And so here comes the egg before the chicken

15 December 2011

Snippets from pending regulatory environments in Europe and US

Karen Bertoli,
chief marketing officer,
and Bob Fuller,
chairman of the MiFID IT Sub Group and director, Fixnetix

News is news when it first occurs and we have all heard the phrase “old news is no news”. One would be hard pressed to not see, hear or read the daily worldwide news with regard to regulatory reactions in this highly volatile marketplace. Compliance dates have been missed or extended, (Dodd-Frank,) rules are still yet to be written, (the European Securities and Markets Authority (ESMA) in relation to European Market Infrastructure Regulation (EMIR) and Markets in Financial Instruments Directive (MiFID) II) lack of staff attending to governmental controls is apparent, (Commodity Futures Trading Commission (CFTC)) and surprise catastrophic financial disasters garner obvious priority, (MF Global).

Goodbye old news and farewell new news - we are clearly in the midst of chronic messages from multiple areas in one community, all of which appear to be stuck in an endlessly tall silo with no way out. Is this mission impossible unstoppable? Increased collaboration between the regulatory bodies, industry partners and solution providers will only turn our community to a new, more fluid trajectory where goals have a better chance of being met.

There is too much going on

The law of unintended consequences suggests that there are outcomes that are not the outcomes intended by a purposeful action – these are broken down into three groups, positive, negative and perverse.

The industry is saying without the detail we do not know what working practices are going to be so how is it possible to regulate them or apply catastrophic rules? How is it possible to have the egg before the chicken?

“The pendulum always goes too fast from one end to the other. We went from a totally regulated world in the 1970s to a totally unregulated world, and now the pendulum is swinging too fast towards regulation,” noted Annika Falkengren, CEO of Swedish bank,
SEB in the FT Review on the top 50 women CEOs in the world. (1)

The devil is in the details

The G20 accord has led to two major pieces of legislation, Dodd-Frank in the US and EMIR, MAD and MiFID 2 in Europe. The G20 accord contained approximately 100 items which, when enacted, will change the way trading, clearing and settlement of OTC derivatives will occur, itself a major change to the industry. However, both the US and European enactment of this accord are going much further with proprietary trading for banks being banned in the US (the Volker rule) and changes to almost all instrument types being proposed in Europe.

This amount of change is likely to have significant unintended consequences including potentially reducing the liquidity in a number of instruments. Indeed the ‘big bang’ approach of implementation currently being pursued by both the US and Europe is very likely to exacerbate these unintended consequences.

Another problem in both the US and Europe is that the detail of the regulations is being decided by separate entities from the law makers, the CFTC and SEC in the US and ESMA in Europe. The amount of detail having to be decided by these entities in such a short time across multiple instruments is again leading to reduced consultation with the industry just to try to make the deadlines imposed by the law makers.

To give a few European examples, MiFID 2 requires that the method of trading and the availability of market data of current over-the-counter (OTC) derivatives is dependent on the definition of standard market size for those instruments, something that is not currently defined at all. The definition of what constitutes an OTF (Organised Trading Facility) is also unclear and again materially affects how institutions trade moving forward. All of the definitions, level 2, as defined in European law are to be decided by ESMA, the expected dates for this are likely to be 2014 to 2015 possibly later. This does not leave the industry much time to adapt to these changes.

Regulatory bodies lost in translation

The other issues facing the markets are the differences in regulation and timing across the globe. At the present time it is unclear how and when the Asia Pacific region will be fulfilling their G20 commitments. This may lead to regulatory arbitrage with trading moving to those regions where the controls over trading, clearing and settlement more closely resemble what is currently used. This potential move has led to different forms of extra territoriality by the US and European legislators.

Industry members on system overload

No doubt the pressure is on for the people who write the cheques for pending compliance solutions. In addition to taking on this financial burden, cheque writers/ business owners/ finance departments are also having to manage the need for speed at any price as well as the demand for “specific” technologies. Back in the day, one walked in a bar and simply ordered a beer. Nowadays, one walks in a bar and chooses from lists as long as a dinner menu. Welcome to the current environment with all trading operations. How to forecast these astronomical costs seems mind boggling and overwhelming.

As algorithmic traders migrate from one firm to the next, they not only bring with them intellectual property but experience and trusted skill on whatever system/ systems that managed the entire life cycle of their trade (pre-trade risk, market data, execution, post-trade). Market makers, broker dealers and the like are now pressed with supplying traders with their technology of choice; and in some cases, face losing good people with some very effective strategies. Yet another challenge for keeping heads above water in this highly competitive and soon to be too quickly regulated marketplace.

For the future?

Solution providers are constantly innovating and there are various new technologies available. 2012 will foresee the requirements needed for connections between all clearers and brokers. Such connections are already in existence with a few vendors, Fixnetix being one, built a global network to offer cross connections for trading multiple markets with risk control on one line. The infrastructure is already in place. The lines are built, data centres in place, compliance for clearers and brokers will be that much easier if choosing the cost efficiency model using outsourcing.

Return-on-technology (ROT) will become a more common term and perhaps even gain a debut spot on a balance sheet for good. Technology choices used to be all about instant gratification and what is being obtained straight away for results? Trading firms must prepare to have long-term relationships with their technologies and partners as well as continue to measure the real cost benefit of building in house, versus outsourcing while being fully compliant as well as keeping traders happy and profitable.

Time to lower the speed limit; the egg cannot come before the chicken

Too much change in too little time with not nearly enough information to formulate a logical conclusion is basically where we are at. Where is the chicken? How many feathers does the chicken have? Where does the chicken live? What does the chicken eat?

1. FT Women at the Top article

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