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.

The battle for the soul of exchange-based equity trading?

The recent statements by Nasdaq regarding the possible use of a trading delay by the proposed IEX Exchange puts the spotlight on a battle for supremacy not just between rival exchanges, but very different philosophies regarding what the ultimate role of exchanges in the global capital markets should be. The established exchanges, willingly or unwillingly, represent the status quo in terms of how exchanges should function. IEX on the other hand hopes to represent the interests of those trading participants who believe that they have been left behind in the race for speed in today's capital markets, especially the retail participants and the smaller buyside. It seems like an inevitable outcome in the aftermath of the global financial crisis, which has stoked the debate on economic inequality and the unfair advantage that a select group of trading participants have over others due to their advanced technological capabilities and use of highly sophisticated financial products. 
Getting back to the objections raised by Nasdaq over the SEC proposal that any delay of less than a millisecond could qualify as immediate, which would enable IEX to operate in the way it wants, there is certainly some substance in Nasdaq's argument. The SEC would have to come up with a solution that is acceptable to both sides, and does not leave it vulnerable to legal challenges. It is going to be an interesting couple of months for industry obervers as they follow the debate over the fairness and validity of the SEC proposal, and the decision on the IEX application.

Citadel Securities and the changing market microstructure

The recent purchase by Citadel Securities of the assets of Citigroup's Automated Trading Desk business has further cemented Citadel's position as a leading market-maker. It follows closely on the heels of Citadel's acquisition of KCG Holdings' designated market maker business at the NYSE. Citadel has also been performing strongly in the swap markets in the US, specifically the swap execution facilities (SEF). It has built a reputation for reliability in difficult market conditions, at a time when broker-dealers are finding it difficult to maintain their market presence.

While the success of Citadel is noteworthy, it represents significant industry and regulatory undercurrents. Investment banks have labored under tougher market conditions and stronger regulatory restrictions. Firms such as Citadel have benefitted as they are not as tightly regulated as the banks. While this trend had been predicted in the years immediately after financial crisis, it is interesting to see the predictions coming to bear. The effect on the market structure has also been profound, and while many of the relevant developments have taken place in the US, other leading capital markets should also see similar changes in the near future due to similar economic and regulatory evolution. Investment banks will continue to narrow their focus in terms of their capital market presence, and we expect the leading ones to carve out specific niches instead ofmaintaining the comprehensive presence they had in the last decade.

From the buyside's point of view, while the lower presence of investment banks could indicate lower volumes and liquidity, it also represents a market in which there might be greater responsiveness to the needs of medium and smaller sized buyside firms.

Moving towards a more stable and healthier OTC derivatives market

The Bank for International Settlements (BIS) recently reported that there was a decline in the cost of replacing outstanding OTC derivatives, the first since the financial crisis. There was a similar decline in the gross notional amount outstanding as well. While this indicates the tough regulatory regimes worldwide in the aftermath of the crisis, it also a sign of a healthier and more resilient OTC derivatives market. Due to the rising regulation-related costs of trading, market participants are looking to make their OTC derivatives trading more efficient. Tools such as trade compression and collateral optimization are being used for this purpose. So the decline in outstanding is also an indication of more efficient trading due to compression. Another sign of the efforts to reduce systemic risk is the rise in volumes of OTC derivatives that are being centrally cleared. The greater use of clearing houses is something that regulators have been espousing for some time, and an approach that most market participants and observers agree with. Besides the internal factors, external economic ones such as interest rates and exchange rates also explain some of the decline in value of OTC derviatives trading. Again, these are a sign of market fluctuations and do not necessarily represent any market decline. In our view, the BIS numbers are indicative of both the changes that regulators have put in place over the last 7-8 years and of a global economy that is still recovering from the financial crisis and the following economic challenges.

Regulation and market surveillance: Challenging times for capital market firms

The recent resignation of the head of the integrity committee at Deutsche Bank has highlighted the complexity around the handling of regulatory requirements, and fines related to Benchmark Manipulation. Firms are struggling to find the right balance between putting checks and balances in place on the one hand and being able to keep the costs of implementing new processes and systems under control on the other. There is also the need to ensure that the surveillance capabilities of capital market participants, trading venues and regulators are able to deal with the possibility of market abuse and manipulation in the future. Regulations such as the upcoming Market Abuse Regulation (MAR) in Europe are placing a lot of emphasis on the intent of traders when it comes to analysing any suspected rogue activity. Surveillance systems need to overlay order and trade data with the related electronic and voice communication in a cross-asset, cross-market context. This is a tricky task at the best of times. To provide some insight into the recent industry trends and updates to the products of the leading vendors, Celent is coming out with a two report series on the topic in the month of May. The first report will look at the recent market trends, while the second one will discuss the updates to vendor products in the last year and the areas in which future development is expected to take place. This research builds upon our four report series from 2015.

MiFID II and you – here before you know it

A brief review indicates that ESMA has given more clarity on its view of fixed income trading in the post-MiFID II world. We are now one step closer to a new world of secondary trading in European bonds. In the context of the heated debate around liquidity in fixed income recently ESMA has moved to an approach that looks at each bond to determine the liquidity thresholds and hence the exact nature of the required pre- and post-trading transparency. ESMA will be looking at 100,000 Euro thresholds with at least two trades occurring daily in at least 80% of trading sessions. Hence, a certain proportion of European bonds will become subject to a wholly new regime of trading-scheduled for January 2017 if there are not additional delays to the start of MiFID II. Bringing a new level of transparency to the pre- and post-trading of fixed income products, in conjunction with the myriad other touch points of MiFID II, will stretch the resources of most financial market participants. While firms have been preparing for some time, there are different degrees of readiness.  For most firms,  the next year will be huge effort, to get ready for this new trading regime.

