The 28th regime offers a potential overhaul of Europe’s capital markets, aimed at addressing key challenges such as financing the green and digital transitions and unlocking private capital. By establishing a streamlined supervisory framework under ESMA, the regime could enhance market integration, reduce fragmentation, and foster cross-border investment. However, it also poses risks, including the possibility of deepening market disparities and hindering the broader goals of the Capital Markets Union. For the regime to succeed, it must balance national interests with the need for a cohesive and competitive European financial market, positioning Europe as a global leader in sustainable finance.

Europe’s capital markets constrained by fragmentation and regulation

Europe’s capital markets are at a critical juncture. The twin challenges of financing the green and digital transitions – requiring an estimated EUR 700–800 billion annually over the next decade – are far beyond the capacity of public budgets and traditional bank lending. Unlocking private capital is no longer optional; it is imperative. However, Europe’s financial landscape remains constrained by structural and regulatory inefficiencies that hinder the development of deep, integrated, and efficient capital markets capable of addressing these challenges.

One of the key issues is the limited scope for retail investors to participate in capital markets. European savers are often confined to low-yield financial products due to consumer protection rules that, while well-intentioned, restrict access to higher-return investment opportunities. This dynamic discourages capital flows into innovative and growth-oriented sectors, stifling the potential for wealth creation and broader economic growth. Revamping savings products and enabling more direct engagement with capital markets could be transformational in mobilising private investment.

The near-elimination of the securitisation market is another glaring bottleneck. In contrast to countries like the US, Canada and Australia, Europe has yet to harness the full potential of securitisation as a tool to recycle capital and fund businesses. Reviving this market could unlock EUR 300–400 billion annually, but doing so requires a coordinated effort to ensure that securitisation products are both attractive to investors and aligned with robust regulatory standards.

Fragmentation of Europe’s capital markets further exacerbates these issues. National supervisory frameworks create inefficiencies, as firms operating across borders must navigate a patchwork of regulations, duplicating efforts and increasing costs. This lack of harmonisation stymies the development of pan-European financial products, which are essential for creating a truly integrated capital market. The current structure inhibits the free flow of capital and restricts market participants from reaping the benefits of scale and competition.

Towards a 28th regime: A new framework for capital markets integration

To address these challenges, a more systematic approach to determining the most efficient supervisory structure is needed. For instance, a “supervisory efficiency test” could be implemented when reviewing legislation such as MiFID or UCITS, evaluating whether supervision should remain national, adopt mutual recognition, or shift to a supranational level based on the complexity and integration of the market. Balancing the “right to move” with the “right to stay” could also help preserve market presence and influence for smaller or less-integrated regions.

Taxation, governance and shareholder rights present additional complexities. These areas are deeply embedded in national legal frameworks and any attempt at harmonisation must tread carefully to avoid disrupting established practices. A gradual approach to transferring responsibilities, informed by the experiences of the banking union, could help mitigate resistance and build trust among stakeholders.

Beyond structural reform, there is a need for a cultural shift in how Europe approaches capital markets. Policymakers must balance the drive for harmonisation with the need to foster innovation and growth. This includes rethinking the role of regulation to ensure it supports, rather than stifles, market development. For example, simplifying processes for asset managers to operate across borders and aligning rules to reduce compliance costs could enhance competitiveness without compromising investor protection.

Harmonisation efforts should focus on eliminating unnecessary national variations, particularly in areas like prospectus standards, to reduce duplication and complexity. Using KPIs to track market integration, leveraging AI and digital tools to overcome language barriers, and enhancing trust among retail investors are practical steps to increase efficiency. Mechanisms such as EU-wide arbitration for dispute resolution could simplify redress for retail investors, building confidence in cross-border products.

One proposed solution to overcome these barriers is the establishment of a ‘28th regime’ for Europe’s capital markets. This concept envisions an optional framework under the European Securities and Markets Authority (ESMA) that would allow firms to opt into centralised supervision while maintaining collaboration with national authorities. Such a regime could streamline oversight for cross-border activities, reduce administrative burdens and foster the creation of pan-European products. By offering a single set of rules and a single supervisor for certain aspects of the market, the 28th regime could significantly enhance market efficiency and attractiveness.

Potential risks and challenges of the 28^th regime

The 28th regime, while offering the potential to streamline Europe’s capital markets, poses several risks that could undermine its intended benefits. One of the main concerns is the possibility of increasing fragmentation within Europe’s financial markets. If some countries opt into the regime while others remain outside, it could create two-speed markets, with the more developed markets benefiting from integration while smaller, less-developed regions fall further behind. This division could worsen existing disparities, making it harder to achieve a truly unified capital market.

Another challenge is the potential for divergent speeds in market development. Countries with more advanced financial markets might implement the regime quickly, while those with less sophisticated markets could struggle, leading to uneven progress across the EU. This imbalance could discourage investment in slower-moving markets and delay the realization of a fully integrated European capital market.

The 28th regime also risks complicating the broader goal of the Capital Markets Union (CMU). Instead of fostering a single, seamless financial market, it could result in the emergence of smaller, regional unions with differing regulatory frameworks. This fragmentation could hinder the free flow of capital across the EU, making it difficult for Europe to compete globally as a unified economic entity. National authorities might also resist the shift toward centralised supervision, fearing a loss of sovereignty and control over domestic markets.

Finally, the 28th regime must strike a delicate balance between national diversity and integration. Europe’s financial markets are deeply rooted in national traditions, and any attempt to harmonize regulations too aggressively could generate significant political resistance. Success will depend on the regime’s ability to incorporate national perspectives while promoting a cohesive, integrated capital market that can compete on the global stage.

