Viewpoint : Regulation & compliance : Denis Orrock

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January 31, 2014

FEES & COMMISSIONS.

Denis Orrock, CEO, GBST Capital Markets examines the growing challenge of dealing commission transparency.

Fees and commissions management continues to be a pressing issue for capital markets firms. Recently, the FCA released a consultation paper focused on the use of dealing commission rules, while the Investment Management Association’s (IMA) pending report from Guy Sears also highlights the importance being placed on this area. With an estimated £3bn of dealing commissions being paid last year it is not hard to see why regulatory bodies are targeting this area, especially in light of the intense scrutiny that the financial sector continues to experience since the onset of the global financial crisis.

Adding to the challenge is the emphasis that asset managers are placing on the quantum of commissions that they are paying today, what value they are receiving in return and how they themselves meet harsher internal and external compliance requirements. The response from asset managers has been the introduction of increasingly complex commission payment structures.

Put the buy- and sellside challenges together and consider the multifarious systems architectures that have arisen out of a ‘best of breed’ approach, and you have a significantly compelling requirement for a centralised fees and commissions platform, one that can readily feed downstream and upstream IT systems.

Evolution of a problem

The multiple trading systems methodology that many capital markets firms employ (either from choice or from growth by acquisition, and therefore inheritance) is one of the origins of the current fees and commissions conundrum. These multiple systems have created a ‘siloed’ approach to technology. In the area of fees and commissions these silos compound maintenance and servicing problems, as it is extremely common that these front and back offices utilise different databases of fees and rules; ones that are not synchronised.

From a transaction processing perspective, we know that certain business lines need to be able to segregate commissions, such as ETFs and other Index-related products whose volumes continue to grow exponentially. Similarly, firms require tiering and ranges of commission levels, all accentuating the problems.

The growing need, in an industry that continues to expand its market offerings, is for a central tool to act as a fees and commissions repository, one that will provide a scalable solution and reduce manual processing and workarounds. Few investment banks have a single service based architecture that will allow all the consuming systems to interact with the fees and commissions data held in a central repository.

Drivers for change

Transparency and clarity are, of course, key issues for the financial services industry as a whole. Within capital markets, articulating the breakdown in fees and commissions being levied – between execution charges, research, corporate access and so on – has become a point of controversy. In the retail and wealth management space, understanding the commission structure has been a bone of contention since before the credit crunch. That debate ultimately resulted in the UK’s Retail Distribution Review (RDR) and the Markets in Financial Instruments Directive (MiFID).

Irrespective of the above drivers, unsettled trades due to incorrect commissions also carry a heavy financial burden for capital markets houses. The cost of rework related to incorrect commissions can be immense. SWIFT and agent related charges alone can cost investment banks in excess of £1.5m a year if fees and commissions processing are not properly managed and centrally resourced.

Operational burden

Capital markets firms have to deal with a myriad of operational issues associated with fees and commissions. One requirement is to handle the amendment and rebooking of trades to capture the correct fees, and then calculate the correct fees to match the trades.

Beyond the setting up of fees and commissions on systems, banks now wish to reconcile figures intra-day; waiting for month end, or batch, processes is not acceptable. If a firm can agree the commission sharing agreement (CSA) element on each trade, it will be able to provide its traders with a true P&L (inclusive of cash) at the close of business.

There is also the number of fee sharing arrangements to consider. These arrangements are struck on an individual client basis and can frequently be unique, or appear to be so. Operations teams have to manage these fees, inputting them into a system. Ensuring similar fee rates are not duplicated and that a fee structure is assigned to multiple clients means fewer rates in

the system and makes the process manageable. Indeed, system limitations on handling the fee structure can restrict striking business deals and will certainly add to the cost of trading as more manual intervention is required – making the process more expensive.

The scale of this type of agreement continues to grow; therefore if banks do not have an automated solution in place now, the operational burden may become intolerable. More and more resource will be required, as incorrect trades remain outstanding for longer.

Being in a position to audit all fees and commissions is not only for the benefit of the accounting, finance and management teams. The sales team can also see the fees they are going to generate and therefore what commissions they are going to earn.

Conclusion

It is widely anticipated that a number of industry announcements will be released on the issue of fees and commissions early in 2014. One contributor to the debate will be the IMA, where Guy Sears has been leading research into commission breakdowns and corporate access. The other will be from the FCA, which is also looking into the same issue.

With new requirements coming into play, legacy solutions and technology will continue to struggle to meet demands for a centralised and versatile fees and commissions hub. Whether it is going to be a directive or regulatory, capital markets firms need a system that is capable of: easily managing all fees and commissions structures; delivering regulatory compliance; provision of better client servicing information and daily visibility of CSAs.

