A last look at Last Look? Barclays and FX market structure

Brad Baliey

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Nov 23rd, 2015

The FX market is trying to digest the latest large FX fine and the impact on market structure. According to last week’s press release from the New York Department of Financial Services (NYDFS), Barclays was fined US$150 million for “automated, electronic foreign exchange trading misconduct.” The order goes on to detail this additional fine is a result of using its Last Look system to automatically reject what Barclays determined would be an unprofitable trade within the time window created by the system’s defined Last Look window. This brings foreign exchange fines by NYDFS against Barclays to $635 million.

After spending time this weekend reading the order, it is clear that the issue at hand is not a Last Look issue, but rather improper customer notification and trading practice. In this case, Barclays was abusing both the intent and scope of Last Look.

While Last Look gets a lot of discussion recently, it is a byproduct of market making in principal markets, such as FX and fixed income from a pre-electronic age, and the translation of those markets into electronic trading. As FX became more electronic, the European banks were early innovators in mapping principal trading functionality into electronic trading. In the case of FX, it became necessary to create a means to quote to thousands of customers through various channels (i.e. single dealer portals, multi dealer platforms, aggregated feed channels) at acceptable bid/ask spreads. Given that there are different types of clients, it is necessary to be able to quote different types of clients with very different risk profiles, technology ability, and holding time frames in different ways. A liquidity provider looks at an HFT counterparty much differently than a large asset manager putting on a hedging FX trade.

Last Look is not inherently a bad practice, but it is a practice that when performed needs to be clearly mapped out to users of a platform. Platforms that incorporate Last Look functionality will be ensuring that guidelines are clear, functionality is sound, and procedures are well documented.

In an OTC principal market, liquidity provision is not free. In the current FX market structure, Last Look is a necessary tool for many liquidity providers. Over time Last Look will become a less important component of FX trading. It is not clear that can be regulated away without disrupting the ability of market makers to provide liquidity in the current market structure, and given the global nature of FX. At the same time, concerns around Last Look are changing the calculus of liquidity between disclosed liquidity and anonymous liquidity.

In my latest report FX Trading 2.0: Technology and Platforms, I explore the evolution of FX and how the market will incorporate all the forces at play. In many ways, after building on incremental change over decades, the FX landscape has shifted abruptly recently. The venue landscape has brought together once disparate centers of liquidity within the same firms. From the perspective of identifying the ideal venue to interact with, the landscape has become more challenging. Many of the FX platforms are separate or partially separate pools of liquidity within the same firm.

Asian post-trade landscape: CCPs, CSDs aiming for global standards

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Nov 20th, 2015

The Asian financial services market is highly fragmented along national boundaries. Lack of unified political will has resulted in regulatory and market practices that vary widely among the countries. The trading landscape in the Asian countries has undergone radical transformation in the last 10 to 15 years. As the countries in the region slowly open up their economies to the outside world, investors from the developed economies have flocked to emerging Asian countries in search of higher returns and portfolio diversification needs. This has resulted in expansion of products and asset classes. Electronification of trading activities has resulted in growing demand for electronic trading tools and ever-lower latency. Consequently, trading activity is high in the Asian countries; in fact many of them rank highly in the world in terms of equity trading volume at their exchanges as well as in exchange traded and over the counter derivative turnover.

Continuous evolution in the trading landscape necessitates changes in the value chain, namely the post-trade functions. Post-trade functionalities generally include clearing, settlement, and custody services that are served by central counterparty clearing houses (CCPs), central securities depositories (CSDs), and custodians. The CCPs and CSDs are fundamental in ensuring smooth, efficient, and stable operations of trading markets. Historically post-trade industry has not received adequate attention, but that is changing now due to greater regulatory focus on managing risks at systemically important institutions. In a recent report we discuss the trends and developments taking place among Asia’s CCPs and CSDs. Some of the highlights from the report include:

