocol. It’s amazing that over the past 10 years we haven’t had something private replace it. That just shows the commitment of the various members to keeping the protocol not just up to date and relevant but also to address these new concerns as they come in, and as these security concerns evolve to ensure that we’re keeping ahead of it as best as we can.
Immediate goals of the group?
Marcus: The first thing is to assess the concern as a group, prioritise what can be addressed and then we will develop a couple of items that are going to come out in the short term, including an updated white paper. We’ve had a white paper on FIX security that’s been out there since 2008, which is something I want to focus on. We need to update that for the community and look at what can be done next, over the coming six months, one year, and five year horizons to better secure FIX for the industry.
Michael: One of our goals is to collaborate and share knowledge in terms of a free and defined best practice. A key part of the general response to areas like a cyber security threat is how we share information amongst the industry.
The element of sharing is a thread that runs through pretty much all FIX working groups. One of the reasons that I think cyber security is a growing focus for the industry is that there is an ever expanding universe of hacking tools; the ability to leverage technologies like cloud and collaboration makes it easier to find and exploit vulnerabilities. One part of this group is that we’re responding to that by seeking to collaborate on our side of the issue, and FIX has the concept of the working group which has set ways and processes of sharing that vital information.
To what extent is this always going to be fire fighting?
Marcus: Much of the battle is simply about making sure that FIX isn’t a significant area of vulnerability. While we have spent money individually as firms protecting our infrastructure, now we’re working to make sure that FIX implementations are protected industry-wide.
Michael: The threat is a constant and we’ve clearly been looking at this problem, and increasing our awareness for some considerable time. I suspect we will always be conscious of it. Some of this discussion has to evolve around how we design the protocol to minimise if not totally mitigate the risk, and as Marcus says, to make sure we are not an area of vulnerabiity. But it’s almost definitely not going away and I think this awareness accounts for a lot of the activity and action across the region with regards to what the regulators are looking at. And that regulatory conversation is definitely developing.
Marcus: I’ve been involved with the SEC’s ongoing cyber security review, and they’re definitely starting to have a deep and knowledgeable focus on cyber security. They’re reaching out to their member firms to have their cyber security experts and representatives speak up. I certainly expect, as we’ve seen from comparable organisations in Canada and Europe, that more prescriptive cyber security regulation will emerge out of the various global regulators. And whether that will be specific to FIX or not, it is certainly going to touch the protocol and be applicable to it.
Michael: I think if you look at the Bank of England, which takes its prudential responsibilities very seriously, it has looked at this in a very deep manner. I have definitely noticed an uptick in regulatory interest in markets such as Hong Kong and Singapore. All the regulators have a prudential responsibility, and this a prudential concern. They’re all seeking to understand the extent of the problem, which goes back to just how do we as an industry respond. My personal view is that the regulators will respond with at least some guidance. And again, there is the collaborative element here. The regulators are consulting and engaging people across the industry.
Tom: One key area is figuring out what should be included in the regulation but it is definitely a good sign that regulators are starting to ask questions on security of their member firms. While there is clearly a responsibility to protect your client’s information, they can start asking questions about how you protect, who can access it, how is it shared etc, and we need to be able to answer those questions when the regulator asks. Europe is probably further ahead of the US in terms of the formulation of that, but the point is the process has already started within firms. The business reasons for security protection are ahead of the regulation at this point. In some areas, you’ll have the regulators driving the behaviour. In this case, it’s the business reasons that are driving the security work being undertaken that have demanded everyone’s attention.
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Trade and Transaction Reporting in the EU

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A new GreySpark Partners report, Trade and Transaction Reporting in the EU, details the status of trade reporting in European Markets Infrastructure Regulation (EMIR) and transaction reporting in the Markets in Financial Instruments Directive (MiFID) II. The report provides a comparison of the two regulations, highlighting where there is scope overlap and where financial institutions are able to leverage compliance work on EMIR to become compliant with MiFID II and MiFIR.