Irrespective of the pronouncements of the industry’s top brass, the reality is that a robust fees and commissions engine will reduce overheads and improve customer servicing, thereby increasing the likelihood of repeat business. For this last reason alone, the capital markets industry needs a new approach to commission management.

©Best Execution 2014

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Viewpoint : MiFID : Retail perspective : Oriol Pujol

By

Ian Rycott

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January 31, 2014

Oriol-Pujol

COMPETITIVENESS VS COMPETITION.

Oriol Pujol, CFA, Head of European Business Development at Winterflood Securities argues that the retail sector in continental Europe has benefited least from the achievements of MiFID and that MiFID II and MiFIR should do for competitiveness what MiFID did for competition.

Seven years into the post-MiFID era and uneven but positive progress has been made in each of its three main objectives of increasing competition, transparency, and levelling the playing field for retail investors.

As a broad coalition of industry participants are working towards reaching consensus on the scope of a second iteration of MiFID, we are witnessing how MiFID II/MIFIR is increasingly shifting towards addressing the unintended consequences of its first iteration as opposed to furthering progress towards each of the aforementioned initial objectives.

Settling for what has been achieved, as opposed to what should be achieved, would be to the detriment of the financial services industry and the still ailing European economy as a whole for the following reasons:

Competition

Firstly, whilst MiFID has succeeded in fostering competition, we must remember that the objective to achieve is not competition per se, but competitiveness. The progress made has been largely restricted to the provision of execution services, the tip of the iceberg of the value chain. The provision of post-trade and infrastructure services, the pillars on which the whole industry rests, remains largely unchallenged.

The practices of firms operating so-called “vertical silos” represent one of the largest obstacles for increased competitiveness in our capital markets. Those firms simultaneously operate execution venues and control vital post-trade infrastructure such as CCPs, CSDs, or both, and often provide access to the infrastructure they own under disadvantageous terms if the trades to process have been executed by a competing venue.

Since circa 80% of the final cost of executing a trade is related to post-trade services and infrastructure, it would be contradictory to expect any improvement in competitiveness without addressing this issue.

Transparency

Secondly, with regards to transparency, the debate is more centred on addressing the unintended consequences of dark pool trading than on acknowledging and adapting to a new market reality. This approach can only lead to further and more unpredictable unintended consequences.

The new market reality is causing an increasingly large share of trading to take place on dark pools not by choice, but by force, with the drivers behind this trend being cost and lack of liquidity.

Five years of challenging market conditions have led firms to consider alternatives that they would possibly not contemplate were it not for significant cost advantages.

As for liquidity, the main issue is that the current interpretation of volume and liquidity as equivalent no longer holds. A stock that trades thousands of times a day in average clips of a few thousand Euros is a high volume stock, but not necessarily a liquid one. This is causing a large number of stocks to be perceived as more liquid than they actually are based solely on their Average Daily Turnover (ADT), which in turn is creating too stringent requirements to place non-displayed limit orders for these stocks in central order books.

Additionally, since true transparency can only be achieved by enabling all actors to make informed decisions before, during and after the investment process, fair and reasonable access to market data should also be a key objective of MiFID II/MiFIR.

Fair should be understood as “technically equal”; it should also be understood that offering multiple choices to all participants is not fair, if some of the options are designed to fit the specific requirements of a narrowly defined type of participant who will use them to the detriment of others. Seeking competitive advantage via lower latency is a legitimate strategy, but it should start outside the walls of an exchange, not within the exchange itself.

With regard to pricing, the cost of market data is becoming unsustainable for an increasingly large number of participants. The pricing policies and practices of exchanges should be reviewed; amongst those that deserve special attention are the lack of clear and easily accessible market data policies and the refusal to unbundle the cost of data.

Finally, special consideration should be given as to why retail investors, whose interests were at the heart of MiFID, have benefited the least from its achievements.

Retail disadvantaged

Although the issues I have discussed affect the industry as a whole, they affect retail investors more than any other type of participant, especially in continental Europe where, with the exception of Equiduct, they lack a retail-specific infrastructure such as the one that has evolved in the UK, with a healthy and very competitive RSP infrastructure that is exclusively focused on servicing retail investors.

As a consequence of this, the average retail investor in continental Europe is trapped in a vicious cycle. The combination of unreasonably priced market data and uncompetitive provision of post-trade services are perpetuating a pre-MiFID status quo, with the overwhelming majority of retail flow being systemically sent to incumbent exchanges (despite best prices being increasingly in alternative venues that, in addition, charge lower fees), and those exchanges charging ever higher market data fees and restricting access to the post-trade infrastructure that they control.

In light of the above, it should come as no surprise that the appeal of equities markets in continental Europe has failed to catch-up with that of its US and UK counterparts, both of which have vibrant SME markets – true engines of innovation and economic growth – overwhelmingly backed by retail investors.

