Put three men and a FIXGlobal’s Edward Mangles around a table; serve them lunch and let the tapes roll. FIXGlobal listened in on a conversation that ranged from regulators to risk and from FX to FIX.

Edward: In defense of the regulator … how should they know what’s going on when neither the sell nor buy-side seem to know?

Vincent: Recent events have shown the divide between the financial market participants and the regulator. For example, the Lehman’s mini bond issue has forced a strong dialogue between the regulator and, in particular, the broker side. But the engagement is slow.

Kent: Retail brokers tend to have a strong voice here in Hong Kong and over the years have developed a strong working relationship with the regulators. Local brokers can at times be pretty outspoken and have proven on many occasions to be an effective lobbying group. From our perspective international brokers tend to be less visible in some of these debates. We see certain common characteristics across Asia where understandably there is a good deal of focus on protecting the retail investor given the high retail investor participation in many of the stock markets in Asia including Taiwan and Korea. The challenge has certainly been in the retail space where there is an overlap of regulatory responsibility in approving and offering products.

Edward: Are we asking the impossible of the regulator to create the same rule book for retail and institutional investors?

Kent: The general principal is that retail investors are less savvy and experienced and regulations need to be explicit. There is a general assumption that as professional investors, institutions can operate with greater flexibility since they can understand the risks in a more sophisticated way. Taking account of this framework then it will not be possible to standardize for both types of investor. The risk is that setting minimum requirements to protect the retail investor may not suit the way business is transacted at an institutional level. Here we advocate consultation and support stronger trade associations.

Vincent: I don’t think you can realistically expect the same regulations for retail traders as for big institutional investors. That’s a utopia that’s never going to exist. These two  groups of investors have different needs. Many regulators – in Europe for example and Luxembourg in particular with their efforts to push through the UCITS 4 protocol – understand that you need different protocols for retail investors.

Kent: But Vincent, every investor has the same goal: making money. It’s only the detailed requirements that are different.

Gerry: There’s certainly a larger burden on the big firms to uphold ethical, legal and fiduciary standards.

Kent: Yes. Retail investors don’t generally have the same constraints on their activities. Institutional investors need a more developed investment process and must ensure fair treatment across all clients regardless of size and fees. Institutional investors will undoubtedly be looking at different investor objectives – for one, they need to be able to implement their strategies in much greater volumes, and in scale, for example.

Edward: How about the role of regulators in curtailing short-selling in many markets? Knee jerk or long-term strategy?

Kent: I’d like to see the ability to short-sell fully resumed as soon as practically possible. We’re now in a situation where some markets have suspended it, and some are allowing it again. This is not ideal. I certainly see the temporary prohibition as a knee-jerk reaction and understandable given the groundswell of public opinion and corporate pressure as the financial crisis took hold – not all of this opinion was entirely rational. In fact, short-selling restrictions can reduce volumes for trading in the markets overall. For one, we have a 130-30 fund. So in this fund, if we’re limited in the number of attractive long-short pair trades we can put on then we’ll just end up trading less. So it’s business that never happens and the unknown would-be client on the other side of our trade – whether they’re institutional or retail – through the exchange, never gets to take advantage of the liquidity. What we need is a greater understanding of how shorting operates. There is a lot of misconception around this issue.

Gerry: I see the value and merit in allowing short selling in varied markets. In markets that don’t allow it, the regulators need to develop this functionality. It encourages more liquidity and volume. But I do understand that in the current environment the regulators have little choice. We won’t know the full impact until later on.

Vincent: The problem is that there’s no consistency among the regulators. Some only forbid short selling on financials. It’s a disruption to competitiveness between various sectors.

Kent: Yes. And not being able to short, will reduce derivatives trading. The fact is, a lot of the shorting that goes on isn’t just one-way, but a strategy with a ‘long’ component to it as well. And funds that relied on the little performance boost from securities lending fees have also seen their returns diminished. The equity finance desks at the brokers have seen a real drop-off in trade volumes because of this.

