By Michael Lynch, Managing Director of Senior Relationship Management, Bank of America Merrill Lynch
First of all, the conference was a great event, and an innovative effort to understand the buy/sell-side challenges that they face every day, including understanding big data and behavioural changes to markets, all the way from PM to Traders.
The conference tackled some really big themes last year, and this year a central theme was thinking about whether a given piece of data is a signal or noise.
The content was extraordinarily relevant and the organization and timing in the first quarter of the year, was great.
It covered a wider range of impactful solutions that address multiple forms of alpha generation. This year, there was a number of breakout sessions to understand and address the challenges faced by the trading desks, in a world where we all have to work smarter and faster to gain an edge in the marketplace.
I think the money managers, particularly those with large platforms, have the money to make the investment to push these innovative technologies into execution. There is also definite scope and potential to make the same investment into their portfolio management process to introduce these new products into their workflow, particularly as it applies to data mining to help their fundamental research go even further.
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Franklin Templeton AIR Summit 2015: Changing Technology, Finding Alpha – Part 3
The beautiful game? : Lynn Strongin Dodds
THE BEAUTIFUL GAME?
Just when you thought that the banks could not possibly have any more dirty laundry to hang out to dry, the $150m FIFA bribery scandal comes along with US federal prosecutors linking several high profile banks including J.P. Morgan Chase, Citigroup, HSBC, Bank of America, UBS and Julius Baer to an indictment of nine FIFA officials and five sports executives.
None of the banks have been accused of wrongdoing but the Department of Justice (DOJ) is looking into whether any of them knowingly conspired with the accused officials. According to the 116 page indictment some of the soccer officials who were accused of corruption “relied heavily on the US financial system in connection with the enterprise.” Beyond the possibility the banks conspired in the alleged FIFA bribery, there are also questions about whether they were, in effect, unwitting accomplices, by failing to detect suspicious activity or comply with anti-money-laundering or know-your-customer rules.
Swiss prosecutors, in a related action, have opened criminal proceedings against unidentified individuals on suspicion of mismanagement and money laundering related to the awarding of rights to host the 2018 World Cup in Russia and Qatar four years later. Despite these accusations, Sepp Blatter has defiantly won a fifth term as president and the football governing body is holding firm to its decision to support the selections of Russia and Qatar.
It takes time – often too long – for lessons to be learnt. One would have thought that the $9bn levied on banks for rigging Libor would have deterred similar behaviour among forex traders. However, old habits die hard and six banks have just coughed up a record $5.7bn for manipulation of the £3.5tn a day currency markets.
Human behaviour can be changed though and industry participants should take heart that there is light at the end of this long tunnel if recent comments by Martin Wheatley, head of the Financial Conduct Authority, are anything to go by. He noted that the heavy fines were working but patience will be required for the message to permeate throughout the organisation. In many companies, the top level management seem to be on board but those on the shop floor have not yet embraced the inevitable cultural change. Wheatley calls it a “work in progress” but actions always speak louder than words. Senior managers not only have to spread the word but those at the pinnacle who insist on staying may have to fall on their sword.
Lynn Strongin Dodds, Editor.
©BestExecution 2015
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A Revolution In Post-trade Operations
With David Pearson, Head of Post-trade Strategy, Fidessa
The post-trade space is a vital area for firms. The consequences for failing to complete the trade cycle are serious; it’s not going to settle and it’s not going to clear. But to date the technology investment profile has been hugely tilted towards the front office where firms earn revenue, and where we’ve seen some new and exciting developments over the last ten years. More recently we’ve seen a greater focus on the post-trade space and recognition that whilst the job is being done, it’s beset with inefficiencies, unnecessary cost and operational risk. Trading organizations are now looking to move away from their historical reliance on proprietary solutions to handle parts of their post-trade business, realizing that there are alternatives.
One of the fundamental questions firms are asking is how resilient is the business to a single point of failure in the post-trade process? They are realizing that it is not acceptable for their business to be wholly reliant on a single, centralized system.
Setting new standards
Some of the larger buy-side firms have led the way, seeking to improve their operational efficiency and reduce operation risk through the adoption of standards, in particular the FIX Protocol. With the success of FIX in transforming front office workflows, its application in post-trade is a natural direction of travel and is resonating across the industry. And certainly Fidessa’s experience of defining the use of FIX for post-trade has led to wholesale improvements in the automation of the operational workflow, so fewer people and less time is spent managing what really ought to be a seamless process.
