Global Markets

senior vice president, Astec Analytics, SunGard’s capital markets business

No “Silly Season” for Securities Lending

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The time known as the “Silly Season” is upon us. An annual tradition, the Silly Season marks that time in the year where nothing of note is happening. As a result, our newspapers usually contain bizarre stories that would never normally get any airtime and people realize that as our politicians are all on holiday, no one is actually running the country. This year is different of course; with the Queen’s Jubilee and the Olympics in London, there is no shortage of activity.

Similarly, securities lending has much going on. For example, the European Securities and Markets Authority (ESMA) has launched new guidelines on income distribution for securities lending. Of arguably more immediate importance, new short selling bans have also been re-introduced in Italy and Spain. Spain has put a three-month ban on all shares in place from July 23, and Italy mandated a new ban for one week only starting July 29 for insurance and banking shares.

In what some have described as an act of desperation, the short selling bans have been introduced as a result of market volatility even though such bans have been shown in the past to be ineffective and indeed even counter-productive to this aim. Such bans have impaired liquidity and damaged already ailing investor confidence; they have also been seen to drive short selling into other European markets.

While securities lending is not equal to short selling, it is a good proxy for measuring such activity, especially as we are now outside of the main dividend season. While it is a little early to see an impact from these bans on lending activity in these locales, prior evidence shows that such bans raise spreads, drive out liquidity and scare investors – presumably exactly what the regulators do not intend. For Spain and Italy, does this herald the start of their own Silly Season, perhaps?

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trading and client connectivity, SunGard’s global trading business

WHY SHOULD BROKERS FOCUS ON TOTAL COST OF OWNERSHIP?

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For smaller European broking firms, particularly those engaged in regional business, the implementation and management of technology and connectivity across multiple trading venues post-MiFID is proving increasingly costly and time-consuming. Adding to this pressure, client and regulatory demands to deliver best execution have to be met in a context of declining volumes and intense competition. The overall pressure on margins means that brokers have to consider carefully how to undertake any business development initiatives in the most efficient and cost-effective ways.

Meanwhile, the overall importance of technology in the delivery of brokerage services continues to grow; and as its use extends across all business processes, its cost also becomes more important. Making the right technology choices is therefore vital, and it is equally important to manage resources efficiently.

There is today an increasingly sharp realization that optimizing the management of technology can make a huge difference to its total cost of ownership (TCO).

It has become clear that regional brokerage firms cannot support the ongoing rise in technology costs that results from a business-as-usual approach, and one consequence of this is rapid growth in the use of managed or hosted services. Brokers can essentially go one or more of three ways (indeed we see increasing numbers now using all of these options):

  1. Outsource execution as a whole.
  2. Use managed, mutualized services for market data and trading.
  3. Apply the same approach for connectivity to clients.

Outsourcing of execution is widely used for global trading – in North America, Asia-Pacific and worldwide emerging markets. The European broker can offer its clients a full service for these regions, while behind the scenes the order flows are sent to local brokers via FIX links and order routing networks. Some firms have gone further and also outsourced expensive multi-venue European execution, including smart routing, but it might be argued that this is akin to “outsourcing your soul” and is a step too far for most. Fortunately, many options exist at the level of having technologies, as distinct from entire business functions, managed by service providers.

The outsourcing of market data management to vendor firms is of course long established, and trading connectivity is an obvious follow-up. In the U.S., order management and connection to markets have been handled almost exclusively via managed services, or software as a service (SaaS), for many years, and European firms are increasingly conscious that trading servers, order management systems and smart routers do not have to be run in-house.

Just as connecting to multiple exchanges is complex, so too is connecting to a large number of clients. A broker is typically required by its clients to deal with a range of connection types over many different networks, both FIX-based and proprietary. A managed services approach can render the technology transparent to both broker and clients, and also can help to deliver the flexibility and speed of response that is typically required by buy-side firms.

The decision to follow the SaaS managed services route is normally a straightforward financial one. Where a technical and operational business process is sufficiently standardized, a brokerage firm gains no competitive advantage by running that process itself. Engaging an experienced managed services provider will almost certainly result in lower TCO, and potentially in some real functional advantages, such as lower latency via co- or near-location of servers for a given trading venue.

