FX trading focus : FX tech : James Watson

January 13, 2015

WHO HAS THE FX TECHNOLOGY BATON?

By James Watson, Managing Director ADS Securities London Limited.

Five years ago any self-respecting FX technology developer was sat behind a desk at one of the main banks. They had the budgets, were making the investments and led development. Any independent tech company knocking on the door of these institutions, selling their latest upgrades, stood little chance. But by 2014 the landscape had changed and now it is the banks that are standing outside the doors of the independent technology companies.

In just five years we have seen a full technology cycle take place, and I predict that FX solutions in 2015 will be developed and delivered by independent vendors or technology companies often linked to brokerages.

Back in 2009 some technology vendors started to offer html front end solutions with full web-based trading rather than the heavy client downloaded systems, and for a few banks this new approach was interesting. But no bank would have looked at any changes to their backend technology. These were always seen as central to the way the bank operated, and closely integrated with the core systems.

The introduction of MiFID, especially around ‘Best Execution’ and the need for Smart Order Routers (SORs), led to greatly increased technology costs for banks. These came along at the same time as a number of other regulatory issues and a drop in market volatility, closely followed by some high profile mergers and partnerships. This put all bank technology budgets under pressure. The focus of IT teams moved away from trading systems and onto the development of compliance solutions.

This opened up development work to a new breed of technology companies. A number of start-ups were created by ex-bank employees, the entrepreneurs who had previously shaped the FX thinking and strategies of global banking giants.

The FX technology ‘baton’ covering development, innovation and risk taking had started moving from the banks to the vendors. There had always been independent, nonbank, technology companies providing brokerages with front and back end systems and there was an opportunity for these companies to step-up, but in most cases this did not happened. The ‘new kids’ on the block, the start-ups, won the day.

These companies, often with around 10 to 15 employees tended to be more nimble and innovative, and have the skills and insight to see gaps and develop systems which brought genuine trading advantage. The tech they introduced, and are still developing, is high quality and is now being sold to even the biggest banks.

So what can be wrong with this? All is good? The banks have passed on the ‘baton’ and it has been picked up by independents and we move forward. But the issue for me is where do we go from here?

The new tech providers need to have the capacity and backing to be able to scale up.The FX technology baton is a heavy weight and these small firms, although they have the innovation, may not have the strength to carry it forward. As they sit in the meetings with the banks and see good profits coming their way I am sure that more than one CEO is looking at their exit strategy.

The industry cannot afford to have these new players subsumed into the old independent technology names. Clients would have moved from company A to company B. B becomes A, and they have to buy back the same technology again. In today’s market this will excite no-one. The thought of the independent tech companies being bought by their competitors or the banks is even less palatable.

For many people not having the big banks in this space is a major concern. These organisation were set-up to do the ‘heavy-lifting’, they had the capacity to deal with all eventualities.

Experience had shown them that you need to invest in all areas, from network engineers through to support teams, and this is just as important as having the best developers. If systems do go down, without the right people in place, it could take months for firms to redesign their architecture and get back online.

So where does this leave us? We are starting to see some of the banks who are still focusing on FX looking at new solutions. The rise in areas like secondary market liquidity means that they are even introducing connects to other liquidity providers. This would never have happened in the past. But, I would argue that even though they are looking at these options, deep down most banks have little appetite for FX risk. If they offer liquidity and then hedge this risk straight out to the market they are not creating a real price. It is therefore very unlikely that having passed on the technology development baton they will want to get back into this space. Their key people have left and they are still faced with other priorities.

I know I have painted a negative picture, but the market always finds a solution. The FX technology baton has been picked up and is being taken forward by a new type of trading firm or organisation, building on the work of the new start-ups.

The development role is now being undertaken by independent financial services companies, brokerages and vendors who have realised that the online trading space is an area to invest into. They are embracing new generation technology, often developed for equities and using it for forex trading. They are focused on latency, fast networks and sophisticated aggregation and making this work for clients.

These companies have the resources and are prepared to make the multi-million dollar investment required to develop new systems. They have benefited from the ‘talent’ which has left banks, and given them new roles, in fast moving entrepreneurial environments. I count my firm amongst this group.

They have also picked up on a key differentiator and USP, which is that platforms now need to be multi-asset. In banks technology was built in silos. Stacks owned by profit centres and aligned to separate budgets. The mythical trader who works across all asset-classes may not exist, but traders who focus, on, for example, the dollar and track its strength or weakness across FX, equities and commodities, and hedge with CFDs and fixed income are becoming an important target group. These traders want to trade on a collateralised basis across a single platform.

We have turned a full circle because it is now the banks who are knocking at the doors of these new technology companies, and asking about white-labelled and deep white-labelled solutions. They are finally feeling comfortable that outsourcing to the right company is a viable and realistic option. New generation technology has moved us forward and its continued development is very good news for the FX industry. The banks have passed on the FX technology baton and I am pleased to say I think it is in good hands.

[divider_line]©BestExecution 2015

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Market opinion : MIFID II & EMIR : Dan Simpson

Ian Rycott

January 13, 2015

THE MIFID/EMIR, BOND.

Daniel Simpson, research analyst at JWG examines the cross-over between these two major pieces of regulation.

MiFID II, just like the European Market Infrastructure Regulation (EMIR) before it, is set to change the rules governing trading in the European Union (EU) forcing the whole industry to make seismic alterations to their operations. Managing these fundamental changes will present a number of huge challenges making the original MiFID’s implementation seem straightforward by comparison.
Unlike its predecessor, MiFID II will be implemented alongside approximately fifty concurrent legislative global initiatives which will impact the way firms need to instigate the new rules. Like its forerunner, however, and unlike EMIR, there is no legislative scope for MiFID II to be delayed, so this implementation must be completed by the 3 January 2017 deadline.
The objectives behind MiFID II, fuelled by the G20’s aggressive regulatory reform agenda set down in Pittsburgh in 2009, are far more ambitious than those of its original incarnation. MiFID II moves away from focusing on the protection of individual investors or the conduct of individual firms and concerns itself with the overall stability and efficiency of the financial system in the EU in its entirety. These substantially broader primary objectives have resulted in a much more extensive set of rules which will have a wider, more invasive effect on the markets.

