The Financial Services Club's Blog

Do you want to sort out the barriers to Clearing & Settlement?

This week saw the inaugural meeting of the Clearing & Settlement Working Group (CAS-WG), which was well attended by over 100 industry figures from all parts of the investment markets and hosted at BT’s City Head Office in St Paul’s (BT are the first sponsor of the CAS-WG).

The CAS-WG has been initiated by the Financial Services Club to provide an opportunity for open discussion and debate amongst senior market practitioners and service providers on issues affecting Clearing and Settlement, and is created in partnership with the Realization Group who facilitate our Subject Group meetings.

The aim is to provide specific input to the regulatory bodies – including the FSA, its successor bodies the PRA and CBA, and Michel Barnier’s team in the European Commission – on the technology implications of regulations in draft and final form that affect Clearing and Settlement operations, such as EMIR and MiFID II, with the intention of ensuring these regulations are practical, appropriate and effective.

At the first meeting, we covered the four big topic areas of Regulations, TARGET2 for Securities (T2S), Giovanni’s barriers and Standards.

In the first discussion:

• David Bailey, Acting Head of Department, Market Infrastructure & Policy, the Financial Services Authority (FSA)
• Andrew Rogan, Policy Director, Capital Markets and Infrastructure, the British Bankers Association (BBA)
• Karl Spielmann, Head of Legal & Compliance, EuroCCP

debated the impact of regulations on post-trade operations and IT, particularly with regards to OTC Derivatives clearing.

This is the core of the European Markets Infrastructure Regulation (EMIR) developments in Europe.

EMIR is part of the EU’s regulatory response to the global financial crisis and has a two-fold purpose:

• to recognise and reinforce the role played by CCPs in mitigating certain aspects of market and counterparty risk, CCPs have been recognised as a critical resource that helped protect the stability of the financial system during the financial crisis.
• the G20 new agenda stresses that new regulation should aim at improving transparency and regulatory oversight of over-the-counter derivatives (OTC) in an internationally consistent and non-discriminatory way.

David, Andrew and Karl discussed this in depth under the Chatham House Rule, so I can’t quote their words here.  There was also a lively debate with the audience, and the net:net is that there’s EMIR, Dodd-Frank, MiFID II, Vickers, Volcker and more coming into force today. 

All of these affect clearing and settlement but none of them are joined-up and, in many instances, it’s more putting the cart before the horse as we’re implementing huge post-trade changes before the basics are agreed and implemented.

The basics being Basel III – the rules for capital which will impact all of the ways in which banks collateralise and leverage their future operations.

In addition, the rules of EMIR appear to be too prescriptive.  We’ve moved well away from the days of principles-based regulation and the Napoleonic rules now seem to apply.

Notably, regulations are far more in vogue today too – gone are the days of Directives – and no-one seems to have worked out (a) will the regulation work to address the issues it seeks to address or (b) how much it will cost to implement these changes.

These are the things that the Working Group will debate as we look at Risk and the first Subject Group spinning out of the CAS-WG meeting is a Regulatory Group.

The CAS-WG Regulatory Subject Group will focus upon interpreting the implications of EMIR on the clearing and settlement technology infrastructures of the City and Europe, and will work closely with other groups such as ISITC’s Working Group which focuses on the impact on operations of new and changing regulation and legislation.

In the second panel:

• Kevin Milne Director, Post-Trade Services, the London Stock Exchange (LSE)
• Henry Raschen, Head of Regulatory and Industry Affairs, HSBC Securities Services
• Kiri Self, Director, the Realization Group

discussed the latest position and situation of TARGET2 for Securities (T2S).

T2S is one of the largest infrastructure projects launched by the Eurosystem so far, and hopes to bring substantial benefits to the European post-trading industry by providing a single pan-European platform for securities settlement in central bank money.

The system is due to go live in June 2015, several years later than originally envisioned but this is because the program is far more ambitious and challenging than first imagined.

As a result, there’s some doubt that June 2015 will be achieved, although the panel all concurred that T2S would go live one day – probably around 2018 – as it will force through change that is necessary if Europe is going to be efficient and effective. 

Namely, it will force the Central Securities Depositories of Europe to compete and no longer be protected by national boundaries.

Part of the discussion got into the pro’s and con’s of T2S, with a clear plus being that it is multicurrency.  T2S will process not just euros, but also Danish Krona and the Romanian Leu.  Shame that GB pounds sterling isn’t included.

Another T2S pro is that it may be a hammer to crack a nut, considering the cost of its development and deployment, but the hammer is a worthy cost as T2S ensures that many of the Giovannini barriers are removed.

Having said that, one of the con’s is that T2S does not incorporate Corporate Actions, but then that’s partly because these are also part of the Giovannini barriers as discussed in the third panel which comprised:

• Dermot Turing, Partner, Clifford Chance
• Rob Fair, Director, Product Management, Euroclear
• Robert Barnes, CEO, UBS MTF
• Andrew Douglas Head of Public Affairs, Europe, DTCC

There are 15 major barriers to create a transparent, seamless, pan-European clearing and settlement market that were originally identified by the Giovannini Group, which was chaired by Alberto Giovannini who released their final recommendations in a detailed report in 2003.

T2S will solve six of the barriers:

1. National differences in information technology and interfaces          
2. National clearing and settlement restrictions that require the use of multiple systems           
3. Differences in national rules relating to corporate actions, beneficial ownership and custody
4. Absence of intra-day settlement finality      
5. Practical impediments to remote access to national clearing and settlement systems             
6. National differences in operating hours/settlement deadlines

and five are being addressed by legal changes already in play through Directives and Regulations, such as MiFID II and EMIR.

That leaves four which are here to stay as they are too politically charged to change.  Most of these are around Company Law and fiscal policies for example, which is why Corporate Actions is missing from T2S and most discussions of European Clearing & Settlement standardisation.

However, when the panel got into the meat of the discussions, it turns out that the Giovannini barriers are no longer relevant anyway as technology, regulatory and market changes are creating a transparent and seamless pan-European clearing capability, regardless of the national borders and barriers.

This would certainly be true if German companies could post their securities settlement through CREST for example, but that’s barrier number nine which discusses the national restrictions on the location of securities.  Until that barrier is solved, even with all the technical will in the world, pan-European processing is not going to be possible.

This led to the final debate around Standards with:

• Richard Young, Regulatory Affairs, SWIFT
• Kevin Houstoun, Co-chair – Global Technical Committee, FIX Protocol Ltd
• George Handjinicolaou, Deputy Chief Executive Officer and Head of Europe, ISDA
• Chris Pickles, Head of Industry Initiatives, Global Banking & Financial Markets, BT

in debate.

This panel agreed that standards were being resolved across global markets through things like the investment roadmap.

The investment roadmap affirms the commitment of each organization (FIX, FpML, SWIFT, XBRL, ISITC and FISD) to the ISO 20022 business model by laying the groundwork for defining a common underlying financial model and ensuring some level of interoperability by producing a consistent direction for utilization of messaging standards and communicating that direction clearly to the industry.

A key to ensuring this roadmap works is that the regulators are behind it, as global markets cannot be globally fragmented and if global standards avoid global fragmentation then that’s in the G20’s interest.

