Dan Hubscher

Wednesday, June 13, 2012

Therapy for Toxic FX Order Flow

Posted by Dan Hubscher

DhubscherAs high frequency and algorithmic trading infiltrate foreign exchange markets some of the problems that dog equities, such as high order cancellations, are arising.

Equities markets, which have seen HFT and algo trading go through the roof, have recently started clamping down on excessive and cancelled orders. As my colleague recently explored, Deutsche Börse, Borsa Italiana, NASDAQ and Direct Edge have all announced intentions to discourage the number of cancelled orders they receive. They will encourage the "good" liquidity, those players with high fill ratios, and punish the "bad".

The IntercontinentalExchange has already seen good results from a policy it implemented last year aiming to discourage "inefficient and excessive messaging without compromising market liquidity." Regulators, too, are taking note; the SEC is considering charging HFT firms for cancelled trades.

A combination of economic incentives and controls makes it happen.  In addition to adjustments to their rebate schemes, exchanges must monitor their market makers in real-time to make sure that they are living up to their quoting obligations. This monitoring can also include spotting the "Stupid Algos" blamed for generating a burden the exchanges cannot bear. 

It was only a matter of time before other asset classes started to see similar problems with excessive orders, and a similar response via a new generation of intelligent “sensing” algos – but with a twist.

FX is increasingly traded by computers.  Consultancy Aite Group said in a report last year that FX algorithms will account for more than 25% of FX trade volume by the end of 2014. And as algorithms take control, the opportunity for a flood of quotes and cancellations increases. Order-to-trade ratios, the number of orders that come in compared with the number filled, FX Algorithm_Toxic Flow Warning_Progress Software create a load on exchanges and electronic markets and they can provide a smokescreen to hide potentially abusive behavior (so-called “quote stuffing”).

We see innovative FX brokers taking measures to rein in unproductive order flow.  Similar to equities marketplaces, FX dealers and brokers are increasingly utilizing tactics that discourage excessive orders, but in a very different way. Because FX is mainly traded via single dealer platforms, multi-dealer platforms such as FXall, and interdealer marketplaces, it is fragmented in a different way from equities. 

So it is the FX brokers that are acting like exchanges and taking the initiative to control toxic order flow with their pricing strategies. Brokers need to see every opportunity and threat hidden in their customers’ flow patterns, and automate their own real-time responses, to stay profitable as markets change. Brokers servicing HFT clients react to predatory algorithms and fluctuating fill ratios by manipulating the spreads they offer.  Traditional customer profiling based on purely historical data is good for strategic decision-making.  But for more tactical decisions with immediate impact,real-time analysis is additionally required. 

A responsive broker can, for example:

  • Mitigate "toxic flow" by detecting predatory patterns in real-time, and automatically widening spreads to those clients
  • Increase business by detecting reduction in flow from “good” clients, and automatically reducing spreads to those clients
  • Preserve the relationship by detecting pending credit breaches, and immediately calling the client

Our customers use the Apama platform to perform their own customer flow analysis.  Both global and regional FX brokers now optimize how they serve their customers based on detailed real-time diagnosis of their flow. Key parameters include P&L on individual trades, an aggregated view of individual trades over time, and the performance of tiered client groups.  Using real-time customer flow analysis brokers (and banks and trading platforms) can figure out which customers are providing the types of order flow that they need. 

Customer flow sits alongside other real-time market trend analytics such as volatility, average daily volume, and depth of book.  For example, flow from a specific customer is high but liquidity is thin - then time of day impacts spreads in addition to customer behavior.  Our customers have also been generating pricing dynamically – adjusting spreads and skews - based on market conditions and customer trading patterns – including HFT patterns.

Dynamic pricing builds on an aggregated order book as source pricing.  A basic pricing service dynamically applies a set spread to the base price generated from the aggregated book.  A more advanced service changes the spread based on any data or rule, for example:

  • Current volatility
  • Depth of book (volume on bid/ask side)
  • Real-time risk parameters such as profit/loss levels
  • News
  • Current vs. target position (changes the spread or skew automatically, and updates the auto-hedger service)
  • Customer tier
  • Historical & real-time customer trading behaviour

Brokers can take input including aggregated FX prices, customer trading patterns, market volatility and hedging activity - all in real time - into the platform. The analysis generates dynamic pricing (spreads/skews) and it can work to incentivize market participants to provide quality - not quantity - orders. 

Toxic order flow, like excessive orders-to-trade, can tax trading systems and create an environment where fraud and market abuse can flourish. Using real-time customer flow analysis to get a handle on your customers' order flow will help to prevent this. Customer flow analysis can be used not only for dynamic pricing, but also for customizing product offerings and enabling banks and brokers to create execution algorithms for their clients to use. By being proactive, FX brokers and banks can avoid the issues that plague equities. And make money along the way.