MiFID II will force firms to make far-reaching strategic decisions about the types of business they engage in, and the ways in which they participate in them, post implementation given the totally unprecedented requirements. One such case will involve the new post-trade rules. Key developments include the introduction of Consolidated Tape Providers (CTPs) and new rules around clearing and access rights. However, before delving too deeply into these new rules, it is worth placing them into the context from which they will be implemented; that is to say, the other major piece of European legislation radically reshaping post-trade structures – EMIR, as well as other interlinked themes, such as transaction and trade reporting.

EMIR is arguably the most significant of the aforementioned 50 initiatives that are concurrent with MiFID II in terms of the scale of interdependencies, and therefore, implementation teams must focus on finding areas where efficiencies can be found by implementing the two side-by-side. With this in mind, the EMIR context must be an important consideration when contemplating MiFID II implementation.

As we have previously covered in Best Execution, the main area of focus currently, in terms of EMIR, is the substantial data quality problems being experienced in trade reporting. In an attempt to address these problems, as of 1 December, new data quality rules came into force, following the Fifth Implementation Progress Report of the G20 Data Gaps Initiative (DGI), published in September by the Financial Stability Board. The DGI began in the aftermath of the crisis and was designed to improve financial data globally, in order to allow more effective assessment and intervention from regulators.

Progress in the making?

Whilst the report states, perhaps optimistically, that ìsignificant progress has been made in implementing the DGI recommendations”, it is also apparent that there is still huge scope for improvement and that making these in a timely manner could be crucial in enabling regulators to spot the next crisis before it happens.

An interesting side-note here is how these serious and widespread data problems will play into the fact that, in the UK, the Financial Conduct Authority (FCA) and Prudential Regulatory Authority (PRA) are proposing some fundamental changes to regulatory accountability. These include the ‘Senior Managers Regime’ which will require firms to allocate a specific range of responsibilities to designated individuals. These individuals will then potentially be held accountable if their firm contravenes a requirement within their area of responsibility, and by ‘accountable’, they do mean potentially criminally liable. The question being, who – if anyone – will be willing to take on that legal responsibility for the accuracy of reports in the current environment? The only thing that is certain is that they will need to be individuals with access to significant enough resources to tackle a problem which is deeply entrenched.

There have been two other recent developments with EMIR. Firstly, on 10 November, the European Securities and Markets Authority (ESMA) unleashed a fresh consultation paper on trade reporting, unveiling plans to overhaul the entire regime, including increasing the number of counterparty data fields from 26 to 32. The most troubling additions were arguably the ETD transaction reference number, the extension of NFC details and the mandating of the LEI.
The other change has been the delay of the clearing obligation under EMIR, with ESMA’s draft Regulatory Technical Standards (RTS) on interest rate derivatives still undergoing Commission assessment. On 20 November, ESMA chair, Steven Maijoor, wrote to the Commission stating that ESMA would delay delivery of their regulatory technical standards (RTS) on the clearing obligation until the assessment has been finalised.

In the post-trade space, clearing is, perhaps, where there is the greatest crossover between EMIR and MiFID II. Over the past year, since the EMIR implementation deadline rolled past, there has been much debate on exactly which derivative trades are subject to mandatory clearing, and ESMA has published two consultation papers on the subject. We are now relatively certain – by recent standards at least – what is exempt (e.g. covered bonds) and what is not but, just as the dust settles on that debate, MiFID II is adding further twists.

The trading obligation for derivatives under MiFID II will force trades, which are covered by the EMIR clearing obligation and deemed sufficiently liquid, to be traded on-exchange. On top of this, MiFID II requires the removal of commercial barriers around clearing houses, obliging them to clear trades on a transparent and non-discriminatory basis, with some, rather complex, qualifications. In addition, there are ongoing ESMA consultations on the definition of a derivative under MiFID, and the definition of FX under both MiFID and EMIR.

The central point here is that clearing is just one of many areas in which MiFID II is intertwined with EMIR, and EMIR is just one of many legislative initiatives that is interdependent with MiFID II. Others include, the Regulation on Wholesale Energy Market Integrity and Transparency (REMIT), Securities Financing Transactions (SFTR), Bank Recovery and Resolution Directive (BRRD), Capital Requirements Directive IV, Market Abuse Directive (MAD/MAR), but there are many, many more. In other words … expect interdependencies to be a topic which crops up more and more in regulatory debates throughout 2015.

[divider_line]©BestExecution 2015

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Future Leaders In Fixed Income Summit : Viewpoint : Paul Reynolds

Ian Rycott

January 13, 2015

METAMORPHOSIS

by Paul Reynolds*

Attending the WBR Fixed Income Leaders conference in Barcelona in November there was a spirited attempt to discuss the implications of MiFID II, due to be implemented in January 2017. A survey of the top EU buyside firms before the event asked how the new market regulations would affect their businesses. 71% of respondents said ‘raising business costs’ is the main way in which new market regulation will affect their organisation. 68% said reduced market liquidity. On the positive side 40% mentioned improved transparency.

A leading global buyside head of trading said ‘regulation has so far failed to address the issues it had intended to address and has generated a series of undesirable side-effects, fragmentation of liquidity being undoubtedly the most evident one’.

Sadly there was no representative from the EU regulatory constituency, although I was informed that those who had been invited were unable to attend.

Fortunately there were more pressing issues to attend to over the two day proceedings such as liquidity in credit markets, transparency, best execution and TCA. Surprisingly though very little was said about the record Euro new issuance in 2014 exceeding that of the previous record in 2013, or the 8% returns on Euro investment grade bonds in 2014 or the dramatic growth of bond ETFs.

With the exception of one or two banks candidly promoting their enthusiasm for the agency broker model the sellside seemed somewhat subdued as they quietly go about further reducing headcount, targeting capital at specific sectors and clients and confronting the minefield of litigation and regulatory implementation.

Thebuyside, on the other hand, were more than willing to express their views on a wide variety of topics like liquidity, technology, SEFs and issue standardisation. The balance of power, and with it some assumption of systemic risk, has now firmly shifted their way. They are, after all, the owners of 99% of corporate bonds issued, 98% of which we heard trade less than once per day and in Europe 55% as little as once per year.

It quickly became clear that what liquidity there was existed in a bifurcated world, namely recent new issues and the go-go bonds of large issuers. Older, smaller and less frequently issued names are distinctly ‘buy and hold’ because all you can sensibly do is ‘buy and hold’ lest you incur pernicious costs in transferring risk.