Gaining pace
The wider buy-side community is now looking for the opportunity to adopt similar ways of working but without the overhead of a large IT investment. What is transforming the industry is the availability of service-based models from trusted suppliers.
We are now seeing solutions like Fidessa’s Affirmation Management Service taking on the work of running and managing the confirmation and affirmation process so that those firms can realize the same operational benefits. It is this service-based approach that is driving widespread adoption of these new workflows across the industry globally, and across asset classes.
Embracing the service model
Firms want to achieve a more efficient business process at the lowest cost but still need to apply the most stringent levels of governance. They are acutely aware that they remain accountable whether or not they are operating the service themselves. Fidessa is seeing a significant increase in the due diligence and ongoing supervision of our services and we welcome that. We are happy to be scrutinized by any customers who wants to assure themselves that when the regulator asks the questions, they can answer knowledgably and confidently.
The most successful outsourcing partnerships work when the firm that is outsourcing is acutely bound into that process; asking the hard questions, leading the way in terms of knowledge, understanding where the regulator is going and maintaining a close relationship with its supplier. We’re seeing an evolution in operational skills towards supervision, process management and oversight and away from pure technology provision and support.
Unstoppable momentum
As a result of the business focus on improving the efficiency of the post-trade process, and reducing the operational risk of the existing models, the combination of a workflow built on an industry standard, and a service-based model is generating an unstoppable momentum in the post-trade operation. We are seeing an increasing number of firms adopt the direct affirmation model with the underlying confidence that they are moving in line with the direction of travel of the industry as a whole, and reaping the business benefits as a result.
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A First Look at Regulation System Compliance and Integrity
By Jim Northey, Principal Consultant and Industry Standards Liaison, CameronTec Group
Technology has created many efficiencies and benefits for the financial industry. However, it is an unfortunate truth that many drawbacks come along with the advantages that are gained. Unforeseen errors are an inevitable reality; some are small enough to go unnoticed by the majority, while others are large enough to shake confidence in the markets and in some cases (such as the Knight Capital glitch in 2012) threaten the well-being and existence of a firm.
In light of market dependence on complex technology, the industry needs to increase efforts in terms of overall system reliability and quality. The Securities and Exchange Commission (“SEC”) addressed this issue by unanimously adopting Regulation System Compliance and Integrity (“Regulation SCI”) in November of 2014 to ensure systems are operating with efficiency in the areas of capacity, integrity, resiliency, availability and security. Originally proposed in March of 2013, the regulation, in short, “establishes uniform requirements relating to the automated systems of market participants and utilities.”
This article will provide background on the events that led up to the proposal and eventual adoption of Reg SCI and which market participants are currently subject to it.
A Brief History of Regulation System Compliance and Integrity
2010 Market Review
More than five years ago in January of 2010, Mary Schapiro, then-Chair of the SEC, asked her staff to begin a comprehensive review of the equity market structure. “It was a review that included gathering views on everything from the impact of high frequency trading to the continued rise of dark pools, to the complexity of a multi-venue market system. The focus was not so much on the infrastructure of our markets,” Schapiro said, “but on the way the markets and market participants operate and behave.”
The review included an evaluation of equity market structure performance in recent years and an assessment of whether market structure rules have kept pace with, among other things, changes in trading technology and practices. The SEC sought public comment which they used to “help determine whether regulatory initiatives to improve the current equity market structure are needed and, if so, the specific nature of such initiatives.”
Flash Crash and Aftermath
Not long after the review took place, the Dow Jones plunged nearly 9% on May 6, 2010, in an event that is now infamously known as the Flash Crash. Soon after the Flash Crash took place, the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues was formed. This committee’s job is to “address market structure and regulatory issues that may contribute to volatility.”