We should therefore ask our regulators to ensure that MiFID II/MiFIR does for competitiveness what MiFID did for competition. We all stand to gain from it.

©Best Execution 2014

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Viewpoint : MiFID : Data strategy : Silvano Stagni

By

Ian Rycott

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January 31, 2014

DATA DILEMMA.

Silvano Stagni, group head of marketing & research at IT consultancy, Hatstand asks if there is a data structure that eases the impact of regulatory change?

Any regulatory change has a substantial impact on data. Capturing information that did not have to be captured before, or requirements brought in by new regulation, will create new sources of data and an increase in volume.

For instance, implementing the countercyclical buffer* (CCB) in Basel III will create the need to capture specific information on the debtor/obligor. The CCB will not depend on the jurisdiction of the office where the credit was ‘booked’ but the one where the debtor/obligor is based. Therefore, it requires a set of data items to replace what previously might just have been achieved with a description.

The review of MiFID (MiFID II/MiFIR) will entail the introduction of best execution to non-equity and a new type of trading venue. It will imply standardised non-equity instruments traded in organised trading venues and the substantial curtailing of dark pool trading, if not an outright ban.

One of the principles of ‘best execution according to MiFID’ is the multiplicity of trading venues. The market reacted to MiFID I by creating a lot of multilateral trading facilities, some of which now trade larger volumes than many regulated exchanges. It is expected that the MiFID review will have the same effect for non-equity. Each new venue will create market data, and the move from dark pool trading to organised trading facilities will create more market data resulting in an exponential increase in volume.

Short of having a crystal ball, what are the requirements of a data structure that will be flexible enough to not only sustain the impact of regulatory change but also simplify the implementation of those changes? Here are some tips:

A clean data structure is a good starting point. Duplication of data should be avoided but also duplication of structures (due to de-normalisation) should be resolved, or at least documented.

Use of reference data, for example the LEI, allows a number of data fields associated to legal entities to become part of a reference data library using the LEI as a link.

Review what market data you use and why. Market data does not just represent a cost – in itself a good enough reason to make sure you only use what you need – it will potentially increase in volume, creating bottlenecks.

Audit your system and data architecture to highlight existing and potential future bottlenecks. Looking at possible ways to improve or eliminate them may not address a specific regulatory requirement but may make their implementation easier.

The four steps listed above will not future proof your data architecture, but they will create a slimmer and more flexible environment that will lessen the pain of implementing new requirements.

* The countercyclical buffer (CCB) is a pre-emptive measure that requires banks to build up capital gradually as imbalances in the credit market develop.

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Viewpoint : MiFID review : Miroslav Budimir

By

Ian Rycott

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January 31, 2014

THE TRANSPARENCY PARADOX.

One aspect of the MiFID Review that has earned particular attention from regulators, the buyside and the sellside is pre-trade transparency and, even more important, its exemptions. Deutsche Börse’s Miroslav Budimir takes a critical look at the state of play.

The most discussed exemption in the ongoing MiFID review is certainly the so-called reference price waiver (RPW). This waiver allows for dark trading as long as the execution price of a security is limited to the bid, ask or midpoint of the bid-ask spread discovered on a reference market of this specific security. The RPW, along with the large in scale waiver, the order management facility waiver and the negotiated trade waiver, was designed to retain beneficial effects of certain order types for the securities markets or, respectively, to prevent the downsides of a fully transparent market, which could show in form of market impact when trading large blocks of securities. This is one of the most important reasons for dark trading, since buying or selling large volumes of an instrument will immediately draw the attention of other market participants who may adopt this specific investment idea which will result in a swift price movement in said instrument thus hurting the outcome for the initial block trader.

The fathers of MiFID introduced a strict price transparency regime in 2007 to overcome the market fragmentation which was caused by the increasing, and much welcomed, competition due to the advent of new trading venues all over Europe. However, many market participants prefer dark trading in order to hide their trading interests from others. But at the same time, they are interested in the trading interests of other market participants.

Transparency is something every market participant wants to benefit from but, at the same time, the appetite to contribute towards it is limited. Pre-trade transparency serves the general interest in its ability to generate fair and efficient prices, especially in a fragmented environment. Neglecting transparency means harm to every single market participant. Nonetheless, regulated dark trading and OTC trading account for more than 40 percent of overall pan-European securities trading, according to Fidessa’s European dark trading report in October 2013.

Another paradox regarding dark trading might even be more curious: A study revealed that less than half of all OTC trades in the Euro Stoxx 50 constituents exceed standard market size, and that 80 percent of all OTC trades could be executed on the reference markets (like Xetra) without any market impact. With these figures in mind, it is really not easy to understand why so many market participants refrain from the safety of lit trading.

