Event Processing blog

Can market surveillance help to keep traders on track?

By Richard Bentley, Vice President, Capital Markets, Progress Software

There’s no doubt that today's high speed capital markets and cross product, cross market trade volumes mean regulation struggles to keep up with changes in the market.  MiFID II is an example of a financial regulatory directive that is seen by many as lacking real detail and remaining open to interpretation - and misinterpretation. In a panel discussion at the TABB Group Trading Surveillance event in London on last Wednesday evening, industry experts agreed that, in Europe at least, few financial services firms are afraid of regulators.

So as many new regulations remain wooly, ignored or have yet to be implemented - or in the case of ESMA (the European Securities and Markets Authority) the regulation is simply statements of clarification – the panel was asked how surveillance and risk is going to be managed moving forward? Questions were also  raised about the regulatory burden in the future and whether those outside of the "Big Five" would be able to resource the demands for growing compliance departments. Will this lead to an uneven playing field?

According to TABB Group new compliance costs are indicated at between 512 and 732 million euro, with ongoing costs between 312 and 586 million euros.  But while regulators are still determining what regulation will look like, the need for market surveillance is undiminished. Traders made about 13.3 billion euros ($18.2 billion) from market manipulation and insider dealing on EU equity markets in 2010, according to an EU commission study.  With some arguing that firms can only do so much to survey markets themselves as trades cross multiple brokers and gateways, the panel discussed the need for fragmented market data to be brought together in a consolidated tape and surveillance performed at an aggregate market-wide level. 

With respect to High Frequency Trading, there was discussion and agreement that pre-trade checks should be built in and regulators should be feared, as in some Asian markets where some market participants adopt a mindset that constantly asks "will I be allowed to trade today". That "Fear Factor" is key and there isn't fear of regulation yet in Europe.

The timeliness of market surveillance was discussed with the panel suggesting that transactions should be monitored retrospectively, but also in real-time as they happen. Clearly, there’s still a role for historic analysis of the market as some abuse takes place over an extended period of time and new abuse scenarios are discovered which can then be applied to historical data. It’s a little like having your DNA stored on file for a time in the future when forensic techniques improve. But there is also no doubt that the need for real-time surveillance to spot manipulation as it happens can be a significant factor for organisations looking to protect themselves and the market, which is one of the reasons it is mandated by Dodd-Frank and MiFID II.

Finally, the panel discussed how turbulent markets and highly publicised breaches of banking controls have demonstrated the importance of protecting market integrity. So while an increase in the complexity of market surveillance inevitably leads to an increase in cost, the panel felt that the punitive and reputational risks associated with surveillance failures justify the business case for improving compliance training, processes and technology.  After all, just as you wouldn’t expect the police to prevent all crime by themselves, it’s clear that investment is needed in surveillance technology to give the regulators a helping hand.

Is Revolution the Path to Transparency?

Revolutions are proliferating.  When you watch a revolution happening elsewhere, political or otherwise, it’s a good time to contemplate the revolution in your own history, or in your future.  There are few among us that can’t point to one or the other.  One of the common drivers is the fear that something is happening where we can’t see it happen, and we want transparency – of process, of government – of whatever seems to be wrong.

The capital markets globally are experiencing a similar revolution now with regulatory change, and the current climate threatens to create a revolt as well.  Market participants may push back on reforms to the point of creating a new state of stress.  Either way, the future presents very real threats to companies that aren’t prepared.  We’re observing a vast expansion of global rulemaking, and a coming deluge of data - especially in the derivatives markets. It’s very expensive and distracting to fix problems after the fact, so we need to act now.  “Hope is not a strategy” – as is often said to have been uttered by famed (American) football coach Vince Lombardi.

In an open letter to Barack Obama published on January 23, 2009, Benjamin Ola Akande advised, "Yet, the fact remains that hope will not reduce housing foreclosures. Hope does not stop a recession. Hope cannot create jobs. Hope will not prevent catastrophic failures of banks. Hope is not a strategy."

