DOL or DOA? The Election and the Conflict of Interest Rule

It’s one of those watershed moments. Clinton wins, and the Department of Labor (DoL) conflict of interest rule takes hold and likely gets extended beyond retirement products to all types of investments. Trump wins, and DoL gets slowed down and perhaps even rolled back.

Assuming Clinton wins (which appears likely) firms will need to gear up on three fronts:

  • Platform: DoL makes paramount the ability to deliver consistent advice across digital and face to face channels. Such consistency requires a clear view of client assets held in house, which in turn implies eliminating legacy product stacks and their underlying technology silos, as I note in a recent report.
  • Product: Offering only proprietary products only is a non-starter under DoL. But too much product choice can be as bad as too little. Firms must demonstrate why programs and portfolios offered are the best for each particular client.
  • Proposition: In a best interest world, the client proposition must extend beyond price. Client education, transparent performance reporting and fee structures, as well as an easy to use digital experience, will distinguish stand outs from the broadly compliant pack.

None of the pain points above lend themselves to easy solutions. As such, the banks and brokerages most affected by DoL are struggling to develop processes that go beyond exemption compliance. I’ll discuss more comprehensive approaches in the All Hands on Deck: Technology's Role in the Scramble to Comply with the DOL Fiduciary Rule  webinar I’m co-hosting this November 14.

I hope you will join me for the webinar, and in the meantime, you will share your thoughts and comments on this post.

Human and Machine-Rise of the Cyborg: The Cycle of Voice Trading

Celent has explored voice trading in Human & Machine-Rise of the Cyborg: The Cycle of Voice Trading, published yesterday. In this piece, we look at the power of voice trading as well as the business drivers, challenges and forces that are driving change in voice communication, collaboration and voice market engagement.

Celent believes that voice is a key channel that will remain relevant and will work more seamlessly with electronic and data channels in the coming years. A move toward unified communication approach and advances in technologies, combined with a challenging business environment, are reshaping the modern trading desk. Cost cutting, front office effectiveness, gleaning better insight into customer behaviour combined with digital automation are pushing this frontier forward. Voice trading remains the major channel for transferring risk, across asset classes, yet remains a challenge due to the difficulties in leveraging this unstructured data set.

Advances in both preparing and leveraging data for advanced analytics are creating a demand for business insights-the demand for better data is ever growing. Firms are beginning to leverage advanced data tools for not only risk mitigation and regulatory requirements, but are creating front office opportunities for better counterparty engagement and communication.

Fintech continues to advance in the capital markets and the implications are profound for incumbent players. Firms that effectively leverage the full spectrum of innovation available are becoming more streamlined and more effective. The overarching need for business model evolution and the importance of technology in the markets continues to ramp up. As one example,last week alternative dealer Citadel Securities hired Microsoft COO to be the new CEO of it electronic market making business.

We are surrounded by advances in voice technology for interacting with machines in our life in general. We are getting comfortable with Apple’s Siri on mobile, and Amazon's Echo in our homes. Similar technologies have advanced in areas outside the capital markets, but leading firms are trying to leverage voice data for better insight, engagement, and automation. While we are nowhere near Robotic Stingray Powered by Heart Cells from Rats published in last week’s WSJ, in merging machine and biological elements we are heading more into an era of the cyborg-where capital market participants will increase their direct engagement with machines via voice interaction.

