Equities trading focus : Block trading : James Baugh

April 29, 2015

Making a comeback

James Baugh, Head of Pan European Sales and Marketing, Capital Markets, London Stock Exchange Group discusses the major trading issues of the day.

What do you think are some key impacts of MiFID II on the trading landscape?

There are a number of areas that together will have a major impact on market structure and the way people trade. The first is the introduction of volume caps of 4% and 8% on dark trading, using either the Reference Price Waiver or the Negotiated Trade Waiver. The second is the requirement for brokers to find a new home for their internal crossing business. Under MiFID II, brokers will only be able to match principal business under a unilateral model against their own capital under the Systematic Internaliser regime. If not, they will have to externalise their flows by using public venues, which for some may mean establishing their own MTF. Some members are already registered as SIs and are looking to see how much flow they can put through these constructs, whilst others are no doubt looking at how they can become registered themselves.

Aside from dark trading, what are the other major issues?

Changing the deferred publication regime from three days to same day, or next day for those trades consummated two hours before close, will have an impact, particularly for those less liquid, difficult to trade names. Regulators are aiming to have details of transactions conducted on trading venues made public as close to real-time as possible, however the shortened timeframe will not give brokers much time to unwind their risk trades. It will increase the cost of capital and could make it even more difficult to trade certain less liquid names.

ESMA’s latest guidance on algo trading is also an area which needs careful consideration. It is recommending firms using algos, which provide liquidity, and essentially look like market making strategies, for at least 30% of the available trading hours will be required to enter a competitive price for 50% of the trading hours. This will definitely change the market making regime and could muddy the waters between what we would consider traditional market making and algo or specialist trading firms. It is unclear whether these obligations will lead to improved liquidity, particularly during times of stress when participation rates, incentivised or otherwise, might drop. Similarly, the definition of competitive price is causing some concern particularly where market makers today are not obligated to quote at the touch, which for less liquid names may not be so important. We believe offering a choice of schemes to best suit the needs of the participants would provide the best outcome.

Separately, the introduction of a new tick regime will result in a reduction in tick size for a significant number of less liquid securities, which could lead to a reduction in pricing stability and a reduction in available size at touch, which clearly we don’t support.

Lastly, price formation could be adversely affected by price band validations that are proposed to be required for all venues on order entry, particularly in less-liquid securities where genuine significant shifts in price cannot occur because orders trying to form the new price will be rejected.

How is the industry responding?

At LSEG we are already responding. In understanding the complexity and cost of developing such solutions we are well placed to work with the industry to address the challenges that MiFID II will inevitably bring about. We are working with 70+ institutions, many of whom have already helped shape our recent Turquoise Block Discovery” and mid-day auction initiatives.

Can you provide more detail on the offerings?

Turquoise Block Discovery” is a new block trading service launched in October 2014. Recognising that MiFID II and the introduction of the double caps will encourage a move to a more Large In Scale, block trading environment, and that those larger trades will be exempt from the caps, Turquoise Block Discovery” aims to address one of the biggest challenges in the market. Namely, the re-aggregation of dark liquidity, fragmented by the introduction of alternative trading venues following the introduction of MiFID I. Turquoise Block Discovery” is the first public European venue to introduce a non-firm conditional order type, which allows members to continue to search other liquidity pools for matching opportunities without the fear of over-trading.

Once a match is found in Turquoise Block Discovery”, members are requested to re-aggregate all their child orders and send the firm parent order to Turquoise Uncross” where the trade is consummated.

This results in a larger block trade, which on order entry is more likely to be Large in Scale and exempt from the caps, whilst saving considerable post trade costs. Already we are seeing average trade sizes resulting from Turquoise Block Discovery” of around €250,000. This is the first public mechanism in Europe to reverse the trend of decreasing trade sizes in dark book trading.

Another new offering is the London Stock Exchange intra-day auction, which is set to be launched in the second half of the year, and will be for all securities using the SETS electronic trading system.

We held a consultation last year with our members to help shape the timing and mechanism of the auction which will take place at midday for two minutes.

Many funds and market participants use midday as a marker to benchmark their portfolios and price a number of complex products and therefore welcome a midday fixing. The midday auction will also provide an alternative for business traded on dark pools which may be of a significant size but not Large In Scale and could be caught by the double caps. As a price forming mechanism on a lit venue, auction business will be exempt from the caps.

How do you see the relationship between the buy and sellside changing?

The buyside are becoming more empowered and want greater control of their order flow. There is also a greater obligation on them to prove to their portfolio managers and end clients that they have done everything they can to achieve best execution. The result is that they want more information as well as tools to measure how their orders are being matched up. They also are monitoring their broker performance more closely. We are also seeing a greater willingness and involvement from the buyside in how we develop innovative solutions to help address the challenges of changing regulation.

Looking ahead what do you think are the greatest challenges?

Regulation will continue to be a key driver for change and with that comes opportunity and innovation. MiFID II presents a number of challenges and working together with both the sellside and buyside, we hope to iron out some of the ambiguities and deliver solutions to address those challenges. Whilst others may also seek to develop their own services, this will take time. Given that monitoring and assessment against the double caps will begin in January 2016, one year ahead of the planned implementation date of MiFID II, this is time the market can ill afford.

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Equities trading focus : Sellside connectivity : Michel Balter

Ian Rycott

April 28, 2015

Making the case for upgrading sellside client connectivity

Michel Balter, Chief Strategy Officer for CameronTec Group, examines the business case for upgrading sellside client connectivity in today’s market climate. Operating successfully in today’s markets amid the harsh realities of shrinking returns and increasing costs requires firms to not only differentiate on service, but importantly to reduce the overall complexity surrounding their electronic trading environments.