Like water however, the fluid nature of investor liquidity means if it is prevented from reaching its’ target, some of it will naturally find new destinations. By that I mean ETFs. We probably could have had an entire conference focussed on this extraordinary derivative of OTC Fixed Income.

The same macro-economic forces that underpin the growth of the OTC market are present in the ETF market, except the market interface and structure lead to dramatically different outcomes. Let’s be clear from the outset, ETFs represent less than 1% of outstanding bond issuance, but the growth rate is dramatic and it may have something to do with how they trade. ETFs are based on a defined index of securities whose compilation is re-balanced periodically. Authorised Participants (APs) create and redeem ETF units in the funds’ primary market. Designated market makers provide liquidity in an order book on an exchange. A client wishing to buy a large block of an ETF can approach an AP, who buys the underlying bonds where possible and presents the basket to the ETF issuer to create the large block of ETF. The ETF issuer calculates the daily NAV of the fund using market levels in the underlying basket of the index. Otherwise volumes are traded on a fully transparent central limit order book on an exchange supported by liquidity from designated market makers.

This market structure would seem to offer the best of all worlds, especially when you add a menu of credit exposure from Investment Grade to High Yield to short and long term sovereign bonds to Emerging Market bonds. In the recent market schism in mid-October ETF volumes went up four to five times whereas underlying cash managed only 30%.

Although the overall market size is relatively small it is growing fast, by as much as $16bn so far this year, almost four times the amount of this time last year. It also meets the expectations of both investors and for once regulators, even MiFID II, in terms of transparency. “ETFs tend to introduce liquidity into the market and are particularly attractive to investors where bonds are less frequently traded,” said Peter Sleep, London-based senior money manager at Seven Investment Management LLP, which manages more than $10 billion. “They offer much greater transparency than is available in the bond market and shine a spotlight on the pricing of bonds.” I did not hear that combination of words very often in Barcelona, in fact not at all.

On balance I would observe that parts of the fixed income market are in rude health. New issuance driven by insatiable demand from central bank zero interest rate policy provides an ideal platform for healthy sellside DCM fees, low cost of capital for industry and stellar returns for the buyside and their customers.

The once dominant sellside trading and sales, engine of profitability as long as anyone can remember, is still in intensive care, but maybe there is hope from an unexpected quarter. The unassuming world of agency brokers is enjoying a consistent upturn in volumes, profits, clients and products. As a rule the agency brokers are not evident at conferences, but they are very well known to both buyside and sellside as efficient and discrete executors of significant volumes in difficult securities. They normally lack a global footprint and tend to specialise in specific sectors. They spend as little as possible on technology and constantly keep costs pared to a minimum.

In spite of the lack of a consensus in Barcelona I think 2015 will see a new phase of evolution in fixed income market infrastructure. A casual observer would most probably remark that the answer is already out there. Here is the thing though, it may not be one single platform. It may actually be a combination of existing and new platforms acting as a seamless suite of solutions covering the potential life cycle of any bond order.

*Paul Reynolds is CEO of Bondcube

©BestExecution 2014

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FX trading focus : Prime-of-prime evolution : Charalambos Psimolophitis

Ian Rycott

January 13, 2015

TOP OF THE POPS.

Best Execution asks FxPro CEO, Charalambos Psimolophitis, about the emergence and evolution of prime-of-prime brokers in FX.

The financial crisis and ensuing regulation has resulted in a dramatic tightening of credit conditions and an end to the generous credit lines and limits that allowed FX market participants, banks and their clients alike, to trade freely with each other. How are prime of prime brokers filling the gap?

As is often the case after a financial crisis, regulatory oversight tightens, risk-aversion sets in, and the big players are more reluctant to enter into new credit relationships. 2008 was no different. But even when the credit lines were disappearing, the need for liquidity in FX continued to grow. In the retail space many new traders came to the market precisely at this time, perhaps seeking new ways to take the reins of their finances. These growing needs, both in the retail and institutional space, led to many smaller primes and prime-of-primes entering the market.

How do they differ from the traditional prime brokerage counterparts?

Prime-of-primes are smaller and offer access to their existing credit relationships. This makes them ideal for businesses that are not able to generate the volumes required by the big banks. This drop-off in available liquidity for smaller firms has led to the boom in prime-of-primes that we’re seeing today. But aside from liquidity, prime-ofprimes are more agile, and are able to offer an increasingly tailored service, having gained a great deal of experience in brokering highly leveraged trades for retail customers.

Who is the target group? Is this new generation just targeting smaller to midsize banks, proprietary trading firms, asset managers and hedge funds, CTAs/CPOs, or active retail traders? Are they also targeting the larger Multi- National Corporations (MNCs) and buyside institutions?

The target market varies between prime-of-primes. We’ve seen a market that is deep enough to see prime-of-primes that cater almost exclusively to the retail trading sector, but they are also becoming increasingly competitive in the institutional space, especially when it comes to providing liquidity to companies and asset managers who fall into that dropoff I just mentioned. As for the larger MNCs and buysides; they are usually adequately catered for by the main primes. We, however, are offering our services to everyone, and justifiably so. At certain volumes we’ve become incredibly competitive.

Do you see competition growing in this space? There have been some high profile exits of prime brokers but there have also been new entrants such as Saxo Bank and Forex Capital Markets? Do you think there is room for any more providers?

Many of the exits we’ve seen over the past few years, especially among the smaller primes, have had to do with increasing risk-appetites since the crisis, and a return to a “business as usual” mentality where hedge funds have cut costs by reducing the number of prime brokers they employ, whereas immediately after the crisis we saw that number increasing. It was always bound to happen, risk-appetites increase the further you move away from a crisis. A TABB Group study released a few years ago showed that the disaggregation we’ve seen in the wake of the crisis was already starting to reverse as early as 2010. As far as FX is concerned we’ve seen more and more options as to where to source liquidity from, and with retail trading continuing to grow, I think there’s a great deal more headroom in this sector.

How can the players differentiate themselves?

Simply by focusing on what they do best. It’s difficult to be all things to all people, but by honing your strengths and optimising every facet of your operations, I think significant value can be added. It’s very similar to all the good advice I’ve ever come across aimed at individual traders; find out what your edge is and work on that, if you can’t find your edge you probably have no business entering the game. Not to forget that the more primeof- primes we have competing, the better the overall level of service becomes. This is what’s truly exciting about the evolution of this sector. It is what led us to launch our own offering (FxPro Prime) in the first place. Almost all the pieces were in place, from the long-standing liquidity relationships to the experience and knowledge of the market. Acquiring the liquidity aggregator, Quotix was the last piece of the puzzle for us and we’re tremendously excited about entering the space.