Post-Brexit questions loom over Europe

The post-Brexit environment is still quite hazy, but the politicians and regulators in the EU are trying to lay markers for future discussions and negotiations. There have been several comments that betray a fear of further demands for exits from  the EU by the politicians and citizens of other countries that have high levels of Euro-scepticism, such as the Netherlands, France and Greece. 
The French president recently stated that clearing for Euro-denominated securities would no longer happen in London and this "could serve as a lesson" to those who are questioning the need for the EU. Strong words indeed for a market that currently gets jittery at the drop of a hat. In a similar move, the president of the German financial regulator, BaFin, has  also expressed doubts on the possibility of the LSE-DB merger if the resultant entity is based in London. The exchanges themselves have mentioned their intention to go on inspite of the added complexity due to Brexit, but I am sure they are keeping an eye on the political headwinds that are developing around them.
On their part, the British politicians and regulators are trying to calm the markets down and lull them into believing that little has changed in the aftermath of Brexit. The desire to delay invoking Article 50 to officially confirm UK's demand for exit is an example of this strategy, although EU leaders are opposed to this move. The claim by the politicans who supported Leave that there would not be any major and immediate economic or financial change after the referendum is another attempt of this nature.
While both these parties would probably be interested in discussing the issues that have arisen behind closed doors, in public they have to make the right noises to ensure damage control. There is also anger and resentment in the EU at the UK's decision and this shows from time to time in some of the comments. The German Chancellor Angela Merkel has a very balanced attitude to Brexit, but she has also conceded that the UK cannot enjoy access to the EU single market the same way as it did earlier, something that was suggested by Boris Johnson. There is a genuine concern in the EU to prevent cherry-picking in this regard. 
The various questions that have arisen post-Brexit will take a while to be answered. But what is clear is that there is going to be a significant parting of ways and the separation is going to be less than amicable, at least in public. For capital market professionals, in this landscape the discussion ends up being about political rather than economic or financial issues, in spite of trying otherwise. The latter have to take a backseat at time like this and this might continue for the weeks and months to come.

To Brexit and beyond!

So the Brexit has finally happened. The equity, forex and bond markets are still reeling from the news, the volatility probably caused as much by the fact that Brexit was unexpected as of yesterday night in the UK as by the event itself.
While the overall impact will reveal itself over the next several years, in the next few months the capital markets would have to deal with issues such as the future of the LSE-DB merger. Does it make sense anymore, and if yes, how do the two parties proceed? One would expect that now there would be political pressure to ensure that trading and jobs do not move away from either London or Frankfurt. Keeping all stakeholders happy would be a more complicated affair, although it could still be done.
EU wide market infrastructure regulations such as T2S and MiFID II would also now be seen in a new light. London was seen as the financial capital of Europe. The EU would now have to proceed with these significant changes at a time when the UK is preparing to exit, and is weighing its options in terms of how best to deal with the rest of Europe. It could take a middle ground as Switzerland has taken, or position itself even further away with more legal and policy independence but less overlap with the European capital markets.
In an earlier blog that considered the possibility of Brexit, I stated that technologically this might be the best time for an event such as the Brexit. Technology is more advanced and we are better connected than ever before across nations and continents. However, undoubtedly there will still be significant impact from an economic, financial and demographic point of view. As always, there will be winners and losers. As a neutral, one hopes that the people in the UK are able to achieve the goals they had envisioned in making this decision.

French effort to use Blockchain for SMEs could have relevance for emerging markets

The recent news that a French consortium is beginning work on building post-trade infrastructure for trading of SME stocks in Europe will be of great interest to market participants across the world. The consortium comprises of BNP Paribas Securities Services, Euronext, Société Générale, Caisse des Dépôts, Euroclear, S2iEM and Paris Europlace.

There have been several notable developments with regard to experiments and adoption of Blockchain and distributed ledger technology in the leading capital markets globally. However, the signficance of this particular announcement lies in the fact that it tries to address the needs of the a sector that usually struggles to obtain easy access to the capital markets. If successful, such a project could drastically reduce the time taken for post-trade operations, slash costs and generally make it easier for SMEs to raise funds.

In a recent Celent report, we had found that most of the leading global post-trade providers believed that it was still a little early to expect major changes due to Blockchain technology. While this may be true, the current development would be of a lot of interest to the emerging markets around the world. In several such countries, the cost of accessing capital markets is comparatively high and the technology is also often found lagging, as in the case of European SMEs. If the French effort becomes successful, it could pave the way for application of Blockchain technology to specific tasks in emerging markets, not just to enable SMEs to raise capital better, but to help the overall market to leapfrog in terms of modernizing the market infrastructure.