Joining The Dots Of Compliance

Michael Karbouris, Head of Business Development, APAC, Nasdaq examines ongoing regulatory and technological changes in surveillance.
Michael KarbourisWhat do manipulation in the FX and LIBOR markets, the explosion of dark pool trading volumes, and the growth of high frequency trading have in common? The answer is that all of these issues are keeping compliance officers up at night, and they are having a profound impact on all stakeholders in the financial markets. In most (if not all) regions, they are influencing investors’ perception of fair and efficient markets and eroding their confidence. In response, broker-dealers, exchanges and regulators alike are stepping up their surveillance efforts across the entire trade lifecycle.
OTC market manipulation made front page news in 2012, when it was revealed that global banks colluded to falsely inflate or deflate their LIBOR rate submissions to profit from trades or affect the perception of their creditworthiness. Fast forward to 2015, and LIBOR has a new benchmark administrator, the rate-setting process has been tweaked, and the banks involved in manipulation have been fined billions of dollars.
In retrospect, poor internal controls are to blame for this market abuse – at least to some extent.
Banks lacked surveillance technology with strong capabilities to connect the dots. They could not link their positions in loans, swaps, options and futures with the LIBOR rate submissions to detect unusual pricing. Further, they were either not scanning electronic communications or not using robust enough systems to detect keywords indicating collusion. The investigation of the LIBOR scandal revealed that the scheme was devised and implemented through emails and instant messages.
Then in June 2013, yet another scandal rocked financial markets. Certain FX dealers at major banks allegedly colluded to profit by trading currencies ahead of large orders at the daily benchmark fix, and sought to influence the fix itself. Several major banks have already been forced to pay billions of dollars in penalties. Since then, the fix process has been changed so that traders need far more capital to manipulate a price because they have to keep buying or selling aggressively over a longer period. Moreover, regulators have forced banks to change their internal processes and increase scrutiny over FX trading.
In light of these incidents, the regulators expect banks to have risk management and surveillance tools that can look across markets and asset classes, and trigger alerts when unusual activity occurs. They need to be able to analyse large data sets, perform an alert run in minutes, and scan all electronic communications for suspicious keywords and relationships.
To be effective, surveillance analysts should be monitoring for patterns such as more active buying or selling, or higher volumes than usual around the fix that influence price (marking the fix), or unusual positioning ahead of the fix (front-running). They also should be watching out for instances where someone is trading a currency they do not normally trade, or trading in a size that is not normal for them.
Banks use surveillance technology not only to detect wrongdoing, but also as an investigative tool to prove scenarios, which are documented for internal and external auditors. When the regulators ask about an irregularity, the bank can say it noticed it too, and explain what was done about it. It can show an audit trail of the investigation and the related communications to explain what transpired. In doing so, it might avoid hefty fines and penalties, not to mention reputational damage.
Dark pool accountability
Electronic trading and other factors have led to a marked decrease in order sizes on exchanges. Dark pools were originally created so asset managers could execute large blocks of stock without information leakage or market impact. But regulators globally are concerned about the growth in dark pool trading and its effect on market integrity. Some countries, including the UK, Australia and Hong Kong are introducing rules to either curtail trading in the dark, or at least ensure higher levels of transparency in dark markets.
Like lit markets, it is possible for dark pools to be abused intentionally. To this end, these venues need to be on the lookout for traders who try to game other participants and manipulate open market prices by using orders that are inconsistent with their intended purpose.