 

Thursday, June 07, 2012

Twice as Nice – Progress Apama Retains Title of Best Algorithmic Trading Platform

Posted by Dan Hubscher

For the second consecutive year, the readers of Profit & Loss Magazine have named Progress Apama the Best Algorithmic Trading System as part of the Readers' Choice Digital Market Awards. The Digital Markets Awards recognize the efforts of the FX services industry in providing the tools and functionality that make trading FX more efficient.

Progress Award picture
In photo: Timothy Jones, Charlie Little, Ben Ernest-Jones Dan Hubscher (from left to right)

It's a tremendous honor and it means even more knowing that it was determined by your votes. So thank you. Let's see if we can make it three in a row!

 

Wednesday, September 14, 2011

Is Revolution the Path to Transparency?

Posted by Dan Hubscher

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 19th through the 22nd, 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.

Wednesday, August 17, 2011

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

Posted by Dan Hubscher

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

 

Wednesday, July 20, 2011

HFT Volume: Cool Liquidity or Just Hot Air?

Posted by Dan Hubscher

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

 

Tuesday, June 14, 2011

Keeping the Train on Track

Posted by Dan Hubscher

It has been said that regulators are struggling to keep up with high frequency and algorithmic trading because they have outdated methodology and technology. This battle has been likened to trying to chase a Ferrari on a bicycle.

But what happens when the regulators are constantly changing the rules, and the Ferraris are turning in the wrong direction at high speed? I liken this to regulators trying to switch tracks while your HFT train is barrelling along at 100 mph. If you do not protect yourself from high speed changes, you might find yourself thrown off the tracks.  

The ability to respond to both regulatory change and split-second market anomalies can make the difference between emerging from the global financial crisis as a leader or as the firm that has to manage the aftermath of a messy derailment.

Imminent, sweeping regulatory reforms are not the only issues that firms have to grapple with.  Market structure changes underway in both the USA and Europe, from exchange mergers to regulatory “fine tuning” such as market maker quoting rules, circuit breakers, and limit up/down rules are already completely changing the game - and the playing field - and firms have to adapt to them. Cross-asset, cross-border trading is proliferating and creating new opportunities for arbitrage trading strategies that can throw a cross-asset "splash crash" into the mix.

Or, as Tabb Group told Advanced Trading: "strategies that go beyond speed, and emphasize 'cross-asset, cross-regional multi-temporal, asymmetric versus symmetric trades, even enhanced front-to-back automation'" are on the way. This means that real-time visibility - for spotting trading abuses, market anomalies and operational errors - is necessary on a global, cross-asset, 24/7 basis to remain in regulatory compliance and mitigate reputational damage.  

Also, when regulations change you need the flexibility to change your systems to match and manage them; flexibility is key. Financial firms are constantly on the move, changing trading strategies and products to stay competitive. New regulations can throw new strategies out of compliance - the tracks keep changing.

And what about looming regulations beyond today’s mandates?   The rush to real-time trade reporting of swaps, for example, is causing some consternation among market participants because it may impede trade flow, according to Operational Risk and Regulation.  Real-time reporting is intended to help in the fight to avoid market abuse and as an early warning system to detect systemic risk. But T0 may be overkill, especially if monitoring and surveillance tools are in place.

In the Risk article, Frederic Ponzo, managing partner at technology consultants GreySpark Partners, said: "The real benefit of real-time surveillance is with identification of fraudulent activities, market manipulation and errors."

 And if you could put compliance in control by building surveillance detection and workflows on your own terms, so much the better. Because every firm is unique, brokers need to customize their case management systems for efficient incident investigations, rapidly and continuously, in addition to customizing real-time abuse detection and market monitoring scenarios. 

By gaining visibility to potentially abusive and erroneous trading activities, with the flexibility to adapt to new trading patterns and regulations, firms can protect themselves and their clients from market risks and not run afoul of shifting market regulations.  They can quickly pinpoint threats and tailor responses without disruption, maintaining regulatory compliance now and into the future - effectively changing tracks at 100mph or more. 

-Dan

 

Monday, June 13, 2011

Tickets Please: Technology to Keep You on the Train

Posted by Dan Hubscher

The ticket to preventing and deterring rogue trading could well be technology.  Although most financial services firms have some form of surveillance and monitoring technology in place, it isn't good enough to keep them from getting kicked off the regulation train.

Financial services firms risk running afoul of new regulations because their technology is not the "right" technology anymore. The burning question now is – what will be the “right” technology be, in an unpredictable future?