Regulators and market participants in emerging markets should now see Blockchain and distributed ledger technology as a relevant means for streamlining their trading infrastructure. To that end, it is also important that they encourage firms within their jurisdiction to experiment and adopt such technology for specific local applications and requirements, and not just wait to see how it evolves in mature markets in the next few years. 

Canada experiments with putting fiat currency on Blockchain

In keeping with the recent focus on Canada in the wealth management blogs, I would like to make note of a significant piece of news with regard to Blockchain and distributed ledger technology. For some time, the use of fiat currency on the blockchain has been touted as a necessary step for the development of distributed ledger technology. While central banks in the UK and the US have taken the lead in discussions on this matter in the past, the Canadian central bank, Bank of Canada, has recently revealed that it is planning to experiment with the use of fiat currency on blockchain. It will use blockchain technology developed by the well-known R3 consortium for interbank payments, involving some of the leading commercial banks in Canada. While this is more of an evolutionary step than a revolutionary one, it shows the growing willingness of central banks to take Blockchain seriously. If the experiment does prove successful, the possibility of interbank payments using Blockchain in a real-life scenario is quite likely. Even though the use of such technology by retail customers in this context is still someway off, Blockchain proponents would realise the significance of this announcement. It should also encourage further innovation within the sector. 

Keeping up with the Canadians

In my last blog post I described the challenge posed by robo-advisors to the bank dominated wealth management industry in Canada. Here I share observations from my recent report, Thawing Market, The Growth of Robo Advice in Canada, while exploring the implications for other markets as well.

The robo advisory business in Canada lags several years behind its US counterpart, but in terms of learnings and understanding, it is catching up fast. This trajectory reflects the natural development of the robo learning curve as well as economic, regulatory and demographic factors common to Canada and other developed markets. These include a low interest rate environment; a graying population and regulator umbrage towards practices that long have defined the wealth management business.

The Regulators Are Talking to Each Other

Let’s start with the regulators, who are clearly are speaking to each other across borders. In the English speaking world alone, the UK and Australia have banned commissions, while Canada and the US have essentially gelded them.

Directives aimed at conflicts of interest and revenue sharing represent a worldwide tailwind for passive instruments (such as ETFs) and the robo advisors that offer them. In Canada, the high fees charged by active mutual funds have battered those older and affluent investors least able to afford them.

The interest rate starved Canadian banking sector, which accounts for a large part of mutual fund sales, can no longer count on the willingness of consumers to pay 200 plus basis points for a fund. Like the citizens of the defunct East Germany, they’ve looked over the proverbial Wall and seen a better way.   

Small but Mighty

In dollar terms, the robo advisory business in Canada is miniscule. But the modest scale of the business belies a complexity of outlooks and approach.

Canadian regulation presumes portfolio oversight by a real life human being. In practice, this means communication from a dedicated advisor to confirm the suitability of the client portfolio, and to ensure the client understands the risks. While communication can be as basic as an email, it appears that advisors will soon be required to pick up the phone and call their clients, or at least those populations (such as the 65+) in need of more tactile support.

All It Takes Is a Phone Call

This requirement represents an alternative to the binary lens through which US automated advisors have played the market. Their worldview has been black and white (i.e., the advisor-assisted “hybrid” model versus “digital only”) and their messaging shrill if not patronizing (“investors need the guidance of an advisor”). Pure play robos have also become more dogmatic. Remember when Wealthfront used to talk about its brainy investment committee led by Burton Malkiel? This message has since been subordinated to talk of APIs and algos.                                                

Instead of using the concept of human engagement (or lack thereof) as a litmus test, or as a cudgel to bash other models, maybe US automated advisor could acknowledge the robo shades in between black and white? The Canadians, in their temperate and accommodating way, appear to be doing just that.

Is this the best time for an event such as Brexit?