That is why a shared business model with a shared vocabulary is so important.

There was a little scepticism in this context as UNIFY and other projects have tried to do this in the past, but the regulatory stick is a key one.

If the markets cannot standardise voluntarily in the way they want, then the regulators will force it through in the way they might not want.

This is why the CAS-WG concluded with a call to action through the creation of a number of specialist Subject Groups, facilitated by the Realization Group.

Anyone can be a member of a Subject Group and anyone can suggest areas that the Subject Groups should focus upon.

At the inaugural meeting, five Subject Groups were suggested, themed around the following areas:

• Regulation: interpreting the implications of EMIR on the clearing and settlement technology infrastructure.

• Risk: assessing the ability of the clearing and settlement technology infrastructure to handle a complete counterparty default of a major bank, CCP or CSD.

• Standards: addressing the development of technology standards to incorporate change, specifically assessing the implementation and operation of the investment roadmap. 

• Transaction Reporting and Trade Data Repositories: identifying the structure for technically reporting through the clearing and settlement technology infrastructures the full transaction history of all financial instruments and, specifically, the methodology for tracking OTC Derivatives from trade to repository.

• Technology: what are the developments in technologies, software, networking, telecommunications and any other capabilities that are relevant to clearing and settlement operations.

These are not specific, limited or exclusive, and there may well be others you believe should be included.  Just let us know what they are, and whether you would like to join them.

There are also a number of Subject Groups already in existence with other organisations.

For example, the Realization Group established the Counterparty Default Management Working Group.

The Counterparty Default Management Working Group has a range of objectives, namely to:

• Identify key challenges and barriers to harmonisation and standardisation of default management practices across major market infrastructure providers e.g. exchanges, clearing houses, central securities depositories.

• Prioritise the key challenges and barriers in terms of impact and importance to markets and  its participants.

• Define an approach to removing the barriers and addressing the challenges with the aim to  establishing harmonised and  standard practices across all markets and underlying  infrastructures.

• Establish best practice frameworks for market participants to manage counterparty defaults  effectively minimising market, credit, liquidity, operational and capital risks.

ISITC also have three key groups in existence today.

• A long-standing working group which focuses on the impact on operations of new and changing regulation and legislation.

• A Post-Trade Operations group focused upon the operational impact of T2S, T+2 and local versus central matching issues.

• An LEI working group, which looks at the practical considerations of using LEIs.

CAS-WG believes in supporting these groups, rather than reinventing them, and hence the regulatory group suggested at the inaugural meeting we will integrate with the ISITC program wherever possible.

We also expect that these groups will report back their activities to the CAS-WG at the next plenary meeting, which is planned for late Q2 2012.

If you would like to be involved in any of these Subject Groups, or want to suggest other Subject Groups, please let us know.

Next Steps

As can be seen, this is just the start of a process and we now need to discover if you have the appetite to get involved.  We will advise all concerned of the progress of these discussions, the dates for meetings of the Subject Groups and the next plenary meetings as these are agreed, and all other dialogue around the development of the CAS-WG. 

Please bear in mind one key thing: this is your group.  You shape it, you form it, you develop it.  Nothing is fixed at this stage, so please let anyone who has an interest in clearing and settlement know about the CAS-WG so that, over time, we can develop a clear mechanism of feedback to the regulatory authorities in London and Brussels of the development of new regulations and their impact on our technology operations.

Finally, we aim to run the CAS-WG so that attendance and involvement is completely free and open.  As participation is intended to be free, we aim to cover the costs of running the CAS-WG through sponsorship.  Sponsorship is open to any organisation that wishes to be seen as a thought-leader in this area, or who wishes to engage and influence the market participants outlined above.  If you are interested in sponsorship, please let us know.

 

 

Wipe out market makers = best execution

Yesterday I wrote about the concept of banks being barred from betting on the bonds and equities markets.

“Own account” trading disappears and the only folks who can “speculate” are those with their own chips to play in the game: the private equity, sovereign wealth, high net wroth assets and their asset managers who back all punts with collateral and cash.

In other words, the current players who systematically internalise will leave.

Bear in mind that a systemic internaliser is defined as a market maker who regularly trade off their own book of business:

MiFID provides that a firm should be treated as a systematic internaliser if it deals with client orders in shares on an “organised, frequent and systematic basis” from its own business account.  These shares would normally be traded through an exchange or regulated market, but the investment firm is basically holding the shares themselves, waiting for the right price to match.

Some fear such trading is risky and allows banks to buck the price because the banks themselves can trade for their own benefit through such internalisation, known as prop or proprietary trading.

It is this trading that is now being targeted as being unacceptable, according to the American Volcker Rule.

The “Volcker rule”, named after Paul Volcker the former Federal Reserve chairman who proposed it, would restrict the ability of banks trading for their own benefit.

The Volcker Rule, along with others such as Vickers, could push systemic internalising out of the banking sector and, as mentioned yesterday, such that trading is purely operated through funds and asset managers who have the collateral.

So who would this impact?

We mentioned Goldman Sachs and Morgan Stanley in the USA yesterday, but the main European systematic internalisers are BNP Paribas, Citigroup, Credit Suisse, Goldman Sachs, Knight Equity Markets, Nomura, Royal Bank of Scotland N.V. (ABN AMRO as was) and UBS.

Now I know I’m pulling the chain a little here but let’s just say that all these guys trading desks, due to regulations and bonus restrictions, see mass exodus.

What is the future?

What does this mean for investment banks?

It means they purely become platform providers.

A little like the City of London describes itself as the Wimbledon of finance – we have no players, but provide the best courts to play upon – future banks will provide the infrastructure but not play.

So the world’s investment markets purely become technology oriented platforms which players plug into to play.

Kind of like  Betfair, Bet365,Ladbrokes, Paddy Power, William Hill and other online gambling and betting services, investment firms become providers of platforms but they don’t play their platforms.

The market makers and systematic internalisers become technology firms, offering the fastest execution at lowest cost with best price, and the high frequency traders in the hedge funds, private equity firms and others trade.

They may trade on their own account or on behalf of sovereign wealth funds and institutional investors, but they trade with collateral, not with depositors’ savings.

And by offering the platforms to trade effectively, the systems move everyone towards best execution.

Best execution is all about trading at fastest speeds at best price and lowest cost, with a guarantee for the likelihood of settlement.

Somehow I can see the regulators being sorely tempted to follow this line of thinking as best execution has been embodied in European and American regulations for some time.

Mind you, you don’t have to think that this is necessarily going to happen as I’ve just re-read the last write-up of the Volcker Rule in the New York Times:

When Paul Volcker called for new rules in 2009 to curb risk-taking by banks, and thus avoid making taxpayers liable in the future for the kind of reckless speculation that caused the financial crisis and resulting bailout, he outlined his proposal in a three-page letter to the president.

Last year, when the Dodd-Frank Wall Street Reform and Consumer Protection Act went to Congress, the Volcker Rule that it contained took up 10 pages.

Last week, when the proposed regulations for the Volcker Rule finally emerged for public comment, the text had swelled to 298 pages and was accompanied by more than 1,300 questions about 400 topics.

Somehow, as with all regulations, it’ll get messed up on the process, whittled down and weakened until it’s a shadow of its former self.

Ah well.