For brokerage firms, the use of SaaS and associated simplification of business processes can enable them to achieve a significant reduction in their TCO and to place management emphasis where it should be: on looking after client relationships and growing revenues.

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CAN FORMER POLITICAL HOTSPOTS BECOME OPPORTUNITIES?

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Investors have many tools at their disposal to overcome obstacles when they explore new and emerging markets. One factor beyond their control, though, is the political environment. Thus when investors search for new markets, they often skip over countries and regions that have even a hint of political unrest.

While this seems generally a prudent course, not all political and economic transitions lead to chaos or war. Some countries learn from their growing pains. They can develop stable democracies with thriving economies that harbor investment opportunities, including those for futures markets.

Of course, there are hotspots where political unrest has seemed to eclipse potential or even established trading opportunities. But, when a country passes the “healthy skepticism” test, is it time to consider them?

Take, for instance, South Africa and Indonesia, which are examples of where opportunities can flourish after major periods of political unrest.

While the politics of South Africa are evolving, so is its economy. Foreign investment has grown substantially in part because of the good business infrastructure, which includes the futures markets.

In 2001, the Johannesburg Stock Exchange (JSE) acquired the South African Futures Exchange (Safex), which resulted in a hub for equities and derivatives trading. (The JSE retained the Safex branding for the commodity and equity derivatives markets.) The commodities market provides price discovery and risk management for grains, precious metals and crude oil markets. The financial derivatives market offers a platform for trading futures and options.

Since the merger, the JSE has taken many steps to open itself up to international trading such as adopting the FIX electronic protocol for trading and working with third-party suppliers of hosted market connectivity. The JSE offers electronic trading, clearing and settlement in equities, financial and agricultural derivatives and other associated instruments.

Another former hotspot is Indonesia, which has youthful demographics, sustainable domestic consumption, and an $813 billion economy that is expected to expand by approximately 6% this year—roughly the same rate as 2011. For futures, there are two trading venues —the Jakarta Futures Exchange (JFE) and the Indonesia Commodity and Derivatives Exchange (ICDX), which serve as the trading venues for indigenous commodities. The JFE and ICDX are aggressive competitors, particularly in the gold and crude palm oil markets. The ICDX is also a trading venue for coal, natural gas, cocoa, coffee and tin. The JFE and ICDX support electronic trading and a variety of market connectivity options that provide widespread access for overseas investors.

While no indexes exist to help measure and predict political unrest, it is clear that major shocks to the political system will reverberate through the economy, including the futures markets. Some turmoil may even halt trading on the major exchanges.

Yet some of today’s hotspots could eventually become attractive investment opportunities once the political factors have settled into somewhat predictable patterns. When once tumultuous countries and regions stabilize, they are likely to need more foreign investors and, as long as there are opportunities, investors will oblige.

To make the most of those opportunities, investors will need good partnerships with stable trading and investment management firms on the ground. They will also need IT providers that know the region and have established inroads into the country’s current networking and IT infrastructure.

global head of connectivity, SunGard’s global trading business

CHINESE METALS

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This blog post also appears on Finextra.

Cross-border M&A among exchanges has proved difficult lately. The latest attempt, the purchase of the London Metal Exchange by Hong Kong Exchanges and Clearing, might actually go through - but with what result?

Hong Kong Exchanges’ bid for the LME follows several failed exchange merger attempts of last year (NYSE Euronext/Deutsche Boerse, LSE/Toronto’s TMX, and Australia’s ASX/Singapore Exchange). The bid is not transformational, as there is very little synergy potential – it is mainly one party bringing its target acquisition closer to its (almost) primary market. The LME sets the price for the vast majority of the world’s base metals and HKEx stands at the gateway to China, the world’s largest consumer and producer.

The price being paid is eye-watering: £1.388 billion is almost a 75% premium over the £800 million reported as NYSE Euronext’s bid before it dropped out of the running last month – though the ICE bid allegedly came very close. It values the LME at 180x net income and at 22x the last traded price for the exchange’s shares. It opens up HKEx to accusations of overpaying, but then again, how do you value something unique? The LME is comfortably the major center for the trading of metals derivatives contracts, with a global market share of about 80%.