During the beginning of the following year, in February 2011, the committee issued recommendations regarding a regulatory response to the Flash Crash. The 14-page report tackled volatility, restrictions on co-location and direct access, and liquidity enhancement issues. The committee outlined 14 recommendations in these areas, which they considered the “most important ones upon which to focus to ensure the integrity of the markets” and to “maximize investor confidence in the aftermath of the many market disruptions over the past several years.” While also acknowledging that there are many other issues that still need to be covered, the conclusion of the response urges the SEC “to continue to use the events of May 6 and the subsequent analysis in their future market structure discussions and rulemaking.”
Roundtable Discussion
Over a year later, on October 2, 2012, the SEC held a roundtable focused on automated trading systems and how regulatory structure could be implemented. This roundtable sparked substantial discussion that would be used in the future to help revise the proposed Reg SCI to its final form.
At the roundtable, several of the panelists called for “implementation at trading firms of quality management systems and specific processes aimed at reducing the incidence of errors.” It was acknowledged that such measures would not eliminate all errors, for which reason mitigating solutions such as kill switches would be necessary. What was not made clear from the discussion was who would operate those switches, how they would be triggered, or how much control regulators would exercise over the process.
Proposal and Adoption of Reg SCI
As industry dependence on technology continued to heighten, Reg SCI was proposed in March 2013 as a response. The SEC initially welcomed comments on the proposal for a 60-day period, which was later extended to 105 days. At the end of the comment period, the SEC had received over 60 comment letters from a variety of submitters. Taking the comments into consideration, Reg SCI was passed on November 19, 2014, and published in the Federal Register on December 5, 2014. The final rule keeps the majority of the language from the initial proposal intact, but does feature several changes to address issues that were raised during the comment period, as well as the automated testing roundtable that was held in 2012.
Effective Date
Regulation SCI became effective on February 3, 2015, 60 days after its publication in the Federal Register. While the SEC understands that entities will need adequate time to prepare for and meet the requirements of Regulation SCI, they have decided to adopt a compliance date for entities subject to Regulation SCI of nine months after the effective date, with few exceptions. Many commenters suggested longer compliance periods or phased-in compliance periods, however the SEC has stated they believe entities need to comply to the rules of Regulation SCI as soon as possible, given the substantial number of system issues that have happened in recent times and in order to strengthen the technology infrastructure of key market participants.
How long do I have to comply?
SCI entities have nine months after the effective date of February 3, 2015, to comply with the regulation. There are only two exceptions to the compliance date for SCI entities:
- ATSs newly meeting volume thresholds will have an additional six months from the time that they first meet the applicable thresholds to comply.
- Entities have 21 months from the effective date to comply with the industry- or sector-wide coordinated testing requirement.
How am I affected?
Who must comply?
The SEC made it clear that Regulation SCI should apply to those entities that they consider the most essential to the efficient functioning of the US Securities markets, which in this case consists of certain self-regulatory organizations (“SCI SRO”), alternative trading systems that satisfy equity volume thresholds (“SCI ATS”), plan processors, and exempt clearing agencies subject to Automation Review Policy (ARP). Collectively, these participants are referred to as “SCI entities.”
In total, there are 44 SCI entities currently subject to the regulation. The breakdown is as follows:
- 27 SCI SROs
- 18 registered national securities exchanges
- seven registered clearing agencies, including DTCC and NSCC
- the Financial Industry Regulatory Authority (“FINRA”)
- the Municipal Securities Rulemaking Board (MSRB)
- 14 SCI ATSs
- Two plan processors
- One exempt clearing agency subject to ARP
Regulation SCI states it applies to “systems operated by or on behalf of” these entities – which means that covered systems operated by third parties do fall under the new regulation. Another detail is that the SEC left the regulation open to the option of expanding compliance to other market participants in the future. Therefore, if you do not currently meet the criteria of an SCI entity, it is possible that you may be effected later on.
Definitions of SCI Entities
SCI SRO
SCI SROs include all national securities exchanges registered under Section 6(b) of the Exchange Act, all registered securities associations, all registered clearing agencies and the Municipal Securities Rulemaking Board (MSRB).
There are two exceptions, including 1. an exchange that lists or trades security futures products that is notice-registered with the SEC as a national securities exchange pursuant to Section 6(g) of the Exchange Act and 2. any limited purpose national securities association registered with the SEC pursuant to Exchange Act Section 15A(k).78
SCI ATS
Any ATS that during at least 4 out of the 6 preceding calendar months, in respect to NMS stocks had 5% or more in any single NMS stock and .25% or more in all NMS stock, OR had 1% or more in all NMS stocks’ average daily dollar value. With respect to non-NMS stocks and for which transactions are reported to a SRO, any ATS that had .5% or more of the average daily dollar value as calculated by the SRO to which such transactions are reported is included as an SCI ATS.
