Regulators to end ASX’s clearing monopoly

Regulators to end ASX’s clearing monopoly

In an interesting development Australian authorities are looking to end Australian Stock Exchange’s (ASX) monopoly on equity clearing and relaxing ownership restrictions that removes a potential hurdle to the ASX’s participation in overseas mergers. First, some background: Australia for long was like many other Asian markets with a single incumbent national exchange that is vertically integrated carrying out clearing and settlement activity. Departing from other Asian market practices, regulators introduced competition in the local exchange space by allowing a foreign player Chi-X, which entered the market in 2011 and quickly took significant share away from ASX. However, clearing of trades, including those conducted at Chi-X, was still conducted by ASX as it was the only clearing agency in the country.

Chi-X has been complaining for some time that this situation gives ASX unfair advantage and possibly creates conflicts of interest in that Chi-X has to depend on its competitor for clearing of its own trades. They have therefore called for introducing competition in the clearing space to mitigate the situation, bring down clearing fees, and accelerate innovation. ASX has cut clearing fees in the past, and again indicated that it would further cut fees by 10% from July, 2016. It has also argued that the Australian clearing market size is not big enough to make multiple clearing houses viable.

While the new changes indeed pave the way for newer players to enter, whether and when that materializes would be interesting to see. The Financial Times observes that these changes are “unlikely to result in the establishment of a rival clearing house in the near future”, but will “create a regulatory framework that gives competition authorities the power to arbitrate disputes about access by rivals to the ASX’s clearing and settlement services.” It may be noted that competition in the OTC clearing space was introduced a while back and LCH.Clearnet has already entered and captured significant market share. Merger with an overseas player, in spite of the rule changes, may not be easy. In Asia, the issue of national pride associated with national entities such as exchanges is a particularly important factor, and can make mergers and acquisition by foreign entities tricky, as was seen in Singapore Exchange’s failed bid to acquire ASX previously.

ASX on its part has been active in upgrading its technology and systems to stay abreast with international best practices and ahead of potential competition. In some cases it is taking the lead in the industry and looking to build innovative solutions that could transform trade processing operations. It would be interesting to observe how these initiatives shape up and what impact these changes have on the Australian and global exchange landscape.

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

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

Nasdaq’s vision for Blockchain

Nasdaq’s vision for Blockchain
Nasdaq has recently one become of the first leading capital market firms to consider the use of Blockchain and Bitcoin technology. It plans to use the technology in its private markets platform to begin with, with the possibility of using it in its clearing houses and CSDs at a later date. In some ways, this is the most significant commitment any large financial market firm has made to adopting Blockchain. Even more interesting is the manner in which Nasdaq has gone about the process. It has made one of its VPs an evangelist of the platform, with a strategic mandate. This is an interesting example of a tech-savvy firm utilizing an innovative approach to encourage and advocate for what it sees as the next big wave of change in the financial markets. However, the open architecture of Blockchain technology and the difficulty in controlling the kind of transactions that could happen through it make it complex to use, and there are some resultant security concerns as well, which is why large banks are normally reluctant to adopt such a technology. So the industry would have to put checks in place before there can be widespread adoption of Blockchain in capital markets. There are already some existing provisions with Blockchain to address these requirements, and we can expect more effort in this regard as time goes on.

On the cusp: regional integration in Asia

On the cusp: regional integration in Asia
It’s 2015, the mid-point of the decade and a good time to start looking at major trends in Asian financial services over the next five to ten years. One of the major themes will be regional integration, which is another way of saying the development of cross-border markets. There are at least two important threads here: the ongoing internationalization of China’s currency, and the development of the ASEAN Economic Community (AEC) in Southeast Asia. RMB internalization is really about the loosening of China’s capital controls and its full-fledged integration into the world economy. And everyone seems to want a piece of this action, including near neighbors such as Singapore who are vying with Hong Kong to be the world’s financial gateway to China. The AEC is well on its way to becoming a reality in 2015, with far-reaching trade agreements designed to facilitate cross-border expansion of dozens of services industries, including financial sectors. While AEC is not grabbing global headlines the way China does, we see increasing interest in Southeast Asia among our FSI and technology vendor clients. From Celent’s point of view, both trends will open significant opportunities across financial services. In banking, common payments platforms and cross-border clearing. In capital markets, cross-border trading platforms for listed and even OTC products. In insurance, the continued development of regional markets. Financial institutions will be challenged to create new business models and technology strategies to extract the opportunities offered by regional integration. It’s the mid-point of the decade, and the beginning of something very big.