In its version of the MiFID review, the European Commission opted for the most extreme modification of the RPW thinkable: complete abolishment. Later, both the European Parliament and the Council decided to re-include the RPW in MiFID II. However, there has been an overall agreement that the RPW in its original design should be further restricted to limit its capacity to decrease price transparency. Therefore, the European Council has proposed an important modification of the RPW in its MiFID II texts. The idea is to add a so-called “Double Volume Cap” mechanism to the existing RPW. The first cap serves to limit dark trading in a given instrument to an overall market share of less than 4 percent on one trading venue. A second cap is supposed to restrict dark trading regarding the whole European securities market: the volume of all trades with the help of the RPW must not reach 8 percent of the overall market share.

In September 2013, a proposal was submitted to the MiFID II-Trialogue team aiming for a modification of the RPW which was recently implemented in Australian and Canadian markets under the name “meaningful price improvement rule”. This concept is based on the idea that price quality could be improved if market participants were allowed to dark trade not only at the bid, ask or midpoint of the bid-ask spread, but to trade everywhere within the spread – hence the term “meaningful price improvement“. Another aspect of this concept is that regarding the order execution in a regulated market, lit orders should be preferred to dark orders.

While this approach sounds reasonable, it actually is a significant softening of the existing RPW rule. The “meaningful price improvement“ rule even has the potential to disrupt the efficiency of European equity trading, and to draw a large part of it into the ‘dark’ since this concept would prove an enormous incentive to make use of the waiver. The following illustration shows the economic impact of introducing a so-called “meaningful price improvement” rule, compared to the current MiFID provision of trading at the bid, ask or midpoint of the bid-ask spread.

Be23_DBoerse_Fig.1

As easily can be seen, the “meaningful price improvement” is a mockery of MiFID’s general transparency requirement. With this approach, trading can effectively be done at any price within the bid-ask spread, compared to the ‘Midpoint’ execution restriction that MiFID foresees today. In the example above, with a 25-cent-spread and a 1-cent tick size, there is a total of 25 allowed execution prices.

The consequence would be that trading on the lit market would decrease, because price formation would start to take place on RPW markets. This leads to wider spreads, hurts the reference price, and impedes price discovery. More so, execution of dark trades with numerous different prices would dilute pre-trade price formation and, ultimately, liquidity. With price discovery suffering and lit market spreads widening, best execution would become very hard to achieve, since market participants will not be able to identify the best prices for their trading ideas.

A rather weighty example for this scenario is the Australian capital market, where the “meaningful price improvement” rule was implemented in May 2013: according to a research by Société Générale, spreads in certain securities have widened by up to 9 percent, with lit book activity reduced. As a consequence, all investors suffer from increasingly ‘untransparent’ price discovery. This example shows most impressively how price quality and, not to forget, the confidence of market participants all over Europe could decrease if pre-trade transparency was weakened any further. In its final shape, MiFID II will have to ensure that price transparency will be preserved or, better, strengthened in the future.

Gomber, Lutat, Pierron and Weber: Shedding Light on the Dark – OTC Equities Trading in Europe In: Journal of Trading, 2011, Vol. 6, Issue 1, pp. 74-86.

©Best Execution 2014

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FX trading focus : MiFID II : Anthony Kirby

By

Ian Rycott

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January 31, 2014

NO TIME TO LOSE.

What can we know for certain regarding the market effect of MiFID II, and the specific impact for evidencing best execution for FX products asks Dr Anthony Kirby, Chair of MiFID BEWG.

AnthonyKirby At the time of writing, the publication of MiFID II in Level I text form is expected to be issued during Spring 2014, with MiFID II slated as taking effect during Q2 of 2016 at the earliest. The timing is designed to coincide with the implementation of accompanying measures such as revisions to the Market Abuse Regulation (MAR/MAD II) and also changes to clearing and reporting of OTC derivatives transactions (including Foreign Exchange or FX Swaps and Forwards) under EMIR.

When it comes to FX transactions, banks carry the largest market share by way of provision, and FX spot markets have been regarded as transparent and fluid for many a year, warranting what some consider to be lighter-touch regulation. MiFID II will introduce a new fourth category of trading venue: the Organised Trading Facility (OTF) to cover the trading of quote-driven instruments such as fixed income and OTC-traded derivatives at the very least. The new category will accompany the existing three categories of provider, including existing MTF (multilateral trading facility) providers in the FX market such as FXAll and Currenex. How single- and multi-dealer platforms (which are the critical contributors to quote-driven FX trades) are likely to respond would be a matter for speculation depending on the ‘devil in the detail’ announced in the actual MiFID II, Level I text.

When it comes to best execution, it is expected that changes to market structure or trading practices would also imply changes to best execution policies and procedures. MiFID I featured an obligation on investment firms to ‘…take all reasonable steps to obtain, when executing orders, the best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order’.

Furthermore, as far as FX was concerned, the scope of MiFID I extended to ancillary services and financial instruments.