The Changing Technology Landscape
Nick Greenland, Head of Broker/ Dealer Relationships BNY Mellon Investment Management EMEA and APAC examines ongoing technology evolution on the buy-side.
The shift from the sell-side to the buy-side is not a new trend – the move of people and technology from one to the other has been talked about a lot, and it was also my route to the buy-side. But to my mind that is just part of the story. If we look at what is happening on the sell-side, they have been under pressure from a global and local regulatory environment. Businesses that were profitable are no longer core or as profitable.
“Necessity is the mother of invention”, and human beings are resourceful – human capital which has been developed in one part of the market is now more desired in other parts of the market. We have seen a wave of innovation across the market in terms of market structure and financial technology, for example the 50+ different platforms that are apparently currently under development in the fixed income market. Human capital has had to reinvent itself – the buy-side is also now under more scrutiny and facing new challenges, and skills valued in one place are now more in demand elsewhere. It is more complex than the sell-side just migrating across, and it definitely isn’t uniform or moving at a constant pace.
The differences between the buy- and sell-side are in some cases blurring and will continue to do so. The effect on the broker dealers, for example in fixed income markets, means that on balance the sell-side is much less able to hold inventory, and there is scope for the buy-side to reassess how it looks at and manages involvement in the asset class. This is not to detract from the sell-side; they still perform many valuable services for the buy-side and we need to understand the changes in roles to be able to get the most out of those relationships for our underlying investors. The pattern of shifting human capital is on balance beneficial for both sides once it has been understood.
We are in a state of unparalleled innovation in the financial markets. As the market conditions have changed, the playing field has changed, and whilst buy-side and investment managers may want to continue as normal, we need to look at different ways of accessing liquidity and obtaining information needed as part of our investment management and trading processes. As part of a level playing field, a solid partnership with the sell-side is the ideal state.
Sell-side evolution
Some of the experiences I have had in my career on the sell-side illustrate this shift. My colleagues and I on the buy- side who share these experiences, perhaps more instinctively, understand the language and rules of the sell-side which differentiates us from the buy-side as we can naturally empathise with the sell-side. Now, on the buy-side, we are able to read the other side of the conversation and understand the at times unspoken sell-side part of the conversation as well. It adds that dimension of clarity. Our partnership (Buy to Sell-side) is much more than transactional day-to-day, it is much more complex and nuanced.
I am very excited that there is a sea change of support amongst the buy-side to understand that whilst we may compete with one another when raising and investing money, we don’t compete when it comes to trading. We all face similar hurdles and have the same fiduciary duties and regulatory obligations and some of us are beginning to share the realisation that together we are stronger. A co-operative of informed buy-side participants has much more power than individual firms. I am excited to be able to pick up the phone and talk to people in the markets around London, Europe and the US on matters of co-operation – how can we make this work for the best advantage of our underlying client and therefore meet our fiduciary duties.
Market initiatives
The very definition of what platform/function is a competitive advantage changes over time and with evolving technologies. As everyone is trying to strip out cost, things that were previously core are no longer core to all in the market. So all firms are starting to ask themselves to redefine their key areas of business, where they can add alpha and what differentiates them. If we can automate and reduce manual intervention and reduce errors, especially for the smaller value tickets, we can make trading as a whole more accurate and timely.
Historically the buy-side have not been as successful in partnering up with peers in industry initiatives and definitely not been as able or willing to invest and hold equity as the sell-side. Therefore, if we can partner with one another in a neutral industry manner to ease the issue at hand, be it information flow, liquidity etc., then that has to be the betterment of our underlying investors who we have a fiduciary duty towards.
There are a range of new and established industry consortia where the buy-side are playing an active part. The best ones in my mind are where the buy-side are “joined up” and are presenting a united front on a level playing field with the sell-side. Saying that, many of these consortia all have different points of origin and one size does not fit all, and many people are involved in multiple initiatives, again to the benefit of the wider industry.
