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April 2010

Tuesday, April 27, 2010

Monitoring and surveillance: the route to market transparency

Posted by Giles Nelson

Again this week, capital markets is under the spotlight, with the SEC and Goldman standoff. Just a few weeks ago, the FSA and UK Serious Organised Crime Agency were making multiple arrests for insider trading. Earlier this year Credit Suisse were fined by the New York Stock Exchange for one of their algorithmic trading strategies damaging the market. Still, electronic trading topics such as dark pools, high frequency trading are being widely debated. The whole capital markets industry is under scrutiny like never before.

Technology can't solve all these problems, but one thing it can do is to help give much more market transparency. We're of the view that to restore confidence in capital markets, organisations involved in trading need to have a much more accurate, real-time view on what's going on. In this way, issues can be prevented or at least identified much more quickly.  I talked about this recently to the Financial Times, here

Last week at the Tradetech conference in London, Progress announced its release of a second generation Market Monitoring and Surveillance Solution Accelerator. This is aimed at trading organisations who want to monitor trading behaviour, whether to ensure compliance with risk limits for example, or to spot abusive patterns of trading behaviour. Brokers, exchanges and regulators are particularly relevant, but buy-side organisations can also benefit from it. Previously this solution accelerator just used Apama. Now it's been extended to use our Responsive Business Process (RPM) suite, which includes not only Apama, but Savvion Business Process Management, which extends the accelerator to give it powerful alert and case management capabilities. We know that monitoring and surveillance in capital markets is important now, and believe it will become more so, which is exactly why we've invested in building out product. You can read the take on this from the financial services analyst Adam Honore here and more from Progress about the accelerator and RPM. A video on the surveillance accelerator is here

As all this is so relevant at the moment and Tradetech is the largest trading event of its kind in Europe (although very equity focused), we thought we'd conduct some research with the participants. We got exactly 100 responses on one day (which made calculating the percentages rather a breeze) to a survey which asked about attitudes to European regulation, high frequency and algorithmic trading and dark pools. Some of the responses relating to market monitoring and surveillance are worth stating here. 75% of respondents agreed to the premise that creating more transparency with real-time trading monitoring systems was preferable to the introduction of new rules and regulations. 65% of respondents believe that European regulators should be sharing equity trading information in real-time. And more than half believe that their own organisation would support regulators having open, real-time access to information about the firm's trading activity. To me, that's a pretty strong sign that the industry wants to open up, rather than be subjected to draconian new rules.

There will be substantial changes to the European equity trading landscape in the coming year. There will be post MiFID regulation change by the European Commission acting on recommendations by the Committee of European Securities Regulators who are taking industry evidence at the moment. Their mantra, as chanted last week, is "transparency, transparency, transparency". Let's hope that this transparency argument is expressed in opening up markets to more monitoring rather than taking a, perhaps politically expedient, route of outlawing certain practices and restricting others.

Wednesday, April 21, 2010

Observations from Tradetech 2010

Posted by Giles Nelson

Day one of Tradetech Europe 2010 has nearly finished. I won't be here tomorrow, so here are some thoughts and take-aways from today's event.

It's fair to say that Tradetech is the premier European equities trading and technology event, and thus very relevant for Progress' business in capital markets, particularly customers using Apama. Progress has a substantial presence as always. It's a good event to meet brokers, hedge funds, exchanges and pretty much every one within the industry. Lots of old friends are here every year. Regarding the event itself, it's pretty well attended considering the recent issues with volcanic ash. It usually takes place in Paris, but I'm sure the organisers were pleased that they chose London this year as the London contingent was able to attend without disruption.

This years big theme really seems to be market structure and regulation. In the third year after MiFID, an event which brought competition into European equity markets, and after the credit crunch, issues about how the market is working, the influence of alternative venues such as dark pool,  and how high-frequency trading is affecting the market are issues front of mind.

What's interesting is how some things stay the same. Richard Balarkas, old Tradetech hand and CEO of Instinet Europe, talked about trading liberalisation in the late 19th and early 20th century. Then, vested interests were complaining about the rise of "bucket shops", giving access to trading on the Chicago Board of Trade via telegraph to people that wouldn't previously have traded. In the view of some at the time, this lead to speculation and "gambling". Regulators were wrestling at the time with the fact that only 1% of CBOT trades resulted in actual delivery of goods - the rest were purely financial transactions and therefore arguably speculative. This reminds me of some of the current debate around the "social usefullness" of high frequency trading which is going on now.