  • There is a great deal of “vertical integration” in the Asian post-trade industry, with exchanges holding majority stakes in most CCPs and many CSDs. There is also a trend toward “horizontal integration” among the Asian post-trade players with growing coverage of products and asset classes.
  • Asian regulators have traditionally taken a conservative approach in shaping their financial markets. Therefore since the crisis of 2008, risk management has emerged as the single most important item on the regulators’ agenda. This has brought greater attention to policies and practices at the CCPs and CSDs.
  • Liberalization of Asian economies is creating opportunities for trading and clearing new products and asset classes. The post-trade players are developing capabilities and infrastructure to support new products.
  • Almost every Asian country is mandating central clearing of OTC derivatives and reporting of trades. Incumbent national CCPs are called upon to facilitate central clearing of OTC derivatives.
  • There is not much competition in the Asian post-trade industry, and except in a few markets that is likely to be so going forward.
  • Most Asian post-trade players, particularly the CCPs, are undertaking major technology transformation initiatives spanning years and spending significant resources to upgrade and overhaul their systems and processes.

Find out more about this report here.

Intra-IDB part II: The ICAP to eCAP deal

Brad Baliey

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Nov 11th, 2015

Where there is smoke there is fire and the proposed outline for a deal which I discussed in my blog this weekend was announced today.  Long time rivals  in the inter dealer broker (IDB) space Tullett Prebon and ICAP are coming together with Tullett buying ICAP in an all-stock deal.

Tullett will now be the 800 lb. gorilla of voice brokering, with about 1500 ICAP brokers  going to Tullett as part of the deal as well as another 1000 employees. The deal will also include certain electronic assets like  ICAP’s 40.2% ownership in iSwap (IRS) , certain JVs and as well as the not clearly defined information services revenue.

The details of the deal terms, economics and structuring are discussed in the press release and the analyst presentation. I will focus on certain key points of the deal looking at the ICAP side.

ICAP has followed a strategy of acquiring growth and putting together an impressive portfolio of front to back  technology assets. Historically, its main challenge in maintaining the voice business was not only the lower margins, and slowing environment for many of the products traded  but the internal competition between its voice and electronic channels. The electronic businesses have not grown as they should, had this internal friction not been present. This is the case across asset classes.

But, as they say, better late than never, and ICAP is on the road to becoming a different company. The new ICAP (let’s call it eCAP) will include:
• FX venue EBS and the related EBS businesses
• Treasury exchange BrokerTec
• Post-trade and processing companies TriOptima and Traiana which serve across asset classes with a focus on FX, rates and credit
• FinTech incubator Euclid which has been active in making strategic bets for the firm
• Tullett will have the right to the ICAP name

What is not entirely clear at this point is what “information services” will remain with eCAP. Given the importance of market data, a detailed understanding of the  value of  eCAP will be a function of whether certain market data assets like data from EBS and BrokerTec will remain with eCAP.

Furthermore, it will be interesting to see if the eCAP has the right to compete in interest rate swaps, or what its plans will be to develop an electronic platform for IRS given the loss of iSwap. I would imagine, given the importance of interest rate swaps in the rate world that the new firm will want to have a robust offering in this area.

In sum,  eCAP will be a lean technology, execution, venue, tools, pricing, and analytics company. Of course, eCAP will still have a vested interested in the voice business as it will hold about 20% of the newly issued Tullett stock.




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Intra-inter dealer broker deal: facing the future

Brad Baliey

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Nov 9th, 2015

Speculation reached the point Friday afternoon such that a press release came out regarding the discussions of two major brokers. ICAP and Tullett Prebon, two of the largest inter dealer brokers (IDBs) announced that they were in advanced discussions; it appears ICAP is poised to sell its voice brokering businesses and certain electronic platforms to Tullett.

On first blush, it looks as though ICAP will be shedding its voice brokering businesses and certain e-platforms; while maintaining such platforms as EBS and Broker Tec (FX and Treasuries) as well as other platform assets, ancillary businesses around these platforms (such as data and analytics), as well as ICAP’s extensive post-trade infrastructure.