What technology do they need to maintain and hone a cutting edge?

Again this is highly dependent on the nature of your business and the types of clients you’re targeting. Obviously latency is always a concern, but in our sector the degree to which you are able to offer a complete package, front-to-back-end, including trading platforms, riskmanagement, reporting software, connectivity solutions; all these are essential to helping you be more competitive by reducing the client’s operational costs.

Some buyside firms are sceptical about achieving best execution in FX. Is this unfair and what are the most optimal tools to improve execution?

I think it betrays a lack of understanding regarding just how much innovation is taking place. Any statement you make as to the quality of FX execution today is likely to already be out of date tomorrow. The technologies we now have at our disposal, thanks to our acquisition of Quotix, allow us to aggregate prices from multiple providers and consume liquidity in a far more efficient manner. As a result our clients receive better bid/ask prices than they would have if they were dealing with any one of our individual liquidity providers. These technological solutions to issues that are essentially hierarchical are why today’s prime-of-primes are becoming so competitive.

Looking ahead, what are the challenges and opportunities?

The challenges are primarily to do with risk. Prime-of-primes have to manage the risk of every entity they on-board. Additionally, the gearing provided to prime-of-prime clients is often higher. In the absence of sound risk management protocols this can be a recipe for disaster.

As great as these challenges are, I think the growth of the prime-of-prime sector is an extremely encouraging sign that our industry is maturing. More high quality liquidity can only be a good thing for all concerned, from institutions down to the individual retail trader.

[divider_line]©BestExecution 2015

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FX trading focus : TCA : Yossi Brandes

Ian Rycott

January 13, 2015

SPREAD REVISITED.

By Yossi Brandes, Managing Director at ITG Analytics.

How informative are spreads for market participants who engage in FX trading? Can proper spread monitoring and analysis further enhance the investment and trading process? If so, how exactly? Can this relatively “old”, sometimes overlooked metric, provide insights into important factors like the likelihood of execution and the cost of liquidity in this OTC market? Can spread analysis support real trading decisions (for example, trading now vs later)?

We find that a relatively simple but enhanced spread metric, size adjusted spread, can help answer these questions. This simple metric can help measure the empirical cost of an immediate execution (“instantaneous execution”) and, once calculated over time, can reveal interesting facts about the quality of liquidity for various currency pairs. Size adjusted spread can lay the foundations for a framework that can simulate the trade-off between an immediate execution and execution over a certain time horizon.

The electronification and fragmentation of the FX market coupled with a best execution theme and a regulatory push have created a need for more transparency.

In addition to that, execution arrangements for all asset classes are being overhauled and trading decisions are under the microscope in all investment desks and trading rooms. The FX market is no exception and there is a clear need for more colour on the market, including decision making tools that can help with investment and trading decisions.

Advancements on the electronic side and the slow but steady move from voice to electronic trading complement this shifting environment very well. FX quotes and trades can now be stored and analysed in a relatively quick manner. Spreads and other spread-type measures can be easily computed and examined.

We have the tools to do so. In what follows, we discuss our data as well as some empirical stylised facts related to our spread metric.

ITG has created a unique FX market database that processes feeds from multiple banks, ECNs and other data providers. On a daily basis around 100 million records, including tradable quotes, indicative quotes and trades, are being processed and stored. That in return, allowed us to reconstruct a synthetic order book for the FX market at every point in time.

Moreover, it allowed us to calculate the spread at the top of the book as well as the spread that a trader will have to pay by “climbing up the order book” or in other words; the cost of an immediate execution in this synthetic order book given time of day and deal size as additional parameters. Size adjusted spread is a metric designed to do just that.

The calculation starting point is the mid quote at the point in time where the trade has to be immediately executed. The actual calculation is a weighted average of the liquidity at each level and the distance from the mid quote of the different quote levels of the order book that need to be touched in order to complete the execution.

An illustration of the order book and size adjusted spread metric can be found in Figure 1

In Table 1, an immediate buy of 7 million EUR/USD at 8:05 will have an empirical cost of 0.207 pips while an immediate sell of 15.75 million EUR/USD will have an empirical cost of 0.193 pips. The implications of this metric are instant. Automation coupled with simulation can allow for multiple applications that can answer multiple questions; for example, at what time of the day is the size adjusted spread typically at its lowest level?

Generalising on size adjusted spreads and running it across different dimensions, for instance size, time of day and currency pairs, indeed allows for interesting observations on both the quality of execution as well as the possible spread cost of an immediate execution in different times of the day.

In Figure 2, one can observe low levels of sizeadjusted spread in the morning times. Figure 2 illustrates the distribution of size-adjusted spread and hence can provide the range of possible results that one can expect at different times of the day (given probabilities). While historical averages are smooth, actual real time values can vary significantly throughout the day in a fraction of a second. Monitoring these fluctuations, with historical levels as references, could help improve trade timing and reduce costs. Assuming enough computer power, the foundation and one of the building blocks for modelling cost for various currency pairs seem to be just lying there. Hence spread revisited.

Displaying the size adjusted spread over time begs for further research on the trade-off between an immediate execution and an execution over a certain time horizon. That in return requires a measure of volatility that will help assess the risk that the market will move against the residuals. The trade-off between immediate execution and a delayed one can be quantified using size adjusted spread on one hand and an FX volatility metric on the other. Figure 3 below, depicts one version of intra-day volatility metric that can be used to measure the delay costs.

Summary

Changes to the OTC markets on the technology and on the regulatory front will continue to drive significant changes in the FX market structure as well as in the way investment and trading decisions are being made. One safe bet in this environment is that data will be more readily available and its quality will improve. Creating and reconstructing an order book in an OTC market has the potential to shape future trading and investment decisions.

How? Research around the dynamics of the order book will provide more transparency into liquidity and will continue to improve the execution quality. Simple but enhanced spread metrics that make use of an order book, like size adjusted spread, provide the foundations not only for cost modelling but also for the introduction of cost effective algorithms that can balance the trade-off between an immediate execution and an execution over a specific time horizon.

Spread, like Bob Dylan’s Highway 61, electrified and revisited.