In the past few years, there has been much focus around architecting and harmonising front office systems across trading desks and asset classes, in order to reduce the disparate silos and redundant technology that can undermine a firm’s long term profitability.

Significant cost reduction

Sellsides can significantly reduce operational costs by bringing their sprawling world of FIX under control and abandoning underperforming and poorly designed legacy systems. This is especially the case for aging FIX routing infrastructure. A large degree of this older FIX technology is designed around silos and represents a mass of dated, disparate systems that have been added over time.

FIX infrastructure technology for today should be optimally designed to really achieve greater business benefits. It needs to be horizontally designed to support a firm’s multiple sites, desks and asset classes, and it should be built on a powerful messaging-engine technology layer, in addition to highly adaptive systems for message routing, automated testing, monitoring, customer on-boarding and risk management.

Integrated and interoperable

An integrated solution will give sellsides the interoperable data they need to achieve sophisticated business insight. Designed correctly, upgrading FIX routing infrastructure can help firms optimise their operations, infrastructure and trading capabilities; significantly helping to lower operating costs and attract and retain clients with a dramatically improved customer value proposition and experience.

Historically, the fallback position for many firms operating within the financial services industry is to remediate issues with quick fixes. But with diminished profits and disappointing volumes, plus regulatory intervention inflating the cost of compliance, the only way up for the sellside is to invest in the right technology to deliver value.

Future-proofing

With neither the sellside or the buyside guaranteeing profit margins under current market conditions, firms with longer-term strategies, mandates and targets are now tasked with investigating technology that will future-proof their trading systems. Indeed, meeting regulatory requirements and addressing and implementing compliance fixes has pushed the capital markets industry into unchartered territory; signalling an unprecedented period during the era of trade automation for embracing solution and service innovation.

CameronTec Group recently spoke with market participants worldwide to put together a white paper summary examining the case for upgrading sellside client connectivity, and highlighting the conclusions:

Sifting through the explosion of complexity. As firms’ trading systems have proliferated, so too has the network of FIX infrastructure supporting these systems and today the result is a muddle of technology and aging infrastructure that is difficult to manage and costly to maintain.
Streamlining cumbersome, decentralised trading infrastructure. Decentralised trading infrastructure means firms have unnecessary duplication across their systems leading to higher costs and resource usage, and compromised client service.
Repercussions of Limited and Non-Invasive Testing. Outages leading to financial disasters are becoming more commonplace, and often the blame rests with lack of adequate testing.
Limited and Decentralised Monitoring. The decentralised nature of a sellside’s trading infrastructure often makes it difficult to gain a complete, real-time view of customer flow.
Inadequate infrastructure that lacks resilience. Many older FIX routing systems do not handle failures. For any serious firm, this alone is a show-stopper.

For a copy of the white paper report visit www.camerontecgroup.com/news/perspectives.

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Post-trade : Clearing & settlement : Mary Bogan

Ian Rycott

April 28, 2015

CLEARING AND SETTLEMENT: THE IMMINENT ARRIVAL.

The road has been littered with many bumps but T2S is almost here. Mary Bogan reports on the final stages.

Target 2 Securities (T2S), the grand ECB project which, hand in hand with the regulatory directive Central Securities Depository Regulation (CSDR), aims to create a single platform for the settlement of domestic and cross-border securities transactions in Europe and convert a complex, fragmented post-trade market into a borderless landscape, has had a creaky passage

Launched in the wake of the financial crisis, the initiative received a cool reception from market participants, struggling under weighty tomes of regulation and troubled balance sheets. Hiccups in the European Central Bank’s (ECB) implementation timetable, accompanied by a simmering euro crisis, led many to doubt the project would ever see the light of day. However, as T2S inches towards imminent launch in June, market sentiment has mellowed and T2S is now seen as a game-changer in Europe.

“The market now recognises this is the right way forward and no one doubts T2S will happen,” says Tom Casteleyn, managing director T2S and market infrastructure at BNY Mellon. “People always knew T2S was a major technical change project. Now they see it as an important step on the road to the simplification and unification of the European post-trade chain that offers large operational and cost-saving benefits as well as new business opportunities.”

A single European settlement platform, accompanied by harmonised settlement market processes, deadlines and functionalities across territories, has obvious advantages for operational efficiency. Equally important though, says Alex Dockx, T2S programme director at J.P. Morgan, is the reduction of payment risks and liquidity benefits.

“T2S settlements will be processed in central bank money and intraday credit needs can be collateralised with assets in T2S. As cash and collateral can be pooled across T2S markets, there are substantial netting and collateral efficiencies as well. In future banks with a European presence will be able to settle their entire T2S activity in central bank money using a single dedicated cash account at a central bank of their choice and use the T2S auto-collateralisation functionality to fund their intraday needs. This will reduce the need for intraday credit facilities from agent banks and allow netting across markets.”

Cost savings?

A recent study by Oliver Wyman and Clearstream estimated that brokers, custodians and banks that engage with T2S stand to pocket between €30m and €70m a year through capital, funding and operating cost savings produced by delayering settlement-related exposures, pooling collateral for settlement and tri-party purposes, netting more cash settlements and simplifying their operations.

While some potential savings look attractive, less appealing is the possibility of at least a short term-term hike in settlement pricing following T2S. Although the Eurosystem has set a headline price of €15 cents for a delivery-versus-payment (DvP) instruction, final charges will depend on how CSDs and other market participants compete in a more open and cut-throat post-trade world.

“There are two great unknowns about T2S,” says Alan Cameron, head of relationship management for international banks at BNP Paribas Securities Services. “We don’t know the end-pricing of CSDs and we don’t know how much liquidity will be used in settlement. It’s what’s stopped banks coming to radical decisions about European settlement. CSDs just don’t know what business is going to look like after T2S.”