Now we have the Dodd-Frank Act in the U.S., MiFID II and EMIR in Europe, all preceded by the de Larosiere Report (EC, 2009), Turner Report (FSA, 2009), Volcker Report (G30, 2009), G20 – Feb 2009 Declarations, Financial Stability Forum Report (FSF, 2009), INF Report (IMF, 2009), Walker Review (UK, 2009), Basel / IOSCO Reviews… the list goes on.  And the rest of the world is watching, waiting, for another revolution.  The intended scope of the most recent reforms seems to almost be panacea, and transparency is the first step.

The next Revolution is happening in Boston, fittingly.  Progress Revolution 2011, from September 19^th through the 22^nd, offers the chance to learn from industry innovators on how they have successfully tackled these challenges within the capital markets.  Customers including PLUS Markets and Morgan Stanley will be there to share success stories.  And Kevin McPartland, Principal at the TABB Group, will be there too.  I’ve included a sneak peek into Kevin’s “Path to Transparency” below.

According to the New York Times, at the Republican Convention in 2008, Rudy Giuliani once said while contemplating Barack Obama’s candidacy, “… ‘change’ is not a destination ... just as ‘hope’ is not a strategy.”  Rudy will be speaking at our Revolution too.  Will you be there?  It will be a lively conference – I hope that you can join us!

-Dan

The Path to Transparency

By Kevin McPartland, Principal, TABB Group

Managing the vast quantities of data born into existence by the Dodd Frank Act and related regulation will present a challenge in the post-DFA environment; but collecting and producing the required data is just the tip of the iceberg. The ability to analyze and act on that data is what will separate the survivors from the winners. This is already true in many other parts of the global financial markets, but the complexities inherent in swaps trading coupled with the speed at which these changes will take place creates unique challenges. Spread this across all five major asset classes and three major geographies, and the complexities become more pronounced.

Margin calculations are proving to be one of the biggest concerns for those revamping their OTC derivatives infrastructure. In a non-cleared world, dealers determine collateral requirements for each client and collect variation margin on a periodic schedule—in some cases once a month, and in other cases once a year. When those swaps are moved to a cleared environment, margin calculations will need to occur at least daily. The result is an upgrade of the current batch process with dozens of inputs to a near-real time process, with hundreds of inputs. Whereas before major dealers could perform margin analysis, client reporting and risk management in a single system, those systems now need to operate independently within an infrastructure that provides the necessary capacity and speed.

The trading desk will require a similar seismic shift, as flow businesses will provide liquidity across multiple trading venues to an expanding client base. Most major dealers are at some stage of developing liquidity aggregation technology intended to provide a single view of liquidity across multiple swap execution venues. Creating this type of virtual order book requires receiving multiple real-time data feeds and aggregating the bids and offers in real time.

Furthermore, rather than comparing model-derived prices to the last trade price to produce quotes, inputs from SEFs, CCPs, SDRs, internal models, third-party models and market data providers will be required inputs to real-time trading algorithms once reserved for exchange-traded derivatives.

Providing clients with execution services presents other challenges. Executing on multiple platforms also means tracking and applying commission rates per client per venue in real time. Trade allocations also complicate the execution process.  In the bilateral world a big asset manager can do a $100 million interest rate swap and spread that exposure across multiple funds as it sees fit. Under the DFA, the executing broker must know which funds are getting how much exposure. Account allocation in and of itself is not new, but cost averaging multiple swap trades and allocating the right exposure at the right price to the proper account presents complex challenges, especially in a near-real time environment.

Risk management, compliance and back-testing data will also require huge increases in processing power, often at lower latencies. Risk models and stress tests, for example, are much more robust than they were before the financial crisis, requiring a considerably higher amount of historical data.

Compliance departments now must store the requisite seven years of data so they can reconstruct any trade at any moment in the past. This is complicated enough in listed markets, when every market data tick must be stored, but for fixed-income securities and other swaps, storing the needed curves means that billions of records must not only be filed away but retrievable on demand. Similar concerns exist for quants back-testing their latest trading strategies: It is not only the new data being generated that must be dealt with. Existing data, too, is about to see a huge uptick in requirements.