The default position for many firms therefore has been that physically settled spot and “commercial” forward FX did not lie within the scope of MiFID.

Moving forward, this situation may be less clear-cut, partly given the cross-effects from regulations such as EMIR/Dodd Frank and partly due to the fall-out from manipulations in the FX markets during 2012-13. As far as European competent authorities are concerned, best execution policies cannot stand alone from product complexity classifications and suitability/ appropriateness clarifications. The obligation to apply best execution under MiFID II may be broadened to more types of FX instruments, but the challenge will be to apply the principles to FX or other quote-driven markets, and/or cases where prices are indicative, where price montages do not exist or pricing on ‘normal commercial terms available with regard for the broader market to ensure that execution results are transparent, fair and reasonable’.

As things stand, the price and depth of (executable) liquidity are the prime considerations for ‘best execution’ with speed a further consideration for FX algorithmic arbitrages. The access to primary and into secondary liquidity pools, and the depth of each, is of interest to the executing parties. In addition, the balance of ‘opportunistic’ liquidity vs ‘natural interest’ is of increasing importance to investors, under both ‘normal’ and ‘stressed’ market conditions. If evidencing to demanding end investors is required (such as sovereign wealth funds) firms will typically need to reach out for ‘best of 3’ quotes but this runs into issues for illiquid currency pairs (e.g. NDFs).

The challenges in doing this include the need to manage the timing and synchronicity of obtaining executable quotes (between single- and multi-dealer platforms) and the lack of market montages. Although audit trails are often used to provide evidence of execution and timings of the same, many firms will resort to screen prints in lieu of providing evidence of a market montage of prices. Market best practices featuring common rules, standards and cut-off criteria, spanning corporates, asset managers, broker/dealers and platform providers are sorely needed.

Even ‘best price’ can be more than what is suggested literally; it often translates into what is transparent, fair, reasonable and ‘evidence-able’, often with regard for the broader market. There are precedents whereby executions outside the normal trading price range for the day led to controversies with some asset servicers and some investment banks – a sensitivity to clients and competent authorities alike. Clearly, these are quality of service issues, with benchmarking, pricing tools and price aggregation all playing key roles – and therefore not simply a matter of regulatory compliance per se.

Moving forward, best practices behind best execution evidencing for FX instruments may therefore need to rely on more components than the traditional approaches used for cash equities under MiFID I. In the absence of prescriptive regulations, these must focus on the definition of best practices behind best execution evidencing and how these should be applied with regard to the complete FX ‘value chain’ (see Fig 1). Audit trails, single bank platforms, multi-bank (aggregation) platforms and increasingly OMS and transaction cost analysis (TCA) tools are all likely solution components, but so too are disclosures (e.g. platform rules concerning prioritisations, blocks, mark-ups and preferential rates). Front office controls and separations of duty are also critical considerations.

Be23_TONY-KIRBY_DIAGRAM

The FX industry has less time on its hands than it might think to develop transparent workable practices in advance of prescriptive or restrictive regulations. Some competent authorities are even pressing for a reversion to a model of trade-by-trade best execution and ‘express-consent’ approval in the meantime. In the absence of organised approaches to developed shared market practices to common issues, the risk is that FX processing becomes the Cinderella of transaction processing – with the loss of confidence and innovation opportunity. The converse is also true and it is up to the industry to decide how best to organise.

©Best Execution 2014

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FX trading focus : Redefining the role of FX : Russell Dinnage

By

Ian Rycott

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January 31, 2014

SUITS YOU SIR?

Russell J. Dinnage, Analyst Consultant at GreySpark Partners looks at redefining the optimal FX sellside business.

RDinnage In November 2012, a group of London-based currency fund managers held private discussions with one another about a growing mismatch they saw emerging in the structure of the FX market.

In dealings with their buyside clients, the currency fund managers agreed that the inherent value in their businesses had become less focused on the advice they could give to institutional and real-money corporate investors on how to structure, price and execute large FX trades. The fund managers concurred that pricing, across the G10 market for currencies, was too uniform, spreads were too small and quality of trade execution was not a concern for real-money investors that were primarily concerned about finding evermore new counterparties to trade with.

Instead, the currency fund managers agreed that, in the future, the necessity of their place in the market would be their ability to connect cash-rich companies, investment houses or even individual investors with the right sellside investment bank. Doing so would allow the fund managers to redefine their place in the FX market from the long-standing role of bespoke, large trade designers into a new role as specialised facilitators of the client trades that generate higher beta for the client than the currency fund managers could provide.