Prices may even rise before they fall, says Isabelle Olivier, head of clearing settlement, SWIFT. “Some domestic CSDs have already increased the price of domestic settlement in advance of T2S. Others are taking a wait-and-see approach before assessing the impact of large project costs and increased competition on margins. I’m confident prices will come down but probably not for three years or four years when all migration waves have been completed and the project is up and running.”

Another factor pushing pricing upwards is the seeming determination of CSDs to remain independent businesses. Many had expected CSDs to merge or form agreements to develop T2S platforms and tackle competition. However, except for a few exceptions such as the Baltic CSDs, consolidation, in what many agree is an overcrowded CSD space, has failed to materialise.

“We’ve been talking about CSD consolidation forever but what we’re actually getting instead is CSD proliferation,” observes Cameron.

Crystal ball gazing

How Europe’s post-trade market infrastructure is likely to shape up in future and which institutions will survive in a post-T2S era, is anyone’s guess. The demarcation lines though between different parts of the chain are already blurring as competition fires up

“Everyone is looking for space up and down the value chain to create the biggest economies of scale possible,” says Andrew Simpson, head of post-trade at Euronext. “You’ve got global custodians, major CSDs, ICSDs, boutique CSDs and local custodians all playing out and vying for territory and services. T2S may well increase fragmentation in the market initially before a more consolidated and simplified structure emerges.”

Generally agreed to be under greatest threat is the business model of the traditional CSD. “Although all CSDs retain natural monopolies as issuers for government securities, the question is where will secondary activity take place?” says Casteleyn. “Will it be equally distributed over different CSDs or will it go to the book of one particular CSD? Remaining a safekeeper for issuers, without winning any secondary market activity, is a model that will be challenged.”

According to Simpson, even small CSDs can thrive in the new environment though perhaps not in their current form. “We can’t hide away from the threat to small CSDs. They can’t do nothing and expect to survive on a small part of the pie. But boutiques have a great offering for banks with their knowledge and understanding of local communities, local tax or bankruptcy laws and more personalised service. They may need to form partnerships or become part of bigger organisations but I’d expect them to retain their national brand identities. The boutique proposition is always necessary.”

Elsewhere, market titans such as global custodians, clearers and exchanges have been preparing for incursions into traditional CSD territory: BNY Mellon has launched its own CSD, London Stock Exchange Group is creating a new CSD in partnership with J.P. Morgan and BNP Paribas is building scale with the launch of an international settlement centre in Lisbon.

According to Olivier, T2S has been a big driver of innovation. “I’ve seen more new types of services, products or alliances in the last two years than in the previous five with, for example, sponsored access to T2S or custodians and new CSDs offering asset servicing only. All these new models are like a tsunami that is shaking up a slow moving, conservative market.”

Not all innovations though may be having the desired effect. Take the moves to meet higher collateral requirements in the industry. “We’ve seen a number of new industry products all designed to liberate and mobilise collateral,” observes Simpson. “But because those services are so specific to the provider, clients tell us they are not mobilising collateral. They’re immobilising it. Collateral is getting parked on firms’ books rather than being made available at the trading or margining level.”

One answer, suggests Simpson, is for firms from right across the market – banks, exchanges and trading firms – to form a community to effect collateral mobilisation. Interestingly, a new initiative to create an industry collateral infrastructure, known as Project Colin, was recently reported to be underway.

The ECB vision for T2S was to create a low-cost, efficient, harmonised post-trade market in Europe. Whether it delivers remains to be seen but what is clear is that the benefits will only be enjoyed by firms that re-write their game plans for a new world.

“When you look at T2S, you’ve got to ask not what T2S can do for you but what you can do for T2S,” says Cameron. “If you just sit still and expect cost savings you’ll be disappointed. You’ve got to adjust your business model to accommodate this new harmonised landscape and if you do, you’ll get cost savings. Behaving the same as you were before is not an option.”

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Regional focus : Shanghai & Hong Kong : Dan Barnes

Ian Rycott

April 28, 2015

A MEASURED APPROACH.

Dan Barnes assesses the ups and downs of the Shanghai-Hong Kong Stock Connect.

In 2014 Hong Kong saw a spate of market reforms, imposing control over electronic trading systems, standardising dark pools and opening the Shanghai-Hong Kong Stock Connect (SHKSC) a two-way pipeline that allows traders based in Shanghai and Hong Kong to access each other’s markets. Market conditions have been positive from a trading perspective.

“Over the last twelve months we have seen a considerable increase in volatility in the market as well as in trading volumes,” says Murat Atamer, co-head of Asia Pacific institutional electronic trading at Bank of America Merrill Lynch (BAML), adding: “China posted record trading volumes during that time and it was reflected in the Hong Kong market as well. In line with volatility, we have seen some limited increases in spreads as well.”

Lee Bray, head of Asia Pacific (APAC) trading at long-only investment manager J.P. Morgan Asset Management adds, “Our trading costs have stayed low over the last year which is a good indicator that liquidity is around for large institutions so the environment seems conducive to business. We have a robust transaction cost analysis (TCA) process using an implementation shortfall (IS) benchmark which means we like to see blocks as quickly as possible in most cases even if volatility is pretty high.”

Given the condition, it might be expected that the SHKSC, which provides a bureaucracy-free option to trade in and out of the mainland, would also be booming. Since 2002 direct investment into China was restricted to firms with either Qualified Foreign Institutional Investor (QFII) status or Renminbi QFII (RQFII) status. Investment out of the country was similarly limited to businesses with Qualified Domestic Institutional Investor (QDII) status. Any firm granted a trading status was also given a quota of trade allowance.

