Moving Beyond the Regulatory Headache

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With Christian Voigt, Senior Regulatory Advisor, Lewis Richardson, Derivatives Product Manager, and Henri Pegeron, Product Manager, Derivatives and Compliance, Fidessa
Christian: Firms should start to think of regulation as more than just a headache. Regulatory change is not a one-time event, it is a continuous process – once MiFID II is out of the way, there will be new regulations rolling out across Europe, Asia and the US. Firms need to work out how they are going to deal with the changes to regulation on an on-going basis and those firms that set up the right processes to prepare themselves appropriately will be best placed for the future.
As an example, MiFID I never mentions the words smart order routing. However, if ten years ago someone had read the details and understood what it meant for the market, they would have anticipated the rise of smart order routing in Europe. Those kinds of market opportunities will always be there for firms who are able to understand the implications of regulation.
From a US angle, how are firms developing to stay ahead of regulation?
Henri: To add to Christian’s point, firms with people who understand global regulation and its implications are ahead of the game. Much of the time regulations are looking to create rules after the fact. By having a clear understanding of what the regulators are attempting to accomplish, a firm has an advantage and knows that it can prepare to operate under those rules. The firms that can suffer are those trying to be reactive to regulation, as opposed to working with it and understanding that regulation is about creating consistency and efficiency. A firm that is continuously upgrading its systems in order to meet regulatory criteria is very unlikely to find the regulation as much of a headache and it becomes more of a maintenance exercise.
In the US, for example, the regulators have seen that some companies are creating opportunities in the listed derivatives market, as they introduce rules around registration and risk controls; if you have read the comments of the CFTC this should not come as a surprise. Those firms that understand that regulation is cyclical, and part of the business lifecycle, can read into the regulatory changes and create positive opportunities for themselves.
How can Asia-Pac firms become more proactive with regards to regulation?
Lewis: In terms of being proactive, it is true that Asian regulators and the exchanges are not moving as quickly as their US counterparts, and that is something international exchanges are trying to leverage. ICE has set up an exchange in Singapore to allow clients to leverage the regulatory arbitrage between Asia and Europe and the US.
Asian brokers also see an opportunity to try and get ahead of regulations where they see things changing in Europe and the US; certain clients are no longer able to work with European or US brokers and so many brokers in Asia are taking on that business.
Do you think that the impact of regulation is more strongly felt by smaller firms?
Lewis: Some of the mid-tier Asian firms are seeing ahead of time what is likely to happen in a year or two once regulations such as MiFID II come into force in Europe. They are trying to be proactive now. However, it is probable that smaller firms will struggle to keep up with the new regulations and the opportunities they create, as they won’t have the same economies of scale as the larger firms.
Henri: What is also interesting is the way the regulation has been written globally means that the industry is becoming ever-more standardised. The regulators are trying to standardise aspects such as risk controls, exchange rules, trade processing, order monitoring, compliance and reporting. A lot of overhead is created with these types of regulatory requirements, especially for firms that may not have been the target of regulation in the past.
Standardisation brings with it the opportunity to call in third party providers who can design consistent industry solutions. Instead of falling behind because you can no longer keep up with the regulatory burden on your own, standardisation opens up an opportunity – firms might want to reassess how they tackle it. The smaller firms in all regions, be they brokers or buy-side firms, will start looking towards using solution providers for many of their regulatory concerns.

Christian: There’s always a regulatory pendulum swinging in the market. At one end it favours the small firms and at the other it favours the larger firms. At the moment, particularly when it comes to global trading (for example where an Asian investor using a European broker wants to access an American exchange), firms need to leverage their size in order to stay ahead of the regulatory curve.
However, we mustn’t forget that in each of these regions there is a sizeable domestic market where Europe only wants to invest in Europe, and so on. These domestic markets are an area where smaller brokers or buy-sides could grow. Stripping out the regulatory complexity by focusing on one region instead of many means that whilst a smaller firm might not be able to serve all clients they would gain considerable cost advantage because of lower overheads. This approach presents a real opportunity for the smaller players.
So firms are refocusing on their core competitive advantage?
Christian: Yes, and this is a global trend, where everybody concentrates on their unique selling proposition. At Fidessa, for example, we are well placed as a technology provider because it is our area of expertise. Smaller brokers are generally very good in their specific market, while other firms might specialise in providing a global standardised service across all markets and that’s why they focus on that.
In that sense technology and advances in outsourcing are enablers, allowing everybody to focus on the one thing that they’re really good at.
Lewis: In Asia there are a number of single market brokers that focus on just Thailand or Taiwan and so on. As those markets grow and begin to attract global interest then the global brokers wanting to access those markets start looking for partners. What’s next for the small market broker? They might start to look to expand into other markets or regions, or to go global. The challenge for them is they have to start looking at the regulations in new regions, they have to figure out how to access those markets, and they start to look for the best solutions and technology to help them grow in each area.
Many struggle beyond their home markets, whether a single market or outside Asia, because they don’t necessarily have the in-house expertise, and that is when they start looking for outsourced solutions to help them.
Henri: Announcements published since Regulation AT indicate they are trying to introduce globalisation to the US futures industry which has traditionally been more regional. To Christian’s point, many futures market participants focus on a distinct aspect of their home market.
In the US, we were a little more apprehensive given that Dodd Frank and the broader derivatives initiatives caused a number of regulatory headaches. But now, five years on, people are starting to realise that regulation is not something to shy away from but essentially to digest, understand and find ways of adapting to.
To what extent do firms have to guess what the regulator is going announce?
Christian: There are many finer details which are still being negotiated not only by the regulators but also the legislators. As MiFID II is so large there are inevitably a significant number of outstanding issues to be resolved. However, having said that, there are a lot of things that can be done.
While we don’t have certainty in some areas, there are others where there has been real progress. This is encouraging considering that firms need to be ready by January 2018. The customers we speak to are all in the process of preparing as much as they can now, so that when it gets closer to the go-live date there will be spare resources to react to market demand.
Lewis: We have seen with a number of our clients that where regulation might be stricter in one region, then they will adopt that standard globally. A good example of this relates to the rules around data security and data protection in Singapore; they are much stricter in Singapore than they are anywhere else in the world.
Christian: We’ve just experienced a period of five to seven years where each region has made significant changes to its regulatory framework. The likelihood that the outcome is neatly aligned across borders is very slim.
Looking forward optimistically, many of those differences should be smoothed out over time. The longstanding debate between the US and Europe over the acceptance of US CCPs or EU CCPs is one example. After more than three years’ debate, the EU and the US finally came to an agreement. Identifying and adapting to those differences will be difficult for a business to manage, but the regulators have a mutual interest in aligning to a common standard. Therefore, I’m optimistic that those issues will be resolved in the future.
Henri: Risk is just one component of the cost to operate in the global landscape. Companies dealing with global regulations have to be aware of how the rules interact with one another. They have to be prepared to spend the time, money and energy in ensuring that they keep up with regulation because there is always a risk of regulatory impact between what might otherwise be similar business practices across jurisdictions.
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