There are probably too many initiatives currently being developed, and too many platforms for all to reach the necessary critical mass. This will mean that in due course there will be some consolidation.
Technological developments
The rise of “electronification” of trading is inevitable and it is a boon for us. Where it is both appropriate and possible for a trader to use those platforms, it enables them to spend more time working with the portfolio managers to give them more market colour and feedback and to spend more time talking about how to execute in more liquidity constrained markets. Making sure that traders have the time and freedom to be part of these industry groups and bodies is important because their input as seasoned and skilled practitioners is needed in the ongoing discussions around the evolution of our market structure.
Most of us have early experiences in life which colour your views, and on build versus buy. I formerly worked for IBM, so my natural inherent question is “why build when you can buy?” If a firm or person can build something more efficiently which meets all your requirements and you can tap into those skills and resources, why should you not take advantage of that? However, it is not a panacea. There are some specific parts of the markets where third-party companies don’t have the expertise required so the buy- or sell-side are better placed to build those technologies themselves. But I think with innovation as people move between the sell-side and buy-side and these consortia and tech companies launch, and companies move into more asset classes and markets, all of the definitions can become a little blurred.
The buy-side is being more demanding of our partners than ever before while the sell-side is enduring a wall of regulatory change and clients are asking more questions. It is natural that the majority of buy-side firms are looking to get the best possible outcome from their people and changing role in the market. And technology is part of that – the market has always been changing and evolving. Experience matters with very few of today’s electronic traders having been around at the time of Black Wednesday (or indeed other periods of “6 sigma events”) – there is a strong element to which human traders and their ability to draw upon experience and relationships are able to take control of the situation and get their clients’ orders executed and manage their clients’ and their own firm’s risk. In an automated electronic environment things move lot more quickly – there is always a balance between people and technology.
There is always a technological drive and change, and there is always risk. The skills of traders are changing as a result. As long as I can remember, people have been looking at technology from two different kinds of the same coin – is it game changing and does it threaten my job. This analysis is overly simplistic. Human beings are very adaptable and it is unfair to say that dyed in the wool traders aren’t capable of being at the forefront of change, but they probably won’t be the ones coding. However they can still be driving the conversation and the industry and feeding in their requirements. Experience is highly valuable – seeing different markets, understanding different participants. Technology can enrich information flow and the decision making process, but it doesn’t replace it.
Commission management – No One Size Fits All
By Anita Karppi, Managing Director, Co-owner K&K Global Consulting (K&KGC), and Kristian Karppi, Managing Director, Co-owner K&K Global Consulting (K&KGC).
54 senior buy-side traders across Asia and Europe voiced their opinions about current and future commission management practices in the K&K Global Consulting Ltd’s (K&KGC) Buy Side Perspectives 2014 Commission Management report co-authored with FourFirth Consultants. This follows a long and intense debate between the UK regulator Financial Conduct Authority (FCA) and the European Securities and Markets Authority (ESMA) who advise the European lawmakers about the future MiFID II regulation.
We conclude in the report that there is unlikely to be a single global approach, not even within many of the Asset Management firms, to commission management. There is an opportunity for the buy-side trading desk to refine their role within the firm and the focus will increasingly be around the value the trader can add in the investment process. K&KGC recommend that buy-side firms evaluate the benefits of establishing a formal Trade Management Oversight Committee (TMOC) to oversee commission management procedures. Unfortunately only a few national regulators and buy-side associations are being pro-active and helping the buy-side firms in this process so there is a strong need for buy-side peer debate, collaborating to resolve the common challenges. Examples of top level responses from the buy-side regarding unbundling:
- 79% say end investors are getting better information on what their commission is spent on.
- 68% confirm that liquidity provision has not been affected due to changing commission management practices.
- 53% think that unbundling provide the firms with a competitive advantage.
- 50% think they receive a cost advantage.
- 42% have reduced the number of brokers due to CSA’s.
The UK FCA was ambitious and early to implement regulation for unbundling in 2014, far ahead of MiFID II, with their own interpretation of how to treat research and corporate access within dealing commission payments. As the UK based buy-side were forced to unbundle their dealing commissions, 59% of the survey respondents chose to use Commission Sharing Agreements (CSA).