Stock Connect slow start

Launched on 17 November 2014, the SHKSC applies a daily and annual quota to trading, however volumes have fallen well below expectation and Atamer reports that trading is predominantly northbound led by alternative investment firms rather than long-only firms.

Bray says, “We are having to rely on the quota where the ability to trade with multiple brokers to source liquidity is a bit less than one would like compared with markets like Hong Kong.”

In part volume expectations were set at a time of frothy excitement. SHKSC was announced and launched at such a pace by the China Securities Regulatory Commission (CSRC) and Hong Kong’s Securities and Futures Commission (SFC) that there was not much time to analyse its likely use.

Alex Godingen, regional head of business development for APAC at trading systems provider Fidessa notes, “The project was brought up very quickly after March 2014, exclusively for political reasons, and in June the exchange started to publish information and timelines in the project, even though it had not been established how it would achieve this connection technically.”

Godingen says the staggered release of information and tight timeframe to deliver for Fidessa’s clients, eight of whom went live on the first day, meant the project was “tough but exciting.”

If it is the case that the SHKSC was oversold initially, it will not under deliver in the long term, according to David Broadfield, head of north Asia institutional e-trading sales at BAML: “Although initial trading volumes weren’t as anticipated, the interest is still huge. The volumes shouldn’t detract from the significance of the Stock Connect launch and what it represents.”

At present the main operational challenge for long-only funds stems from the T+0 settlement cycle and batch based transfer window, which until late last year could only settle stock movements between a broker and custodian at 7.30pm at night, in effect mandating a T-1 settlement cycle. In a concession to the problems this poses a 15-minute window was introduced at 7.45am although this still requires far more operational precision than a T+2 cycle found in other markets.

“Under the current model firms have to pre-deliver their shares free-of-payment to their broker and that has a huge number of problems,” says James O’Sullivan, head of client development, banks and broker dealers, BNP Paribas Securities Services Hong Kong. “There is counterparty risk, information leakage around trading ideas and the operational risk of delivering those shares in a 15-minute time window.”

Attempts have been made to work around the issue. For example, BNP Paribas has used its custody and broking operations to internalise the settlement process. “By having a relationship on the execution and custody side it means you don’t have to pre-deliver your securities in order to sell and we in effect offer synthetic delivery vs payment (DVP),” says O’Sullivan. “That takes away the counterparty risk and eliminates the operational risk of pre-delivery in the 15-minute window. We have been able to respond to a market inefficiency.”

The bank reports requests for information on an almost daily basis, from asset managers based in Asia, Europe and the US, while a European bank has also reportedly signed up to use the integrated model, which required several months of work. “There are lots of internal and regulatory processes that many firms have to go through despite their enthusiasm,” says O’Sullivan.

Models like this can create an alternative operational model for investment managers that are challenged by the beneficial ownership rules, although the complexity that some can pose may still be a concern.

Bray says: “If you find a system that has increased flexibility then there is an increased risk of buying and selling into the wrong account. And so the large funds that have a lot of business have stuck with the plain vanilla model.”

The next steps

More structural reforms are underway to make the model work more effectively. Bray says that a group is currently working on a new omnibus account type model with the authorities. “This allows for special segregated accounts which have the potential to help enormously, but there are inherent problems around the initial suggestion which still need ironing out,” he observes.

There are good reasons to think that the authorities will resolves this and other issues. Small changes, such as a restricted volume stock lending programme which opened on 2 March 2015 are allowing market operators to test the water before significant change are made.

Earlier reforms have proven valuable. Atamer says that the requirement to better understand trading platforms has added rigour to the market. “People are better documented and testing and so on is much better,” he adds.

“The impact has been positive. On the exchange side it resulted in positive steps from the SEHK as well as a closing auction in line with sellside and buyside recommendations. They are also introducing volatility interruption measures, but these may not be completely effective under certain scenarios.”

Likewise the standardisation of dark pool rules around participation was positive he says, although the small level of dark activity might be better supported by the exchange having its own dark pool as exists in Australia. “The regulatory burden on it would be lower,” he notes. “The small broker pools are provided for client benefit and having something on the exchange side would benefit clients. Accessibility could be for all brokers.”

The mainland markets are also keen on progress, albeit measured. Sylvain Thieullent, APAC director of sales and client Services at Horizon Software, says that the appetite for technology underlies the expanding business models and appetite for trading activity.

“In China there has been increased interest in market-making exchange traded funds and index arbitrage,” he says. “There are a lot of restrictions on what you can do and in how the technology has advanced over there; in some cases technology can hark back to the start of market electronification, but that is changing fast. Market participants have the capacity to change and I think a lot will change over the next two years, especially at the exchanges.”

With progress being made on the mainland and in Hong Kong, market participants are positive about the future.

O’Sullivan says, “The exchange is very open to building the market that people want, but I think market participants will need to have some patience as it will take time. They are keen to demonstrate incremental improvements.”

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Trading venues : Turquoise : Robert Barnes

Ian Rycott

April 28, 2015

BUILDING BLOCKS.

Robert Barnes, CEO of Turquoise tells Best Execution how the exchange is moving with the times.

What was the goal when Turquoise launched in 2006?

Turquoise was created as a pan-European MTF, by users for users, to innovate and offer benefits for the wider community. Our focus is clear: to offer efficiency at the point of execution. We’ve created a multi-country platform on one connection, trading securities of 18 countries, giving clients access to a lit order book including emerging market securities and midpoint with size priority where larger orders jump to the front of the queue.

We achieved a new record in January 2015, trading an average daily value of €5.1 billion compared to €1.8 billion two years previously. We have grown more than four times in midpoint and, in 2014, covered our costs each month for the first time. Turquoise now has 9% of pan-European order book share of trading.

Do you see fragmentation as a problem in the current marketplace?