Celent roundtable in Zurich: Swiss banking plus a dash of fintech

Audience Swiss banking may be at a crossroads, but the Celent Swiss Banking 2025 roundtable in Zurich revealed decided optimism among participants. The 15 attendees ranged from senior representatives of global and Swiss banks to the heads of advisory firms and leaders of the Swiss and German stock exchanges. A consensus view was that the increased use of digital technology will help Swiss banking reconcile traditional values of stability and discretion with the need for transparency and scale. While the industry faces ongoing regulatory and compliance demands as well as overcapacity issues, automation offers a way to counteract the inevitable compression of fee structures. Several robo advisory vehicles are already up and running in Switzerland, with even the most traditional firms seeking to rationalize their service models. The private, invitation-only event was part of a series of targeted roundtables offered by Celent’s Securities & Investments Practice, such as a session delivered last year in London. The success of the inaugural Zurich event speaks to future sessions in Switzerland and elsewhere in Europe designed to provide thought leadership and engage senior level audiences around key issues. “Events like these offer a forum for thought leadership that seldom can be replicated elsewhere,” said Research Director Brad Bailey, who led a lively discussion around liquidity in capital markets.

The future is here

The pressures are well known in banking and the capital markets. Each month there are front page articles of scaling back, overhauling, reorganizing, or closing major bank lines. A continued reworking, a forging of a new business is occurring. Old models are shrinking and being replaced by new business models or being cast aside. Since the 2008 crisis, wave after wave of pressure has made this perfectly clear. Capital constraints, on-going regulatory pressures, and an ultra-low interest rate environment have all struck hard at the existing banking & broker/dealer system. Nearly all players-big and small- are rethinking the very core of their businesses. And this is a multi-threaded problem across all businesses: equities, FX, fixed income, and derivatives. Banks and broker/dealers are trying to balance their existing franchises against the pressures they are facing to create a lean profitable business that supports their clients. There are no easy answers, given the strong interdependence between the wealth, asset management, and capital markets businesses across all products. Many of the solutions are moving from efficiency, or cost-cutting to effectiveness. Costs are being cut-there are improvements in risk, compliance, processing. The cost side is getting better but the challenge remains on the revenue side. This drive for effectiveness is driving business models that support internal and external clients from a compliance, transparency, regulatory, fairness and cost perspective are driving more automation and electronic trading solutions. Celent will be discussing the evolving landscape of innovation in automation and technology at two upcoming roundtables. On September 15th in London we will be looking at changes in the US and European fixed income markets and how new technologies are driving change. Then on September 22nd in Zurich, we will be looking at wealth management and the capital markets and the many changes that are occurring in Swiss banking.

De-accumulation: why automated advice delivery makes sense

In my last post, I rap the DoL and other regulatory bodies for focusing on accumulation at the expense of the payout function. The result of this imbalance has been to help blind retirement savers to the risks of running out of money. But it’s not just regulators at fault. Part of the “payout problem” revolves around how the advisor gets paid. Namely, what advisor wants to help draw down client assets when his fee is based on AUM? Some advisors are getting around this conflict or disincentive by working on retainer. But automated delivery of advice (whether via “robo advice” or a hybrid model) represents a cleaner (and ultimately more equitable) solution, in that it allows for low cost, transparent and scalable client servicing. What’s more, the efficiencies inherent to the automated advice model are amplified by actuarial considerations. Today, the post retirement period can last 40 years, in many cases longer than a career. With a three or four decade service runway, the advisor can earn good money (even at reduced fee levels) while building relationships with successive generations. It’s an arrangement that works for all sides.

In the fiduciary fight, key players are biting off as much as they can chew

In my last post, I note the acceleration of Department of Labor (DoL) efforts to bring greater transparency to the DC business. The latest guidance from DoL attempts to boost clarity around sponsor obligations pursuant to the sale of annuities. This guidance is important because to date, regulatory attention has fallen disproportionately on the accumulation side of the DC business. Helping participants to successfully manage the payout function is a noble and (as I discuss in my recent report on de-accumulation) challenging goal. Time is of the essence if the US is to forestall a doomsday scenario of retirees outliving their savings. At the same time, it is important to keep in mind that economics are not the only consideration driving the DoL push. Rather, the newfound urgency underscores the Department’s desire to put its imprimatur on an issue that is being tackled by multiple actors (e.g. Treasury; the SEC, which announced last month its compliance-focused ReTIRE Initiative; and lobbying groups such as SIFMA and NAIFA) and from multiple standpoints. In particular, a torrent of litigation (the capstone of which was the Tibble vs. Edison verdict) appears to be shifting decision power to the courts. Legal actions are also shining a spotlight on fees. This presents a cart-before-the-horse problem for DoL, in that excessive fees are an issue that a uniform fiduciary standard is supposed to address. Having assumed the mantle of defined contribution crusader, the DoL risks falling behind events.  The pressure on DoL will only become more acute as we enter the twilight of the Obama administration. The upshot? Look for a wave of bulletins and other forms of guidance from the DoL, particularly in the wake of the upcoming August hearings. While the fiduciary debate to date has gotten less attention than it deserves, it will rise to the top of the political agenda this fall, despite resistance from industry lobbyists. Indeed, given the weight of the government and private sector entities (among them the AARP) behind reform efforts , the end result may actually have teeth.