One method of manipulating prices in the dark is to test liquidity by placing a small order in a dark pool to see if it gets executed, “pinging” the dark pool. If it does, a larger order is placed in the lit market to narrow the spread and push the indicative execution price in the dark market in a beneficial direction. Ultimately, a larger order is executed in the dark pool at the manipulated price.
Using a bait and switch or spoofing strategy across both lit and dark markets, traders enter orders with the goal of creating fictitious volume on one side of the order book. In these cases, traders place a large sell order in the lit market to influence other market participants to sell more aggressively. If the bait is taken, the manipulator can then buy the security at a lower price in the dark market, safely hidden away from view.
Dark pools must also monitor for front-running activity not just in the most deliberate cases of proprietary order flow being executed prior to client order flow, but also more general cases. These include front-running the release of research reports or using insider information by executing in dark markets. Typically, front-running of large price movements in a dark market may be indicative of potentially suspicious activity.
There is no one-size-fits-all surveillance solution. A dark pool that operates as a crossing network is different from one that operates as a multilateral trading facility, and the regulators treat them differently.
Ultimately, the onus is on dark pools to operate exactly the way they are advertised to operate. They need to deploy policies and procedures, human resources and automated technology to ensure integrity. A holistic surveillance system should be employed, utilising algorithms to monitor all dark market trading activity for suspicious behavior and anomalous price movements, and generate alerts when suspicious events occur. Over time, dark pool operators can understand trends and patterns, as well as the activities of specific participants active in their marketplace.
Expanding supervisory responsibilities
Many trades today are executed via algorithms. Market participants and regulators are keenly aware that fat finger errors and technology glitches can have a devastating impact on investor confidence. The flash crash of May 6, 2010 was the first in a string of such events, which has increased regulatory focus on both risk and manipulation.
The front office is required to do pre-trade risk checks as the first line of defence against machines or humans going haywire, and to ensure orders do not exceed specified limits. Traders can pre-define risky events and adjust parameters so the program will shut down in a controlled manner should any one of them occur. Additional layers prohibit traders from sending orders that exceed a certain number of contracts or shares, and orders are rejected that do not pass a price reasonability check. In contrast, market surveillance for manipulation (not risk) has mainly been a post-trade function. But newer regulatory initiatives are causing the lines between surveillance and risk to become blurred. The front office increasingly needs to watch for algorithms that can potentially be used to manipulate market prices through front-running, bait and switch techniques and spoofing. While most market participants use algorithms to execute trades, they might not be adept at examining them for potentially manipulative behavior. Surveillance systems, with logic programmed to watch for manipulative activities and patterns, can help the trading desk understand normal versus abnormal behavior and help them to mitigate regulatory risk before trading.
Overall, trade supervision is an important first line of defence to ensuring market fairness and integrity, and certainly an area that will attract more attention in the future.
The surveillance platform as the common denominator
A common solution to all these disparate issues involves taking a thoughtful, holistic approach to processes and procedures. Firms should define the role of the front office in surveillance and hold trading desks accountable for their activities. Surveillance teams should be empowered with the knowhow and tools to monitor order flow in OTC asset classes as well as dark trading activity in multilateral trading facilities and internalisation engines. In addition, firms should evaluate their current platform to ensure it is sufficiently robust to be effective and efficient across a wide array of investigations now and in the future.
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Tech Spend Key in Australia and Beyond