Striking the right balance

A well-designed 28th regime could be a game-changer for Europe’s capital markets, fostering greater integration and dynamism. By offering a streamlined framework for cross-border supervision, it holds the potential to position Europe as a global leader in sustainable finance. This regime could channel much-needed private capital into the green and digital transitions, aligning with Europe’s environmental and economic objectives. However, time is of the essence: delays in reforming Europe’s capital markets will result in missed opportunities and underutilized private capital, further delaying the continent’s growth prospects.

Despite the benefits, the 28th regime carries risks that must be carefully managed. Fragmentation remains a major concern. If some countries opt in while others stay out, it could create a two-tiered market, exacerbating disparities between more and less developed markets. This could hinder the smooth flow of capital and undermine efforts to create a truly unified capital market. Additionally, uneven speeds of implementation across the EU could create imbalances, potentially discouraging investment in slower-moving markets and delaying Europe’s capital market ambitions.

The 28th regime also risks complicating the broader Capital Markets Union (CMU) project. Rather than fostering a single, integrated European market, it might inadvertently lead to smaller, regionally divided unions. This could create obstacles to pan-European financial products and undermine the goal of a competitive, unified market. Furthermore, national resistance to centralised supervision could delay or derail progress, making it essential for the regime to balance national sovereignty with the need for a more integrated market.

In conclusion, the 28th regime represents a bold step toward the integration of Europe’s capital markets, but these risks must be addressed for it to succeed. A careful, collaborative approach that balances ambition with pragmatism will be essential for transforming Europe’s capital markets into a globally competitive and sustainable financial hub. Only through a cohesive, pan-European framework can Europe achieve its financial and sustainability goals.

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A year ago, I’d never have imagined myself stepping away from the world of the front-office.

I’d been working in the front-office as a trader or a vendor for my entire career and after selling Broadway Technologies to Bloomberg back in 2023 a number of other opportunities in the front office world presented themselves.

Among these opportunities was the chance to lead Duco and as I considered my choices, I realised just how crowded the front-office landscape has become.

Traders have so much choice in technology that it’s becoming difficult to do anything that really moves the needle. The more I learned about Duco and the problems the company was solving for middle- and back-office teams across the globe, the more it dawned on me just how ripe and exciting the opportunity for innovation outside of the front office is.

This realisation comes alongside a shift in attitudes across the industry wherein business and market trends are reshaping capital markets, putting greater focus on the middle- and back-offices. It’s no secret that these functions have been overlooked and underfunded when it comes to innovation which has left them with outdated technology stacks and inefficient operating models – but that’s all changing.

Firms are waking up to the idea that value is created across the business, not just by the front-office. As the spotlight spreads across the whole organisation, the pivotal role of the middle- and back-office shines bright. 

Operations are now seen as value creators and, with the right technology, they can surely rise to the challenge.

Thinking about value from start to finish

People used to think about capital markets firms as having a front-office that made all the money, with middle- and back-offices doing the admin and tidying up loose ends. Attitudes are changing now because macroeconomic conditions, market forces and regulatory pressures are creating an environment where firms must look at their business more holistically – front to back.

According to analysis by Oliver Wyman and Morgan Stanley, capital markets firms are increasingly focusing on operational efficiency, regulatory compliance, and cost reduction. The latter in particular has become such an issue because it has risen in line with revenue growth during the good times, but when the revenue outlook softened those costs were still there.

Banks’ top priority now is plugging the gaping cost holes at the center of their operations, alongside improving operational efficiency, reducing risk and ensuring compliance with an ever-stricter set of regulatory requirements.

And even if the front-office remains in the driving seat, the fact of the matter is that most capital markets firms have a lot of operational baggage. At some point that baggage becomes too much and the engine cuts out. Middle- and back-offices are full of inefficient systems, manual processes and thousands of overburdened workers trying to get things done. There’s a point at which that stops being scalable – and there’s a strong argument in favour of the fact that the industry is already long past that point.

Capital markets firms are increasingly waking up to the idea that lean, agile and efficient back- and middle-offices are essential to remaining competitive and meeting the main challenges of the day.

According to GreySpark Partners, “post-trade functionality is clearly the single most important area of differentiation among competing banks”. They list securities operations, derivatives operations, portfolio & risk management and bank-client interactions & communications as the top four areas of differentiation among competing banks. What makes you competitive isn’t about who can trade or invest better, it’s about who runs the most streamlined machine.

It’s time for a change

The middle- and back-office needs better technology to achieve their firm’s strategic goals around cost, efficiency and compliance. While the pace of innovation in the front-office may have slowed, the opposite is true in the post-trade arena. 

That’s not to say no one is innovating, more that there are still so many fundamental challenges that are being addressed, or in need of a new solution. Capital markets firms have long struggled with five core challenges around data: the issues of endless variety, constant change, overwhelming scale, hidden lifecycles and a lack of control.

Capital markets firms rely on a number of core automation systems that specialise in a particular asset class which act like the motorways for your data. However, outside of this exists a complex network of point solutions and end-user computing (EUC), all held together by manual work, in order to handle the portion of data that couldn’t travel down the motorway. 

But, the amount of data traveling these roads is growing. You don’t even have to look that far back to see just how fast this is happening. Futures and options trading volumes, for example, have hit a new record for six consecutive years, with volumes rising 64% year-on-year to 137.3 billion contracts in 2023.