One can dream.

 

 

Casino capitalism: only for those who can afford the chips

For some time there’s been debate about whether Vickers or Volcker is the right way to go.

Should investment banks be divided from their retailing and commercial siblings by a fence, or completely separated so that one cannot poison the other?

Should banks be allowed to play in the markets off their own account, or should such risky practices be outlawed?

The debate will continue for a while and it’s clear there is a possible revolutionary outcome as, eventually, markets will decide how to behave.

This will be through a mixture of the law of unintended consequences and the law of Darwinism.

For the former, we’ve seen the impact of unintended regulatory consequences before.

When the Markets in Financial Instruments Directive (MiFID) was formulated, everyone believed it would seriously impact the systematic internaliser – the banks that trade mainly off their own account.

It did, but not in the way the regulations intended.

Instead, the regulations opened Europe’s markets to full electronic trading strategies and allowed Chi-X to decimate the traditional equities exchanges’ business.

The systematic internalisers leveraged such facilities, particularly through dark pools, and suddenly the majority of equities trading in European markets flowed through systems rather than people.

It is also why the surge in OTC Derivatives trading arose, some would say, as the human touch in banking moved from trading to creativity.

Now the regulators are trying to rewrite the rules for high frequency operations and OTC Derivatives.

We all know that means that, in the law of unintended consequences, they are again creating a new market structure that they may not foresee.

This is because the Volcker Rule – the rule introduced as part of Dodd-Frank in the USA that bans proprietary trading – means that many of the world’s leading speculators, traders and masters of the universe are already moving out of the banking network and into the investor network.

From Forbes Magazine recently: “The Volcker Rule would impact investment banking giant Goldman Sachs the most followed by Morgan Stanley. The two firms derive 48% and 27% of their total consolidated revenues from principal transactions respectively … Bank of America and JPMorgan Chase see about 9% and 8% of their total consolidated revenue come from such transactions. Citigroup will be the least hit with just 5% of its total revenue at stake.”

No wonder Goldman is seeing a mini-Exodus.

Bloomberg recently reported that Goldman Sachs lost two leaders of its biggest division.  

“Edward K. Eisler, 42, and David B. Heller, 44, are retiring from the company, where they helped lead the securities trading division since February 2008 … Eisler and Heller join about 50 Goldman Sachs partners who left the firm in the past 12 months, according to company filings, internal memos and news reports.”

What is today a mini-Exodus is likely to become a waterfall over time, as banks close down areas of business that the regulators make undesirable or untenable such as proprietary trading, along with restrictions around the level of pay rewards by curtailing bonuses.

For example, the law in the UK has changed such that “the practice of up-front cash bonuses has stopped.  The practice of guaranteed bonuses has been sharply curtailed, at least in the London market.  Bonuses now have to contain a very significant element of deferral.  At least 40% of the bonus for a significant risk taker has to be deferred for a period of at least three years.”

Increasing tax, decreasing bonus levels, a tougher job climate – over 200,000 banking jobs were taken out last year – and a general gloom over investment banking – RBS is closing its investment division – all mean that the world of capital markets is being reinvented.

The reinvention is slow at first, but will become noticeable by 2015 and notable by 2020.

What does it look like?

It’s a guess, but the future looks like one where banks no longer participate in active trading and risk.

The trading risks are taken by those who are willing to lose, and they have to have their own collateral and assets upfront in order to be able to play therefore.

That means private equity, sovereign wealth and the high net worth will be the risk takers and trading speculators.

Institutional investors, pension funds, hedge funds will also be in the game.

But banks will not be able to play.

Their inability to play will be partly due to limitations by law – Volcker, Vickers and the like – but more by the natural market selection for talent.

Real trading talent will no longer be won by the banks, due to their inability to pay and remunerate, and therefore others will hire the big guns.

Banks will be forced to focus away from trading and more toward client acquisition and satisfaction.

Banks will become hugely focused upon corporate relationship management, improving treasury returns and demonstrating real value to their clients’ CFO.

Their focal point will be to gain and retain high value relationships at the top tier of the markets, looking after their corporate client’s needs for risk management and advising them on hedging strategies for the future.

A new world where casino capitalism will only be played by those who can afford the chips.

 

Monthly MiFID MTF Monitor, March 2011

We are pleased to provide our monthly monitor of MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

March 2011

February 2011

 

Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Volume of Trading

March 2011

February 2011

Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Trade Count

March 2011

February 2011

 
Source: Thomson Reuters Equity Market Share Reporter

  

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter 

Source: Thomson Reuters Equity Market Share Reporter 

    

Source: Thomson Reuters Equity Market Share Reporter

 

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

 

For last month's monitor, click here.

 

Banks will absolutely be disintermediated

OK, so I said that banks would absolutely not be disintermediated last week, and it sparked some interesting debate and dialogue.

A few folks were incredulous that I could say this; others thought it made eminent sense; some noted that the movement of money could be disintermediated, but the holding of money could not; whilst others were up in arms over the fact that I could possibly believe any of it.

Well, for those who know me, it was written with a deep sense of irony and disbelief.

I absolutely believe that banks will be disintermediated and have believed it for a long time.

However, I also believe that some of the system will be protected and will never be destroyed or replaced.

This is the part that governments are regulating, protecting, licensing and calling too big to fail, or 2B2F.

The 2B2F area is the core of the monetary system, and needs to be protected.

If your social media account is compromised, it doesn’t matter too much that someone sends a status update saying: “I’m flat on my face in a flap” or worse from your account.

Sticks and stones will break my bones, but names cannot hurt me.

Losing money can hurt though, so it does matter if they steal all your worldly wealth.

This is the part that will never be disintermediated, and I guess that’s the part that Nancy Pierce of HSBC and Mark Buitenhek of ING were saying is core.

• “We will absolutely not be disintermediated … who’s better to move the money than the banks?” Nancy Pierce, Head of Product Management for Payments and Cash Management Europe, HSBC

• “Banks need to reinvent themselves as they will be disintermediated by other banks, because we are the only ones that are trusted for secure transaction processing.” Mark Buitenhek, Global Head of Payments and Cash Management, ING

But it’s open season for the rest of the financial system and yes, there are companies that claim they could replace VISA, MasterCard, SWIFT and other infrastructures.

In fact, as discussed on Monday, it’s warfare between the banks, card processors and PayPal.

The iDEAL system originating from the Netherlands gains more traction for banks across Europe as an alternative to PayPal; this is in the same moment as AMEX opens a P2P platform, as does VISA, as an alternative to PayPal; and this is in the same breath as PayPal stretches out towards physical store paypoints to compete with VISA, AMEX and MasterCard, as the online world merges with the offline.

A similar story can be seen in capital markets where the rise of Chi-X, from upstart electronic trading platform to the biggest trading system in Europe, took place in just two years (doubleclick image to see full size version):

Source: Monthly MiFID Monitor / Thomson Reuters Equity Market Share Reporter

A similar story can be seen with BATS in the USA, which is why BATS is buying Chi-X.

So disruption can occur.

In the latter case, it’s down to deregulation.

In the case of PayPal, it’s down to disruptive innovation and the dilemma of something that appears to be innocuous at first but soon becomes mainstream, e.g. with $4.2 billion revenues forecast for 2011, PayPal is now almost half the size of Citigroup’s Global Transaction Services business.