Fragmentation is a common factor worldwide, with the rise in electronic trading resulting in smaller trade sizes. We value the importance of the midpoint, as witnessed by the success of Turquoise Uncross™, our randomised midpoint uncrossing for larger and less time sensitive passive orders. It has become the first order book mechanism in Europe to reverse shrinking trade size, doubling the average trade size within midpoint of €10,000 per order and higher when matching orders facilitated by Turquoise Block Discovery™.

What lay behind your decision to launch Turquoise Block Discovery™ in October 2014?

Turquoise Block Discovery™ was launched in anticipation of the arrival of MiFID II. It facilitates larger block orders by matching Block Indications and interacting with existing liquidity in Turquoise Uncross™. Investors can trade exceptionally large blocks with no information leakage in both large and mid cap stocks. Averaging €200,000 per trade, the level of many block transactions are above the large-scale threshold contained in MiFID II. We are ahead of the field in fulfilling the needs of our clients. If a customer has a trade at €1.5 million, we match it at midpoint and this can also match inside the lit order book tick size, all through one connection. If members undertake a single trade at, say, €1.5 million, we’re also delivering significant savings in post-trade clearing costs compared with 150 trade tickets times €10,000 average trade size

How do you feel about the increased competition in the market?

A key feature of a well-developed financial centre is competition and entrepreneurial activity. There’ll always be new entrants because that’s the natural cycle of a healthy ecosystem. We’re innovators ourselves and believe we’re at the centre of this new landscape. We listen to and respond to customer needs, mitigate costs and offer a niche service.

What are the main areas of growth that lie ahead for Turquoise?

We’re looking to continue to raise our visibility across the continent, widen our membership to include more brokers and intermediaries at the regional and sector level and to pursue still more innovation. We want to diversify the variables that are important to our customers and to extend our trading in mid and small caps to create an even more inclusive stock universe. We’re also keen to broaden our geographical spread to include more countries under the MiFID umbrella.

Our focus is on helping our customers get their business done.

How do you anticipate that other asset classes will evolve in terms of trading venues?

Non-equities products can definitely benefit from economies of scale and participating in regulated platforms. From July 2014, regulatory non-objection enabled CCPs to clear Exchange Traded Funds (ETFs) on a fully interoperable basis. ETFs today are not recognised as MiFID liquid instruments, but from January 3, 2017 go live of MiFID II, ETFs become MiFID instruments. MiFID II represents a good opportunity to create an on-order book structure and improve post-trade activities. Ultimately, we thank the regulators for providing a framework within which we can behave as entrepreneurs.

There is an increasing focus on long-term self-management of pensions and old age security; with real returns near zero, there’s more emphasis on efficient capital markets with low market impact costs at the instant of execution. Efficient market structures with lower implicit execution costs can add to long-term returns.

What do you think the impact has been on the primary exchanges of the arrival of the many MTFs now in the marketplace?

We see ourselves not as competition but in co-operation with primary markets to grow the pie rather than just taking a slice of it.

Turquoise is clearly positioned not to compete with primary markets for listings. Our focus is relentless innovation of quality intraday execution; no opening auction, no closing auction, just lit and midpoint dark continuous trading.

Secondary market liquidity drives primary market liquidity. Increasing trading activity can contribute to lower implicit costs of investment and ultimately lower costs for issuers. This is particularly true for smaller companies which often suffer from high implicit costs due to investors facing wider bid-offer spreads.

At Turquoise, we are big promoters in building liquidity beyond blue chips to mid and small caps. We have made it a priority to increase our coverage of smaller issuers and bringing on board investors, including domestic brokers and retail intermediaries that specialise in this area.

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Trading venues : Aquis Exchange : Alasdair Haynes

Ian Rycott

April 28, 2015

CHANGING MINDSETS.

Alasdair Haynes talks to Best Execution about the progress made by Aquis.

Where does Aquis Exchange fit into the constantly shifting environment of equities trading venues?

You need a variety of players to make a strong ecosystem. ITG and Chi-X, both of which I previously headed up, have a track record of being at the forefront of evolution and Aquis is exactly the same. Our subscription-based pricing model, in which clients are charged according to the traffic they generate, rather than a percentage of the value of each stock traded, is completely new for European exchanges. We’re disruptive in a very beneficial way. There’s always room for innovators who bring something different into the market which either improves a situation or solves a problem.

How has the first year of trading been?

I’m generally pleased with the progress we’ve made. It’s been a tough first year but that’s usual for start-ups. You have to be very determined when you’re forcing change on an industry that instinctively doesn’t like change. Overall, we’ve had a successful launch with no technical glitches and we’ve already got seven of the top 10 investment banks on board trading with us. We’ve achieved some very good market shares, including in the Swiss and Swedish markets, as well as in individual stocks. Each month we’re doing better in terms of market share and volumes of trading.

We now need to work on people connecting with us. Some participants have been slower to start than at first indicated, which makes the time period to profitability longer than anticipated. Decision-making is far slower these days because of all the regulation. The industry is in a prolonged period of de-risking. But I believe the Aquis model is very good for the market and its participants. Asset managers and end users like it, because our pricing model means there are no hidden costs. We’re encouraging transparency, fairness and inclusivity and keeping things simple: all the principles that MiFID is trying to achieve in the marketplace.

What are you focusing on over the next two to three years?

We want to continue to bring major players on board, including the remaining three of the top ten investment banks. New order types are being launched over the next few quarters, all part of our drive to innovate. We’re a technology provider and see major growth ahead in technology sales and partnerships. For example, surveillance is one of the new criteria stipulated in MiFID II, with which every exchange will need to comply. We already have a system which we’re happy to sell to other participants. In that sense, our exchange acts as our shop window for other products.