This means an increasing amount of resources are needed to manually transform, enrich, reconcile and validate the trade data that isn’t fully automated. This data is still mission-critical – it fuels internal reporting, informs P&L calculations and risk management. It’s under increasing scrutiny from regulators and must follow ever-more prescriptive rules around format and quality. 

The ‘last mile’ has therefore grown over the years into a spaghetti junction, filled with opaque and risky processes, outdated technology and legions of ‘Human APIs’ manually holding it all together.

But it’s a problem that can be solved by innovations in cloud computing, Software-as-a-Service, no-code applications, machine learning and AI. Data automation is a transformational approach to managing data that leverages these amazing technologies and enables firms to overcome historic challenges around data.

Duco clients, for example, isdemising on-premise legacy systems automating end-user computing like spreadsheets in their hundreds eradicating manual processes from their operations. 

The need for an innovation mindset

So, the technology is there to help middle- and back-offices to innovate towards smarter, more efficient, transparent and low-risk operating models. But the existence of technology isn’t enough on its own.

Operations have long been change-averse. It’s entirely understandable; they’re dealing with mission-critical processes and everyone knows that transformation projects are difficult. They’ve also spent decades working with technology in a certain way: on-premise, hard-coded, maintained and operated by IT. It’s difficult to think differently when you’re used to doing things a certain way. 

Therefore, to truly benefit from the latest advances and thinking around technology, processes and people, firms need to adopt an innovation mindset. In my first six months at Duco I spoke to dozens of customers, and the top question was: “How can we do more with the platform?”

That’s the innovation mindset right there, thinking not about how to do the same things a bit more efficiently, but to ask whether it’s possible to do things in an entirely different way. To move, for example, from a reactive operating model built around the need to clean up after bad data to a data-centric operating model, where controls are put in place proactively to ensure STP. One where exceptions really are exceptional.

Santander’s José Muñoz described this mindset onstage at Sibos, asserting that “transformation should be a third of your time. We try to focus people on change all the time, as part of their business-as-usual.”

Santander aren’t the only firm who are starting to view change as a necessary part of run-the-bank. The leading capital markets firms recognise that they can’t afford to stand still. Operations leaders like José are looking to push the boundaries of what’s possible, and that’s what’s so exciting about being a technology vendor in this space. We have the capability, and the market is demanding something different to what they’re used to. It’s the perfect environment for innovation to flourish.

Operations is in the spotlight

It’s never been a more exciting time to be in the middle- and back-offices. The spotlight is shifting to look across the business as firms realise that value creation happens everywhere. The technology is there for you to make big changes and solve your long-standing challenges. Plus, the market trends, regulatory changes and demands of the business need you to innovate.

The challenges are big, but the solutions are there. With the right mindset, you can be a driver of serious change in your organisation. Are you ready?

The post The most exciting place for innovation in capital markets? Operations. appeared first on The TRADE.

While the UK general election result was priced in, and data from TraX showing a slight uptick in UK Government bond prices, markets were rattled by gains made by the political far right – initially in the European Parliament elections, and then in France following Emmanuel Macron’s decision to call a snap election.

The expected initial gains by the far right in the French election led to a winning left-wing coalition in the second round amongst taxing political manoeuvres. The result is a divided Assemblée Nationale with no absolute majority, leaving Europe’s second largest economy without clear direction.

This has caused havoc for French capital markets, and it will certainly take time to reassure investors as the political picture slowly settles. We are already seeing a busier than expected summer in markets – which we largely expect to continue – with heightened volatility, a challenging liquidity environment and a likely continued ‘higher-for-longer’ interest rate scenario.

The events in Europe and their knock-on effects into markets have now been further heightened by the US presidential election in November. With President Biden dropping out and Kamala Harris now Donald Trump’s opponent, investors are weighing up the potential impacts of the respective candidate’s presidency. During the build-up to the election, markets will be in flux as they as prepare for a Trump or Harris presidency.

Despite all these uncertainties, the broad outlook for investors in bond markets remains promising – known for their relative security and stability, they have maintained high yields compared to recent history.

Investors need to focus on selecting the right markets and sectors, effectively managing risks, and allowing for best execution within that market.  

And while the challenge of market entry and accessing liquidity is always there, continued technological advancements are forming the foundation upon which innovative tools applied across the trade lifecycle are developed and refined. There are today a myriad of technologies and solutions that can help.

This approach forms the basis of how MarketAxess is innovating, with high-quality market data being at the core of any technological advancement. The proliferation of high-quality datasets in bond markets has also driven its broader evolution: the automation of the market.

As seen with many industries, the bond markets have also recognised the potential of artificial intelligence (AI) and machine learning (ML). At MarketAxess we have used this to address a range of activities, with one key example being price discovery – one of the main headaches for investors – wherein CP+ provides an accurate tool for predictive real-time pricing for global credit and rates markets.

Bond markets are democratising through the expansion of new liquidity pools and increased accessibility to global markets.

This is embodied in our all-to-all trading model, Open Trading. It has continued to strengthen markets by identifying new pockets of liquidity, which is critical not only for traditional markets such as Eurobonds, US investment grade and high yield credit, but also for unlocking opportunities in developing markets and enabling investors to access more opportunities, and with speed.

More and more markets are progressively opening up and evolving, as investors demand greater access to local and hard currency debt. A notable recent example is the inclusion of Indian government bonds in JP Morgan’s emerging market debt index, which enhances tradability and attracts foreign investment in India.