It is difficult to read financial news at present without coming across extensive coverage of the Brexit referendum in the UK and its possible impact. As part of the financial sector, capital markets could be at the forefront in terms of bearing the impact of any likely change. There are already widespread claims of how London could lose its position as the premier European financial center. Of special relevance is the advantage that London has due to the 'passporting' principle, which allows leading U.S. or Asian banks and other firms to access the Europan market without any restrictions. Certainly with regard to these firms, if the UK leaves the EU, US and Asian banks that have based their teams in London while serving the European market will have second thoughts about doing so. Different alternatives have been touted, including Paris, Frankfurt and even Dublin. Some believe that all of these cities, and some other European financial centers as well, would benefit from the departure of the leading global banks from London, but this could lead to fragmentation in the European financial industry and reduce the effectiveness and competitiveness of European firms. 
There are various views and opinions that have been expressed during the run-up to the referendum. Many of these hold water. But in my humble view, when it comes to competitiveness, if the departure of the UK from the EU does lead to a fragmentation of the European financial industry, then this is the best time for it to happen. Technology has today advanced to a level that to an outsider, there would be little tangible difference if a thousand people in a bank are based across four difference financial centers in Europe instead of being in one place they were earlier, namely, London. There would certainly be a one-off rise in cost due to such as move, but the industry should be able to take that in its stride. Furthermore, a more fragmented industry in Europe would also have the ability to address national and regional requirements better than a single leading financial center. So financial creativity and innovation might get a boost across Europe. One would expect that London would continue to be a leading financial center globally, but it might be forced to reinvent itself to continue to be relevant for global banks and financial firms from outside the UK. Therefore, as a neutral and a student of capital market technology trends, Brexit does not necessarily hold many fears and might even lead to some interesting outcomes. Whether people in the City of London or the rest of the UK or indeed Europe have the same view, is of course, another matter!

Is exchange consolidation desirable for global markets?

The CEO of Deutsche Börse made some very interesting remarks at the recent IDX derivatives industry conference in London. He argued that the proposed merger between Deutsche Börse and LSE would aid the development of trading in global markets because it would unite and harmonize the European capital markets, which are more fragmented than those in the US and Asia according to him. However, in this author's view, the merger of two large global exchanges raises as many questions as it answers. While one can agree that there would be less fragmentation and more harmonization, the main issue is whether the European market has a high level of fragmentation when compared with its global counterparts. Due to the European Union, European capital markets are much less fragmented than the Asia-Pacific, Middle-East and Africa, and Latin America. There has been a great degree of harmonization over the years, driven both by common regulation and industry mergers & takeovers. It is difficult to argue that there is a pressing need for more integration at this point. Instead, the main argument for the merger of LSE and Deutsche Börse is the fact that it would create a larger exchange that would be able to take on the likes of CME, Nasdaq and some of the leading Asian exchanges more easily. The expected reduction in headcount would also make for a more efficient, streamlined, and competitive exchange. But there are concerns that remain from an antitrust point of view and it is quite likely the Deutsche Börse CEO was trying to assuage these when he spoke about the positive effect of such a merger on global markets. If the merger does go ahead with regulatory approval, the advantage for other leading exchanges would be the higher possibility of such mergers and takeovers being approved in the future as well, since these could well be expected in an industry that is undergoing heavy consolidation due to economic and technological factors.

Benchmark manipulation and market surveillance

The CFTC has recently revealed the instant messages written by Citigroup traders related to benchmark manipulation. Having recently published a report on Market Surveillance industry trends and soon to publish another one on the leading vendors, this seemed quite relevant. Current surveillance systems, be it for trade or communications surveillance, use the latest technology to capture possible instances of market abuse or manipulation. The capabilities are far beyond what was available a few years ago, and are holistic and comprehensive in nature. But in the end, the system is only as good as the people using it. The recent revelations have put a question mark over not just the traders involved in the benchmark manipulation scandal, but also the management of some of the leading institutions. Some firms are now going to great lengths to monitor their traders, but this is not an end in itself. The industry culture has to be transformed. The next instance of manipulation will not be in the same place and firms would have to overcome the motivation to profit in order to ensure compliance. The rise in the levels of regulation in the last few years probably would play the part of a positive reinforcer in the decision-making process and help influence industry culture, but is not a guarantor of propriety.