[divider_line]© BestExecution 2015

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Post-trade : The impact of regulation : Alexandra Foster & Jon Vyse

Ian Rycott

January 12, 2015

IMPACT ASSESSMENT

To find out what impact regulation is having from the perspective of a technology services provider, Best Execution spoke to BT’s Alexandra Foster, global head of strategy & business development, financial technology services, and BT’s Jon Vyse, head of post-trade and payments messaging, global banking & financial markets.

Why are global regulators advocating the adoption of robust and reliable infrastructure? Is this due to the increasing cyber security threat? What are the other reasons and which regulations specifically target this area in the post-trade world?

Alexandra Foster: I think every regulatory initiative goes back to the original G20 recommendations and the need to reduce systemic risk. This has been one of the main drivers for the need for reliable, robust and sustainable infrastructure.

Jon Vyse: There are concerns over cyber security being the next black swan event and it is being taken very seriously. However, it is one of a number of many different worries of regulators and central banks. Overall, they are focusing on the need to manage and mitigate the operational risks that can lead to systemic risk. The Bank of England, for example, has identified critical market players and has made a number of recommendations over the years about making them subject to higher standards of resilience. This is to ensure that if one party goes off air or out of business, it will not cause the same severe disruption that we saw in 2008.

What has been the impact?

Alexandra Foster: What we have seen is a move to managed services and a demand for an end-to-end solution across the lifecycle of a trade from pre-trade, through trade and execution, to clearing and settlement to efficiently manage operational risks. It may well be that firms need to work with more than one service provider in each area in order to meet the regulatory requirements for operational resilience.

Why are alternative networks vital to ensuring the high availability of essential services, such as financial messaging? How do they work and what are the benefits in the post-trade world?

Alexandra Foster: We are in a changing environment with regulation moving the industry towards standardisation. FIX Trading Community is one group that has done a lot of work in the pre-trade space and is looking to develop standardised messaging formats for post-trade. However, it will be a long journey as there are around 180 different protocols in the market and people are using different tools. This is why we believe it is important to offer an agnostic service that can handle all relevant and multiple financial message formats.

Jon Vyse: Our aim is to support the market when it is ready to move, but I agree it will take time because several banks are reluctant to adopt standards because they want to maintain their competitive advantage. However, the current situation is not sustainable and standardisation will be forced upon the market and we want to be able to respond to it. I do not think though that there will only be one messaging format that is used but there will be different ones to address different markets. In a way it is like mobile phones in that there are different brands but they all use the same core networks.

What are the cost savings?

Alexandra Foster: A Yankee Group report found that moving to a managed communications environment can help users to achieve year-on-year savings in total cost of ownership of communications of over 50%. One of our clients, Winterflood Securities, said by moving to BT SettleNET their network costs have reduced by around two-thirds. BT SettleNET is a managed service linking financial institutions with CREST, the central securities depository for the electronic settlement of UK, Irish and international securities, operated by Euroclear UK & Ireland.
What does a one-stop-shop service include and what are the benefits of using this approach?

Alexandra Foster: I am not sure I would call it a wholesale one-stop-shop because it sounds like the outsourcing arrangements of the 1980s. Instead, people are opting more for end to end reliable and scalable managed services that can deliver the right business outcomes. As I said previously, there will be more than one provider. For example, you may have one solution for the post-trade and another for the pre-trade.
Looking at the impact of other regulatory initiatives, what solutions are buyside firms looking for in collateral management. What gaps need to be filled?

Jon Vyse: The whole collateral management space appears to be creating opportunities. The issue is about moving collateral in the most efficient way possible around the world in order to address the supply and demand balances. This will require solid infrastructure and we are currently talking to several people about how we can support them. I think it will take a while – maybe a year or two – before solutions emerge.

Alexandra Foster: As I mentioned earlier, everything comes back to the G20 recommendations and I can see regulations coalescing to create global liquidity hubs. This will require automation and the ability to allocate collateral to the most liquid places whether it is Singapore, London or New York to cover global exposures. I can also see the development of collateral algos and routers to help people find the best places to post collateral in real time. It is not in play at the moment but there are several discussions taking place on the subject.

As you have both said there are a lot of opportunities being created from regulation, what challenges do you foresee?

Alexandra Foster: I would say artificial intelligence and machine learning and the data requirements they will bring as well as the development of visualisation tools. We used them for the Olympics in London and we are now looking at how they can be used in the post-trade world. Another challenge is how companies manage the adoption of the cloud when reviewing their policies regarding regulations. The most important thing though is to be proactive and not reactive to these challenges.

Jon Vyse: I would say one of the biggest challenges is the ability to implement the changes brought by regulation at a sufficient pace. Traditionally the industry has been slow and relied on old systems but today regulations are demanding firms to move at a much quicker rate than they are used to.

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FX trading focus : Market surveillance : John Bates

Ian Rycott

January 12, 2015

A TIME TO ACT, NOT OVER-REACT.

Dr John Bates, Member of the Executive Board & Chief Marketing and Strategy Officer at Software AG, spoke to Roger Aitken about the issues around the recent FX rate-rigging saga.

Given the sheer size of the global FX market, which according to a recent Bank for International Settlements’ Triennial Survey (Sept 2013) put average daily FX spot trading volumes at $5.3 trillion, would you agree or disagree that it would take collusion of an inordinate magnitude – as some suggested prior the regulators’ fines on a group of major banks – for a strategy of fixing rates to work reliably and consecutively?

I would strongly disagree. Where the FX markets differ is firstly the degree of control that a relatively small number of dealers can have over a huge liquidity pool and, secondly the level of influence – and therefore profit – to be made from very small movements.

With regard to control, collusion between a small group of banks – who between them command a very large market share – can skew a market, whatever its size. Where FX differs from, say, equities is that a dozen or so very big banks control the same market share in FX that many times that number control in the equities space. So it’s not about market size, but rather about a share of that market concentrated in the hands of a few large players.

In terms of influence, much rides on the FX fixes. Take the 4pm fix, for example, it’s not about the profit from manipulating the price up or down, but the profit from the countless derivative instruments, structured products and so on that depend on the fix.

This means that a small movement in FX markets can have a huge impact when we look at the total effect on related instruments. It’s one of the harder areas to monitor using electronic tools and distinguishes FX from exchange-traded equities and futures markets, placing new requirements on surveillance technologies, processes and practices.