Looking ahead, the second half of this year will no doubt be uncertain for investors, with a backdrop of political and economic risks; elections, persistent inflation and central bank policies. This will challenge market participants on many levels.

For investors to successfully navigate bond markets during this time, they need the tools and data behind them to make effective decisions. While many are already using some of these tools today selectively, we expect to see much wider adoption across investor-types and markets going forward as they seek new ways to remain competitive in challenging markets.  

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With broker-dealers seeking ways to enhance efficiency and reduce costs, many are turning to automation. Unfortunately, broker-dealers can’t trust artificial intelligence (AI) yet with crucial aspects like compliance and risk management. Recent Large Language Models (LLM) achievements show remarkable results in summarising existing information and recognising patterns in mixed content like recorded sound, images, and video. However, decision-making processes that are a crucial part of compliance and risk management are far from being fully automated by the usage of the LLM-like AI. In particular, so-called AI hallucinations are a noticeable side effect of the LLM application in different spheres of IT and automation. 

Fortunately, there are multiple ways to automate these business areas with good old automation software crafted specifically for its purpose, time-tested, and configurable to suit each brokerage’s needs. 

Limiting risk exposure

Risks emerge when clients sell options, short stocks, and take advantage of a leverage provided by a broker. Different broker-dealers have their own criteria for measuring an acceptable level of risk the client takes intraday and whether to limit it or not. Say, if a client exceeds a safe number of orders daily, their orders should be alerted or sent to a risk desk for review before being further routed to execution. Other limiting parameters can be the total used margin, daily unrealised loss, or the total size of derivative products’ position in the client’s portfolio. Regulators oblige broker-dealers to monitor client risk if they offer derivatives trading. However, broker-dealers themselves may put additional controls in place to avoid situations when their clients can’t cover losses due to a lack of funds. 

In this scenario, risk exposure can be automated to detect such clients and their risky operations. Broker-dealers can fine-tune risk management to assign risk profiles or bespoke risk parameters on the individual account or account group level. At the same time, the software will not distract the risk desk department with clients’ orders that do not increase the risk exposure or are below the accepted risk level. 

Post-trade operations 

When it comes to operations, involving corporate actions can be entirely automated without the need for interruptions from a broker-dealer’s staff. In the case of a stock split and reverse stock split, merger, or acquisition, clients’ portfolios can be automatically updated with the new number of equities they’re eligible for. Dividends can also be automatically represented as cash transactions or as an equity increase. 

As regards reconciliation, we’ve learned through our work with brokers that they spend too much time on manual reconciliation due to legacy systems and missing integrations between them. To keep up with growing trading volumes and the number of end users, as well as the recent implementation of the T+1 settlement rule, brokers should automate reconciliation with the latest technology. 

The perfectly automated process looks the following way: a broker’s trading platform is integrated with their venue of choice for custody, clearing, and settlement. The tool syncs transaction data in the client’s trading platform with the venue’s “Start of Day” (SOD) files. If there’s a mismatch between the broker’s data and SOD files, the broker’s trading officers use a specially developed web UI to approve adjustments in the trading platform database. The process might be further automated by automatically adjusting the trading platform records and intrade syncs. The tool supports individual and bulk corrections. Thus, a broker’s staff doesn’t have to search for mismatches and update them manually in something as outdated as an Excel file. 

In addition, brokers might get a substantial competitive advantage if they implement a tool for clients that notifies them about all prospective commissions and fees they’ll have to pay before sending orders for execution.  

Order routing is another key factor. Smart and thoroughly thought-through order routing poses no risk and only brings gains to broker-dealers. While being aligned with the best execution rule, a broker-dealer has the right to route client orders not only to public exchanges but also to dark pools and alternative trading systems (ATSs). 

What’s different about sending orders to dark pools and ATSs is that broker-dealers can save on execution fees and get paid for order flow. 

Why automation is required here — dark pools and ATSs prefer orders manually issued by traders and not algorithmically generated orders, let alone pay for them. Intelligent order routing allows us to define execution destinations per order/account according to this aspect. 

Besides this basic filtering, there are four automation scripts for intelligent order routing according to: traded volume, percentage of orders sent to a particular venue, user groups, primary and secondary destinations, routing time, depending on trading hours. 

The bottom line

Automation undoubtedly improves brokers’ operations. It makes their processes more efficient, reduces risks, and improves overall performance. By using automation tools in important areas like risk management, post-trade operations, reconciliation, corporate actions, commissions, and order routing, broker-dealers can make their work easier and gain an advantage in the industry. 

As automation changes, broker-dealers should carefully consider each automation solution’s benefits and possible impacts. This careful approach helps broker-dealers make good decisions that meet their goals and the rules. Ultimately, using automation well can help broker-dealers succeed in a changing and competitive market. 

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In the global and often highly unpredictable world of capital markets, adaptability to change may well be paramount, but not always possible to enact quickly. Recently, the European Securities and Markets Authority (ESMA) issued a “call for evidence” to consult on shortening the settlement cycle across equities, fixed income, and exchange-traded funds (ETFs). While seeking market feedback is commendable, the urgency of transitioning to a T+1 settlement cycle — a model where transactions are settled the next business day — is a tough proposition but ultimately a change that is inevitable. 

The fragmented nature of European equity markets means that a coordinated shift alone will not suffice to expedite this transition. The complexity and inherent challenges of implementing T+1 in Europe are significantly greater compared to the U.S which so far has seen a successful implementation of a shorter settlement cycle. As things stand, T+1 in Europe is much more likely to result in exceptions and increased trade disputes.