Do you expect the changes taking place within equities trading venues to be mirrored in other asset classes?

All asset classes have their own idiosyncrasies but the concept is the same. We are now seeing more efforts to regulate the non-equities markets, with firms launching TCA for fixed income, for example. It will ultimately happen in other classes, but at a slow pace, because changing people’s behaviour takes time. The direction is definitely for multi-asset class trading on lit exchanges, to deliver increased transparency.

Post MiFID I, can end users now expect better best execution?

MiFID I had some very good results in terms of encouraging competition but recent studies show that best execution hasn’t been fully embraced and is seldom passed down to the end user, which is very frustrating for the buyside. I’m often amazed how poor it is. There is a lot of work to be done there and I think the rules on the best execution criteria need to be more prescriptive. If firms are to be more accountable to their customers, that means giving something away at the same price and many don’t like that. Personally, I welcome anything that pushes towards best execution as a principle. It’s the backbone of what we’ve tried to do at Aquis.

Is the regulatory drive towards trading on exchange rather than in dark pools unstoppable, even at the expense of liquidity?

The political drive to limit dark pools does look unstoppable but there is a genuine market need for non-lit place for block trades. I suspect the market will find a way around the issue. Dark pools aren’t the answer to everything, however, and more on-exchange transparent trading may be good for confidence in and within the market.

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Trading venues : BATS Chi-X : Mark Hemsley

Ian Rycott

April 28, 2015

CHAMPIONING THE CAUSE.

Mark Hemsley, CEO, BATS Chi-X Europe explains the move into FX.

As the landscape for trading venues continues to evolve, how does BATS Chi-X Europe fit into the whole picture?

As Europe’s largest stock exchange, we’re in a strong position. When you consider the notional value traded across our order-books in January, and add that to the total reported to BXTR, our OTC trade-reporting service, more than a third of all equity trades done in Europe (whether they be on- or off- exchange) touch our systems. We consider ourselves champions of a single, united marketplace and we are focussed on breaking down barriers to competition to make the European market deeper and more liquid – so as to benefit all participants.

What were the drivers behind your recent decision to acquire Hotspot FX? What will the advantages be, both for BATS Chi-X and for your customer base?

Hotspot is a leader in the FX market and is well positioned for growth, making it a great addition to BATS’ growing global offering. The transaction moves BATS into the world’s largest and most global asset class, and for the first time, we will have a presence in Asia. Furthermore, there is structural change afoot in the foreign exchange market: regulatory scrutiny is forcing increased transparency and greater automation, while large dealers are converting an increasing percentage of their businesses to an agency model. At a macro level, FX volatility is picking up and coming off a cyclical trough.

Are there any challenges that are specific to the FX market? What lessons can be learnt from your experience operating in equities trading?

There is plenty of crossover: both FX and equity markets are highly liquid asset classes. While the FX market doesn’t have a closing bell, and functions across continents 24 hours a day, we have huge experience of running exchanges and technology across different time zones and jurisdictions. With the FX market becoming more automated, and moving to more transparency, our team’s experience of creating and operating transparent, multi-market electronic exchanges will come to the fore.

Do you expect multi-asset class trading eventually to become the norm?

Clearly there’s a regulatory drive towards that market structure in other asset classes – alongside the FX market, you’re also seeing it in bond trading. But we firmly believe that the right market structure depends very much on the asset, and on its liquidity. Our job as an exchange is simply to provide the apparatus and market structures to enable trades in those assets to execute in an orderly and fair environment.

What is the impact of new arrivals Luminex and Plato likely to be?

We’re following the progress of both. Once they’re up and running, we’ll be able to get a better sense of their offering. Right now, both seem to be at a project stage, and it’s probably too early to comment. As far as we’re concerned, our solutions will follow the final publication of MiFID II technical guidance: given how prone regulation can be to last minute changes, it makes sense to us to wait.

What do you think the trading venue landscape will look like in 3-5 years’ time? Who will be the winners and losers as things continue to evolve?

That scale will help to reduce costs for investors. With the advent of a European consolidated tape, a more federated, united marketplace would benefit all those that look to raise money – or make money – from European capital markets whether they be banks, brokers, or most importantly, companies and investors.

What opportunities and challenges now lie ahead for BATS Chi-X?

Our business model continues to operate in the way it always has done: identify market inefficiencies and then work to smooth them out. Europe has progressed a great deal since MiFID I – and our success as the largest exchange operating in Europe today is evidence of this – but there is still a long way to go.

The playing field still remains very tilted in favour of incumbents – particularly when you look at the picture for market data for example – or vertical structures – like clearing and settlement. So while equities trading may be a little simpler, there’s still a huge amount to be done.

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Viewpoint : The impact of regulation : MiFID Review : Silvano Stagni

Ian Rycott

April 27, 2015

GETTING YOUR DUCKS IN A ROW.

Silvano Stagni, group head of marketing & research at IT consultancy Hatstand, considers the MiFID Review and asks if you will you be able prove the ‘Best’ in your ‘Execution’?

It is common knowledge that the MiFID Review (MiFID II/MiFIR) extends the scope of the directive to non-equity financial instruments. The review also redefines client classification. Clients are rated by financial instrument. A client may be ‘professional’ for shares, bonds and credit derivatives, but ‘non-professional’ for other types of financial instruments.

The emphasis of the directive has changed. MiFID II/MIFIR provides a definition of best execution by identifying four pillars: price, cost of trading, speed of execution of the order, and the likelihood of the order being executed (liquidity).

There is now an emphasis on proving the quality of the execution. Institutions will have to report on it. Obligations will vary depending on client classification (Non-Professional, Professional and Executive Counterparty). Clients will have the information necessary to assess the quality of execution from a mix of reports provided by Execution Venues and Financial Institutions (FI).