The real issue of disintermediation therefore, is not around the core of banking – the holding money area that is protected by banking licences – but around the boundaries of banking.

The thing is the boundaries is where all the profit lies.

The boundaries is everything from savings to investments, cards to loans, trade finance to treasury dashboards, insurances to wealth management, foreign exchanges to bond markets, pensions to mutual funds, swaps to futures, mortgages to marriages …

In fact, everything in a bank can be broken down into components of functionality and then traded in and out by new competitors.

Source: ACI Worldwide

This is the picture I’ve talked about for a while, where all of the processes and functions of a bank can become apps that users can download and integrate to build their own bank.

The Build-Your-Own-Bank (BYOB) is the new generation of banking.

It’s the generation where anyone from a banksimple to a Mint can step in and take out a piece of core banking.

That’s what disintermediation is really all about.

Taking out the parts of banking where there is not enough competition, and leaving the bits of banking that aren’t worth competing against … which is the part that is protected by licence because it’s too big to fail.

BYOB will absolutely be disintermediating, whilst 2B2F will never be disintermediated.

That’s the real bottom-line.

• “Could we see a wholesale version of Zopa or PayPal? Yes, I think we can.” David Birch, Director, Consult Hyperion

• “Disintermediation is well under way, and will happen very quickly.” Daniel Marovitz, Head of Product Management, Global Transaction Banking, Deutsche Bank

 

Monthly MiFID Monitor, February 2011

We are pleased to provide our eleventh month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

February 2011

January 2011

 

Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Volume of Trading

February 2011

January 2011

 
Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Trade Count

February 2011

January 2011

 

Source: Thomson Reuters Equity Market Share Reporter

  

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter 

  

Source: Thomson Reuters Equity Market Share Reporter 

    

Source: Thomson Reuters Equity Market Share Reporter

 

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

 

For last month's monitor, click here.

 

 

Monthly MiFID Monitor, January 2011

We are pleased to provide our tenth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

January 2011

December 2010

 

Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Volume of Trading

January 2011

December 2010

 

Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Trade Count

January 2011

December 2010

 

Source: Thomson Reuters Equity Market Share Reporter

  

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter 

  

Source: Thomson Reuters Equity Market Share Reporter 

  

Source: Thomson Reuters Equity Market Share Reporter

 

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

 

For last month's monitor, click here.

 

Monthly MiFID Monitor, December 2010

We are pleased to provide our ninth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

December 2010

November 2010

 

Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Volume of Trading

December 2010

November 2010

Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Trade Count

December 2010

November 2010

 

Source: Thomson Reuters Equity Market Share Reporter

  

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter 

 Source: Thomson Reuters Equity Market Share Reporter 

Source: Thomson Reuters Equity Market Share Reporter

 

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

 

For last month's monitor, click here.

2010 Review: Capital Markets

Investment banking has had a rocky year all year. Pilloried by politics, public and the media, the investment banker is currently about as popular as a Vampire at a Blood Bank ... not a bad analogy as the refrain all year has been about that giant Vampire Squid that is known as Goldman Sachs.

Goldmans do bring it upon themselves though, as paying $111 million in bonuses this year sits badly with the average Joe. And I must admit that any bank that makes $100 million a day in profit most days, along with an admittance of how they manipulate markets and screw customers, has to be suspect.

The trouble with this is that it brings a whole cloud over the industry, as all banks are now viewed as being casino capitalists, robbing the economies to line their pockets with cash.

Not true.

There are some who might do this, but not every bank is Goldman Sachs.

However, it does mean that most of 2010 has been taken up with regulators and politicians wondering what to do about things like ‘dark pools’ and ‘high frequency trading’.

DARK POOLS

In the case of dark pools, they suspect these of being suspect because of the market manipulating suspicions created by the world’s leading investment bank, Goldman.

It means that regulators have been looking with deep scrutiny at trying to raise the illuminations on dark pools, even though these pools are argued to be good for markets as they increase liquidity by allowing block trading to occur that would otherwise be avoided if such trading was transparent.

Certainly, in Europe, the new revisions to MiFID could damage such trading, as illustrated by this May article from Financial News:

“NYSE Euronext and Deutsche Börse, have argued the regulators should use MiFID II to clamp down on the trading venues, known as dark pools, arguing they lack transparency and are open only to institutional investors, but not retail investors.

“But Rolet, who this week marks his first anniversary as chief executive of the UK exchange, said: ‘The biggest challenge is transparency and the balance between retail and institutional needs. Without institutional crossing networks (the so-called dark pools) some of the latent wholesale liquidity would go unexecuted or be simply more difficult to execute.’

“He said bank dark pools, which enabled customers to trade large orders privately away from the glare of the public exchange order books, served a valuable function in a market where there had been a sharp reduction in average trade size resulting from algorithmic and arbitrage activities.

“He added: ‘Transparency may have diminished in some areas but in formulating a response we should be careful to ensure that the differing needs of wholesale and retail participants are properly recognised.’

“The LSE chief executive and the exchange’s largest investment bank members, believe strict rules on bank dark pools would make it more expensive for institutional customers, such as pension scheme managers and hedge funds, to execute business.”

The result is that the European Parliament took on board a report produced by Kay Swinburne, rapporteur to the Economic and Monetary Affairs committee of the Parliament, during the summer recommending that dark pools be reclassified as multilateral trading facilities (MTFs) or systematic internalisers (SIs), and therefore lit.

The report has now been adopted as part of the MiFID review, and also places limits on order sizes. In other words, it wipes out the very reason for dark pools, as in large block orders placed outside the general exchanges to avoid market movements in advance of the order placement and processing.

HIGH FREQUENCY TRADING (HFT)

Swinburne’s report goes further and recommends a number of other restrictive changes, including:

• Making High Frequency Trading (HFTs) subject to mandatory liquidity provisions;
• An “ongoing regulatory review” of the algorithms used by HFTs;
• Making Multilateral Trading Facilities (MTFs) such as Chi-X Europe, subject to the same level of supervision as Regulated Exchanges.

In particular, there is a focus upon HFT, which has been augmented after the issues in America in May that created the conditions for the ‘flash crash’, something I’ve blogged about too often this year.

Therefore, I won’t do it again, except to say that between targeting dark pools AND HFT, the regulators are doing their utmost to kill any market liquidity and alpha investing strategies that exist.

Is that a good thing?

No, because the regulators are in danger of throwing the baby out with the bathwater.

REGULATORY NIGHTMARES

This was demonstrating by the reactions of the corporates, where they made it clear that the discussions of regulators about ‘systemically important’ and ‘commercial activities’ was purely speculative wording with no practical implementation ability.

In fact, it is concerning that the regulations being developed will more likely kill the markets:

• By clamping down on bonuses, investment bankers will all move out into hedge funds and private equity;
• By eradicating risky activity, regulators are also eradicating worthwhile investment activity;
• By locking down trading pools and practices that create liquidity, markets will seize up and cough and die;
• By demanding collateral placement to cover trading exposures, markets will be more restricted to just the largest players with deep pockets; and
• By banning prop trading, market makers will no longer make markets and trade and investment flows that fuel economies will disappear.

