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

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?

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.

Citadel Securities and the changing market microstructure

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.

Volcker Rule compliance and expected impact

Volcker Rule compliance and expected impact
The compliance date of July 21 for the Volcker Rule is almost upon us. The broad aim of the regulation is to curtail the speculative trading of banks and there are several important aspects of the rule related to including controls on proprietary trading, emphasis on liquidity planning, limits on investment in covered funds and so on. Among the various areas related to the rule, the last aspect relating to the limits on investment in covered funds is possibly the greatest challenge, since it relates to banks’ investments in tens of thousands of securities and funds. This can be a significant operational hurdle in terms of identification of covered funds and divestment from these. On the whole, the big banks are fairly well prepared to deal with the deadline but the regulation is expected to be difficult to comply with for mid and small sized banks as these have fewer resources to deal with such requirements. Some vendors have introduced automated tools to help banks meet Volcker Rule requirements for covered funds, but not all banks would be able to use such platforms or automate their processes sufficiently on their own. Overall, the regulatory measure  is expected to reduce the overall liquidity in the markets. Once implemented, we can expect to have a more controlled approach to trading from market participants. The markets might well be safer after all these changes, but to some extent these will come at the expense of trading volumes and profitability.

Fixed income markets and ‘self-trading’

Fixed income markets and ‘self-trading’
The interesting insights from a recent regulatory report into the operation of the US fixed income market on October 15 2014 continue to intrigue observers and raise important questions about how the market trades. A remarkable point referred to the high proportion of ‘self-trading’ between mainly prop traders’ own automated systems. This was 14.9% for the 10-year cash Treasuries and 11.5% for the futures equivalent. While this might not have been the leading reason for the high levels of volatility on that day, it is certainly an attribute that requires careful attention. Logically speaking, such self-trading can lead to artificial market levels and prices that are quite different from what they would be without high levels of self-trading. Price volatility can also be affected by high proportion of self-trading. Prop traders often have several independent algorithms running in the market and therefore are more liable to be affected by this phenomenon. The regulators’ report also noted how other participants such as banks and hedge funds did not have much self-trading. While the jury is still out on the undesirable effects of self-trading, and how responsible it was for any price swings, we can agree that it cannot really be desirable for the markets. Some exchanges and trading firms have already taken steps to curb such trading, but it is important that the firms that are more susceptible to undertake such trades try to stamp them out on their own, even if it means slowing their trading a little for the sake of reducing lower systemic risk overall.

Regulating HFT in US Fixed Income markets

Regulating HFT in US Fixed Income markets
The recent report by the US regulators on the high levels of volatility in US treasury market on October 15 last year has raised almost as many questions as it has answered, not necessarily because it is controversial, but because this is an area that required greater attention from both regulators and market participants. This report can be seen as a part of an on-going process in the industry to improve its capabilities to handle the advanced technology being used for trading today. One of the recommendations of the report was to have new registration requirements for automated traders. In a market where most leading participants and new tech-savvy entrants are using advanced high frequency trading technology, mere registration would not deter or suffice. The emphasis should be on revamping the risk management protocols and the regulators’ risk management and surveillance systems. The regulators also touch upon these issues in their report when they stress that there were a number of factors at play in the wild swing on October 15. Hence, it is important to focus on this aspect than create deterrents for new or innovative market participants.

Post-trade and the clouds over Europe

Post-trade and the clouds over Europe
Europe has been dealing lately with all the issues around the Greek debt and the possibility of a “Grexit”. While the final decision on the matter would have its significant repercussions, the uncertainty that has come with the problem in the last few months is also expected to have its own associated costs. It could also impact the long-term competitiveness of the region vis-à-vis its competitors in the US and Asia-Pacific. When we focus specifically on the capital market issues. there are several significant regulatory changes happening in the European capital markets at this point in time. EMIR, Mifid II, Basel III, T2S and CSDR are all regulations at various stages of implementation. From a post-trade point of view, several of these regulations are expected to have significant impact, especially when we talk about T2S and CSDR. However, the continuing concern over regulatory implementation in Europe is that the delay and uncertainty over when the regulations come into effect could prove costly for the region overall. An example is the delay by European Securities and Markets Authority (ESMA) in providing the draft technical standards. Similarly, the recent decision by Monte Titoli to delay joining the T2S, at least for a few months has proven to be a setback for the project, considering it was easily the largest CSD to participate in the first phase and would have been instrumental in measuring the effectiveness and success of the implementation. There is a lot of ground that the regulators and industry are trying to cover in an economy that is still suffering from the after-shocks of the financial crisis. While trying to do everything in a hurry isn’t the answer, it is important to ensure that the deadlines are kept as much as possible, otherwise on-going delays will directly impact European market’s competitiveness.