Vincent: Now the regulators are trying to encourage investors to buy again in a bear market – and there’s a lot of inconsistency between the messages they’re sending now and what they were telling us six months ago.

For years, the financial community has heard rumours of the impending consolidation of desktop capabilities.

Paul Squires, Head of Trading, AXA Investment Managers opens up about the relationship between the buy-side and exchanges, and the perceived effects of recent consolidation among exchanges.

From Trading Desk to Trading Floor

We trade on an exchange in the name of a broker, which means there is a buffer between the exchange and the buy-side. The interaction we have with the exchanges and MTF’s works much better now. The MTF’s have done a good job engaging with the buy-side over the past few years, which makes a lot of sense when you think of the evolving landscape of market structure. Historically, buy-side firms and exchanges were never quite sure if they needed to pay much attention to each other; however, there is a much more collaborative dialogue now. Most buy-side desks have mixed feelings about some of the bigger exchanges, in much the same way that some of the brokers have mixed feelings about the positioning of exchanges. On the up-side, there is a sort of national, utility element to the exchanges. For things like index funds, primary exchanges own the end of day official pricing.

Before MiFID, the primary  exchanges were responsible for more of the trade and transaction reporting and it was easier to interpret that data compared with the  fragmentation of trade reporting following the first MiFID installment. On the buy-side, we have this simplistic view that it is positive for reporting to be centralised through the primary exchanges because having liquidity in a single venue is something we see as beneficial. Also, the level of monitoring around the primary exchanges is higher than around the MTF’s, and therefore, things like governance and robustness tend to be greater. Generally speaking, we see the primary exchange as a kind of trustworthy elder statesmen in the world of market structure. Where I think the challenges around the exchanges lie are that innovation can be bogged down by their hierarchy and organizational structure, and therefore, cannot compete quite as dynamically as some of the MTF’s, which clearly have much lighter infrastructure considerations. It is no surprise that some of the primary exchanges have lost market share to the MTF’s, who have been nimble, technology focused and reactive in the face of a changing environment.

Exchange Consolidation

We find it quite fascinating to see what will happen. Given the rate of market expansion, globalization and regulatory changes - all of which lends itself to consolidation - it was an inevitability. Exchanges have to be forward thinking about what their long term roles will be and although there are different aspects to this, what we tend to focus on is cash equities only. When people think of the Toronto or London exchanges merging, they think it is kind of interesting. Deutsche Boerse and NYSE Euronext, on the other hand, is fairly mind-blowing. In a wider context, the really interesting developments for us, the market participants, are for exchanges to look into other asset classes and areas of activity to secure a revenue stream for the future. The real impetus is not from cash equities; it is very much about clearing, OTC, potentially, fixed income markets and looking at what they can do in more commercial areas.

Net Gain/Loss from Exchange Mergers

We would hope to see technical enhancements at the exchanges. By applying a rule of best practices, the things that work well for the Toronto Stock Exchange or the London Stock Exchange could be transported to the other exchange, as with Deutsche Boerse and NYSE Euronext. The technical platforms and order book layout are quite relevant, so we would hope to see some enhancement in that area. Nonetheless, I would not necessarily promote a uniform market layout or order book structure, as I do not think we need that in every single exchange we trade on. To some extent, the more that order books’ structures align, the more it helps traders who are trading multiple markets. We can  pre-constrain a lot of unique exchange rules in our systems, but there are segments where human intelligence and manual control of the various elements are vital. In this respect, we would see any alignment of market practices as a fairly positive development.

The obvious potential negative outcome of the mergers is in returning to situations where the exchanges have too much of a monopolistic position and can potentially raise costs without the market having any ability to challenge it. If the MTF’s or exchanges raise their costs, we do not necessarily see that on the buy-side because of the buffer that the broker provides. There is a fairly high margin in the commission rates we pay our brokers and they cover their costs of trading our orders on the venues, and those venue transaction prices would have to increase exponentially for it to become a direct factor for us. Of course, it does eat away at margins for the brokers, and it may come to a point where they need to pass those costs on. The buy-side is somewhat safeguarded from rising venue costs, but not completely.