Meanwhile, on the sellside of the FX market, the currency fund managers agreed that the natural proclivity of Tier I and Tier II banks to focus on eeking out a measure of proprietary profitability in FX dealing during a period of record low inter-bank market volumes was becoming increasingly frustrating for institutional and real-money corporate clients. In an effort to assuage this buyside anxiousness, the fund managers agreed that what these banks really needed was the ability to secure – almost on a daily basis – new pools of FX liquidity, especially if these pools held exposure to emerging markets (EM) or exotic currencies that could be utilised to revive the ailing practice of carry trading.

For the group of currency fund managers, the question then became: how would they go about better connecting their clients with banks searching for new pools of FX liquidity? In December 2013, this question remains unanswered, and the largest FX dealers are becoming increasingly concerned.

Take, for example, the Nov. 29 comments of Deutsche Bank’s global head of FX Kevin Rodgers at an event run by FX Week in London. In a classic sellside critique of the provision of FX liquidity by high-frequency trading firms, Rodgers opined “don’t call it liquidity” when HFT trading outfits act as non-bank FX market makers on daily basis within so-called dealer-to-client, multi-dealer platforms (MDP) like Thomson Reuters Matching/ FXall or HotspotFX.

“The market has moments when liquidity falls away and then comes back again, and [liquidity] is a lot patchier than it has been historically. There are fewer market-makers and less risk capital being deployed, and you are already seeing the consequences [of these factors] in the market,” Rodgers said. He added that if there was another financial crisis akin to the events of 2008, then the experience of market-making banks being solely responsible for keeping liquidity flowing in the wider FX market would be “unpleasant.”

Luckily for the FX market Deutsche Bank is not the only large dealer on the street with an acute awareness of the challenges posed by Rodgers’ concerns for long-term sustainable G10 currency liquidity. Based on GreySpark Partners’ observations of leading sellside FX dealers, several banks were beginning at the end of 2013 to take a top-down, reorganisational approach to their long-standing business models for G10 and EM FX.

In doing so, the banks could effectively kill two birds with one stone through refinements to e-FX strategies for pricing clients into emerging or exotics currency markets that will likely result in better buyside client retention across the board.

Resolving the FX liquidity conundrum

It is no secret that the majority of Tier I FX banks recognise that, in order to drive growth in EM currencies business and the wider base of clients this focus yields, a strong base of voice and e-FX G10 dealing capacity is required. And while many of these banks are already taking steps to reorganise their FX businesses so that they intermingle with rates and credit trading, there is at least one large European sellside firm that sees a deeper level of opportunity created by this reorganisational move.

The opportunity for the bank in question lies in the standardisation of FX options pricing via a single-dealer platform (SDP) for EM clients by packing the options into structured derivative products. In seeking to include more of these structured FX options derivative products on its SDP, the bank hopes it will be able to provide e-FX services to a wider base of EM clients under one, consolidated dealing framework through the commoditisation of sophisticated products that are notoriously difficult to price electronically.

The opportunities for banks with an SDP capable of pricing clients trading FX options into structured derivatives products that can be commoditised over time are clear. According to the 2013 edition of the Bank of International Settlement’s annual FX market survey, non-dealer financials accounted for 61% of the total volume recorded in FX options and other products in 2013 (see Figure 1).

Be23_GreySpark_Fig1 Of that 61% of FX options turnover in 2013, hedge funds were responsible for 21% of the non-dealer financial counterparty volumes.

Organisational or structural changes by banks to increase their ability to electronically price FX options for clients reflects the sellside’s desire to remain nimble in EM regions where trading in a number of asset classes remains largely over-thecounter and, as a result, unregulated. In the EU and US, the new normal of the best execution-focused regulatory environment has led many leading FX dealers to tell GreySpark that they are increasingly frustrated at the need to provide clients with spot or forward FX pricing on MDPs because the bid/ask spreads in the requests for quote they receive on many FX SEF platforms are too narrow.

Instead, further development of a banks’ e-FX business on its SDP is becoming the priority as FX trading is reorganised to better partner with the rates and credit businesses. There are a number of innovative, SDP-focused solutions in the works to address these needs.

Suits you, sir?

These types of sellside developments are good news for the currency fund managers seeking new avenues of investment opportunities for their institutional and real-money corporate clients. According to a report published recently by US private bank Brown Brothers Harriman, investment managers want their sellside partners to offer more access to bespoke trading opportunities that can be commoditised over time. The reason is simple: as operating expenses rise and investment risks generally increase in regulated and unregulated environments alike, many buyside firms are considering ending the in-house management of their FX exposures, according to the BBH report.

The final frontier then becomes the provision of FX transaction cost analysis (TCA) in an effort to quantify the effectiveness of best execution regulatory standards in the EU and US. However, FX market-consensus on what the final form of the ideal currencies trading TCA solution should be remains a long-term challenge.