And, even if fundamental behaviours indicative of FX rate fixing are relatively new to vendors and compliance teams alike, the mantra for market surveillance is that if behaviours manifest themselves in trading activity, then appropriate technology can be applied to spot those behaviours. The evidence is in the data.

Cutting-edge technology certainly exists for banks and brokers to deploy within their institutions as well as the regulators, but isn’t technology just one part of the puzzle and it also requires people and processes to link the dots, spot abuse and actually report it?

I don’t think technology is the solution to the problem, in the same way that technology is not the cause of the problem. That said, it’s certainly relevant to both aspects of the debate.

As vendors, we have been working in this space for more than a decade helping banks price and stream more competitive spreads in realtime, as well as helping their clients aggregate liquidity and intelligently route orders to the best prices.

As margins have narrowed and impacted the traditional way intermediaries like banks and brokers make their money, it’s not surprising in some ways that strategies for protecting commissions and profit have been employed by some market participants. This inherent conflict of interest – where those charged with acting in the best interests of their clients are also the ones (individuals and institutions) that stand to benefit directly from doing the opposite – is fundamentally at the heart of the matter. Technology can certainly help detect and prevent abusive trading patterns, but the agency/principal model on which the industry is built means temptation will always be there.

Considering that foreign exchange is the asset class underpinning all other asset classes, market surveillance monitoring systems must be able to spot abuse in a multiasset manner. So, does it makes good sense for firms to have a multi-asset surveillance monitoring capability in place to spot patterns and correlate issues across asset classes and are the firms doing enough?

Multi-asset and crossasset class surveillance is a necessity. It’s simply no longer cost-effective to view trade surveillance technologies as being siloed by asset classes and firms are increasingly viewing surveillance and compliance as a horizontal capability across the firm. Moreover, as we’ve already seen, more sophisticated forms of abuse involve activity in more than one instrument, such as the Singapore NDF/Spot manipulation and similar things in other derivatives markets. So, unless firms consider surveillance holistically they will be left exposed as well as out of pocket.

As to whether firms are doing enough, I suspect not. It’s critical for firms to get ahead of the regulator. Simply waiting for the next crisis and reacting accordingly is a recipe for spiralling costs and reputational disaster. A consequence of this is that firms are increasingly investing in more open platforms with more flexible data models and integration possibilities across the business, to allow new monitoring strategies to be deployed quickly.

With the FX market being a largely unregulated market – especially for spot FX that trades OTC – and the fact that a number of instruments fall outside the scope of regulation, do the different regulatory authorities around the world need to collaborate and co-operate more to combat abuse – in pursuit of a more harmonised and common regulatory framework?

Regulatory compliance is not about voluntary participation, so firms have no choice. Of course, in FX specific regulation has been light-touch or nonexistent, but broader legal frameworks such as anti-trust or anti-competitiveness rules are certainly relevant to FX today. Hence the focus by regulators on allegations of trader collusion.

I do not believe that lack of co-ordinated regulation should be set up as a scapegoat. That said, there is a lot of new regulatory activity on its way and, like many in the industry, I can see political attention in legislative form focused more closely on FX in the near future, especially now that MiFID is out of the way.

In relation to FX benchmarking processes do you think there is a need to improve them and possibly widen the number of benchmarks and the ‘fix’ time window, rather than seeing a regulatory backlash that could result in increased costs and lower liquidity or lead to the FX fix no longer being provided?

Revamping the FX rate mechanism, LIBOR and other features of market structure susceptible to manipulation is certainly preferable to yet even more regulation. However, capital markets are aggressive, highly profit-driven and, as a result, not known for their restraint. It might be good to think that the industry could pre-emptively and proactively change to a sounder moral footing, but history would indicate that scandal followed by public and political backlash followed by over-regulation is a more likely future scenario.

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The FCA And Unbundling

GlobalTrading

January 12, 2015

An edited conversation between David Lawton, Director of Markets, FCA and Edward Mangles, Regional Director, Asia Pacfic, FIX Trading Community.
The FSA introduced a new regime for what dealing commissions could be used for in addition to execution back in 2006. We have reviewed it a couple of times since then and are presenting a further round of review this year with.
There are three elements to this;

The first is that in response to industry questioning, we have clarified in our guidance precisely what research can be bought using commissions.

The second is that we have done a thematic review of how both buy-side and sell-side firms are complying with our rules and we’re presenting that back to the industry.

Thirdly, given that in Europe we are in the context of introducing some new legislation , the FCA are keen to put forward some thoughts on what the more ideal longer term arrangements for dealing commissions in the market for research might look like.

While this is a scenario that will remain at the forefront of our agenda, we have no concrete plans for doing another thematic review. There are a number of issues that we want to follow up on with the individual firms who are in our sample but no further review should be required because, as I noted earlier, this is something that has been a big part of our wholesale conduct agenda for the last few years. It’s an important part of how the market works and I’m sure it’s something that will remain at the forefront of the FCA’s mind.
Self assessment
We have published the results of our thematic review setting out what we found in terms of good practice and less good practice as a means of communicating to the firms that weren’t in our sample our expectations as to how the rules should be complied with. We are now looking for all firms to benchmark themselves against that material.
One of the challenges in this space is that research is being bundled up with execution. Our regime is designed to incentivise buy-side firms to identify and put a value on the research that they want to pay for with commissions. We accept that there isn’t really a free market in research yet and that brokers currently provide a bundled service, so we are encouraging fund managers to have a dialogue with brokers to get them to price research. If that is not happening, fund managers can also look at benchmarking against other valuations that they can find. We do recognise that it’s a challenge and that’s one of the reasons we think a longer term better arrangement would be unbundling in this market and seeing research provided and priced for separately.
Our paper surmises two things: the first is that we expect firms to be doing more within the context of the current regime to comply with our rules than they are now. In our survey of 17 buy-side firms, we only found two that were delivering something that we think is fully compatible with our rules. The second point is that we recognise that there are some structural issues across the entire marketplace that need to be looked at.
Our goal is to have a marketplace in which the end investors are best served: in which fund managers are acting as good agents for their clients in terms of the use of their funds and seeking and securing research which is in the best interest of the end investors. The key concern we have about the current arrangements is that the incentives and the market structures don’t drive us to that conclusion.
CSAs
During the thematic review, the firms that were following better practices tended to be the firms that were using CSAs. However, they are not a universal panacea because they still they’re associated with payments to research linked to the volume of trading. CSAs need to be used with care; they’re not mandated by our regime but they are a helpful tool.
Smaller firms
In regard to longer term structural arrangements for smaller firms, our key conclusion is that we think that the market would be improved if there were some unbundling of research from commissions.
We think that a market for research that was separate from commissions could in fact be to the benefit of all brokers both large and small and it would enable smaller brokers to focus on commissioning the research that was particularly tailored to their fund management strategy.
We want fund managers to do more in terms of transparency and accountability: I think it is right that conceptually we can see the benefits of separating research from commissions. That links us back to the European debate where under the revised method, the legislation places greater restrictions on what fund managers can receive in return for commission and the European Securities and Markets Authority’s consultation on what limited benefits might be acceptable associated with the payment of commissions.
So monetary and non-monetary benefits are allowed but anything more than that is not, so the gap between that and full unbundling in our view is relatively small.
And our analysis suggests that this produces a marketplace that is more competitive. It reinvigorates the market for research which benefits the industry as a whole. One of the questions that we’re often asked in this debate is whether the UK is planning to change the rules unilaterally. The answer is that we are not proposing any rule changes at this stage. We are very keen to engage in the European debate about what the final method rules should look like and recognise the importance that there is a level playing field across Europe.
A better functioning market for research and commission arrangements would in fact provide competitive advantage to the fund management industry. We think it will be beneficial to be more transparent and open to end investors about how the funds are being used.
Global conversation
There is already a very lively debate in Europe around finalising the rules and we’re fully engaged in that. Globally I think this topic remains of interest to markets and securities regulators as an important structural feature of how the marketplace works. Aspects of it are already under discussion in IOSCO. We’d be very supportive of global discussions and it’s something that comes up regularly in our bilateral discussions with other key markets regulators.