Buy side insight for Fixed Income platforms

Buy side insight for Fixed Income platforms
Time keeps becoming scarcer and we all become more selective on what conference we will attend or speak at. But yesterday, as I was by chance in Paris, I dropped by one of the potentially nth conference on fixed income, and was presently surprised by the value of its content. Congrats to Trading Screen for pulling it off. Let me share with you a few takeaways, mainly from a great buy side panel: 1) One of the buy sides (whom we all know are the ones calling the shots nowadays) summarized his selection process for choosing a new trading platform as follows: i) Who owns the platform? A bank (negative points) or a vendor (positive points if strong balance sheet). I would add exchanges (they are neutral) and interdealer brokers (for whom it is one of the only options to remain in business) to that list, but the latter will have a challenge at connecting all the buy side. I have an open question here: why wouldn’t the big buy side invest together in a platform they believe in with Equity so that they can reap the benefits of the success they will bring to it as the banks did with Tradeweb?Aren’t they in the business of investing? ii) Buy side is not an option: if the buy side doesn’t all connect together in an automated way, the success rate of the platform will be low. (c.f. who’s calling the shots). iii) The need for an independent clearing agent from ownership and/or for the functionality to choose one’s own clearing agent. Here I actually pushed the question further as a big custodian is currently rumored to be the clearing agent of a MD2C platform’s new product: should custodians be involved, should they become agent brokers since they have the assets of the AMs (and a clean balance sheet, may I add?), or be a platform? Some people in the audience laughed at that one, pretty sad considering what some of the big global custodians have in pipe, let’s assume these were brokers who have never taken the time to understand what happens “post” trade… thankfully at least two of the big buy sides in the panel actually got my point: there could be room for some innovative matching engine to team up with custodians (Algomi?). See last year’s Celent report: Innovation in Focus: The Analytics Powering Fixed Income Matching for a comparison of the functionalities of the new matching vendors. iv) Flexibility of interactivity: the buy side has to be able to choose to interact only with each other, to exclude toxic flow, to include some banks, etc. Everyday potentially in different ways. So just a switch functionality for the other side of the trade. Some new platforms thankfully already have that in their rule book/functionalities such as Bondcube or TradeCross (Trading Screen’s 2.0 version of Galaxy). In our report we actually had mentioned the “selective multicast” capability of Baymarkets for banks to select what prices to send to what client in cascades; this is an interesting adaptation for the buy side to select who to send what interest or order or request for quote to whom in cascade or not. 2) Another point that was made was that there is no first mover advantage, this is taking time to pick up as AMs are adapting to change and regulations on transparency is not final: I could not agree more as we have been having these discussions for the past 3-4 years non-stop, and the number of professionals buy and sell side interested keeps increasing. Still, at some point the big AMs will have to jump on one ship as the cost of illiquidity is becoming too expensive for their funds’ performance (nice presentation on that from an AM quant). 3) Last but not least is the cost of connectivity to all of these platforms‎, apart from the time spent to connect to them (and to convince senior management to connect to them?). This has to be corroborated also by the lack of screen space available for new entrants, the need to come in via other or incumbent screens maybe? Or via a web browser? 4) Last interesting point which is an idea we have been pushing out at Celent for a while: the buy-side could go directly to the issuers: yes, and they already do actually, for big infrastructure projects or issues whereby they already have a relationship with the issue. A platform with both and no brokers, banks to build the book and syndicate and sustain the price? CSDs and iCSDs have a role to play here: such a platform could work with Dutch auctions or even normal auction process, but it would work more in the interest of the smaller buy side than the big ones obviously, creating a level playing field… hence hard to make it pick up… SMEs and small institutions could meet on P2P lending platforms through aggregators of interest such as Orchard though. More in an upcoming report on these… As for TradeCross‎, I still need to get a demo but we already know that it will be All-to-All (but in the flexible way mentioned above, not our old definition with CLOB and level playing field), anonymous, an MTF, trading with all-in price (commission), interest and orders, multiple trading models (did they mean protocols?), spread or price or yield trading and with a web browser if need be. No go live date as of yet.