OTC derivatives regulations in US and Europe

OTC derivatives regulations in US and Europe
There has been an ongoing dialogue for some time now between the European capital markets regulator European Securities and Markets Authority (ESMA) and the Commodity Futures Trading Commission (CFTC) of the US regarding the requirements for clearing of OTC derivatives. In the opinion of market participants, the lack of agreement, over issues such as margin requirements and the period for which a transaction can be considered to be at risk, is highly detrimental to the efficient functioning of the global capital markets. The evidence has also shown that increasingly there are two separate pools of liquidity operating in the US and European markets respectively, a sub-optimal and undesirable state of affairs. However, from the point of view of the trading participants, the important thing to keep in mind for the future is that the two regulators are in ongoing discussions and the contentious issues are specific and not pervasive. There is also a great deal of respect and understanding that has been displayed by both regulators for the other’s point of view, all of which bodes well for overcoming their differences. An agreement would allow for greater liquidity and higher levels of market efficiency, and should also provide a much needed boost to global derivatives trading.

AIIB, NDB and the global capital markets

AIIB, NDB and the global capital markets
We have recently seen the advent of two multilateral lending institutions that could have important ramifications for the global financial markets, including specifically the capital markets. The Asian Infrastructure Investment Bank (AIIB) is an initiative led by China, and the New Development Bank (NDB) is a combined effort of the BRICS nations, namely, China, Russia, Brazil, India, and South Africa. The AIIB would be based in Beijing and the NDB in Shanghai. If successful, these banks could challenge the domination of the IMF and the World Bank, and strengthen China’s claim as being a counterbalance to the US domination of the global financial markets. But not everyone sees these new organizations as competitors for existing lending bodies. The World Bank and IMF have themselves come out in support of the AIIB, as it could create a much needed emphasis on infrastructure development in Asia. Also, AIIB is hoping to learn from the past experience of World Bank, including by hiring its alumni. Such new banks could also lead to changes at the IMF and World Bank which might be forced to streamline their operations in order to remain meaningful. From the capital market point of view, an important effect of AIIB and NDB could be an increase in the importance of the Renminbi as a reserve currency, and a decrease in the relevance of the US dollar. While this would make for a more diverse marketplace, it might also create friction between the leading global economies, as evidenced by the US refusal to support the AIIB at a time when all its allies welcomed or indeed joined it. Finally, it is possible to see AIIB & NDB as institutions that allow emerging markets such as the BRICS countries to assert themselves on the world stage, something that IMF has not allowed them to do, as it has failed to reform in the last few years to take their economic growth and increased buying power into consideration. We will just have to wait and see to find out if they are indeed able to live up to their promise in this regard.

Finance meets fashion: #wearables in wealth management

Finance meets fashion: #wearables in wealth management
In my upcoming report, due out in the next several days, I take a look at wearable technology and the wealth management industry. What is wearable technology? Who are the possible users of wearable technology in the wealth management industry? What is the future for wearables in wealth management? Wearable technology is quickly gaining interest and momentum among consumers and enterprises. Wearables are digital devices that can be worn on the body (i.e., glasses, watches, cameras, clips), can be controlled with minimal manual input, and offer real time access to and the collection of data. This data can ultimately be used to influence real world decisions and behavior; wearables have the potential to alter the way we go about our daily lives. Wearables span multiple categories, including, but not limited to health, finance, and lifestyle. Achieving the “quantitative self” has never been easier. In this report, Celent will explore the role of wearables in wealth management and assess if wearables have the potential to move beyond the mass affluent and serve the HNW by, for example, integrating with an advisor’s CRM system.  Celent will provide an overview of the wearables market, examine the drivers for adoption, study the potential impact of wearables on the retail investor and wealth managers, and conclude with a prospective look on wearables in the wealth management industry.