The price and assurances on the maintenance of transaction terms and LME’s business model look likely to win shareholder approval – though could ICE try to disrupt the party as it did a few years back in Chicago? The approval of the UK regulator looks a little more complicated (political interference is possible, with yet another UK exchange passing into foreign hands), but may well be granted: the LME will remain under UK oversight, and HKEx has undertaken to maintain a robust governance structure (although this last promise might merit examination, coming as it does from an exchange which has six of its 13 board members appointed by the Hong Kong government).

In the wake of the announcement of the bid’s acceptance on Friday June 15, 2012, HKEx’s share prices tanked (though recovered some ground on Tuesday), indicating negative market sentiment that is partly due to the high price being paid, but may also signal concerns over the strategic issues that will determine the success or failure of the investment.

The HKEx strategy depends not only on the continued vitality of Chinese growth, but also on the loosening of rules that impede Chinese firms’ access to foreign exchanges. The determining factor may ultimately be the willingness of the China Securities Regulatory Commission (CSRC) to allow HKEx to compete on the same terms as the mainland Chinese exchanges. Small wonder, then, that we see nervousness reflected in HKEx’s share price.

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senior product specialist, SunGard's capital markets business

COMPLIANCE AND SURVEILLANCE: A COMPETITIVE EDGE IN EUROPE

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This blog post originally appeared on TabbFORUM.

Spending on market surveillance solutions covering pan-European equities and derivatives markets is set to grow by at least eight percent in 2012, increasing from €105M in 2011 to €126M by 2014, according to recent research from TABB Group.

Rebecca Healey, a senior analyst with TABB Group, sets the scene nicely in her recent report: “The finance industry now has a stark choice. It must demonstrate a corporate group responsibility and fully engage with the legislative process to restore faith in the markets, or accept the investable disparagement of the industry and the regulatory strait jacket in which it will undoubtedly be cast.” It is clear that the Commission and ESMA have a strong ambition and will do extensive and industry-wide changes if they see them as necessary, which the resent ESMA Guidelines already demonstrate.

With the formation of the ESMA-Pol Standing Committee, the Commission is making a clear statement that it is serious with the ambition to track down and prosecute cross-market and cross-jurisdiction market abuse cases. Looking at FSA penalties over the last few years, we see that both the actual amounts are increasing and the focus is broadening to include cross-border regulation, which is demonstrated in Healy’s report.

The above makes it clear that there is a real business case for surveillance solutions, not least to avoid penalties and reputational damage, but also to be able to clearly demonstrate and broadcast that corporate responsibility and integrity is high on the agenda with regard to customers, regulators and owners.

For the forward-thinking firm, there are quite a few opportunities in this increased cross-market, cross-asset class and linked product focus.

Surveillance and supervision systems can now increase their scope and capacity to span across a firm’s full trading activity and should include functions such as social media and become fully integrated into corporate risk analysis functions. These systems will then provide the opportunity to competitively present decision makers with peer behavior reports and pricing reports, allowing firms to better understand their regulatory risk as well as to explore new products and adjust their pricing models for existing products, to remain as competitive as possible.

Compliance and surveillance is now becoming a big opportunity to get ahead of the competition and perhaps even more importantly in today’s climate, also a way to demonstrate a company’s full commitment to corporate responsibly and engagement in the evolving regulatory landscape.

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trading and client connectivity, SunGard’s global trading business

HOW REAL-TIME CAN RISK MANAGEMENT BE?

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This blog post also appears on ATMonitor.

The regulatory push towards real-time trading risk management was addressed in a panel session at the 2012 SunGard Industry Seminar in London. The discussion pulled together of a lot of useful information for participants, but ultimately didn’t generate too much controversy. It seems that the regulators are for the most part pushing at an open door with their demands for tighter pre-trade risk controls. Stories abound, we’re told, of risk management teams now able to pursue projects they had long thought important or even necessary, but had historically lost out to other competing priorities.

During the panel discussion, Simmy Grewal of Aite Group presented a round-up of the major regulatory initiatives that touch on this area. It’s a considerable list.