And none of the above really addresses the issue anyway, which was how the risk models created by the markets enabled massive risk exposures to be allowable when they were clearly, in hindsight, untenable and unworkable.

Where’s the regulation that addresses this area?

Which part of the regulatory structures of Dodd-Frank in the USA and MiFID II in Europe is addressing the fundamental question: how to eradicate products in banking that fuel risk, if the risk model has not been proven, tested and is comprehensible and comprehensive.

Meanwhile, we have had a few other key areas of regulatory focus, such as how to unravel a major global bank in 48 hours so that we can allow the too big to fail banks ... to fail.

CLEARING AND SETTLEMENT

Finally, there has to be a nod towards clearing and settlement. The whole clearing and settlement field is still a mess, with most of Giovannini’s barriers still unaddressed. That’s because of national market interests and focus.

During SIBOS, this all became clear as we spent so much time discussing interoperability that it became a buzzword, and we all know what you do with buzzwords don’t you?

Yep so, to finish the year, here’s a nice little buzzword bingo card for y’all to play with when you get back to the office in January (doubleclick to enlarge) ...

Oh yes, and if you're a real MiFID freak then Dechert produced a nice four-page PDF detailing the revised regulatory regime they anticipate this month.

Monthly MiFID Monitor, November 2010

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

November 2010

 

October 2010

Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Volume of Trading

November 2010

October 2010

 

Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Trade Count

November 2010

 

October 2010

Source: Thomson Reuters Equity Market Share Reporter

  

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

 

 

Trading Strategies: Garbage In, Garbage Out

I’m a little bit mature these days ... some of you might even say old ... but you realise you’re getting on when something looks like an antique and you realise that, when you first saw it, you thought it was the future.

In my case, this would be the first mainframe I programmed.

Way back when, I was trained in an ancient programming art called PL/1, using JCL.

That’s Programming Language One and the Job Control Language, for those who were wondering.

This was during a graduate year out, training with IBM as a programmer on their wondrous S/360 instruction set mainframe processor.

Yabba-dabba doo. 

I still remember creating this amazing program that played Black Jack.

Not very useful for IBM, but good training for me before going to Las Vegas.

Oops, sorry, good programming experience I mean.

Walking down the corridor with my 100's of punch cards carefully placed in order, I still remember to this day dropping them all as I opened the door to the computer room.

Result: I had to go through the whole lot to put them back in order ... line by line of code, card by card.

Each card was a line of code you see.

I realise that not many folks will remember the days of punch card programming, but this picture puts it in context:

The cards only held a limited amount of data, and so 800 million punch cards would equal today’s 64GB microSD.

Oh, and the programming was harder back then. For example, here’s a bit of JCL:

//IS198CPY JOB (IS198T30500),'COPY JOB',CLASS=L,MSGCLASS=X

//COPY01 EXEC PGM=IEBGENER

//SYSPRINT DD SYSOUT=*

//SYSUT1 DD DSN=OLDFILE,DISP=SHR

//SYSUT2 DD DSN=NEWFILE,

// DISP=(NEW,CATLG,DELETE),

// SPACE=(CYL,(40,5),RLSE),

// DCB=(LRECL=115,BLKSIZE=1150)

//SYSIN DD DUMMY

That’s nine punch cards, 25 words and over a 1,000 characters.

What does it say?

It’s JCL for “copy oldFile newFile”, the latter being the radical innovation of MS-DOS!

Now it’s just drag and drop!

The reason for sharing this nostalgia is that there was a key lesson back then.

It was the mantra of every programmer.

The mantra was: “Garbage In, Garbage Out” (GIGO).

One line of code or instruction in the wrong place would screw up the whole system.

So you had to be careful how you programmed, with lots of phase controls and management checkpoints built into the system to ensure you could not enter anything that would mess up the whole.

Detailed user testing and acceptance tests were then placed into these checkpoints.

Eventually, you would be able to add the new code and rollout the system.

This got really rigorous when you were talking about 300,000+ lines of code for payroll apps or similar, where each line of code would have a linkage and knock-on effect with all the other lines of code.

This is why new developments took so long, as there was such a danger of messing up.

It's also why you were looking at years to develop systems, rather than days or months.

Everything is faster now, which is good, but the mantra of GIGO remains.

In fact, it's even more essential as programming is so much easier these days, that making serious errors is also easier if the right controls are not put into place.

And the essence of programming is still the same: the program is only as good as the people who program it.

Humans make errors, not machines.

After wallowing in the good old days for a bit, you’re probably wondering what's the point?

The point is that GIGO is a lesson that is just as critical today as it was back then, and regulators seem to be in danger of losing sight of this fact.

This suspicion was prompted by a headline yesterday: European Parliament piles pressure on dark pools.

This headline was immediately followed by another headline: Regulator warns of the dangers of High Frequency Trading.

This was a commentary from Martin Wheatley, CEO of the Hong Kong Securities and Futures Commission and formerly a Deputy Chief Executive of the London Stock Exchange, on the BBC’s Business Daily program.

These headlines follow on from Christine Lagarde, the respected French Finance Minister, comments: “My natural tendency would be at least to regulate, to oversee [HFT] very strictly and after a cost-benefit analysis of these methods, maybe to forbid it. Or at least give market authorities the power to forbid it in circumstances that are considered exceptional.”

This is all in response to the flash crash in the USA in May, where share prices bounced around massively during a short period of trading.

This is an issue that has prompted several new global regulatory movements.

For example, IOSCO are drafting proposals to restrict HFT activities which will be published next year, and other global regulatory movements are underway to control market activities in order to avoid further flash crashes.

All of this movement seems to be saying:

HIGH FREQUENCY TRADING IS BAD AND SHOULD BE STOPPED

... when all of this has nothing to do with High Frequency Trading.

It is to do with the programming of the systems by the people who want to be engaged in High Frequency Trading.

And it is this programming that is flawed.

For example, the flash crash was not caused by High Frequency Trading, but by a plain old vanilla trade from an asset manager.

The issue is that the trade sparked rapid movements amongst the automated HFT systems in response.

For example, the SEC report shows that, over the course of just 14 seconds, 27,000 contracts of e-Mini S&P 500 futures were traded, half by HFTs.

On a net basis, however, only 200 additional contracts were bought in those seconds.

So what this is really showing is that there is a huge volume of trading at razor thin margins, which is why firms engage in HFT strategies, which will react to abnormal market actions.

However, it is the abnormal market action that causes the issue, not the High Frequency Trading.

Therefore the target for regulation should be:

• To ensure that markets stop trading fast when a ‘flash crash’ style moment occurs, which is what the SEC has put in place with their circuit breakers whereby a share price movement of more than ten percent in a five minute period halts trading;
• To ensure that there is more uniformity of markets to avoid fragmentation, as it is fragmentation that causes dramatic action by HFT systems because wide disparities between execution venues and poor visibility causes the systems to sell automatically, as they start running in fear;
• To ensure that trade reporting is tightened up across the board, as inconsistent post-trade reporting is a key reason why item (b)’s fragmentation exists, and consistent post-trade reporting standards across all key markets would make a massive difference; and
• To ensure that there is efficient price formation which, within Europe, requires a consolidated tape as the lack of a visible single venue for pricing is causing cost overheads and adds to the issues of fragmentation.