Detecting, preventing and deterring market abuse can only be effective when it permeates financial services activities from pre-trade to settlement. The number of different places that trading activity occurs is constantly increasing. Trading can be done at the office, or via cell phone. Or a trader can begin to work a deal at the office, go for lunch and finish it via instant messaging with his broker.

Surveillance is necessary in order to provide transparency in trading activity, whether it is via formal trading platforms, using an instant messenger platform, e-mails, Twitter or other social media sites, or even old-fashioned phone conversations. Compliance officers need to have full visibility in order to spot and prevent abusive trading activity - and that vision has to encompass it all; every message, every trade, every conversation, every Tweet has to be recorded, taped and downloaded into a database for on-the-spot or future scrutiny.

The technology of yesterday will not be able to cope with the audit trail of today. Plus those audit trails need to occur in real-time, not just looking back over history. This means that current methods, employing historical analysis of already-old data just won't do. Analysis has to be done both in real-time and historically in order to make sense. It has to span asset classes including cash equities, interest rates, swaps, commodities, OTC derivatives - cleared or not. Silos can no longer exist in terms of monitoring; trading today is truly democratic, crossing borders, asset classes and currencies.

New market abuses seemingly proliferate by the day. Some are really the old ones - only done faster (like front running), but there are fresh ones too. Just last week the SEC suspended trading in 17 OTC microcap stocks because of doubts over the publicly available information on the companies.  Here, investigators from different offices and working groups used “a coordinated, proactive approach to detecting and deterring fraud.”

Packaged applications cannot handle new rules or monitor new types of market abuses. Add flash crashes, mini flash crashes, cross-asset crashes (we call these "splash crashes") to the mix and a picture starts to reveal itself. In this picture there are Chief Compliance and Technology Officers handing the regulatory conductors their tickets to prove that they have the right technology, and then getting kicked off the train because they have the wrong tickets.

Flexible, extensible surveillance and monitoring technology is the top-up fare needed to stay on the train. If you can see every move your traders make today, you can take control. If you can see every move your traders make down the line, you will stay in control.  A real-time platform that can handle the massive, increasing volumes of transactions and events in today's electronic marketplaces, and handle the rules of tomorrow’s, is imperative to staying on top of rapidly changing regulations. 

-Dan

 

Thursday, June 09, 2011

All Change: When to Prepare for New Regulations

Posted by Dan Hubscher

As financial institutions bemoan the uncertainty still hovering over Dodd-Frank implementation and possible delays, there are steps that they can take to prepare for them even before the ink dries. Otherwise compliance can cause major disruptions to their business operations.

Brokers, in particular, cannot afford to wait to protect themselves and their clients from market risks, and from running afoul of shifting market regulations. Attracting new clients - and retaining existing clients - will depend increasingly upon whether a broker has measures in place to protect a client's interests.

Dipping an unprotected toe into a market where a flash crash can happen at any moment can be frightening. This is not scaremongering, it is the market today; insider trading and market manipulation can happen within the best of trading firms.  And algorithms allowed to run without proper controls can take a company's balance sheet from black to red, or worse. The debate around the notion of regulators reviewing algos before they go to market (see Larry Tabb’s article and resulting commentary here) is a clear indication of nervous market sentiment (no Twitter trading analytics required). 

Regulators are laying miles of new tracks (rules) for high-speed and heavy freight trains running through the electronic trading frontier, and they are preparing to make sure the trains stay on the tracks. Trade monitoring, auditing, and abuse prevention requirements abound throughout the proposed rules, including recent efforts to detect market manipulation. But there is little reason for financial firms to wait for strict definitions of what “sufficient” measures are in a market that continuously gives us examples of what to detect, prevent, and deter.  

By gaining real-time visibility to potentially abusive and erroneous trading activities, brokers can quickly pinpoint threats.   But brokers need to constantly adapt detection scenarios to new threats; and they also need to tailor their responses and modify them without disrupting their trading operations.  Responsiveness is more than lightning-quick reflexes.  Flexibility is also key; and is what will transform regulatory compliance into competitive advantage now and into the future.

Despite complaints, media interest and suggestions to the contrary, algorithms and high frequency trading are not going away. When problems such as crashes or abuse occur it is partly because regulators have not yet had the chance to get a uniform, industry-wide grip on how long-standing underlying market practices manifest in the new, high-speed environment, and how compliance departments should monitor them.

HFT is not necessarily the culprit; market structure must also be questioned.   High frequency trading shops often act as de-facto market makers. During the flash crash some HFT’s algorithms sensed a problem and pulled out.  If HFT's have replaced traditional market makers, why have the market making obligations not carried over?  And should they?  Now we must ask who - if anyone - should have an obligation to stay in the game when things go wrong, and the eventual answer will change market participants’ business models.