  • The U.S. SEC Market Access Rule (15c3-5) is designed to eliminate “naked access” to equity execution venues and requires brokers to establish pre-trade risk controls in all cases.
  • The U.S. CFTC’s proposal for position limits on commodity derivatives (part of the Dodd-Frank legislation) still faces legal challenges, and requires more work on establishment of futures/swaps equivalents, but if enforced later this year, will effectively require global controls of pre-trade risk.
  • In the EU, the MiFID II proposals include text that implies ESMA will develop commodity derivative position limit standards similar to those of the CFTC.
  • Also in the EU, ESMA’s Guidelines on pre-trade risk management for automated trading engines are currently being incorporated into national regulations.
  • The real-time application of credit valuation adjustment (CVA) techniques to provide accurate measures of counterparty and liquidity risk exposures in OTC markets is required under the Basel III rules.

Stuart Adams of FIX Protocol Limited brought an interesting perspective to the discussion: FPL has been very active in the pre-trade risk field, and is due shortly to publish an update to its 2011 Risk Controls guidelines, extending their scope to cover listed derivatives as well as equities.

Throughout the discussion, the panel addressed questions around three different areas.

How real-time can risk management be?

You don’t get more real-time than pre-trade – which is now being required in a range of cases. The major difficulty with being fully real-time is that in most trading firms of any size there will be multiple trading architectures in use, and also there will be trading on multiple exchanges. Limits and margin then have to be allocated and shared across them, and it’s hard to do this optimally. This is a particular challenge in derivatives trading, given the complexities of managing margin. Risk also has to be managed across related asset classes – typically futures, options and swaps.

The push for better risk management comes at the same time as an urgent priority on lower latency. This places tight limits on how much checking you can do pre-trade and creates a challenge for software builders – how fast can they make the checks run? As a result, we see firms making necessary practical compromises: for example, pattern risk controls (recommended in the FPL Guidelines) are generally placed post-trade.

Where do buy- and sell-side firms need to place emphasis in their compliance efforts?

There are difficult decisions here, given that many other issues are live at the same time, particularly in Europe, with the rest of MiFID and the MAD review. But getting pre-trade risk management right, across the industry, has to be a major priority. There will be no excuses for anyone breaking a limit.

Firms need to ensure that comprehensive software controls are in place for all electronic trading, whether from screens or automated trading engines. Where these already exist, the systems in place and how they are configured need to be reviewed. Not all systems will be capable of handling all checks in 15c3-5 or the ESMA Guidelines. Firms also need to ensure that the controls are well documented.

The challenges multiply where different markets and diverse trading architectures are involved, but technology solutions exist that can help optimize the management of such environments.

Can some real business benefits be gained at the same time?

Arguably, given the scale of what can happen in an electronic trading environment, every trading firm should be on the same side as the regulators. We’ve certainly seen examples of both brokers and buy-side firms using the regulations as a lever to make risk management or technology improvements that did not previously get budget or resource focus. This shouldn’t come as a surprise. We are, after all, talking about the avoidance of what could in the worst case be catastrophic risks.

This panel session amounted to a general agreement that there is little point in fighting the regulatory direction on pre-trade risk management and that in many ways it will benefit business. The big issues include assuring the quality of systems for each trading architecture and asset class, and deciding how far to go with the more complex controls in order to optimize the use of available capital and margin.

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senior vice president, Astec Analytics, SunGard’s capital markets business

ADDED PRESSURE: ECJ ON FRENCH WITHHOLDING TAX

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This blog post also appears on Finextra.

The European Court of Justice (ECJ) has now ruled as of May 10, 2012, on the tax discrimination alleged by nine institutions over withholding tax levied on foreign investors in French equities compared with domestic funds which are exempt. Withholding tax is levied at up to 25% on dividends paid out to investors by equity issuers, but where investors from different countries are not taxed at the same level, it is considered to be contrary to the Free Movement of Capital across the European Union.

As if the incoming French president did not have enough issues to contend with, the French Government could be facing actions for up to EUR20Bn in tax reclaims by foreign investors – and EUR5Bn of that may be crossing the channel to the UK.