Chauncy Stark, General Manager of Foreign Exchange and Cross Asset Trading, NAB, explains the Australian banks’ approach to technology spending.
Q3_15_Chauncy StarkThe banking world is evolving at break-neck speed. Global banks are retreating to their core markets and new regulations are changing the fundamentals of foreign exchange and fixed income trading. Banks, especially those in Australia, are reconsidering how they deploy technology to remain relevant and meet new demands.
Foreign exchange markets were early adopters of electronic trading platforms. Over the past decade we’ve seen fundamental shifts in volume and liquidity and the very nature of the way customers trade. FX technology development is ongoing and will continue to shape the distribution and risk management of all FICC products.
NAB continues to invest in building out our digital capabilities from front office through to back office. Within trading alone we have a team of 10 dedicated e-FX specialists and they handle a range of tasks from building automated risk management algorithms through to managing databases that enable us to measure market impact across trades and clients. Conventional traders are also becoming more tech-savvy.
Opportunities at scale
As outlined above, there has been an explosion in investment in technology. New foreign exchange market-making technologies have drastically expanded banks’ ability to attract volume. As an example, the top five global banks now account for roughly 40+% of global FX volume and they are increasingly operating like exchanges in the way that they internalise risk. Therefore, in recent years, competing in FX has become a scale game and investing in technology one of the only tickets to playing in that game. The magnitude of investment required to maintain a top 10 ranking creates barriers to entry though as technology matures cheaper solutions are emerging.
That said, technology advancements also bring opportunity. Traders and sales people are able to be more innovative in the products and services they deliver to customers. The changing regulatory environment has squeezed the expansionist technology drive in favour of compliance and monitoring solutions.
FX trading technology has filtered into fixed income, commodities and other areas. Fixed income cash has successfully adopted some of the FX technology, but the picture is less clear in products such as interest rate swaps. Current electronic trading platforms cannot handle customised products as well as vanilla products. So, at this point in time, it would appear the fixed income market may be close to reaching its limit in terms of how much can be electronically traded but that could change in the very near future.
Buy-side bears the cost
Market liquidity has been quite topical. Firstly regulation is forcing banks to hold more capital and limit proprietary trading activity. This means fewer price-makers and less balance sheet available to clear client risk. In terms of liquidity, this means the buy-side will have to accept higher transaction costs. If you combine this with the SNB abandoning the Euro peg earlier this year, there is an even bigger impact on liquidity.
Though, liquidity has now normalised, we are still seeing more “liquidity holes” when markets start moving. The conclusion is that the larger liquidity providers have become more defensive in their risk settings and technology investment will help manage these risks.
Value for clients
We have multiple ways of helping each client and we appreciate that each customer is unique. Technology makes it easy for clients to get access to the products and services they need which in turn helps us develop more meaningful relationships with them.
As I’ve mentioned before, in Australia, global investment banks have retreated away from Australia and back to their core markets. Learning the needs of new clients and exploring how to best meet their trading needs will continue to be a focus for NAB.
New challenges, new technology
Providing a point of differentiation is vital. Creating a more efficient trading environment – in terms of trading, access and user experience – and combining multiple systems into one trading platform is the way forward. There is no need to duplicate multiple single-dealer platforms when they could be run together.
At NAB we are looking at opportunities to apply different technologies in unique ways particularly in the business and consumer space. We are adapting trading technology and using it in innovative ways to support other businesses.
The obvious choice is to extract as much value as we can from our investment in sophisticated technology. If we just confine investment to FX products, we are missing tremendous opportunities.