Friday’s press release detailed the assets that would be part of the transaction. In summary:
• ICAP’s three regionally managed voice broking businesses in EMEA, the Americas and Asia Pacific (1,458 voice brokers);
• (“APAC”), including all e-trading products and services developed by ICAP’s e-Commerce team (including Fusion and Scrapbook) (together “Global Broking”);
• ICAP’s 40.23% economic interest in iSwap, a global electronic trading platform for EUR, USD, GBP and AUD IRS;
• Revenues and operating profits from sales of information services products directly attributable to Global Brokering and iSwap; and,
• Certain JVs and investments.

IDBs have struggled in the post-crisis world to deal with the changing dynamics of regulation, the nature of their place in the market and lower volumes. Furthermore, MiFID II is on the horizon in Europe and will further change the competitive nature of the IDB space. More importantly, in many cases, IDBs have struggled for years with the right formula to develop electronic distribution and sales channels without cannibalizing their core voice businesses.

The pressure on the IDB community has been immense. ICAP now has an opportunity to focus on an electronic future, across assets, from font to back office.  ICAP, with holdings across markets will now be a considerably leaner technology company. It will be able to serve its traditional dealer clients as well as other businesses in the changing capital market world.

It is very likely in the next day, with the confirmation of a deal, ICAP will be beginning a path toward being a very different, technology and processing based company.

As a final note, it will be interesting to see if there are any other competitors, on the side-lines, who will be positioned to step-in and change the final parameters, or even players in the deal (as was the case with BGC/Cantor in the GFI Group deal).

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FinTech and Mexico – could we see a Unicorn arise from Guadalajara?

David Easthope

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Nov 3rd, 2015

I recently moderated a FinTech panel at a conference hosted by AMEXCAP in San Francisco. AMEXCAP currently represents 59 venture capital/private equity firms that actively invest in Mexico. The event showed that Mexico is advancing relative to Brazil with respect to providing favorable conditions for FinTech entrepreneurship (internet penetration above 50M as one of those conditions). In Mexico, FinTech capital mostly flows from established VCs, but this is starting to evolve.

The FinTech ecosystem has been evolving and maturing in Latin America for the last three years or so, mainly due to the effort of some participants including Celent, to connect all key players of the ecosystem.We believe is essential to work in an ecosystem, a network of participants, regardless of the geographic location in Latin America. The sustained and increasing development in the region requires the existence of this ecosystem.

In the USA where there are geographical pockets of Innovation, such as Silicon Valley, that brings the actors together based on proximity, nothing exactly like this exists in Latin America. However, Guadalajara is emerging as a place that might create more density of entrepreneurship as established tech players are there, such as IBM, and entrepreneurs are increasingly choosing to locate there. For example, a crowdfunding platform called PitchBull decided to locate Mexican operations in Guadalajara.

Technology allows business to be conceived locally, nationally, regionally, and internationally, and therefor provide the scale needed for a FinTech player to build from Mexico to beyond.

Will Mexico specialize its FinTech around issues specific to Mexico, such as low bank account penetration, a lack of quality credit card data relevant to car issuers, and a mostly cash economy? Perhaps a FinTech unicorn can arise from Mexico based on solving for these unique business conditions.

Launch of Luminex shows competitive market structure of US equities

Brad Baliey

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Nov 2nd, 2015

The launch for trading this week of  Luminex is another example of the creative forces that come to light in the competitive and open market structure of US equities. Luminex will create an entirely dark, non-quoted, market protocol for real money buyside institutions. This has been described by some as as an exclusive club, but so what?

The Luminex ATS is owned by a consortium of buy side firms: Blackrock, BNY Mellon, Capital Group, Fidelity, Invesco, J.P. Morgan Asset Management, MFS Investment Management, State Street Global Advisor, and T.Rowe Price.  The platform will begin trading this week with seventy three institutions with a minimum AUM threshold of 1 billion dollars. In aggregate, between the consortium owners and the other members of the ATS represent nearly 65% of US fund assets under management.