Fixed Income transparency is taking centre stage in Europe

Fixed Income transparency is taking centre stage in Europe
Two weeks ago at the Afme (Association for Financial Markets in Europe) conference in London, Fixed Income finally took centre stage! After years of talking about Equities, ATS then MTF, the rise and fall of hedge funds, high frequency trading and MiFID, maybe a little help from the financial crisis and thereafter (or was it before?) from regulators with MiFID2, Basel3, Solvency2 and the proposed Volcker rule there is finally enough meat on the table to have a full meal, even for our great financial champions. Extremely high quality of speakers, extremely high quality of panels, extremely high quality of attendance, but what struck me most was that we have to watch this space: competition could be heating up… It all started in 2010 when the Cassiopeia Committee, supported by the French ministry of Finance and Economy, sent out an open request for information (why not a request for proposal?) for an electronic institutional European corporate bond trading MTF, together with a set of extremely detailed guidelines on how to do it best according to them, including an all-to-all platform (meaning open to buy and sell-side members), order-book and CCP. Three proposals for new projects were made, one by NyseEuronext, one by MTS, and one by TradingScreen (another one, they realised, already existed for retail, EuroTLX) and there was no winner because this was not a competition. In Italy, when MiFID was transposed by legislative decree into Italian law, the way Fixed Income assets became traded was no different than the way Equities were traded. In fact, now Italian retail liquidity in Fixed Income is fragmented between one exchange (Borsa Italiana), four MTFs (amongst which EuroTLX) and seventeen internalizers. And to guarantee best execution in Fixed Income some Italian brokers route orders to the venue where liquidity and the best price are and enable asset managers to rebalance their portfolios through DMA systems. Of course this is not institutional flow, it is retail (roughly €50k). It probably is impossible to see such a model being extended to institutional sizes. In European Fixed Income historically most institutional trades were done over-the-counter with a bilateral agreement. There was no order-book, no clearing house, not even commissions, banks still today get paid with a piece of the bid-ask spread they quote to the buy-side. How could you expect a Fixed Income trader to price €50k or €20M with the same spread since if they do not get paid a commission proportional to the size of the trade? But transparency is a goal many European asset managers are aiming for and if they already get some pre and/or post-trade data from brokers or electronic platforms such as MarketAxess, or Tradeweb, there is no consolidated tape or TRACE-like data in Europe yet. Hopefully regulators will find a public or private provider for a European Tape, and MiFID2 will impose new and more stringent reporting rules that will not hinder liquidity or reduce trade sizes as some argue. Liquidity is also not comparable between Equities and Fixed Income: there are many more securities (just think of the Nestlé stock just being one and its numerous sister bonds with many different structures, coupons and maturities) and only 3-5% of them are actually liquid. Typically they trade right after the issuance, but then die away, except for unforeseen events such as downgrades. We have seen a lot of these recently in European govies but it has also meant that European corporate bonds’ liquidity has dried up. Will this change with MiFID2? To me the fact that some of the new electronic institutional fixed income platforms have pricings based on commissions and order-books is a clear push towards transparency. It looks like current market players are also preparing for MiFID2. Bloomberg for example, could in time become an OTF with firm prices for the buy-side; Vega-Chi, will be offering not only convertible bonds but also financials and high yield European bonds to the buy-side; UBS PIN-FI, already offers a wholesale platform for the buy-side with firm prices next to its retail odd-lot business. How many more of these projects are in the pipeline? The story does not say however how, post MiFID2, buy or sell-side firms will have to go through the headache of having to decide to which platform they are going to have to link up to guarantee best execution to a pension fund or insurance client, and how to integrate it best with risk management systems, and how much it will cost in terms of resources and money… We all know how much traders like to work on such operational projects, let alone the traders of the asset managers… And… Did I mention that most of these traders do not have an order management system (OMS) or execution management system (EMS) to route liquidity to the best platforms or trading venues? Because, remember, this is not Equity, it’s Fixed Income, traders actually do have to stream liquidity themselves because rarely here do they find firm orders, they’re mostly looking at Requests for Quotes (RFQs) that still have to be negotiated. I think I have a topic for my next research… To be continued!