Human beings continue to possess attributes that computers cannot. But the human intelligence to slow things down in times of stress, or provide real liquidity in a two-sided market - not just volume - is a decision that can be automated. This is necessary, in fact, because humans can't step in fast enough in today's hyper-speed markets. Therefore, financial organizations have no choice but to use technology and applications that ensure compliance, though not at the expense of efficient trading operations. This kind of technology enables firms to be compliant in new ways, including transparency and reporting.

The ability to detect abuse and operational errors in real time, along with the flexibility to modify scenarios in response to new conditions, while staying ahead as regulations change, differentiates a broker competitively. The buy side wants safety in the marketplace, and it is up to the sell side to make sure their buy side customers feel secure.

New regulations bring new headaches to organisations as they have to add or change both applications and operations to comply. Having the ability to sense threats, and to respond in real-time, is just the compliance “price of entry” to the market today.  Being able to comply with new mandates quickly is the differentiator, and there will be no shortage of surprises in store as the regulatory trains rumble towards an unknown destination. 

-Dan

 

 

Friday, June 03, 2011

Using technology to prepare for regulatory change: how can market surveillance technologies help?

Posted by Richard Bentley

Richard BentleyBecoming and remaining compliant is a key consideration for brokers and exchanges, especially in a time of regulatory change. It frequently makes the top of the list in surveys on their primary concerns, which is unsurprising given the current confusion surrounding financial regulation.

In this video our experts comment on how technology can be used to help the trading community prepare for upcoming changes to specific regulations, and the overall regulatory approach. We speak to:

These experts give their views on how market surveillance and monitoring tools might be able to help market participants as they prepare for change.

Wednesday, June 01, 2011

All Aboard: New Regulations Take Many Tracks

Posted by Dan Hubscher

The regulatory trains in Europe and the US have left their respective stations and are headed down the tracks, but they will change tracks many times along the route before reaching their destination. Thick tomes of proposed operating rules have to be interpreted even as interested financial services parties line up to persuade regulators to change tracks (in order to accommodate their particular demands). Passengers should be prepared for delays.

The significant regulatory rethink in Europe on two levels - derivatives and MiFID II, combined with the slow-drip interpretation of US Dodd-Frank rules are leading to a thick “London Fog” on both sides of the pond.  While some market participants are wanting to act but experiencing confusion and misunderstanding, others are quite clear in their approach to the unknown – wait and see.  From banks to brokers and funds to financial advisors, everyone is looking for clarity.

What we know so far is that both regions want to move as much OTC trading as possible onto clearing platforms; and both support setting position limits by trader type to try and spot speculative activity. The US and the UK support splitting banking activities from speculative, or proprietary, trading. The US, UK and EU all seem agreed that hedge funds should at least be registered. All are under short deadlines to implement new rules.  Some deadlines from the Dodd-Frank Act are slipping, while others remain intact.  And MiFID II’s draft publication is scheduled for July.

There is an additional kink in the UK's track, where there is an impression of a regulatory void now that the Financial Services Authority is being broken up

While the US and Europe hurry to regulate the rest of the world has to scurry to catch up. Until the G20's plans are in place in late 2012 there is a lack of harmony - a global regulatory framework that is full of holes and pitfalls. Regulatory arbitrage is a hot topic and has already begun with the shift of trading personnel to more lightly regulated areas. Transparency is not well served by disparate regulatory frameworks.

The ultimate goal for regulators has to be visibility; the ability to see across geographies, asset classes, exchanges and market participants. Cross border trading is a reality and problems can happen - as we’ve seen - so regulators do need to cooperate, just as we are already seeing with the US and UK.

Market participants cannot really afford to wait for regulatory harmony, however, nor can they wait for local regulatory clarity to satisfy their own need for visibility. Hot button issues such high frequency trading, algorithmic trading, dark pools and flash crashes (or splash crashes) may all be clarified in due course. But likely some issues will remain open for a long time to come.  Regardless, firms need to move forward now, carefully of course, in order to move smoothly into compliance.

Despite all the noise to do with algo and high frequency trading, the changes that regulators and exchanges are making are to try and better contain HFT issues, not to take HFT away.   How trading is conducted and governed may change, but liquidity, reduced spreads, and lowered trading costs need to stay.

Using surveillance and monitoring technology alongside HFT will not entirely prevent flash crashes or fat fingers, but it will go a long way toward helping you to protect yourself when these things happen. If you can sense problems and protect yourself when something untoward occurs, you won't get caught in a 'deer in the headlights' moment. 

Don't be the guy standing on the track when the train comes along. The 'deer in the headlights' will not win against the barrelling train. Be the guy (or the deer) who heard the whistle and got safely out of the way. 

-Dan