This interview has been prepared for education and information purposes and does not constitute financial product advice.

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Buy-Side: Taking Control Of Technology

Ben Jefferys, Head of Trading Solutions, IRESS, examines increasing ownership of technology and trading on the buy-side.
Ben JefferysA changing dynamic in equities trading is the increasing prevalence of buy-sides taking more control of their order flow. This is largely in response to the need to trade global markets more directly.
This trend is clear for smaller sized orders and orders involving algorithms where liquidity is readily available. (The exception is block-sized trades. Brokers still have active block and facilitation desks. Block-sized crossing pools such as Liquidnet and ITG continue to innovate by providing direct services to the buy-side.)
In the past sell-side brokers have offered value-added services to differentiate themselves such as smart order routing (SOR) and transactional cost analysis (TCA). But buy-sides now don’t value these as much as they did in the past. So sell-side offerings have become more commoditised and the buy-side is taking more control of order routing and decisions about where and when to trade.
Trading is changing and both sides are adapting. New regulations, for example the proposed Financial Conduct Authority UK (FCA) changes regarding unbundling will further drive this trend as dealing commissions can no longer include payment for broker research.
Connections on a global scale
A related theme sees geography and time zone being less of a barrier when it comes to facilitating trading where technology becomes the enabler for the buy- and sell-side. The challenge now is how to connect quickly and efficiently whilst maintaining a sufficient level of availability and redundancy.
For some regions, such as Europe, trading cross-border or internationally has always been the norm. This is not the case in other regions where, for various reasons, technology as a solution to this challenge has been less widely adopted.
This is despite a growing number of options for both buy-side and sell-side to pick and choose the technology that best suits them and break away from some of the constraints of the past.
An example is Australia where the superannuation or pension industry invests substantial amounts each year into the domestic equities market. Because of the ever-increasing superannuation pool in Australia, fund managers are increasingly looking outside the domestic equities market to ensure sustainable returns. The superannuation pool in Australia is currently $1.8 trillion AUD and is forecast to quadruple to $7.6 trillion by 2033. One of the ways that fund managers are seeking alpha outside of the domestic market is through trading more international cash equities. In the past, trading internationally was expensive and those fund managers with an international mandate often outsourced their international trading to a counterparty overseas.
Access to international markets is now more viable because the capital and service cost of technology is lower and the need more pressing.
Technology has also changed the landscape for the sell-side brokers. In particular, technology has made offering services in other markets easier because of greater technology options.
Capacity constraints
To support the functional shift from the sell- to the buy-side, the industry is trying to avoid the limitations of the past, such as an inadequate ability to change their systems to react and adapt.
Importantly, more robust and scalable solutions are being deployed as electronic trading and connectivity matures. The industry has also become much more cost conscious, helping all brokers to remain competitive, reactive and scalable. As an example, bulge-bracket brokers are relying less on in-house trading technology, freeing them from huge development and maintenance costs. This allows the buy-side in particular to outsource commoditised components and focus their efforts on parts of the stack that differentiate them.
In addition, managing connectivity is a major consideration for buy- and sell-sides. It’s critical to be able to access and on-board clients from across the globe in an efficient manner while minimising costs. Only the biggest players in the market have the scale to warrant their own international connectivity networks and dedicated, leased lines remain eye-wateringly expensive when connecting globally. Finding the right blend of connectivity, service and support that fits the business is essential. Similarly shared infrastructure service providers that deliver cheaper access but, like a dedicated line, require each end of the connection to manage what goes through it.
Then there are hub technologies and networks that allow both buy- and sell-sides to access all counterparties via a single connection. These offerings provide global reach and cost-effectiveness and are fully managed.
This is not to say the era of in-house trading technology and self-managed connectivity networks is over as there will always be niches to fulfil. But for many a different model is required to succeed in today’s market.
‘Flexibility’ as a service
All too often the buy- or sell-side finds it difficult to change due to the huge costs of new technology. This is true for proprietary technology and, vendor-based solutions that come with lengthy and expensive contracts. Outsourcing to vendors can bring transparency with regards to costs. But this rarely relieves the buy- or sell-side from the associated costs of deploying and maintaining an outsourced solution. With a higher need for flexibility vendors need to offer products and, importantly, their service in a different way.
Software as a Service (SaaS) – think of it as pay-as-you-go or pay for what you use – for software and connectivity services is becoming increasingly popular. This involves a fully managed service that incorporates software and connectivity.
The result is more flexibility for the buy- and sell-sides, which are no longer limited by previous technology choices. The key is how to efficiently and effectively integrate all the components in the system.
Nevertheless, the outcome is an ability to adopt and scale more quickly and cheaply.
Overall, unlocking new opportunities is driving change for the buy- and sell-sides. Accessibility and connectivity become the keys to success with buy-sides taking more control of their order flow and sell-sides reaching out to find new clients in new regions.
Cost efficient, flexible and scalable connectivity that is reliable has become a key factor in facilitating business across the globe and, as a trend, shows no sign of slowing down.
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Expanding The Connect