Unlike the relative uniformity of the US market, Europe consists of multiple exchanges and clearing houses, each with its own regulations and practices. This fragmentation complicates the implementation of a harmonised T+1 model across the region. It is not as if this is a new phenomenon. Way back in 2001, European think-thank the Giovannini Group,  filed a damming report on the copious inefficiencies that exists in the European clearing and settlement infrastructure.  

At the heart of this complexity over two decades on from this report is the absence of a single Central Securities Depository (CSD) in Europe. In contrast to the US, where the Depository Trust & Clearing Corporation (DTCC) serves as the single CSD. Europe has multiple CSDs across different countries, each operating under its own rules and systems. This lack of a unified CSD infrastructure means that harmonising the settlement cycle requires coordinating not just between market participants, but also between these various CSDs, adding another layer of complexity to the transition.

Additionally, the nature of cross-border trading in Europe further complicates a move anytime soon to T+1. Market participants often engage in trades where the seller and buyer operate in different countries with different CSDs, unlike in the US where all securities trades settle in the US market infrastructure (except where the realignment occurs between participants in Euroclear and Clearstream for European investors).  

Consider a scenario where one party sells their position at Euroclear in France, but the buyer wants to hold them in Brussels at a different CSD. Equities tend to settle where the liquidity is, which depends on where the exchange is located. If a market participant wants to buy BP shares, they typically trade on the London Stock Exchange (LSE) and then settle in Crest (EUI). Similarly, for a French stock traded on Euronext, settlement typically occurs at Euroclear in France. This cross-border trading adds another layer of complexity to the settlement process. 

Therefore, any misstep or delay in trade confirmation and matching in these scenarios is highly likely to lead to an increase in settlement failures and disputes. The shorter settlement cycle will certainly necessitate much faster and more accurate communication between counterparties. In a fragmented market like Europe, where different countries and exchanges operate under various systems, ensuring seamless communication will be challenging. 

This problem is exacerbated by the fact that many financial institutions are wedded to using phone and email to handle very high volumes of issues with their counterparties. While phone and email are ubiquitous, they are not efficient for resolving trade disputes. These methods are slow, prone to errors, and lack the immediacy required for the rapid resolution needed in a T+1 environment. 

To avoid further lagging behind the US, and to harbour any hopes of moving to T+1 within the next few years, European authorities must prioritise this transition and address the underlying issues that could impede it. Market participants can also do a lot to streamline the way trades are settled and exceptions resolved. This includes agreeing more of the post trade components at the point of trade, enhancing much faster dispute resolution mechanisms to ensure clearer communication channels between broker-dealers, asset managers and custodians. Only then can Europe hope to reap the benefits of T+1, such as increased liquidity, reduced risk, and improved global competitiveness.

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Last month, the London Stock Exchange Group (LSEG) released a 49-page paper discussing their view on the UK consolidated tape (CT) for equities, in which the exchange attempted to deter the Financial Conduct Authority’s (FCA) consideration of a market-wide request for a pre-trade equities CT. However, while LSEG pointed to the challenges, the paper did not provide constructive suggestions.

Healthy development of the industry should not only focus on latency or the velocity factor, but also the three other aspects of the 4 V’s, namely: veracity, variety, and volume. As the former chair of the US Securities and Exchange Commission (SEC), Mary Jo White, previously stated, there’s a need to “deemphasise speed as a key to trading success”.

For the greater good

Let’s discern the agreeable market phenomena in the report and the obstacles that hinder the greater good and healthy reform of the UK equities markets.

One premise of those who oppose pre-trade CT is related to aggregation distance/ location differential issues being inevitable or un-addressable. Yet, LSEG and the industry should be well informed by now that Time-Lock Encryption (TLE) can solve this problem.

TLE is not a speedbump, it protects time sensitive information from being decrypted prematurely. We are not asking any regulators to prescribe a certain technology. The FCA has full authority to mandate proper security protection over both CT and the trading venues’ proprietary products (PPs). Requiring synchronisation of both CT and PP in accordance with an ‘atomic clock’ and prevents the circumvention of security measures. It eliminates the problem of where the CT data centre is located.

Post-trade CT shows where the market ‘was’ – it is after-the-fact, i.e. not actionable. One can see the market faster with pre-trade transparency. Pre-trade CT and/or PPs enable market participants to seize opportunities on price stability and/or destabilising factors or indicators.

Consider CT as a compromise which can offer alternates to PPs and other value-added services (VAS), it should be affordable and widely available to the have-nots. If the have-nots are willing to commit their limited resources in using PP or VAS, price and availability of PP or VAS must be within reach and the functions should enable a reasonable chance for the have-nots to compete with the haves.

A healthy balance between the relative distance of CT, PPs, and VAS is critical, or else the haves will exploit the gap and exacerbate class conflicts and cultural clashes.

The ever-rising cost of data

Many of the functions of CT providers are performed today by constituents, such as the consolidation of proprietary data feeds and calculation of BBOs. LSEG’s self-interest to preserve their own turfs – including their subsidiaries MayStreet and Refinitiv – is understandable. However, one of the stated goals of the FCA is to “affect competitive pressures for existing sellers of market data, resulting in cheaper, higher quality and more accessible data for its users”.

LSEG is slick to argue that “the cost and complexity of taking direct feeds in the UK is more manageable” when comparing to the European Economic Area and the US. Is it “manageable,” or is it in essence, telling their clients to continue tolerate their rent seeking behaviours?