In the end these changes should achieve some of the goals set forth by Congress as they enacted Dodd Frank – increased transparency and reduced systemic risk.  The road there will be bumpy and expensive, but the opportunities created by both the journey and the destination will outweigh any short term pain.

This perspective was taken from the recent TABB Group study Technology and Financial Reform: Data, Derivatives and Decision Making.

Progress Revolution Session Sneak Peek: Transforming Your Bank to Become Operationally Responsive

Within the banking industry today, we’re observing a significant expansion of choices available to customers, and subsequently loyalty to the primary bank is eroding. What specifically is driving attrition? 

Results from a 2011 customer survey conducted by Capgemini show that “quality of service” and “ease of doing business” are the factors that most strongly influence a customer to both initially select AND leave a bank.

What does this mean for a bank conducting business in the current competitive landscape? It means that connecting with your customer at the right time and right place is critically important. The question that remains is exactly how this seamless connection between the organization and the customer is achieved in the real world.

Immediacy is the critical overlay, and immediacy is achieved through real-time data capture and reporting translated into highly targeted, more relevant offers. Real-time data capture and responsiveness put you in a position to move fluidly with your customer base.  There’s no lag time where a lucrative window of opportunity closes before you have the opportunity to act.

It’s all about connecting with customers on their terms, and this is best achieved through automating the process.  For instance, if you have a customer that has deposited a large check outside the parameters of their typical deposit cycles, you can present an offer for a high yield savings account. This type of offer works well when you connect with your customer immediately because the large deposit is still top of mind, and other choices for investment have likely not yet been identified.

Essentially you’re able to capitalize on your preemptive knowledge that this customer is likely in the market for a savings account product BEFORE the customer is able to research competitive options. 

By anticipating your customers’ needs you’re delivering on the most important factor in retention – ease of doing business.

When you have the tools in place to serve up the right offering to the right customer at the right time, everyone wins.  You don’t want your customer to jump ship because they think you don’t have what they need.  And your customer really doesn’t want to spend their valuable time and energy searching for a solution that they could quickly and easily secure from you.

The beauty of Responsive Customer Engagement is that it evolves operational efficiency into operational agility.  It’s not enough to streamline processes and collect data – it’s about how quickly and effectively you can translate data capture and analysis into real-time, relevant communication with your customers. Believe me, if you’re not focused on real-time customer engagement, it’s highly likely that your competitors are.

I hope that you can join me in Boston on September 21^st at Progress Revolution Boston 2011 to discuss how to leverage software solutions to not only improve operational efficiency but also increase customer engagement and loyalty.  I’m going to be covering cross-sell and up-sell marketing, payment management, and customer on-boarding and other timely topics, and look forward to a lively exchange of ideas!   

 

 

 

 

 

 

DON'T PANIC! Maybe a Depressed Robot is to Blame

The market frenzy that whiplashed global markets last week has been - unsurprisingly  - blamed on high frequency trading. Headlines such as these fuelled the fire:

• "The Trading Game is Causing Market Panic" - The Atlantic.
• "High speed traders are exacerbating volatility" -  the Financial Times.
• "High Frequency Traders Win in Market Bloodbath" - the Wall Street Journal.
• "High Frequency Trading May Be Making Things Worse On Stock Markets" - HuffPo.
• "Black box trading is the real hazard to markets, says Lord Myners" - The Guardian

As you can see, the media, brokers, and investors were quick to point fingers at HFT and, in the meantime, the SEC has sent out subpoenas to high-frequency trading firms in relation to last year's flash crash probe, according to the Wall Street Journal.

But does HFT cause panic? Panic, which is an emotional reaction to fear,  is an inflammatory word. Panic is contagious, especially in markets. Because panic is ultimately a human emotion it may not be the most accurate word to describe the moves of cold-blooded trading algorithms. But when you see trading robots hit stop-loss after stop-loss, triggering buying or selling in light-speed over and over again, the voluminous activity is bound to mimic actual panic.