Finally, the fact that we have HFT and dark pools is not the cause of issues.

HFT and dark pools exist thanks to bank innovation in utilising the latest technologies of low latency fibre and unlimited scale computing to deliver best execution to clients and make markets.

Just because they trade in volume and in the dark is what makes the regulators worry.

They are scared of things that are out of control or lack transparency, which is what they believe is the case with HFT and dark pools.

However, their real worry should be the people programming these systems and how they program them, and whether the regulations on how they program and the way in which their programs trade are right.

I get the impression that it is more the regulator’s fear of these systems, rather than the people who program them, that is driving their agenda.

That is wrong and I urgently recommend the regulators consider the “Garbage In, Garbage Out” (GIGO) programming mantra, before they commit GIGO with their regulations.

 

What is High Frequency Trading?

A children's guide to High Frequency Trading, co-location and proximity hosting (possibly NSFW) ...

 

Monthly MiFID Monitor

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

October 2010

September 2010

 
Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Volume of Trading

October 2010

September 2010

 
Source: Thomson Reuters Equity Market Share Reporter

 

Market Share based upon Trade Count

October 2010

September 2010

 
Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

 
Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

   

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

 

Monthly MiFID MTF Monitor, September 2010

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

 
Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

 
Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

 
Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

September 2010

August 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

 
Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

Best Execution and Global Trading

In the last of my blog entries on capital markets regulations and restructuring, I thought it worth mopping up best execution and global trading platforms, as these were referenced in the first item as a key part of future market change.

Oh, and if you missed them, here are the previous blog entries:

• Part One: SEC to crackdown on HFT?
• Part Two: What was the cause of the 'flash crash'
• Part Three: Exactly what is and how big are 'dark pools'?
• Part Four: MiFID II - the post-trade agenda

In the case of best execution and global platforms, we have two final pieces of the mix that will shape tomorrow’s trading.

Best execution was a hotly debated pre-MiFID discussion, with many arguments over what it meant.

It finally seemed to settle on something along the lines of: brokers and dealers are obliged to obtain the best possible result of a trade for a client, taking into account not just price but costs, speed, likelihood of execution and settlement, size and other considerations.

The problem is that this definition was too fuzzy and has never really been tested by a regulator.

For example, Google “best execution” and you get a whole range of garbled returns. Google “MiFID fine best execution” and you don’t even find anyone who has been fined for failing to provide best execution.

So much for that.

Mind you, there have been fines related to best execution. For example, the FSA has fined Instinet, Credit Suisse, Barclays, Commerzbank and more for failures in reporting on trades, most of which are related to date time stamp reporting.

This is due to orders through smart order routers getting different timings as they go through different servers, such that the sequence of trade execution is misreported; a practice the FSA is clearly not going to tolerate as it opens the market to further potential abuse if timings are inaccurate. Just look at what happens with low latency, and you’ll see why this is important.

So best execution is still under the microscope, but it appears that the regulators have done far better working out the theory of best execution than the practice of it.

Meanwhile, the idea of a global trading platform is getting closer, as Chi-X moves to Asia and BATS is over here. So here’s a vision of tomorrow: you can post trades to any venue anywhere in real-time and get collateral management and clearing handled by the trade venues, such that you have no post-trade headaches.

How?

Well, this relates to something that was mentioned to me about trade venues looking at the global markets and targeting clearing and settlement hubs such as EuroCCP/DTCC to enable global management of collateral. What then happens is that the posting of settlement is also automated.

I can’t quite see that happening today, although the concept is one where regional clearing and settlement hubs emerge that support regional trade execution venues, all linked via low latency technologies to enable global trading.

Yowser ... that’s a hard concept to swallow but, if it happened, how the hell would regulators manage these markets?

As I mention these trends btw, Jeremy Grant who focuses upon trading trends for the Financial Times is attending the MiFID conference in Brussels today. Some interesting tweets already:

Sharon Bowles (MEP)

On HFT: “Who is thinking what they are doing any more?”
On Best Execution: “It needs more supervision, great consistency and better implementation”
On MiFID: “We must be careful not to reverse engineer MiFID and come up with the wrong objectives”

Michel Barnier, DG of Internal Markets

“We will take a very, very close look at high-frequency trading.”
“Technological complexity or technological developments cannot be used as an excuse to derogate from the fundamental principles of transparency, responsibility and appropriate regulation.”

This is Part Five in a Series of Posts on the Regulatory Agenda for Capital Markets:

• Part One: SEC to crackdown on HFT?
• Part Two: What was the cause of the 'flash crash'
• Part Three: Exactly what is and how big are 'dark pools'?
• Part Four: MiFID II - the post-trade agenda
• Part Five: Best Execution and Global Trading
  

These items also build upon a series of posts about the Deutsche Börse:

• If you can't afford the tech, get out of the market
• Circuit breakers on the Deutsche Börse
• Forget Frankfurt, I'm moving to Basildon

MiFID II: the post-trade agenda

One of the big topics in capital markets is intra-day liquidity and post-trade transparency.

Such discussions are far more noticeable now because the whole reason for this crisis, according to some, was the loss of trust between counterparties. That loss of trust was based upon counterparties not having enough liquidity to cover their positions. After all, if Lehmans could collapse with billions of dollars of debt – and they were AAA rated – then anyone could collapse.

We then had this dialogue around the right levels of counterparty cover and collateral required in the markets at start of day, end of day and intraday to enable effective trading.

There were discussions of whether it should be like the Russian markets, where collateral has to be pre-posted every morning to cover the day’s trading.

Or whether there was a way to just put circuit breakers on the markets, like the Eurex Clearing model discussed last week, although that liquidity control is based upon self-management.

There have been other discussions about regulatory controls of liquidity risk, such as those provided by the UK’s FSA that requested real-time reporting of liquidity positions, at an estimated cost of £2 billion in new technology spending.

Meantime, Europe announced the de Larosière reforms a year ago, and these reforms are now coming into play as the three new regulatory authorities- the European Banking Authority, the European Insurance Authority and the European Securities Authority - come into play.

And, of course, America is trying their darndest to sort out the mess of OTC Derivatives and fragmeneted trade reporting.

So, in summary, we have global, regional and national regulations working together and apart to try and lock down this space, as illustrated by this slide (doubleclick image to enlarge):

Stolen from Harald Keller’s (Senior Manager, Payments Markets, SWIFT) presentation – for more click here

Overall, the focus of all these regulatory changes is around liquidity risk, which brings in several other key elements including collateral management, clearing and settlement and post-trade reporting.

For example, at last week’s meeting in Germany, Robert Barnes of UBS kept using the line: “post-trade reporting is the next pre-trade”.

What he meant by this is that if you have real-time trade reporting, then that helps the markets with transparency of investment strategies and where the next trades will come from. Therefore, if you can immediately see who traded those two million Apple shares on the dark pool, then you can immediately alter your algo strategies to suit.

Bring in the algo news feeds et al and he’s right.

The trouble with this is that post-trade reporting is good if people do it, but a lot of trading operations ignore trade reporting. In fact, the only post-trade reporting market that seems efficient is London thanks to Boat. In some other markets, T+3 is the order of the day ... or even worse.