The battle is not yet over of course, as foreign funds will likely have to prove that they are sufficiently similar to the tax-exempt French domestic funds in order to be treated the same way. Another option available to the French Government may be to solve the discrimination by taxing the domestic funds the same way as the foreign investors – this is not without precedent and may even be a vote winner in France if it can be sold as a tax on banks and bankers rather than the end investor.

On the positive side for claimants, the ECJ have refused to apply a temporal limit to the claims, so past discriminated investors can also take action going forward.

As far as securities lending is concerned, this could have a dramatic effect on one of the most lucrative markets in Europe. Dividend arbitrage, or yield enhancement as it is often known, involves the lending of equities over dividend periods from a fund that suffers withholding tax to one that does not. The enhancement to the dividend is then shared between the funds rather than paid as tax to the relevant tax authority. Without funds being discriminated on the basis of tax, there is no trade.

If this ruling is upheld and indeed enforced, as similar rulings have previously been in Sweden and Spain, then this is yet another downward pressure on earnings in an already embattled market and potentially sets a further precedent for other countries to follow.

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managing director, Asia-Pacific, SunGard's capital markets business

THE PROMISE OF MALAYSIA

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This blog post also appears on TabbFORUM and ATMonitor.

If any country epitomizes the wilder side of capital markets trading in Asia, it’s Malaysia. But there are signs that Malaysia is ripe for a bit of refinement, which would give this dynamic country the focus it needs to be more competitive in global markets.

On the upside, there are many growth opportunities and a lot of energy to be found in Malaysia. The more relaxed regulatory environment is a striking contrast to the more mature markets of Europe and North America. It’s also a market where major brokers are consolidating to get ready for the next stage of Malaysia’s national evolution. On the other hand, the country’s tendency toward a more free-for-all spirit can sometimes be seen as a challenge.

A case-in-point is the challenge facing the Bursa Malaysia as it attempts to move its members to a new trading platform. The exchange is slated to decommission its incumbent legacy trading platform and 8,000 terminals in use by exchange members by the end of 2012. Not only has the expiration date of the system been changed at the behest of members, but an effort to involve more external suppliers has unraveled as the exchange’s members have not selected a single supplier or set of suppliers that will provide access to the exchange’s new system. This has occurred in an environment that has less regulation and is governed by a great sensitivity to the price tag for any new trading technology, making for a very competitive environment for suppliers.

Despite the growing pains, major brokers in Malaysia are seeing the need to combine forces to become more powerful regional and global players. Even established Malaysian firms are reaching out beyond borders to improve their profile in the region. For instance, the CIMB Group Holdings of Malaysia, a commercial bank that offers investment banking, announced in early April that it will buy the Asian equities business of the Royal Bank of Scotland Group (RBS) for £88.4 million ($142.7 million).

Malaysia is also reaching out on the derivatives front. Bursa Malaysia has had a strategic agreement with the CME Group since 2009, with the partnership making contracts available through the electronic trading platform CME Globex. This synergy is an ambitious attempt to expand the Malaysian derivatives market and the effort has been gaining ground.

Yet it is equities that seem to hold the greatest promise. Malaysia is working to make Bursa Malaysia much more connected to other Asian exchanges to facilitate cross-border trading and thus attract more international investors. Bursa Malaysia and the Singapore Exchange are slated to inaugurate their connection by June. This is the first move in a much larger effort to create electronic trading connections among many Asian exchanges. The Bursa Malaysia-Singapore link will coincide with a summer launch for the highly touted ASEAN Trading Link, an initiative of the Association of South East Asian Nations dedicated to paving the way for an economic pact that parallels the European Union.

With so much happening in Malaysia, trading software and services providers face an ever-growing list of requirements from market participants that want to keep up with the rapid rate of change. All suppliers will have to offer products, features and support that go far beyond meeting local and regional mandates. They must offer the innovative capabilities, partnerships and technical support required for achieving global reach, thus guaranteeing customers a path for growth. This is essential, as Malaysia is one market that is not going to rest on its laurels.

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head of Valdi Options US, SunGard's capital markets business

3 KEY AREAS TO WATCH IN OPTIONS TRADING IN 2012

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This blog post originally appeared on TabbFORUM.