ESMA on the other hand, have deemed the current use and practice of CSA’s as not entirely meeting the objective of decoupling research charges from transactions. Something that subsequent to the UK FCA initiative has given unfair advantage to the largest banks who had such CSA arrangements with the buy-side and are subsequently rapidly gaining market share to the detriment of smaller brokers. The buy-side in Continental Europe were given more time to choose their preferred method of unbundling and the buy-side in Sweden and Germany has alternative means to unbundling which they deem more efficient and less administrative compared to CSA agreements. Various buy-side associations are now lobbying and coming up with alternative solutions for how CSA agreements can remain in use within MiFID II.
The UK buy-side also waved farewell to the use of dealing commissions to fund corporate access services. ESMA is not following suit, being descriptive about the future classification of corporate access. This means that an unfair form of regulatory arbitrage where a fund manager based outside the UK may be permitted to meet a CEO of a listed company in the UK funded by dealing commission charges, whilst a fund manager in the same firm but based in the UK is not.
The European buy-side will, successively as new legislation is rolled out country by country, need to transition to budgeting fixed, instead of relative, amounts of research budgets on a quarterly basis which should not be linked to transactions. The buy-side will apply stronger due diligence of what form of research they are consuming and paying for and if the charges can be passed on to their clients or not. To complicate the challenges further, where bundled dealing commissions have been exempt from value added tax, the European authorities have been unwilling to confirm that the unbundled research component will remain tax exempt. Consequently independent research providers will increasingly be set in a fairer competitive position against research brokers.
With such dynamic changes and inconsistency, the Asia based buy-side are still observing how regulation will emerge, not only in Europe but also in the U.S.A., in order to predict the national Asian regulators next move. The Asia based buy-side have a significantly higher dependency on the relationships with their sell-side partners and are protecting the mutual interest in paying for relatively higher service levels.
More detailed analysis and commentary can be found in the Buy Side Perspectives 2014 report about Commission Management from K&KGC. To purchase the full report, please email editor@fixglobal.com and take advantage of the GlobalTrading readers’ 10% discount.
Connections with China, Market Structure and Buy-side Initiatives
Hong Kong’s electronic trading community convened for the 13th Asia Pacific Trading Summit, with connections with China, market structure and buy-side initiatives featuring prominently in the discussion.
Attended by key industry leaders from the buy-side, sell-side, regulators and technical solution providers, the day began with an examination of the success of the Stock Connect program. Interest is driven by the rapid increase in trading volumes starting from Q2 of 2015, combined with the potential extension of the scheme to the Shenzhen Stock Exchange and the looming prospect of MSCI inclusion of A-shares, although challenges around the daily quotas and custodial arrangements persist. Chinese regulators are deliberately pursuing separate channels for foreign investors to access different parts of their capital markets in an effort to maintaining stability. Convergence of these channels will likely take place but much legal, regulatory and technical work needs to be done.
While Chinese trading links continue to drive headlines, much work is being done to improve efficiency at multi-asset trading desks. To set the backdrop for this discussion, the Singapore Exchange shared details of their new bond trading platform, which will be the first over the counter liquidity venue that is solely dedicated to Asian bonds. Trading costs, regulatory changes and simplified technology are driving the trend to multi-asset trading, but the reality of one trader covering all asset classes in Asia is unlikely.
Within Hong Kong, the new dark pool licensing regime is meant to protect retail investors from inconsistency of information, however, retail can often carry a greater risk of information leakage for larger trades. The Hong Kong Exchange’s consultation on the Volatility Control Mechanism and Closing Auction Session were widely reviewed as positive steps in developing Hong Kong’s market structure. With a wider gap in opinion between retail and institutional investors over the proposed rules, local brokers and their clients will likely require greater education.
An even greater need for discussion and collaboration exists between the buy-side and sell-side as they work out a solution to new rules about unbundling commission payments and research. Larger buy-side firms are likely to have worked out a solution already to allocate funds for research, but smaller firms may struggle to maintain adequate access. On the sell-side, new models for provisioning research, whether in tiers, menus or nominal fees are being explored. Much of the long-tail concern is over the future development of analyst talent and the retention of seasoned analysts.
Look out for more in-depth coverage of the event in the Q3 edition of the GlobalTrading Journal.