Partners, not providers: the vendor relationship as a two-way street

GlobalTrading

January 12, 2015

Pershing’s John Vrettos discusses his approach to vendor selection, relationships management and resource allocation.
Whether a firm integrates third-party service providers into its trade processing technology was commonly a question of price. This focus on commoditised products and services has evolved to now include areas of specialisation and expertise. With a greater emphasis on the broader strategic relationship, the “technology provider as consultant” has access to more of the client’s infrastructure and wallet in exchange for providing greater efficiency across the entire trade process.
On the trading side, our focus has been on technologies and services where we find a) there is more specialised knowledge and expertise, or the potential therein for greater specialized services, and b) where the technology is commoditised. We find that there is generally more competitiveness in pricing and service levels when the services are more commoditised.
The common theme we hear from prospective clients time and again is, “We are looking at where we can get specialised knowledge and get it better and cheaper than developing in-house.” As the relationship with providers has changed, the discussion is no longer solely focused on delivering solutions at the most economic price point. For example, we look to integrate third-party solutions into our technology ecosystem from firms that will invest time to understand our business and our business needs. It is not just who is the cheapest, but who provides quality service and functionality at a competitive price.
As trading has evolved at Pershing, we trade for multiple types of clients, and each business type has their own needs. Pershing has built a very sophisticated risk management control system to service its retail business, but different solutions are needed to trade for institutional clients through high-speed DMA or algorithmic capabilities. To meet the institutional clients’ requirements for speed in trade processing and market access, as well different types of risk controls and parameters, we enhance our solutions by integrating specialised service providers.
We have a strong development culture and control focus on our core processing engines. As a clearing firm, our services, solutions and information processing is critically important. The trade processing engine is internally controlled as well as most of the core platform tools we offer our advisors. We prefer to control the advisor interface and where we can, we want to provide an optimized client experience and manage it in a way that lets us support our clients in the best possible manner.
Pershing is committed to developing and providing our clients with solutions that meet their evolving needs. At the same time we recognize the value of integrating third-party services into our technology ecosystem to enhance the solutions we offer clients. We balance the use of internal resources and integrated solutions to offer our clients more choices and with solutions that deliver the greatest strategic impact.
For example, we currently use Convergex’s Connex in our connectivity to market places and liquidity pools and to manage some client connectivity, both inbound and outbound. . We have also leveraged Connex for risk management tools, utilizing their complementary expertise to enhance the array of client solutions Pershing offers clients.
When considering a third-party solution there are a number of considerations that must be made. We look at credit risk and other regulatory requirements before bringing that into vendor discussions to ensure we address both the business and the credit risk needs. We also have to consider the inbound and outbound processing needs of the interfaces between our internal systems and the external provider. Often, these strategic relationships lead to applications in other areas of our business-which enhances the solutions we bring to market and benefits both our clients as well as the vendors we work with. In the end, it all comes down to creating and maintaining strong relationships. Our relationships with third-party vendors have yielded mutually beneficial outcomes- whereby their solutions have helped our clients, and Pershing, in turn, has helped the vendors to improve their offerings- which they can then bring to market elsewhere. By working with our clients and providers to arrive at the best possible solutions, everyone has an opportunity to benefit.