The last several months have been crazy for financial exchanges. We had anxiously waited for the Deutsche Bourse–New York Stock Exchange deal to close — a merger that would have fundamentally changed the global exchange landscape for derivatives trading — and watched the deal get blocked by the European Commission. Now, as we eagerly anticipate the implementation of Dodd-Frank legislation and the Volcker rule in the U.S. in the coming months, we should consider how the final implementation will affect trading volumes, trading strategies and compliance needs for those engaged in derivatives trading.

One thing is certain: activity in the financial arena isn’t likely to settle down any time soon.  Within the listed options space in particular, here are three key trends worth tracking as we continue to make our way through 2012:

1. More U.S. options exchanges ARE coming.

Even though there are already nine options exchanges up and running in the U.S. today, I expect one-two more exchanges to be up and running by year-end.  NASDAQ has stated its intent to launch a third exchange (to complement its existing PHLX and NOM options markets). A new entity, the MIAX options exchange based in Miami, plans to launch during 2012. While competition is generally a good thing in the marketplace, is there sufficient U.S. options trading activity to justify 11 exchanges? And if 11 U.S. options exchanges can be supported, what is the additional cost to trading firms, brokers, vendors and others who now have to run lines and build out additional infrastructure to these new exchanges? Each options exchange will have to serve well-defined customer niches within the industry in order to sustain ongoing business.

2. Options exchanges WILL continue to roll out new products.

It shouldn’t come as a surprise that options exchanges need products that participants want to trade. Will the exchanges be able to create products that are reasonably easy to use and understand and that actually serve a useful trading / hedging purpose for the trader? Absolutely! The difficulty will be figuring out which new products will have long-run staying power in the options space. For example, VIX options and some ETF options have been quite successful over the past few years in terms of trading volume – some lesser-known contracts, not as much. Although they are going through approval stages right now, I am quite curious to see if either “Super-LEAP” options (contracts with 4-5 year expiration dates) or “mini-options” (contracts on high priced stocks that deliver 10 shares instead of the typical 100 shares) generate consistent trading interest across the industry. The introduction of new option contracts becomes even more important in a U.S. options market with up to 11 exchanges – as each exchange seeks to differentiate itself from its competitors.

3. Foreign options exchanges WILL draw more interest and activity.

Foreign options exchanges like Brazil’s BM&FBOVESPA and Korea’s KRX already possess significant trading volume, so they are certainly in a position to command attention in the options industry. Since both markets are derivatives hubs in their respective regions of South America and Asia, they can more readily leverage their prior successes into the next two or three years of options trading. In many trading circles, existing volume and liquidity begets MORE volume and liquidity, so both Brazil and Korea are well positioned in that way. Lastly, given that Brazil and Korea serve accelerating regional economies in South America and Asia, these markets are primed to draw increasing options trading interest from the likes of hedgers and speculators across their own regions. Moreover, I predict each of these exchanges will reach out to and work with their neighbors (like Chile or Hong Kong) to promote additional regional strength. Since full exchange mergers are tough to accomplish these days, I also see strong, targeted partnerships taking place between selected U.S. options exchanges and some of their foreign exchange counterparts in the months ahead.

These three trends in the options markets form an interesting foundation for derivatives trading on both a national and international level. Stay tuned to see what develops.

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senior product specialist, SunGard's capital markets business

REGULATORY SPOTLIGHT: ESMA GUIDELINES ON MARKET ABUSE AND SURVEILLANCE

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Contributor: Magnus Almqvist, senior product specialist, SunGard’s capital markets business

This blog post originally appeared on TabbFORUM.

The passage of the Dodd Frank Act, the Market Abuse Directive (MAD) and MiFID, as well as the newly issued Guideline 2012/122 from the European Securities and Markets Authority (ESMA), which covers algorithmic and direct market access (DMA) electronic trading, is clear evidence that the regulation of financial markets continues to go through unprecedented rate of change.

The pace of regulatory change is not only unprecedented – it’s speeding up. In December 2011, ESMA issued an initial set of guidelines around algorithmic and direct market access (DMA) electronic trading. The final requirements, Guideline 2012/122 or “Systems and controls in an automated trading environment for trading platforms, investment firms and competent authorities,” were released in February 2012 and are due to be implemented on May 1.