The firm will be run as a not-for-profit with a low cost structure. The market protocol is completely dark, and non-quoted. Furthermore, it will run as entirely closed system, with no ability to route orders from within Luminex.

The fabric of integrated venues-exchanges, ECNs, ATSs, internalization engines that make up the U.S. equity markets create an environment that offers tremendous choice for investors and traders of all stripes.  From the smallest retail clients, offered the key to this entire lattice at the cheapest and quickest executions ever through the wholesale market, to  the largest financial institutions, who can create a venue that meets their needs-moving natural size,  minimizing market impact and information leakage.

Luminex is a powerful example of innovation in a market that fosters (perhaps forces) innovation. It will be an example of what a buy side consortium can create in an equity market with an already existing diverse means of accessing liquidity. Furthermore, it can set the tone, and structure for the evolution of other buy side consortia in asset classes with less diverse liquidity choices than US equities, and where access to liquidity remains an ongoing challenge, such as in fixed income.

Whether another purely dark venue, with no incentivized intermediaries can gain noticeable market share, is always an open question. Low match rates are typical of a venue of this sort- but the users of the platform represent such a large chunk of assets under management and resident, natural liquidity is so great within the subscriber firms. It will be interesting to see the results of trading with this network and the market protocol.


ICE ices other exchanges in picking up major market data provider

Brad Baliey

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Oct 26th, 2015

Intercontinental Exchange (ICE) has agreed to buy market data provider Interactive Data Corporation (IDC) from its private equity owners for $5.2 billion in cash and stock from Silver Lake and Warburg Incus.

Bringing together a large exchange complex like ICE and approximately the third largest provider of market data is a very interesting merger, but ultimately makes a lot of sense. The need for market data is increasing across asset classes, and this is a particularly good fit for ICE given that it trades in so many of the commodity, equity and fixed income products.

The synergies for an exchange in acquiring a major market data is strategically logical as exchanges rely more and more on market data in their revenue models.

One area given the strength ICE has in credit brokerage and clearing, and the increased move to electronic trading across fixed income products, is the IDC continuous pricing tool which is becoming an important part of the means of pricing bonds in an increasingly electronic world.

Challenging times for the post-trade industry: improving efficiency and achieving stability amidst growing complexity

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Oct 22nd, 2015

The challenges facing the CCPs and CSDs are manifold. Not only are they having to adapt to the downstream effects of changes in the trading environment, they are also presented with unique challenges impacting their business and operating models. Celent just published a research study titled “Challenging Times for the Post-Trade Industry: Improving Efficiency and Achieving Stability Amidst Growing Complexity” analyzing the global, regional, and local developments impacting the CCPs and CSDs.

The changing regulatory environment is the dominant force impacting post-trade industry players. Several key regulations such as Dodd-Frank, Basel III, CRD IV, MiFID II, EMIR, CSD Regulations, and AIFMD are having impact on the way CCPs and CSDs perform. At times there is a lack of clarity and co-ordination among regulators in different jurisdictions; this results in lack of synchronization and standardization of some of the key regulations, creating confusion and making the job of responding to the changes difficult for industry participants.

In addition to regulatory changes, market structure related changes  (such as T2S in Europe and shortening of settlement cycle across the world) are having significant impact on post-trade players. Though not traditionally very competitive, the post-trade industry is likely to become more competitive. Europe is leading the way in this regard, with CCP interoperability already in place and T2S and CSDR likely to do the same among the CSDs. Learning from the European example, other markets are considering introduction of competition in their CCP space by allowing international players in domestic markets. Post-trade players have been laggards compared to other parts of the capital market value chain when it comes to adoption of technology. Driven by regulatory and market forces, as well as emerging concerns around cybersecurity, they are now undergoing major reviews and upgrades in their technology and operations.