This article describes what a Financial Institution has to provide to its clients. An execution venue, it will have to provide a different type of report. FIs licensed as Organised Trading Facilities (OTFs) or Systematic Internalisers (SI) will have to provide both set of reports.

A Financial Institution reporting obligation will be fulfilled using a report called the “Order Flow and Execution Quality Report”. This report consists of three sections:

Summary by order type which reports the total percentage of the volume of each order type (see below).
Top five venues of execution, based on the details of the previous rolling 12 months.
A data report sorted by order type and execution venue. In this section the volume in each trading venue by order type and any extra information that may have influenced the decision to use that specific execution venue, such as inducements, a close link or discounts, must be stated.

The format of the report as laid out in the consultation paper, has much interesting information both on the principles of best execution and on the report itself.

The top 5 venues receiving a percentage of all orders must be listed. An order should be placed with at least five trading venues whenever possible. MiFID I stated the requirement to distribute orders among multiple trading venues. Whilst the Review mentions ‘five top trading venues’, this could mean ‘at least’ five.

In the current market, this seems easy to achieve with equities but more difficult with non-equity instruments. This is an erroneous perception because:

In those jurisdictions where MiFID I was extended to bonds (Italy, Germany and Denmark) Multilateral Trading Facilities (MTFs) were set up to deal with secondary trades of highly liquid bonds. Any regulated market could create alternative trading venues for the most liquid non-equity contracts.
MiFID II/MiFIR defines a fourth type of trading venue, the Organised Trading Facility (OTF), specifically for non-equity trades. This gives every company currently operating a trading platform the option to register as an OTF. It will therefore be possible to have five venues where a financial instrument could be traded.
Under the terms laid out in the version that was under consultation until early March 2015, all possible ‘execution venues’ will have to be listed (if they are in the top five) such as market makers, OTC, etc. This however may yet change.

Differentiation must be made between a Market Order (an order to buy or sell an investment immediately at the best available current price), a Limit Order (an order to buy or sell an investment at a specified price or better. It cannot be executed if the price set by the investor cannot be met during the period of time when the order is open) and Other Orders. All of this needs to be reported by financial instrument.

The definition of financial instrument needs to be precise enough to reveal differences in order execution behaviours, but aggregated enough to ensure that the reporting obligations on investment firms are proportionate. There is a suggestion to calibrate the classes of financial instruments to include the definitions in Annex I, section C of level 1 MiFID II (list of financial instruments in scope).

Whilst the logic behind this report is straightforward, collecting all the required information and making sure that all ‘the ducks are lined up’ is not. There is a large amount of data to collect and there is also the need to establish the top five execution venues per financial instrument on a 12-month rolling basis. To date, there are no provisions for a transition period, therefore it would be prudent to start capturing the information that will be required sooner rather than later.

A Financial Institution may also have to prepare a second ‘Execution Quality’ report if it is also an ‘Execution Venue’. This applies if it is a Market Maker, if it seeks a licence as OTF or SI, or if it executes OTC trades. The only information specified is that it will have to report on the four pillars of best execution: price, total cost of transaction, speed of execution and likelihood of execution. The requirements for this report are not as clearly defined as the one discussed above.

This of course means more data; data that might not be currently captured. It might therefore be prudent to start reviewing data capture and to discuss whether to seek to be registered as an OTF or SI in anticipation of the imposition of the requirements for the relevant additional reporting.

MiFID II/MiFIR may not be imminent but it is coming. ‘Line up your ducks in a row’ as soon as you can, it will pay off later.

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Market review : FX

Ian Rycott

April 27, 2015

PATIENCE REQUIRED.

By Noureldeen Al Hammoury

Q1 2015 will be remembered by FX traders for one single event which had a significant impact on all currencies and markets. When the Swiss National Bank (SNB) removed their peg to the euro it is estimated that losses across the industry exceeded US$70bn. However, this was not an isolated event, it was part of a global trend which is still on-going.

From the start of 2015 to the end of Q1, Central Banks around the world have been involved in an aggressive currency war. There have been over 30 interventions, from Denmark to the People’s Republic of China. Normally a war is associated with an aggressive move to assert dominance, but this is a war between countries trying to devalue their currencies in order to gain trading advantage. Stimulus programmes and quantitative easing (QE) are being used as economic weapons to try and promote growth, to raise inflation rates and to tackle unemployment. As soon as one country pushed its currency lower the next was forced to respond and the battle is still continuing.

The US ended its stimulus programme in October 2014 and Europe, through the European Central Bank, started their QE initiative on the 9th March 2015. In between these actions, on the 15th January, the Swiss National Bank removed their peg to the euro. The reaction to this was swift and dramatic. Within minutes the EUR/CHF had fallen by 30 per cent.

FX trading is now based on state-of-the-art, fast electronic systems, used by hundreds of thousands of traders globally. These systems access deep liquidity and offer tight pricing often with little direct human intervention. When faced with a trading event of this significance liquidity dries-up, prices spike and clients are stopped out. It is literally a financial tsunami.

All about the dollar

As a result of the currency wars and the ending of the US Federal Reserve’s (Fed) stimulus package, the dollar began strengthening across the board. This started in 2014 and continued throughout Q1 2015, and by the middle of March it had reached a 12-year high against the euro at US$1.045. From the start of the year GBP fell by 5.3%; JPY by 2.13% and the CNH by 1.38%, as governments looked to weaken their currencies to support their export markets and stimulate growth. Europe, in particular, has been fighting against the spectre of deflation, hence the introduction of their Quantitative Easing (QE) programme, which will look to purchase 1.14trn over a two year period.