Guideline 2012/122 is significant. It covers both client and proprietary trading and would affect firms engaged in purely proprietary trading as well as those offering DMA, who would now need to surveil and report on trading activities performed by their DMA clients. The timeframe gives regulators, market places and market participants only a few months to implement changes to pre-trade systems, order management systems, surveillance and monitoring systems, and internal organizations and processes – a very tall order.

If we take a moment from the rush to comply with all of this, we can identify a few trends, both among the rules and regulations and in the greater market, that help predict where the markets might be heading and what firms will need from their market surveillance and supervision systems.

Trends in Regulations

  • Surveillance on order level. Market abuse is increasingly done at order level, where actors seek to gain a market advantage by creating a false picture of price movement and/or liquidity through various strategies. Spoofing and layering are very good examples, and the £8M fine issued by the UK’s Financial Services Authority in 2011 is a prime example how important it is to safeguard your firm and identify suspected cases as soon as possible. This will help ensure that appropriate actions can be taken before you make headlines in the press.
  • Real time. Regulators are increasingly expecting trading platform and market participants to be able to very quickly act and report on observed potential market abuse and suspicious orders. The ESMA Guideline explicitly states near real time, although ESMA does not currently provide an exact definition what that means. It is clear, however, that the trend is moving towards intraday detection, with appropriate actions being taken and reporting to the competent authority on the day of trading.
  • Cover all orders and trades flows that are electronically sent to a trading platform. This includes order flow routed via DMA, where under ESMA, market participants will have to monitor client order and trade flows for potential erroneous transactions and market abuse and report any suspicious orders and trades.
  • Flexibility and ease of change. ESMA’s Guideline includes a list of explicit market abuse cases that a surveillance solution should be capable of detecting. This trend of explicitly demanding that surveillance solutions be able to monitor for certain behaviors will likely continue. It is therefore important that systems can easily change and introduce new alerts and reports. Closely tied to this is the ability to fine tune alerts to watch the market at an appropriate level. Surveillance officers also need to focus their efforts on investigating relevant suspected cases of abuse rather than trawling through false positives. Both the technology and the role of people are an ongoing effort and parameters need to be adjusted continuously, as market volatility and behaviors naturally change over time.

Volumes and Market Evolution

The volume of messages that needs to be processed by a surveillance and supervision system is ever increasing. The move to automated trading applications and the introduction of High Frequency Trading (HFT) strategies will continue to push up volumes. Proposed rules and regulatory changes will limit or slow down the rate of increasing order rates, but there is no doubt that the high volumes we see today are here to stay and will continue to increase. That means that regulators, trading venues and market participants will have to implement organizations, processes and surveillance and monitoring systems that can cope with these vast message volumes and accurately pinpoint suspicious trading.

More Asset Classes

The MAD and MiFID reviews share Dodd Frank’s objective to ensure orderly and fair OTC markets. The proposed introduction of Organized Trading Facilities (OTFs) and Central Counterparty Clearing (CCP) obligations on OTC trading – and the inclusion of trading done on an OTF under MAD – means that your surveillance and monitoring organization will need to be able to manage and analyze these new asset classes and market models.

Cross-Asset Classes

Regulators are starting to look at market abuse across linked products, such as front running on a derivative when you have a client order on the underlying, or moving the price on a commodity while holding a very large futures position. Your surveillance solution will need to monitor for these patterns and be configurable to search across different asset classes as market structures evolve.

Cross-Market and Cross-Borders

Trading is moving to cross-market places and cross-borders. In order to get a complete picture of trading patterns and order books, your solution must be able to monitor the same instrument traded at several venues and detect patters across these.

Surveillance and monitoring are a key focus for anyone that wishes to remain competitive in the financial markets. Organizations need flexible and agile processes and tools to keep up with the rate of change that we are expecting over the next several years.

There are also opportunities for the organizations that are willing to look holistically at how they monitor all of their market activities. The more demanding regulations are actually an opportunity to get a clear and concise view trading across asset classes and markets, reducing financial and regulatory risk across the board. Surely this is a good thing for everyone?

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