Ironically, as the sellside banks work to further commoditise their FX structured product offerings in a bid to streamline the electronic provision of EM and exotics exposure, there are also several currency fund managers in London that are developing FX price benchmarking and indices for general consumption. These new attempts at a baseline of FX data could one-day lead to the creation of a new, market-leading currencies TCA solution, according to one of the fund managers. The fund manager added that if his firm did not develop this type of trade transparency solution first, then the sellside would.

Be23_GreySpark_Fig2

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The changing nature of algos in Asia

By

GlobalTrading

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January 20, 2014

Rob Hodgkinson, Director APAC, First Derivatives looks at the changing nature of algos across Asia, and what it could mean for trading structure.

Algos are typically structured as
-(a) Execution strategies (TWAP, VWAP etc),
-(b) Proprietary (prop) trading strategies (Statistical Arbitrage, Mean Reversion, Pairs Trading)
-(c) HFT algos (ultra-low latency, FPGA based solutions, etc)
There has been an increase in ‘packaged strategies’ for DMA clients such as TWAP, VWAP to facilitate trade execution (ie more flow through ‘vanilla’ algos), and also an interest in more competitive prop trading strategies (seeking enhanced backtesting and strategies based on more proven, verifiable mathematical models). The focus on HFT strategies has largely dissipated due to expensive infrastructure, diminishing spreads and lower returns.
There has also been increased competition to provide more efficient trading platforms (Chi-X Australia, ATPs, lit/dark pools etc) and a move to provide common infrastructure to facilitate sell side competition. This includes tick as a service, co-location solutions, common algo testing and infrastructure.
In particular as the strategies themselves become more competitive, and regulations become more stringent, and punitive in that fines are widely being applied for market misconduct of algorithmic strategies, we are specifically seeing a move to much more robust use of:
– historical data models for backtesting (both for PnL model verification and strategic stress testing to ensure models fully comply under all circumstances).
– more dynamic simulation models to facilitate random market moves, shocks, and verification for strategy conflicts – primarily within a participant, but also between participants. The testing infrastructure sought should provide multiple trading venues, not just one market venue.
This is leading to more competitive strategies and more efficient venues that can provide more cost-effective trade execution as spreads narrow, but regulatory compliance increases.
The trading desk flow is becoming more automated as orders are directed to multiple venues, and there is now a strong requirement to ensure compliance on order flow across all venues to avoid financial penalties yet ensure competitive trading strategies. The increased compliance and surveillance focus is highly apparent.
What comes next
A full service testing infrastructure for algorithmic trading across multiple venues with multiple participants having access to run their tests both alone and concurrently with other participants. Historical focus in the past has been on participants to test their own strategies, but it is also clear that potential strategy conflicts between participants must also be fully tested before reaching production. This is only possible through the use of a shared testing infrastructure, but to be complete should also provide multiple market venues (e.g. HKEX, TSE, SGX, ASX etc) so that strategies can be fully tested, with the presence of other participants also concurrently testing on the same platform. The sensible way to do this is to provide a backtesting platform that offers (a) historical market replay, (b) a price adjusted market replay so that historical orders are price adjusted to be more realistic of the current testing environment, for example when strategies might interfere and shift the current bid/ask, and (c) fully simulated testing complete with time scheduled market shocks (eg to move a security or sector by a significant percent in a defined time period … eg 5 msecs or 5 minutes). By capturing all orders and trades, participants, the exchange and the regulator are able to analyse the specific behaviour of all participants’ strategies to verify a shift in order burst rates, increased spoofing or radical positions shifts in response to such market shifts. The improved quality of market behaviour is apparent as such testing can only improve the behaviour of all strategies in the production market.

News : MiFID II agreed

By

Ian Rycott

-

January 15, 2014

European officials reach MiFID II agreement

The EU will curb high-speed trading and commodity speculation under an agreement reached by member states and the European Parliament. The revised Markets in Financial Instruments Directive, which will be implemented by the end of 2016, also will establish organised trading facilities, a type of trading platform for bonds and over-the-counter derivatives contracts.

Source: gfma SmartBrief

Download AFME’s news release.
Reuters (15 Jan.)

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Announcement : GRC partners with REGIS-TR

By

Ian Rycott

-

January 9, 2014

GRC PARTNERS WITH REGIS-TR TO PROVIDE EMIR COMPLIANT TRADE REPORTING SERVICES.

GRC to deliver comprehensive centralised solution to buy side and corporate customers for new derivatives regulatory trade reporting requirements, via REGIS-TR Trade Repository.

Partnership leverages REGIS-TR’s unique third-party reporting model, enabling third parties to report on behalf of a number of underlying clients without necessarily on-boarding each underlying entity individually.

To see full press release CLICK HERE

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Identifying Systemic Risk

By

GlobalTrading

-

January 8, 2014

Shane Worner, Senior Economist, IOSCO, looks at the major systemic threats facing markets, and how regulators can work together to mitigate the risk.