Strategising Trading And Technology

GlobalTrading

January 5, 2015

Matt Howell, Trader, T. Rowe Price examines how trading and technology are evolving their relationship.
At the start of the year a small group of traders and technologists from across T. Rowe Price were given the task of organising an event to explore the relationship between trading and technology. Our remit was to explore new possibilities, try not to be restricted by our current capabilities, and here management particularly encouraged us to take a radically different approach from how this topic has been tackled in the past.
We started with a blank sheet of paper which had “trading and technology” written on it and not a lot else. We then got out there and talked to our peers, technology guys on the sell-side and different vendors to try and get a sense of how other people have been approaching new technology and strategy and what lessons could be learned from their successes and failures. Historically the approach of trading towards technology has always been short term and practical; “I’ve got a problem, fix it now regardless of implications down the line”. Whilst acknowledging that some issues are short term in nature, we increasingly believed that this approach stymied innovation while increasing complexity, and that a more strategic approach was going to be required.
At the beginning, there was no expectation that this was going to evolve into anything more strategic but as we worked on it, it became apparent that with the current environment there was a real opportunity to make a difference because the rate of technological change is accelerating. There is an opportunity for T. Rowe Price’s trading to develop a competitive advantage and improve its service clients, both internal and external.
Traders need information
To help us assess where we could have most impact we sent out a questionnaire to the entire global trading team. We asked them where they thought technology could make the biggest improvement to their workflow, and what questions they thought technology could provide the answers to. There was a surprising degree of homogeneity across geographies and asset classes. Traders said they wanted help making their workflow more efficient, reducing manual processes, filtering/sorting data and solutions needed to recognise the high value on desktop real estate. But the most powerful finding was that when we examined the results in aggregate, looking at the words most frequently used in the responses three words topped the table. In isolation none of them were a surprise but when you put them together it really sums up what technology can do for us as an industry sector: the three words used most often were “Traders Need Information.”
So we decided to organise a conference specifically geared around longer-term objectives. We collected together a group of technology vendors (both start-ups and incumbents), industry specialists and a couple of thought leaders from outside the world of finance to help us set the tone. A wide group from within T. Rowe Price was invited to come along and share their thoughts on these presentations and then a smaller group met to discuss our findings and start to formulate post conference strategy.
In order to best leverage input from the conference attendees we set up an internal “Livefeed”. This was a social media style intranet site where we encouraged all the participants to engage during the 2 days. We really didn’t know how people would end up using it and we deliberately didn’t leave any strict guidelines on how to use the site. Although we had a couple of people in the room who committed ahead of time to contribute content throughout the sessions in general we left the forum to develop as organically as possible. Would people use hashtags? Would people contribute questions or just make comments? Would the feed end up looking like Twitter or more like the nested conversations that happen on Facebook?
During the event we had more than 200 associates from around the firm visiting this site and contributions from nearly half of them. We had status updates, longer blog posts, and some associates searched the web to find relevant material while presentations were ongoing. The content generated was an invaluable source of material for follow-up sessions and the approach promoted global connectivity by allowing associates from any location, not able to attend in person, to follow and join the conversation, see the presentation materials, and speaker bios. It also enabled the team attending the forum to collaborate their thoughts, questions, and comments in real time. The Q&A sessions of the forum were noticeably more interactive and insightful because often they were already being discussed on the “LiveFeed”.
Trading and technology in the future
The challenge associated with trading is that traders are conditioned to be methodical and meticulous in the way that we approach things. The nature of the market itself is such that we look for short term fixes to immediate problems. In order to innovate, trading needs to change its mind-set and to start thinking about things over longer periods of time. This is going to be one of the biggest challenges. We need to keep trading engaged over those periods where it might not seem much progress is being made. That is one of the reasons that we have started some small project teams to try and keep a higher level of ownership of some of our projects and use these to keep the whole group engaged on the longer-term target.
For example, one of the technologies we are assessing at the moment is a social media insight platform. We want to look at how financially relevant social media might be useful to us, but rather than deliver the platform as a fully developed solution to our traders, we have set up a small trial group. We will see how they progress, write up the findings and keep the dialogue open during the assessment. Social media content, particularly Twitter, has elements that are relevant to short term trading but less relevant for our fundamental investment process, which is much longer term. The idea of getting something off Twitter really quickly and then trading off the back of it isn’t something that works for us. However, when the analysts come and talk to the trading team about ideas, we could certainly learn something from what’s going on in social media: maybe that’s where trading could partner with research? There is certainly an opportunity to use some of the social media tools that we use in our personal lives to enhance the way we collaborate in our business life to make communication more efficient.
Prioritisation remains one of the biggest challenges. When we started looking into the topic we realised that we didn’t want to focus on fixing/mending short term workflow issues around our existing technology. We already have a pretty robust process for attending to these requirements and for dealing with the immediate challenges thrown at us by regulation and market structure.
Our purpose is to challenge technology with a vision of where trading wants to go. Still in the very early stages of pushing this vision through to realisation, we acknowledge that the process will be a three to five-year road with many bumps along the way. We do at least now know what trading wants. We have a vision we can point people towards and a viewpoint that we’ve carefully articulated to provide some structure around the ways to approach things going forward.
Hopefully the days when the business dictates which platform to use are gone. In this new partnership, we’re going to acknowledge that technology and technologists will be better equipped and able to respond to the challenges presented to them. We can say: this is your area of expertise, here is the vision of where we want to go but we want you to assess the technologies available and come to us with solutions rather than trying to shoe horn in solutions that the business is giving you.
Because of this there has to be a much more committed approach from trading towards technology. So far, trading has helped developed the vision, but it doesn’t stop there. Both groups need to work together towards finding the best solution. The next step is for technology to take away the ideas generated and start to come back to the business with suggestions. These ideas will be assessed using small flexible teams across both trading and technology and the results and lessons learnt fed back into the wider group. The vision we developed will be used as a roadmap to ensure that we remain on track but there will also be flexibility within the governance structure to reassess the goals periodically and check they are still relevant.
Collaboration, both internally and externally is going to be key to making all of this a success. We hope to have open discussions regarding our progress and use those discussions to find the people who can help us to learn. By using the platform that we used for the “Livefeed” we are already having conversations with a much wider group of individuals that we ever could have using e-mail and we aren’t cluttering up anyone’s inbox.
Some of the design principles we agreed on also help us address this issue. Going forward we plan to deploy small pilots, test and learn and make development more of an iterative process. Implicit in all of this is a willingness to fail occasionally and use those failures to improve solutions going forward.
There is also a commitment towards more effective data architecture and reducing complexity. This should help us make solutions more modular and stop them becoming bloated and inflexible. Data management and big data are where the real challenges lie. This is very much on the longer term horizon and clearly going to be a technology-driven project but here trading can provide some impetus and support for the process. We work with a large number of different sources of data: there’s definitely a place for some kind of aggregation of that data and once you start thinking about getting data into one place or just getting data together, then you can start thinking about imaginatively tying it all together.

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WHO HAS THE FX TECHNOLOGY BATON?

By James Watson, Managing Director ADS Securities London Limited.

THE MIFID/EMIR, BOND.

Daniel Simpson, research analyst at JWG examines the cross-over between these two major pieces of regulation.

Progress in the making?

METAMORPHOSIS

by Paul Reynolds*

TOP OF THE POPS.

Best Execution asks FxPro CEO, Charalambos Psimolophitis, about the emergence and evolution of prime-of-prime brokers in FX.

SPREAD REVISITED.

By Yossi Brandes, Managing Director at ITG Analytics.

IMPACT ASSESSMENT

A TIME TO ACT, NOT OVER-REACT.

Dr John Bates, Member of the Executive Board & Chief Marketing and Strategy Officer at Software AG, spoke to Roger Aitken about the issues around the recent FX rate-rigging saga.

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