European equities trading has changed a lot. Vodafone, a UK listed stock, has now only about 30% of its average European daily volume traded on the London Stock Exchange (LSE). The rest is traded on alternative trading venues across Europe. However, Xavier Rolet, CEO of the LSE, believes that there's a long way to go. He stated  that "the European equities market remains anaemic when compared to the US". Volumes, adjusted for relative market capitalisation, are about 15% of that in the US.

Regulation of European markets is a thorny issue. Regulation is fragmented, together with the market itself. CESR - the Committee of European Securities Regulators, the nearest Europe has to a single regulator - is taking evidence on a whole range of issues and will recommend a set of reforms to the European Commission in July this year. These recommendations will relate to post-trade transparency and information quality and enhanced information about systematic internalisers and broker crossing systems. CESR is also looking at other issues such as algorithmic trading and co-location. Legislation will follow towards the end of 2010.

Equity markets are in a sensitive place. There's still more deregulation to do, more competition to be encouraged and yet, with sentiment as it is, regulators may decide to introduce more rules and regulations to prevent this taking place. The CESR proposals will be about "transparency, transparency, transparency" - as part of this we believe that more real-time market monitoring and surveillance by all participants is key to bringing back confidence in the markets and ensuring that draconian rules don't have to be introduced.

Emerging markets were talked about in one session, and Cathryn Lyall from BM&FBovespa in the UK, talked about Brazil in particular. We've seen Brazil become a pretty significant market recently. Not only have demand grown for all Progress products substantially but Apama is now being used by 18 clients for algorithmic trading of both equities and derivatives. Brazil is the gorilla in the Latin American region. It accounts for 90% of cash equities and 95% of derivatives business in Latin America. 90% of Brazilian trading is on exchange. Brazil emerged largely unscathed from the credit crunch and it's taken only 2-3 years to achieve the level of trading infrastructure that took perhaps 10-15 years to evolve in the US and Europe. More still needs to happen. Although the regulatory regime has an enviable reputation, it is moving slowly. Concerns regarding naked and sponsored access are holding up liberalisation that would lead to DMA and co-located access to the equities market, something which is place already for derivatives.

So, that's what I saw as highlights from the day. Tradetech seems, still, to be the place the whole industry gathers.

Tuesday, April 20, 2010

Predictions for increased transparency in Capital Markets

Posted by Giles Nelson

  It is my view that one of the most significant causes of the global financial crisis was a lack of transparency in financial markets.  Put simply, that means no one, not regulators or market participants, knew what the size of certain derivatives markets (like credit default swaps) was, who held what positions, or what the consequences of holding positions could be.  If financial reform brings nothing else, it should at least hold banks accountable for the business they conduct, and that means full disclosure and constant monitoring by responsible regulators.  

This action would help provide the basis for preventing future crises. No matter how inventive financial products may become, if regulators have complete and detailed information about financial markets and banks’ activities there, better assessments of risk can be made. This means that if necessary, banks’ activities can be reigned in through higher capital requirements or similar measures.  Simply limiting banks’ ability to conduct certain business is a blunt instrument that does not resolve the lack of transparency and likely will hamper economic growth.

Market transparency exhibits itself in many forms. Particularly relevant is that related to electronic trading. Therefore, I predict that regulators will require banks to implement relevant stronger pre-trade risk mechanisms. Regulators, such as the FSA & SEC, will ultimately bring in new rules to mitigate against, for example, the risk of algorithms ‘going mad’. This is exemplified by Credit Suisse, which was fined $150,000 by the NYSE earlier this year for “failing to adequately supervise development, deployment and operation of proprietary algorithms.”

Furthermore, volumes traded via high frequency trading will increase, although at a much slower pace than last year, and at the same time the emotive debates about high frequency trading creating a two-tier system and an unfair market will die down.

In addition, with regards to mid market MiFID monitoring, greater responsibility for compliance will be extended from exchanges to the banks themselves. Banks and brokers will soon be mandated to implement more trade monitoring and surveillance technology. There will also be no leeway on Dark Pools; they just simply have to change and be mandated to show they have adequate surveillance processes and technology in place. They will also have to expose more pricing information to the market and regulators.

This year will see a definite shift to an increasingly transparent – and therefore improved – working environment within capital markets. The ongoing development of market surveillance technologies and changes in attitudes to compliance will drive this forward, creating a more open and fairer marketplace for all.