So one thing that MiFID II is likely to do is to bring in some mandatory trade reporting requirements that strengthen the moves where the first version of MiFID failed.

Another facet to MiFID II will be some form of mandatory real-time reporting of trades, and a clearing and settlement directive incorporated as part of this.

Now that’s a leap of imagination –real-time trade reporting, real-time liquidity positioning and real-time clearing and settlement.

I’ve blogged about real-time opportunities before, and do NOT think that the European Securities Authority, the European Commission or the ECB would be silly enough to mandate real-time everything, but I do think they will want to see true interoperability across all clearing systems.

The LinkUp Alliance and Code of Conduct has gone some way down this route, but the situation is still pretty fragmented as can be seen from this chart, courtesy of Robert Barnes at UBS:

Sure, this is slightly out-of-date, but things haven’t changed that much and so transparency of trades, simple and straight through clearing and real-time liquidity management are definitely order of the day for the regulatory agenda.

This is Part Four in a Series of Posts on the Regulatory Agenda for Capital Markets:

• Part One: SEC to crackdown on HFT?
• Part Two: What was the cause of the 'flash crash'
• Part Three: Exactly what is and how big are 'dark pools'?
• Part Four: MiFID II - the post-trade agenda
• Part Five: Best Execution and Global Trading

These items also build upon a series of posts about the Deutsche Börse:

• If you can't afford the tech, get out of the market
• Circuit breakers on the Deutsche Börse
• Forget Frankfurt, I'm moving to Basildon

Dark Pools are 1.36% of all EU trading

After the earlier discussions of flash crashes and HFT, on to dark pools.

It was interesting that a colleague made the statement this week that all orders could be seen on US exchanges before they are filled as that may be true for some markets, but dark pools exist to ensure that orders cannot be seen before they are filled, which is why they’re so popular.

Take an investor in a particular stock, let’s say they want to buy two million shares in Apple.

Two million Apple shares is a lot, especially as the shares trade at $268 per share. The result is that you’ll move the share price if anyone sees your trade in so large a block of shares.

So you a few choices: split the block order into multiple sub orders, all of which gradually trade as little trade executions and the wider market has little knowledge of such a large order flow until the sub orders are filled; or place the order onto a dark pool where it sits until a message comes across it that can match the order’s requirements, and then it’s filled.

Either way, it creates a better market by allowing order flows of significant volumes without the markets reacting positively or negatively to your investment until it has been executed.

Now here’s the problem.

Regulators don’t like it.

They don’t like it because it’s scary. It’s dark.

They think that dark pools create bad markets because they allow dark trading with zero transparency.

Equally, it’s not fair for the traditional stock exchanges where order visibility is clear and transparent. These dark pools, because they are dark, keep things too secret.

Now, there are a number of mistakes in that logic.

First, dark pools are good for markets as they increase liquidity. They are purely executing block orders that would have been sub-divided into multiple order flows previously.

Second, they are good because they get best price execution for those trading, and allow market investors to make large order trades without punitive anti-trades occurring.

Third, they are transparent in post-trade. Post-trade reporting means that you can see dark pool trading transparently after the fact, as it should be, rather than before where the intentions are made but the action has not been taken.

However, as MiFID II is under discussion, some are resisting the march of dark pools, particularly the traditional exchanges. For example, earlier this year, the Federation of European Stock Exchanges (FESE) said that dark pools accounted for 40 percent of total EU equities trading. This was clarified afterwards as being a misquote, with the point being more that OTC trading accounts for 40 percent of European trading. Even so, the rotten tomato throw stuck to the blotting book of dark pools, with others coming out and saying that FESE’s figures are just wrong.

CESR finally stated that it was more like 2% of European trading in dark pools, a figure that seems more realistic, whilst the FSA estimated 1.25%.

Who’s right and who’s wrong?

The FSA.

In June 2010, Thomson Reuters Equity Market Share Reporter (EMSR) showed that dark pool trading accounted for 1.36% of all on and off exchange trading in Europe across 50 trade venues.

The value was €21.9 billion of trading, against a total value of €1.62 trillion across all exchanges. That compares with just 0.85% of trading on dark pools in January 2010 (€10bn against €1.18tn) and just 0.23% in January 2009 (€2.4bn against €1.062tn).

In terms of venues here are the June market share figures by Value:

Volume:

And Trade Count:

Compare the value traded on Turquoise, Chi-X and Smartpool in June with January 2010:

And January 2009:

And you can see how dynamically this market is changing.

(taken from our monthly MiFID monitor using Thomson Reuters EMSR)

This is Part Three in a Series of Posts on the Regulatory Agenda for Capital Markets:

• Part One: SEC to crackdown on HFT?
• Part Two: What was the cause of the 'flash crash'
• Part Three: Exactly what is and how big are 'dark pools'?
• Part Four: MiFID II - the post-trade agenda
• Part Five: Best Execution and Global Trading
  

These items also build upon a series of posts about the Deutsche Börse:

• If you can't afford the tech, get out of the market
• Circuit breakers on the Deutsche Börse
• Forget Frankfurt, I'm moving to Basildon

Monthly MiFID MTF Monitor: August 2010

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

We are pleased to provide our eighth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

August 2010

July 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

Monthly MiFID MTF Monitor: July 2010

We are pleased to provide our seventh month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

July 2010

June 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

July 2010

June 2010

 

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

July 2010

June 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

We are pleased to provide our seventh month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

July 2010

June 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

July 2010

June 2010

 

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

July 2010

June 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

We are pleased to provide our seventh month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

July 2010

June 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

July 2010

June 2010

 

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

July 2010

June 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

Revising MiFID and RegNMS for HFT

Gawd, I hate acronymns and look at that!  Three in one blog entry title!!!

Anyways, for the nerdy-nerd equities guys, this will grab their attention.

It's all to do with trading in European and American stocks and shares using High Frequency Trading (HFT) systems, and the regulations therein with EU MiFID rules applying over here and USA RegNMS rules applying over there.

These rules are going to be overhauled soon thanks to the Flash Crash, that dreaded thing that caused US stock markets to go haywire on May 6th.  There has been lots and lots written about the Flash Crash of May 6th, but there’s not been a great deal saying it was a good thing ... until you meet JPMorgan.

In this week’s Eye on the Market, they identify five things they like about the Flash Crash, namely:

[1] Stock-specific circuit breakers.

The U.S. has been slow to install circuit breakers on major exchanges, relying instead on “clearly erroneous trade rules” that cancel trades after the fact. In Asia and Europe, circuit-breakers have been around for a while. In Asia, trading is restricted outside of pre-specified daily bands of 5%, 10% and 15% (different by market). In Europe (e.g., Deutsche Bourse), trading is halted for 5 minutes after a 3%-10% move, and then reopened. In the wake of the Flash Crash, 10% circuit breakers are now applied to a few stocks as part of a pilot program (they have already been triggered on Citigroup, Anadarko and the Washington Post Company). If we are going to exist in a world with automated robots doing the lion’s share of daily trading, circuit breakers may be needed to prevent unintended and unmanageable meltdowns.

Another topic under discussion by the SEC: prevent HFTs from having “unfiltered, naked access” to the exchanges by requiring them to live by the same pre-trade risk management controls that clearing members do. Why? As noted by the Chicago Fed, “high-frequency trading has the potential to generate errors and losses at a speed and magnitude far greater than that in a floor or screen-based trading environment”.