Coming off the back of the US QE programme, which flooded the markets with cheap money, US equities continued their strong growth from January to February, with the S&P up 3% and the Dow Jones up 3.6%. In March a correction did happen but most of the losses were quickly recovered. It is clear equities love QE and the same upward move, experienced in the US, has started in Europe, led by the German markets with the DAX crossing the 12,000 level for the first time.

Slippery slope

2014 was not a good year for oil and the start of 2015 was no better, with West Texas Intermediate (WTI) bottoming out at US$43.58 and Brent Crude down at US$45.19. In February both recovered some ground, WTI gaining 4.5% and Brent Crude advancing by 18.7%. These were the first gains following seven consecutive months of declines. However, after the minor rally WTI crude traded within a tight range between US$53.50 and US$48.0 while Brent Crude traded between US$62.50 and U$56.50. But, there was no clear direction, which left the commodity price drifting.

There are many interlinked factors influencing oil prices. However, the main production countries are well aware that the global demand for oil in 2015 is estimated at around 91 million barrels a day, and there are no real alternatives to oil for at least the next ten years. This means demand will remain and there are no obvious reasons why oil prices will not rebound to previous levels. However, a new direction is unlikely to emerge until after the next OPEC meeting in June.

So Q1 has seen a financial tsunami, currency wars, the dollar strengthening, oil declining and the threat of a new recession. These events would normally be enough for a three-month period, but in trying to evaluate what was happening we also need to look at the messages which are coming from the US Federal Reserve.

The Fed has been very difficult to interpret especially in relation to the timing of any rate hike. Global economies have been rising and falling as they try to evaluate the comments by Janet Yellen, the Chairman of the Federal Reserve. The phrase that caused most discussion was ‘patience is required’.

Analysts have variously seen this expression as confirming that a hike in the Federal fund rate will take place in June, or as clear indication that there will be no interest rate increase until September. With 92% of the US economic releases having come in negative or worse than expected, and the White House pointing to the strength of the dollar as a ‘headwind for growth’, the logic for a rise is not obvious.

With the US equity markets at an all-time high and the economy coming under more and more pressure, investors are well aware that a market correction could hit at any time. If it is thought a rate hike will happen the dollar strengthens, and equities slip, and vice versa, with these scenarios being played out on a weekly basis. If the rate increase does take place and equities do start to lose value it is not clear what will prevent a significant sell-off.

So where does that leave us for Q2 and the second half of the year? One factor, which is good for the FX industry, is that volatility looks as though it is here to stay. We can expect to see changes in the dollar, sterling, gold and oil which will change the markets. It is also possible that before these moves happen we could even get parity for the EUR/USD. And, I would not be surprised if we are still having to be ‘patient’ about a US rate rise late into the year.

This market analysis was provided by Noureldeen Al Hammoury, Chief Market Strategist at ADS Securities.

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News review : Regulation & compliance

Ian Rycott

April 27, 2015

BANKS WIN NINE MONTH SWAP MARGIN RULE DELAY.

The Basel Committee on Banking Supervision and the International Organisation of Securities Commissions has delayed the date for the introduction of minimum global rules on the collateral needed to back trades in the $691trn market for swaps and other over-the-counter derivatives. Banks will now have until September 2016 instead of a December 2015 start.

Under the original plan from 2013, the measures would have been phased in over a four-year period, beginning in December this year with the “largest, most active and most systemically important derivatives market participants.”

Swap users had called for a delay, warning that a lack of certainty over precisely how countries would implement the rules meant they couldn’t complete their own technical work on schedule. The industry argued that it needed time to make the necessary wide-ranging changes to infrastructure, technology, risk management tools and documentation.

The industry had hoped that the timeline would have been pushed back by two years but Timothy Massad, chairman of the Commodity Futures Trading Commission, had indicated that the breathing space would be limited. However regulators in the US, Europe and Japan, the three biggest OTC markets, have yet to finalise the rules.

The International Swaps and Derivatives Association, a trade body representing the biggest banks and asset managers, said it was “grateful that regulators have listened to concerns”. Its chief executive, Scott O’Malia, notes that: “The revised implementation date should give firms additional time to develop, implement and test new systems.”

The Basel and IOSCO rules will apply to deals of more than €50m. The timetable for implementation varies depending on the size of the firm’s OTC derivatives trading activities. Under the previous plan, the earliest possible date for having to fully apply the rules on initial margin was November 30, 2016. This moves to August 31, 2017 under the revised timetable. As for variation margin, the previous regime had a single start date of December 1, which now shifts to September 1, 2016 or March 1, 2017 depending on a firm’s trading activities.

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Making a comeback

James Baugh, Head of Pan European Sales and Marketing, Capital Markets, London Stock Exchange Group discusses the major trading issues of the day.

Making the case for upgrading sellside client connectivity

CLEARING AND SETTLEMENT: THE IMMINENT ARRIVAL.

The road has been littered with many bumps but T2S is almost here. Mary Bogan reports on the final stages.

A MEASURED APPROACH.

Dan Barnes assesses the ups and downs of the Shanghai-Hong Kong Stock Connect.

BUILDING BLOCKS.

Robert Barnes, CEO of Turquoise tells Best Execution how the exchange is moving with the times.

CHANGING MINDSETS.

Alasdair Haynes talks to Best Execution about the progress made by Aquis.

CHAMPIONING THE CAUSE.

Mark Hemsley, CEO, BATS Chi-X Europe explains the move into FX.

GETTING YOUR DUCKS IN A ROW.

Silvano Stagni, group head of marketing & research at IT consultancy Hatstand, considers the MiFID Review and asks if you will you be able prove the ‘Best’ in your ‘Execution’?

PATIENCE REQUIRED.

By Noureldeen Al Hammoury

BANKS WIN NINE MONTH SWAP MARGIN RULE DELAY.

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