We identified 12 key markets across the globe for this analysis including the US, UK, Germany, Czech Republic, Japan, Australia, Hong Kong, China, India, Brazil, Mexico, and Chile. This research is part of Celent’s ongoing coverage of the post-trade industry and was commissioned by Nasdaq , while Celent kept full editorial control. To complement Celent’s post-trade knowledge base from our existing and ongoing research, this research greatly benefitted from detailed discussions with representatives from 17 major industry participants representing different types and categories of players across the world. Find out more about the report at Celent or Nasdaq’s website.

MiFID II, multi-asset trading among key themes at Fixed Income Leaders Summit

Brad Baliey

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Oct 19th, 2015

Several key themes emerged from the sessions at the Fixed Income Leaders Summit last week in Barcelona. Below are the two of the major themes:

Regulation – MiFIR/MiFID II dominated the agenda
Following last month’s RTS release, most people wanted details on the impact to their business, likelihood of changes to the ESMA document and if there will be a push back to the January 2017 start.

  • While European sell side and large buy side have been engaged in varying degrees with the process, US firms and smaller European buy side firms are still not clear that Europe is boiling the ocean with MiFIR/MiFID II.
  • It was clear that buy side preparation for engaging with the evolving execution space OTF/MTS/RM and SI is extremely low. And of course, the reasons are clear—there is a fundamental lack of clarity on expectations to operate in the new regime as well as the actual timing when these requirements will be manifest.
  • While the debate to finalize and accept the RTS proposal from ESMA occurs, there is tremendous confusion on final requirements. Without a delay to the January 2017 implementation, the longer the debate, potentially the less time firms will have to prepare and implement to the final required state.
  • The top concern that the buy side had was the fear that their traditional market making liquidity providers will exit the credit and rates markets and the liquidity from alternative providers,and in platforms, will not be sufficient to satisfy their trading needs.

Multi-Asset Trading
Most buy side firms are looking to leverage the best tools that exist from other asset classes into their daily workflows in fixed income products. While all were cognizant of the deep differences between equities, FX and the fixed income universe, the buy side was engaged in discussions on the details of the regulatory, market structure, liquidity, and technology challenges; and clearly were looking for multi-asset solutions for fixed income connectivity, analysis and TCA.

  • Firms were deeply engaged in discussions that shed light on the process that other asset classes went through, and how that process played out. There is a great deal of trying to understand the context of the MiFIR/MiFID II change with lessons from other recent regulatory changes. There was a strong desire to understand the implications of Regulation NMS on US equities and the respective market structure, fragmentation and technology implications. Likewise, MiFID I and the SEF rules in the US and the move to centrally cleared swaps and derivatives in the US was another area that was discussed to glean lessons for changes that might come to Europe.
  • Europe is boiling the ocean in fixed income with MiFID II and firms are trying to understand the myriad changes, the timing of change, and the many complicated means of judging the type of rules that will apply in government and corporate bonds.

When it comes to RIA growth, all is not what it seems

Will Trout

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Oct 16th, 2015

The continued accrual of AUM by the RIA channel masks some hard truths. First, the success of the independent advisor industry remains very much linked to the failures of the traditional brokerage model. Registered reps continue to flee an environment they see as oppressive and poorly aligned to client interests. Second, while robos are not yet taking much business from RIAs, they are exerting pressure on fees. The emergence of RIA roll ups like HighTower speaks to a much needed focus on scale.

Sure, there will always be the man-and-a-dog shop with its loyal clientele. The most skilled and strategic advisors still can name their price, with value add services like financial planning and wealth transfer commanding a premium.

That said, it won’t be long before the investments-focused customer resists paying his human advisor for much beyond running the machines. Sound futuristic? Well, it’s what many advisors do today: they use an algorithm to generate an asset allocation based on client goals, followed by a yearly check in. The real wonder is that clients pay 1% for this kind of hand-holding.