[2] More balance to the HFT discussion.

HFT supporters claim they are providers of liquidity to the market, and that HFT makes U.S. markets more efficient than ever. Suggestions to the contrary have been deemed “utterly laughable” by firms defending them. However, the Flash Crash highlights the uncertainties around these assertions.

While volumes have tripled in the last few years, there’s a big difference between volume and liquidity (the ability to transact without moving the price). In an industry barometer survey1 conducted by the Tabb Group in May of this year, barely half the participants had a high degree of confidence in the US equity market structure; 73% did not believe the market structure is “orderly”.

One of the survey recommendations: HFTs should be required to register as broker-dealers.

To be sure, there were weaknesses in the old specialist system as well2. But specialists were required to maintain a fair and orderly market, and post quotes that were part of the National Best Bid and Offer system; their reputations mattered. HFTs have no such requirements (no minimum shares or minimum quote times); one proposal would require quotes to be valid for at least one second. The SEC has broadened the trader reporting system in order to analyze HFT activity more closely.

[3] Proposals requiring HFTs to act more like the floor specialists they’re replacing.

With the advent of HFTs, cancelled orders have soared. Today’s ratio of 30 cancelled orders for each one executed means that 97% are cancelled.

To curb abusive practices, some market participants recommend applying a fee to HFTs for an excessive number of cancelled orders. The increase in cancelled orders is one reason we do not agree that increased order depth on S&P 500 stocks at the NBBO is a clear indication of greater liquidity, as some market research alleges. Quotes pulled within a nano-second of being posted, and which are part of an algorithmic order detection exercise, don’t seem like liquidity in the traditional sense. Ameritrade’s representative on the recent SEC Roundtable referred to this as “opportunistic liquidity”.

[4] More discussion around HFT “co-location”.

Some HFTs co-locate computer servers inside stock exchanges3 to minimize the milliseconds (or nanoseconds) required to scan existing orders, and have algorithms act on this information. As trading execution and IPO listing fees declined, exchanges have tried to make up the difference by selling access to market data. Some exchanges have products which give clients a faster look at quotes, in exchange for a fee. As a result, some HFTs end up with access to information sooner than institutional or retail investors who rely on more standard venues (such as SIP Quotes).

The search for co-location benefits has existed forever (in polite company, “order anticipation strategies”). Broker-dealers in past decades argued that being closer to floor traders on the CBOT was an advantage to their clients. But historical parallels can lose their meaning when the instruments of battle change: one HFT computer can reportedly decode more than 5 million messages per second. The Flash Crash has increased the debate around whether co-location confers advantages to HFTs, and whether there should be obligations and responsibilities that accompany them.

[5] Asset managers learn that “cheapest <> best”.

After the NYSE moved to decimalization in 2001, bid-offer spreads fell almost in half on S&P 500 stocks (less so for the Russell 2000 stocks, where HFTs are less active). Schwab retail commissions fell from $35 in 2003 to less than $10 in 2009. This trend is confirmed by broader research from the American Association of Individual Investors. So if the prism of success is bid-offer costs and commissions on individual trades, the battle has been won.

But is that the right prism to define what makes an optimal marketplace? Part of the HFT industry tracks the order flow of larger investors who leave electronic footprints4. Using algorithms which include spraying the tape with thousands of quotes, the intentions of large investors is ferreted out. This can result in higher trading costs for such investors, and by extension, their clients, who include 401k investors, and pensioners participating in state and corporate plans. Quantitative Services Group computes analyses of HFT impacts on execution costs. They estimate that HFT tracking algorithms can drive execution costs up 1.5 to 3 times, even when institutional investors parcel trades into smaller orders to avoid detection.

There’s lots more of interest in their report, which you can read in full and download if you want:

JPMorgan's Eye on the Market

Meanwhile, you may note that a lot of it is about High Frequency Trading (HFT), which I’ve written quite a bit about recently:

• Who's afraid of HFT, HFT, HFT?
• High frequency trading in jeopardy thanks to flash crash
• More Banking Statistics: Algo and High Frequency Trading

as have many others.

This means that this area is going to get regulated, and it will mean significant restructuring.  For example, back in January, the SEC started a consultation through the Concept Release - a request for public comment on securities issues - on HFT and more.

Key areas under review include:

Market Quality Metrics

What are the best metrics for assessing market quality for long-term investors and have these metrics improved or worsened in recent years?

Fairness of Market Structure

Is the current highly automated, high-speed market structure fundamentally fair for investors?

High Frequency Trading

What types of strategies are used by the proprietary trading firms loosely referred to as high frequency traders, and are these strategies beneficial or harmful for other investors?

Is the overall use of any harmful strategies by proprietary firms sufficiently widespread that the Commission should consider a regulatory initiative in this area?

Co-Location

Do co-location services (which enable exchange customers to potentially route trades faster by placing their computer servers in close proximity to an exchange's computer system) give proprietary trading firms an unfair advantage?

If so, should the proprietary firms that use these services be subject to any specific trading obligations?

Dark Liquidity

Has the trading volume of undisplayed trading centres (such as dark pools) reached a sufficiently significant level that it has detracted from the quality of public price discovery?

If more individual investor orders were routed to public markets, would it promote quote competition in the public markets, lead to narrower spreads, and ultimately improve order execution quality for individual investors beyond current levels?

Are a significant number of individual investor orders executed in dark pools and, if so, what is the execution quality for these orders?

Lots of comments have been received on the Concept Release, and its conclusion cannot be far away.

Now we have a European response to this area with Kay Swinburne, rapporteur to the Economic and Monetary Affairs committee of the Parliament, producing a draft report last week. This report provides indication of much of what might be in the revised MiFID and very little is left untouched.

Jeremy Grant over at the Financial Times, has picked out some of the more interesting nuggets from Kay’s report:

• She suggests it may be necessary for “informal market makers” – read: HFTs – to be subject to mandatory liquidity provisions;
• Calls for an “ongoing regulatory review” of the algorithms used by HFTs;
• Seeks an examination of HFT to determine whether market flow generated automatically is providing “real liquidity” to the market and what the effect of this is on overall price discovery;
• Suggests that, “in the interests of equitable treatment”, rules need to be introduced so that MTFs (multilateral trading facilities”, like Chi-X Europe) are subject to the same level of supervision as exchanges, under certain circumstances;
• Calls for new provisions under Mifid for “broker crossing networks”, including requirements that they submit to authorities “orders matched in the system”, and “details on access to the system”; and
• Suggests a minimum order size for dark pools.

This is pretty dramatic stuff and Jeremy finishes his column by referencing David Doyle, a regular speaker at the FSClub, returning to the London meeting on 12th January 2011 for our annual EU regulatory update.

David presented on the key changes in MiFID at a conference at the London Stock Exchange last week, stressing that “the whole review of MiFID will have as its driving principle investor protection – that is, the interest of the retail investor, not the operators of exchanges, dark pools and HFTs.”

Too true David, too true.

If you’re interested in more of what David had to say, here are his slides:

Mi fid, david doyle, july2010

View more presentations from Chris Skinner.