The markets today make the struggle between human investors versus high frequency trading firms look like an intergalactic battle. But while the humans are sitting behind the wheel of a broken-down old car, HFTs are soaring on a spaceship equipped with an Infinite Improbability Drive. 

And the algorithms that dominate the markets - along with their HFT owners - are getting a bad reputation. They are being portrayed as the villains in this uber-sensitive economic environment.

The current dialog casts them as Vogons, the bad guys in the brilliant Hitchhikers Guide to the Galaxy (BBC series and books by Douglas Adams). The Vogons are described as "one of the most unpleasant races in the galaxy. Not actually evil, but bad-tempered, bureaucratic, officious, and callous."

High frequency trading is not actually evil either, it is the natural development of quantitative trading, and algorithmic trading which grew out of the new market structure and automation. Although quantitative trading takes the emotion OUT of trading, something has gone wrong. The effect on volatility is a matter of debate; perceptions around this question are creating panic and upsetting investors.

Investors boycotted HFT in the week ended August 10th, dragging $50 or $60 billion out of the stock market and walking it over into safer money market accounts. So what can be done to restore investor confidence? One bemused market participant said last week that what was needed was an algorithm with a built-in panic button. Instead of tumbling after the market when a stop is hit, the algo could pause and take a breath and think about what it is doing.  But would that lessen volatility? Because, again, thinking is a human activity.

Ford Prefect, one of the protagonists in Hitchhikers, said about Vogons: "They don't think, they don't imagine, most of them can't even spell, they just run things." Like the Vogons, algorithms are not great thinkers. And, with upwards of 70% of equities trading being done by algorithms, they do pretty much run things.

But blaming HFT (or Vogons) for market swings is like blaming social media for the riots in England. Yes, it was easier to get everyone together for a looting-and-burning session by using Twitter and Facebook, which made the situation worse.  And social media also helped people organize the clean-up. Would the same have happened, differently, without social media?  Likely yes.  HFT and social media have another thing in common - because they are automated they can easily be monitored and controlled, if regulations allow it. What if authorities could recognize the electronic early signs of a riot, send a warning to citizens, and arrive at the scene faster?  In the UK, the government is considering blocking Twitter and Facebook during a major national emergency. 

I am not suggesting that the government or the regulators should block HFT when markets run riot. And our markets are still tinkering with just the right recipe for actual panic buttons; witness the dislocations of the May 6th flash crash and the ensuing coordinated circuit breaker and other limit debates.

There a number of government investigations - including the US and the UK - into high frequency trading practices. Some are trying to shine a light on algorithms and determine whether their behavior is perhaps predatory or disruptive. Lifting the veil of secrecy on algorithmic and high frequency trading could be a way of regaining investor confidence. But that is a double-edged sword; if firms offer up too much about the methodologies and strategies behind their algos they could also be giving away their secret formulae.

Giving regulators a balanced peek under the covers might help. Regulators already can and do deploy market surveillance and monitoring tools to help prevent market abuse at high speed. That may be a difficult pill to swallow, but the Hitchhiker’s Guide would tell us – DON’T PANIC.  As many damning studies as there are, others come to a different conclusion ("Study gives backing to high-speed trading" – Financial News).  If something isn't done proactively - and soon - then investors, politicians, regulators and other nay-sayers are going to be calling for an end to HFT completely.

As Marvin the depressed robot in Hitchhikers said: "I've calculated your chance of survival, but I don't think you'll like it." 

-Dan

 

HFT Volume: Cool Liquidity or Just Hot Air?

There have been some heated public debates recently about the kind of liquidity that is being provided by high frequency trading. In an earlier post on Tabb Forum Candyce Edelen from Propel Growth asks if HFTs provide liquidity or do they just provide volume?

Liquidity is bread and butter for firms associated with financial markets; it provides an easy way to get in and out of markets while - hopefully - making money. It is essential to investors who want to know that they can get in or out of a market when they choose. Therefore liquidity is good. (The icing on the cake would be over the counter derivatives markets where firms can use opacity to their profitable advantage.)