As far back as 2008, IOSCO recognised that systemic risk builds up in the securities markets through the overuse of products, whether through the overuse of a particular activity or within institutions themselves. A strategic review, which took place after 2008, recognised that systemic risk is something that securities market regulators should be concerned about, and so IOSCO implemented two new principles:

Principle Six – which states that regulators should look beyond the boundaries of their regulatory remit to see where risks are building up, and;
Principle Seven – which states that, if need be, those risks be brought into formal regulation to mitigate against possible future incidences.

We therefore set up the research department at the IOSCO secretariat, to look at issues of systemic risk at a global level (given we are a global organisation). Our aim is to inform our members of the areas they should be looking at, and providing them with more information on where they should focus their attention. Furthermore, as we are the securities market standard setter we have a unique view of what’s going on. We connect with the markets, the securities market regulators, and we’re involved with the banking regulators.
Creating the report
The processes involved in developing this report were particularly rigorous. This is the first time we have ventured into this area – a forward looking globally public report. As an organisation, we tend to focus on standard setting and policy work.
Whilst creating the report we visited and interviewed many market participants. We have our own committee responsible for emerging risk which is comprised of the 30 chief regulators of our major members, who were involved in the creation of the report, and we surveyed the broader community, both regulatory and industry. The risks from the low interest rate environment, risks from collateral management, derivatives risk, and emerging markets capital flows were clearly the four main areas that people were really concerned about.
We want this report to be an important part of the debate on risk mitigation in the market and we want to be seen as being engaged with the industry and the concerns of its participants. We have had a positive response from many of our regulatory members. Our Chairman, Greg Medcraft, has been championing this report as a means of demonstrating how we are thinking about issues beyond our core standard setting and policy work.
Regulatory arbitrage
Regulatory arbitrage is one of the biggest issues that we’re going to have to tackle as a global organisation. The cross-jurisdictional aspect of regulation is huge, particularly as so many jurisdictions implement their own regulation which is incompatible with regulation implemented by other jurisdictions.
As the global standard setter we are mindful that we don’t want to see fragmentation in market regulation, as this will drive fragmentation of markets through ring-fencing assets etc.
One of the key challenges for the next couple of years is to how to globally converge the key regulators so that they are internationally consistent. If a regulator is the first to move when setting regulation, and then the standards come in afterwards, it’s hard to find common ground as a standard setter when you’ve got so many people who have moved first.
I think we must try to convince people to look at the standard first, to ensure globally consistent regulation based on globally consistent standards, and then to move forward from there.
Emerging markets
I think that emerging markets have a relatively easy time of it: as emerging markets are not yet well-developed or established, it’s actually quite easy to set up from a lower base point. There are already principles and standards established to assist with the setting up of those markets and there are good technical assistance programmes in place at IOSCO.
It is far harder for developed markets. They need financial innovation at the margin in order to drive the industry forward. If you look at regulators in the UK, Singapore and Australia for example; their jobs are far more complex. They involve more regulatory challenges and also complexities within corporate governance. It is much easier to hide things in more developed markets than in emerging markets, which are far more transparent.
In conclusion, these are the issues that IOSCO is going be working on in order to better understand what’s going on, because essentially this is securities market activity. We should be providing analysis in order to provide better policy in this area.

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FEES & COMMISSIONS.

Denis Orrock, CEO, GBST Capital Markets examines the growing challenge of dealing commission transparency.

Evolution of a problem

Drivers for change

Operational burden

Conclusion

COMPETITIVENESS VS COMPETITION.

Oriol Pujol, CFA, Head of European Business Development at Winterflood Securities argues that the retail sector in continental Europe has benefited least from the achievements of MiFID and that MiFID II and MiFIR should do for competitiveness what MiFID did for competition.

Competition

Transparency

Retail disadvantaged

DATA DILEMMA.

Silvano Stagni, group head of marketing & research at IT consultancy, Hatstand asks if there is a data structure that eases the impact of regulatory change?

THE TRANSPARENCY PARADOX.

One aspect of the MiFID Review that has earned particular attention from regulators, the buyside and the sellside is pre-trade transparency and, even more important, its exemptions. Deutsche Börse’s Miroslav Budimir takes a critical look at the state of play.

NO TIME TO LOSE.

What can we know for certain regarding the market effect of MiFID II, and the specific impact for evidencing best execution for FX products asks Dr Anthony Kirby, Chair of MiFID BEWG.

SUITS YOU SIR?

Russell J. Dinnage, Analyst Consultant at GreySpark Partners looks at redefining the optimal FX sellside business.

Resolving the FX liquidity conundrum

Suits you, sir?

European officials reach MiFID II agreement

GRC PARTNERS WITH REGIS-TR TO PROVIDE EMIR COMPLIANT TRADE REPORTING SERVICES.

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