A better way to “manage” the ever-rising cost of market data/ PPs is by mixing-and-matching the use CT with selected PP(s) to optimise between cost and one’s trade appetite and style. PPs’ usage varied depending on whether one being a hunter (performance optimisers, asset gatherers), or is a farmer (asset maximisers, retail) types of firms along the industry value chain.

Performance optimisers, latency arbitrageurs, alternative investment/ hedge funds, etc. would want expanded core data like the market data infrastructure rule (MDIR) in the US, while they are unlikely to switch to CT and their demand for PP is inelastic. 

LSEG presumption of sell-side would stay on direct feeds is an overstatement. If given the sell-side and buy-side a choice to use pre-trade CT, they would selectively drop usage of a certain PPs to save cost.

LSEG’s study, assuming a delay of 10 milliseconds, presents a dire picture: “Delay would cause the price to be incorrect by 9-18% of a spread (average 14%) and the volume displayed on the tape to be incorrect by22-25% (average 37%) […] translates to slippage of 9-19% (average 14%) of a spread in terms of weighted mid-point.

Looking at these numbers, it reminds one of these two NYSE studies – “Price improvement, tick harmonization & investor benefit” and “The Impact of Tick Constrained Securities on the U.S. Equity Markets.” One similarity can be drawn – both LSEG and NYSE studies are about ‘queuing and wait time at the checkout counters’ if putting in layperson terms. 

Latency impacts

In recent times, Cboe has proposed that a pre-trade CT works and previously provided their views to measure latency impact in a report released in April 2023. We think slippage and other phenomena are related to capabilities differences between lit exchanges, multilateral trading Facilities (MTFs), systematic internalisers (SIs), single dealer platforms (SDPs), approved publication arrangements (APAs).

However not everyone shops at the centralised marketplace or sells their products there. Buying habits have changed and sellers are modernising their distribution channels (the shopping mall versus online purchase). 

The SEC’s tick size/ minimum pricing increments proposal aimed at closing any minor differences between the different market centres’ capabilities in sub-penny trading that may be used as tactics to disrupt the quote priority. 

If adopted, it will force almost all stocks to trade at least 4-8 ticks wide, amid NASDAQ and other research having indicated a stock has optimal trading with a 2-3 tick spread. However, this artificially altering the queue (equal waiting line at all checkout counters) may affect the “apparent,” not the real supply and demand for securities.

Not to be misunderstood, it is true that “if everybody is transacting off-market, there is no point in having markets. Markets exist to help price discovery, and price discovery requires accurate and comprehensive trading data.” One size does not fit all, the noumenon of “venue-by-venue competition” is indeed a brutal Warring States Period.

The waiting line at “checkout counters” are indeed not equal due to lit exchanges may continue to exploit their dominance in market data, connectivity, and/or in combination with access fee rebates, enhanced market making discount to selectively provide perks to the elites. 

In racing to gain the edge over each other, other venues introduce a speed bump (e.g. liquidity enhancing access delayed), proliferate order-types (e.g. midpoint-extend-life order), come up with new business models (e.g. market-on-close) and create other privileges (e.g. exclusive access to certain pegging orders).

Regional disparity 

The UK, US, and the EU are indifferent in terms of people jockeying around trying to make money, and different market centres use different ways to redirect order flow. Among them there could be formal or informal alliances.

There will be complaints about rules being skewed in favour of certain entities, as well as new way(s) to exploit or circumvent the rule. The UK and the EU do not have the controversial order protection rule like the US, the FCA does not necessarily need the same trade-through requirements but still provide essential investor protection if policy makers consider the Exchanges, MTFs, SIs, SDPs, APAs as different streaming platforms. 

A consistent copyright licensing mechanism aligns and addresses the economic viability of a constituent. By putting a value on quotes and trades composition, different streaming platforms would give proper considerations (optimise reach to targeted subscribers/ market participants, while bear corresponding cost in using others’ copyrighted materials) to minimise price pick-off and prevent their exploit of economy of scope and scale.

It eliminates conflict of interest, ensures efficiency in deployment of resources, and harmonises different market centres. Market forces will determine the optimal subscription/ access fees by the different venues.

A growing pie means a bigger piece for everyone

Lastly, expanded core data under the US MDIR (including odd lots, depth-of-book, etc.) and the bureaucracy under the SEC proposed CT Plan Version 2 would undoubtedly heighten the cost of market data and cause dysfunctional of the CT. The UK and EU should learn accordingly.

Time-lock encryption and copyright licensing mechanism have proven successes in other industries to lower cost and improve all 4Vs. Let’s agree to revitalise and realign incentives and capabilities with all market centres for the greater good of the overall industry. The pie will grow and with a bigger piece for everyone.

The post Agree to disagree on LSEG’s view on UK consolidated tape for equities appeared first on The TRADE.

Performance and reliability 

Performance and reliability should not conflict in a well-designed exchange. Whether there are three or five working nodes, users should not experience any type of performance dip. 

The additional nodes should proactively ensure consistent performance in case the primary node fails. An overly reliable system might require more efforts in terms of maintenance, but as the primary node is independent, the additional clusters will not slow down the system.

For example, a single-instance matching engine might suffice for a demo or test environment of a retail exchange with moderate latency requirements, but it is insufficient for a system to rely on one node, as it becomes a single point of failure risk. If the one node fails, everything fails. 

Replication as a solution 

To prioritise reliability, a replicated system design is adopted where multiple instances of gateways, matching engines, and databases run simultaneously. Such architecture enhances failure resilience as replicated components can take over in case of individual malfunctions. 