Liquidity, from the word liquid, depicts a flow of activity that is smooth and constant.  Investopedia says that liquidity is characterized by a high level of trading activity.

It is clear is that HFT provides that high level of trading activity. What is less clear is: is it really liquidity? High quote-to-cancel rates, with pre-programmed cancellations sometimes happening in 2 to 5 milliseconds, lead to perceived rather than actual volume. Liquidity only occurs when buyer and seller can get together and deal. If a sell quote disappears before the buyer is even aware of it, what advantage does that offer the buyer?

I applaud Edelen for asking outright whether HFTs increase liquidity or just volume.  The “just volume” replies were no surprise, but some thoughtful counter-arguments appeared in the comments to support the liquidity argument as well.  Interesting, but no consensus.  So how we expect regulators to figure it out is anybody’s guess.

There is also a lack of clarity as to whether HFTs should be market makers, thereby ensuring liquidity even in volatile markets. Edelen asks if we need new obligations for the new breed of market makers. The May 6th flash crash demonstrated what happens when uncertainty and extreme price movements occurred - the market makers fled. Computerized trading algorithms quit the marketplace even when their owners were designated as market makers, thus steepening the fall. But, since traditional market makers have all but disappeared, HFT market makers are what we have left. If you take them away, what remains?

In the flurry of comments to Edelen's article, it seems that on this at least the pundits seem stumped.  They remarked on what the obligations and incentives are or are not, but could not seem to find an answer to what they should be.  Instead they go away from market makers to seemingly trying to redefine what the market itself ought to be instead – with little success.  This may give us a clue as to why regulators and legislators can’t figure it out either.

And do we need a level playing field as some are calling for? If everyone gets the same data at the same time and can only trade at the same speed, will that solve the problems? Intuitively people seem to feel the answer is “yes” but the commentators could not even agree what the playing field or fields would look like.  Most seemed to shy away from trying to put the genie back in the bottle and going back to the way things were.  Dark pools are another sore subject, with some claiming that the growing level of volume traded in dark pools (possibly 30% of volume) is due to the fear that HFTs are creating in the lit markets.

High frequency trading is here to stay, and debate over its role and future is healthy. But are all HFTs the same, asks Edelen? Here finally we seem to have some consensus from the pundits, who appear to have argued themselves into this position:  There is Good HFT and there is Bad HFT.  We can’t define it, but we think we know it when we see it. This is the same as with any tool or technology or trading model – there are beneficial and irresponsible or harmful uses; the line between them is blurry, and the distinction springs from the user of the tool, not the tool itself.

So what are we to do with the “Bad HFT?”  This seems to be the real question.  So far we’ve heard:

• The regulators haven’t figured it out and can’t – regulators worldwide have managed to define a small number of abusive trading scenarios, and demand compliance, but they can’t hope to cover it all
• The markets themselves haven’t figured it out and don’t have much incentive to do so
• The market participants can't come to a consensus - and probably won’t
• Wishing HFT away won’t fix it – either by slowing it down with a Tobin Tax, or a liquidity fee, or by outlawing it altogether – that is throwing out the baby with the bath water and someone will always find a way to abuse what remains.

What we are left with is the capitalist mantra of “buyer beware.”  But there are ways that the buyer can equip himself to join the 21st Century and - at the same time - protect himself from high frequency errors, fraud or predators.  

As we’ve often said, high speed trading needs high speed controls.  Like a car racing down the highway, some controls will come from the lurking cop (the regulator). But the driver needs to make sure the brakes work as well as the gas pedal in order to avoid an accident.  Of course, the speed itself begs the question of whether HFT needs to have a speed limit in order to stay under control.  We don't think a speed limit is necessary.

Instead, the issue is detecting abuse and mistakes, regardless of speed or source.  If you have the market surveillance and monitoring tools that can alert you to problems occurring at high speed - if you can monitor your own car, and the cars on the road around you and see a problem coming - an accident can be avoided. And if there is no accident, despite how fast the car is going, then the cops won't have to be called out.

-Dan