Shane Neal, Head Trader at Matthews Asia, examines the enhanced model of the Shanghai-Hong Kong Stock Connect, and the drive towards Shenzhen.
Shane NealLaunched in November of last year, the Shanghai-Hong Kong Stock Connect (SH-HK Connect) initiative provides mutual market access between the Hong Kong Stock Exchange (HKEX) and the Shanghai Stock Exchange (SSE). This is undoubtedly one of the most interesting market structure developments I have seen in my career. The exchanges, regulators, banks, brokerages and fund managers have devoted vast resources to ensure its successful implementation. Many traders were tasked with understanding and communicating various new aspects of settlement mechanisms, taxation, and the securities laws, as the China model provided some unique features. At Matthews Asia, we began using the SH-HK Connect in the first half of 2015 as a complement to our investments in Chinese-listed A-shares via the Qualified Foreign Institutional Investor (QFII) program.
The enhanced model
An original feature of the SH-HK Connect trade workflow required sellers to transfer securities to be sold into the account of the executing broker prior to the trade as a way to ensure stock was available for delivery and reduce risk of failed settlement. Many fund managers had concerns that this pre-delivery of shares in free-of-payment method would lead to information leakage, and it could also conflict with custody compliance requirements in several jurisdictions. To address this concern, an integrated model of pre-trade checking was designed by banks that had the ability to link their execution and sub-custodian platform. This allowed for a fund’s assets to remain in custody as the broker could verify positions prior to trading without free of payment transfer. While effective in addressing the issues surrounding pre-delivery, an investment manager was left with a single broker trading solution based on a fund’s sub-custodial relationship.
The developers of SH-HK Connect more recently introduced special segregated accounts (SPSA), whereby investors open account(s) with a unique ID in the Central Clearing and Settlement System (CCASS) via their custodian, in order to keep shareholdings of investors separate. Once the SPSA accounts are open, a fund manager can link multiple brokers, which I believe is the best way forward for SH-HK Connect. This model could be enhanced to closely resemble other ID-based markets in Asia, with linked broker trading accounts and omnibus trading agreements maintained by brokers, as this is already familiar to most foreign investors.
Increasing investor participation
In order to attract more participation, regulators in China and Hong Kong have been receptive to feedback for reforms to the program, which is clearly set to develop and grow. A few issues continue to arise when discussing SH-HK Connect with those already using it and those still waiting for enhancements.
One challenge for international investors remains the T+0 settlement of securities, and T+1 settlement for cash, as it is not in-line with developed market practice, and creates operational challenges and potential counterparty risk. Investors with operations departments in other time zones may find it difficult or costly to accommodate. With foreigners making up a small portion of the market currently, it is unrealistic to think China will adopt an entirely new trade settlement mechanism. Hopefully, China can find a way to accommodate foreign investors while the market matures.
It also seems that the regulations governing stock borrowing and lending of northbound Stock Connect securities could benefit from modifications. At present, only SH-HK Connect exchange participants can lend SSE securities, but these entities aren’t typically capitalised for stock borrowing and lending operations, so short selling of SSE securities has been a non-event. An alternative arrangement may be to allow for the affiliate entities of the exchange participants in London or New York to conduct stock borrowing and lending operations.
Lastly, the daily trading limit imposed on northbound access was also highlighted as a “capital mobility” issue by MSCI in its recent decision to postpone the introduction of China A-shares into its global indices. Many investors believe this daily limit should be lifted because it is a great source of uncertainty for investors who need to trade near the close of day. As modifications and developments like these are introduced, the overall accessibility of the China A-share market for foreign institutional investors will likely improve.
IPOs
There is no shortage of potential issuers or lack of liquidity in China’s A-share market, which are the two of the biggest challenges faced by many other global exchanges. Over 500 A-share IPOs are pending listing according to the CSRC website, so there is certainly interest among foreign investors to access the China’s IPO market. At present, SH-HK Connect participants are restricted from participating in China’s IPO market. QFII and RQFII (Renminbi Qualified Foreign Institutional Investors) investment schemes allow for investors to participate in IPOs, but it can be complicated and dominated by retail investors.
Additionally, it seems that both the regulators in Hong Kong and in China would have concerns about who is accessing an IPO via the northbound Stock Connect link and the protections required for investors in the primary market. Since investor IDs are not required to track northbound trading, it seems unlikely that the regulators would be able to open IPO participation outside the domestic market and QFII/RQFII investment schemes. Something interesting to watch for will be the eventual first rights offering conducted by an A-share listed company with shareholders via the northbound Stock Connect. This would be a good test for regulators and market participants and could be a stepping stone for future primary market developments.
The Shenzhen desire
The regulatory and technological framework for SH-HK Connect can be used to for additional trading links, like the much anticipated Shenzhen-Hong Kong Connect (SZ-HK Connect). The Shenzhen Stock Exchange (SZSE) is dominated by small and medium sized companies, as compared to Shanghai-listed companies, most of which are mature businesses. Access to trading SZSE listed securities had been limited to domestic and QFII/RQFII investors, so the SZ-HK Connect will increase the investable universe for many international investors into more diverse sectors and market capitalisations. The official launch date and details regarding the number of stocks available via the SZ-HK Connect are still pending, but I’d expect a similar timeline of events that preceded the Shanghai-Hong Kong Connect launch. First there would be a joint announcement by the HKEX and SZSE, followed by a period of systems testing, then publication of final rules and tax clarity, before going live. From my recent meetings with representatives from the CSRC and SSE they are clear in saying that the mechanism for any future trading links will be consistent with that of the SH-HK Connect. I would expect other major global exchanges have discussed their own links to China. This opportunity could also grow to include different asset classes as well. It’s possible to envision HKEX, as owner of the London Metal Exchange, making commodities futures trading available to mainland China.
These trading links and other future developments represent a significant step in China’s financial reforms and the opening of China’s capital markets.
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Trends in Equities Trading 2015

GreySpark_Trends-in-Equities

Trends in Equities Trading 2015

A new GreySpark Partners report, Trends in Equities Trading 2015, analyses the implications for investment banks of how the long-standing relationship between equities markets volatility and the ability of bank equities trading businesses to generate profitable levels of revenue now appears broken. Before 2009, volatility historically played a key role in the ability of Tier I and Tier II banks to generate sustained levels of equities trading-related revenue.

https://research.greyspark.com/2015/trends-equities-trading-2015

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