However, this replication comes at the cost of requiring more resources such as additional hosts for extra datasets, increases disk storage, etc. due to the overhead involved in maintaining multiple synchronised datasets.

Addressing latency

Latency is a critical factor, especially for institutional players who engage in algorithmic trading and require swift order processing. Crypto exchanges and retail-centric trading platforms may operate comfortably with latencies ranging from 200-500 microseconds, often hosted in cloud environments for their cost-effectiveness and ease of setup. 

In contrast, institutional venues lean towards bare-metal installations with hardware acceleration to minimise latency further.

High-performance and high-reliability systems

The most demanding trading applications expect both stellar performance and robust reliability. To achieve this, state-of-the-art matching engines operate entirely in RAM, avoiding latency introduced by disk or solid-state drives.

For enhanced reliability, these systems use replication techniques, running multiple engine instances in parallel and employing consensus algorithms to ensure synchronised states across replicas. 

Throughput and scalability 

Exchanges must also be designed to handle sudden surges in trading activity, such as those seen during “black swan” events or market movements driven by social media.

Clusters of independent order processing units and strategies like horizontal scaling, where instrument lists are segmented and managed by individual engine instances, are deployed to ensure scalability and high throughput.

The consensus challenge

Maintaining consensus across distributed systems, especially under high loads, is a complex task. The RAFT protocol is the best solution at the moment to achieve consensus between matching engine clusters, in other words to ensure all engine replicas agree on input sequences.

This might involve electing a “leader” node responsible for input propagation, with systems in place to elect new leaders in case of failure, thus maintaining system consistency and reliability. 

Persistence, recovery, and storage needs

Exchange venues often have to fulfill extensive reporting obligations, necessitating a system that stores event histories without impairing performance. Regular snapshots of the matching engine’s state complement a full event log, allowing for quick recovery and state resumption. 

Additionally, separate storage solutions cater to the extensive querying needs without taxing the matching engine.

In conclusion, designing a matching engine that marries high performance with unwavering reliability is a complex yet achievable goal. It requires an understanding of the interconnectedness of latency and throughput: when the exchange grows in popularity its throughput increases; to increase throughput, the engineering team should work on achieving the lowest latency possible. 

Other key technology considerations are state synchronisation alongside sophisticated replication and consensus strategies.

As the financial trading landscape continues to evolve, so too must the technological backbone that supports it, ensuring that trading venues can withstand the tests of both time and volume without sacrificing speed or stability.

The post A balancing act – Performance and reliability in trading matching engines appeared first on The TRADE.

The market infrastructure community has been debating the topic of time for the last few years. How late should our markets be open? How fast should settlement be? We’ve moved on, a little, from trading latency to the concept of perpetual markets, but before we head down that route, we should take stock of what it actually means to our own lives. 

My last blog was all about people and that’s the thing we need to think about first when it comes to these big market structure questions. Yes, there will always be demand from someone in the market for a 24/7 opportunity to trade – be it night-owl retail traders in domestic markets or international traders who want access to foreign trading in their opening hours. But what impact does this have on the industry as a whole on a global scale?  

From a domestic market infrastructure perspective, it means reduced need, or even elimination of the need, for dual listed shares. If you can access them directly in their domestic markets, why would you go anywhere else? The changes in one market, as is always the case, then kick off a veritable arms race in the others. But is this one race that we should be starting? 

Before you start emailing me, yes, I know some markets are already open beyond normal trading hours. Yes, I know crypto is one of them. Just because it sort-of works in one market, doesn’t mean it will work in others. And we’ve all heard the liquidity issues that have occurred in such markets. 

The recent decision by Robinhood to pause its out of hours trading offering due to concerns about a black swan event caused by geopolitical tensions in the Middle East caused retail trading keyboard warriors to take to social media and complain. If markets that are supposed to be open are closed, clients are dissatisfied. A basic lesson, but extend that to things like Consumer Duty obligations and investor protection requirements. Unhappy clients means unhappy regulators, it means competitive disadvantages, it means reputational impacts.  

Moreover, think about the current focus on operational resilience – more hours open means more opportunities for cyber-attacks to happen or outages to occur. Technology isn’t infallible, so that means more oversight. I know some people are going to come back with “but blockchain” or “but artificial intelligence” and my response is the same: technology isn’t infallible. Until Skynet is fully operational and we’re not in control of the world at large, the liability for the resilience, safety and soundness of our markets sits with us mere humans. 

And humans need sleep. They have lives outside of work (at least I hope they do!). If everything becomes 24/7, someone is going to have to pick up those oversight responsibilities and the processes that normally get done in the working day that will extend into the middle of the night. Choices always have consequences for someone within your organisation. 

Profits might increase a little (as of now, it’s hard to tell how much demand there will be) but what impact will it have on our working lives? That’s the question we should really be asking first. 

The post Does the industry really want to be on 24/7? appeared first on The TRADE.

Last year saw a notable increase in the adoption of generative AI, such as OpenAI’s ChatGPT, Google’s Bard (now Gemini) and Microsoft’s Copilot. This trend represents an evolutionary leap in how companies across various sectors are integrating technology. As AI becomes a staple in the workplace, especially for traders and their complementary compliance teams, organisations are now faced with the challenge of understanding its full potential to identify and mitigate compliance risks, as well as manage the immense increase in the data produced.

In June 2023, McKinsey & Company outlined the potential value of these new technologies. It is predicted that generative AI could affect risk and compliance worldwide significantly, potentially to the tune of $250 billion. This is partly due to its ability to protect traders against bogus claims, identify gaps in communication that could indicate off-channel conversations and capture data in a way that maintains the context of all messages. 