SEFCON II thoughts

SEFCON II thoughts
I attended SEFCON II, the second annual conference on SEFs (swap execution facilities), market structure and technology in New York on Monday. SEFs are venues where much OTC derivatives execution activity will migrate due to the Dodd-Frank Act (DFA). A number of my conclusions: 1) For many IDBs (inter-dealer brokers), becoming a SEF will largely be a re-classification of the hybrid business model they already pursue, but with meaningful investment in connectivity to CCPs and other trading partners. DFA builds some barriers to entry for these players in terms of up-front investment. 2) The issue of whether voice matching will be allowed off-SEF for certain swaps and without a requisite number of RFQs (request for quotes) is probably where the biggest disagreement between policy makers and market participants presently resides. Many in the industry believe that regulators are overstating the benefits of pre-trade transparency while not disputing electronic capture of acitvity post-trade. To put it another way, one SEFCON participant said “without the exception for voice trading, it will kill liquidity in size [for certain swaps]” 3) There will be an impact of DFA on SEF activity outside the US 4) Many platforms such as Tradeweb are already seeing increased volumes 5) Timing is in dispute, but the consensus seems to be that the clearing mandate will be implemented in 2Q 2012 6) One question hanging in the air is: what will the regulators do with all the data without significant investments in “Big data” know-how? Implications: What is apparent is that while brokers continue to invest in the SEF opportunity from a revenue perspective and for ultimate compliance, there is an understanding that the eventual rules and models may change, so actual best practices may (and most likely will) be different from what we envision in 2011. Flexibility in design is very important for brokers and vendors when they invest in IT solutions without a clear picturre. In other words, build adaptable frameworks, design highly configurable solutions and workflow, and adopt existing standards as much as possible to be efficient.

Final SIBOS thoughts- providing more clarity on OTC derivatives reform

Final SIBOS thoughts- providing more clarity on OTC derivatives reform
After a few days, it is clear that despite the flurry of activity in Toronto that much remains to be done for the global securities industry for a return to ‘normalcy’, if it can be done at all. From the Celent S&I practice perspective, the tone overall at SIBOS was one of subdued concern mixed with pessimism regarding the global economic situation and proposed legislation, including Dodd Frank and EMIR (OTC derivatives reform). Firms are looking for a firm foundation upon which to stand. Because the market is so unpredictable, it is difficult to envision scenarios where brokerage operations, clearing institutions, market infrastructure, transactional banks, and IT vendors can grow and increase market share. As a result of this difficulty in seeing into the future, an upcoming capital markets report will analyze and assess Dodd-Frank and EMIR in the area of OTC derivatives reform. We will lay out the most plausible scenarios, determine which is the most likely scenario, and build out a number of implications from the IT perspective. We hope that this will give clients firmer ground upon which to stand as they seek support and budget to purchase new IT solutions, develop new features and modules, set up new business ventures and challenge competitors with greater optimism. Stay posted.

SIBOS Wrap up- More short-termism than long-termism

SIBOS Wrap up- More short-termism than long-termism
For the S&I team, SIBOS was a whirlwind of activity and it was nice having it in Toronto- not too far. While I will summarize my thoughts from the conference next week, it was quite eerie timing to have so much market turbulence as we were discussing regulatory reform, derivatives trading and market structure developments and the latest in GUIs, widgets and other tools for back and middle office operations. Even as I left SIBOS and walked a few blocks into a meeting with the Toronto Stock Exchange I caught a glimpse of the global market carnage. Clearly, there is much change coming for the industry and we have to consider that even as we detect and analyze long term trends and evaluate the minutia of vendor offerings, near-term inflection points can disrupt planning and move things in a new direction