While communications monitoring can be associated with micromanaging, there are significant benefits for traders, primarily, as it provides them with a line of defence if a client makes claims about alleged promises made. While of course, if a trader wants to communicate in a way that is not monitored, they can find a way to do so, firms should provide guidance and channels for compliant communication to mitigate against litigious action.

While our research indicates that 65% of highly regulated businesses are concerned about understanding new regulations, under a quarter see the lack of clarity on rules for generative AI as a major worry. This suggests that there is not enough urgency in grasping the innovative methods and processes that trading teams are using, as well as how to make the most of the synthetic data created by AI. 

Therefore, the challenge is to understand how generative AI can be used to assist traders in content management, risk navigation and regulatory compliance and then monitoring usage.

The potential of generative AI for trading professionals

As AI tools become more common, there is an increasing demand for systems that can handle AI-created content, especially in terms of compliance in highly regulated trading teams. The issue however, is twofold: firstly, companies must determine how to stick to regulations when they use generative AI. Secondly, they should be ready to use AI to help with compliance, especially as the technology generates so much data that managing risk manually is no longer realistic.

For instance, AI tools such as Microsoft’s Copilot can effectively double the content each employee creates, making it essential to have strong systems for saving and monitoring this data. Since regulatory requirements demand that trading teams collect and keep records of information, the systems used to archive this data must be upgraded to handle the huge growth in content developed by AI.

Monitoring the content AI creates and where it is then shared is something businesses are focusing on. Our research found that 71% of businesses in heavily regulated sectors are reconsidering their digital communication rules. This is partly because there have been more fines for communication that happens outside of official channels in many developed markets. 

While it is important to monitor for unfair trading practices in AI-generated content and the channels it is shared on, it is also crucial to navigate non-financial risk. The UK’s Financial Conduct Authority (FCA) is paying close attention to non-financial risks, including company culture and how employees behave. Advanced AI systems can help by quickly flagging potential red flags in the content of messages and the context they were shared in to detect bullying and sexual harassment.

Companies now have the ability to monitor content with AI, changing how they handle risks to their reputation. This is especially important for trading organisations that are increasingly worried about their public image and how their employees act. AI tools help keep an eye on activities that could damage their reputation, allowing companies to deal with problems early before they turn into bigger crises. 

Regulatory perspectives on generative AI

The FCA has been cautious to regulate using AI in order to promote growth in the technology sector and increase economic and business activity. However, as AI becomes more common in the industry, the FCA will need to update its advice on how to use it. We should watch what is happening in other countries to get an idea of the kind of changes that British regulators might think about in the future. 

The US Securities and Exchange Commission (SEC) has previously made statements about generative AI that are even more cautious than those of the UK’s regulator. SEC chair, Gary Gensler, has warned that AI could affect the stability of financial markets because it might lead to fraud and conflicts of interest. Additionally, president Joe Biden’s Executive Order on AI emphasises that regulators are more focused on protecting consumers than on promoting innovation.

Similarly, the European Union’s AI Act plans to sort AI systems into four levels of risk, based on how they are used. This way of looking at AI shows that compliance teams in the UK need to be prepared for stricter views on AI in trading in the near future.

Generative AI presents a tough test but also a great opportunity for trading institutions. Financial companies need to be flexible, using AI to handle the flood of data and keep their business running smoothly. If they do this, they can stay ahead with new technology, turning possible upheaval into a competitive edge.

The post How compliant traders can manage the generative AI synthetic data tsunami appeared first on The TRADE.

The fines weren’t huge – $400,000 in total for both firms combined – but the precedent that has been set here is the important thing. Firms must now expect their technology usage to be under even greater regulatory scrutiny, especially in the investment and trading arenas. If your firm is claiming to use AI to support a function, it better be living up to those promises, in other words.

The European Securities and Markets Authority (ESMA) has already scanned fund documentation for references to AI, and therefore, already has data to hand to begin investigations around AI washing should it choose to go down the same path as the SEC. It’s fairly clear from that research already that many funds (and other types of industry participant) have made reference to AI usage but may not have implemented the technology sufficiently enough to merit the label.

One of Firebrand Research’s predictions for this year was that AI would be big news in the regulatory arena, both from an oversight and a usage standpoint and this news proves the validity of that trend. Numerous governments have prioritised regulations around the ethical use of AI, especially in fields and functions where AI might supplement and potentially, eventually replace human decision-making. However, the practical use of AI and the marketing of that usage by firms hasn’t been much discussed in wider industry arena up until now.

It’s interesting to note that regulators are talking a lot more about their own plans to make use of AI in their supervisory efforts and not every regulator is on the same page when it comes to regulating firms’ technology usage. The Financial Conduct Authority’s (FCA) Nikhil Rathi has repeatedly reassured the industry over the last few public speeches he’s made that the regulator will not “jump in immediately and seek to regulate in detail”. But that doesn’t rule it out completely in the longer term.

Firms can expect to add proof of AI usage to the ever-growing list of governance and reporting items that need to be maintained just in case a regulator or two come knocking. Reputational and regulatory risk are also two of the topics I’ll be covering with a panel of front office experts in an upcoming webinar with Wall Street Horizon. We’ll be looking at how firms can manage the plethora of risks coming their way in 2024 and arm themselves with the right data sets to stay ahead. You can register for said webinar here: https://www.wallstreethorizon.com/dataminds.

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