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The Impact Of European Regulation


Rudolf Siebel, Managing Director of BVI Bundesverband Investment und Asset Management, shares the perspectives of German asset managers and their regulatory requirements for the coming year.
Rudolf SiebelBVI represents the German investment fund and asset management industry, which manages approximately 2 trillion Euros in assets such as bonds, equities and derivatives.
The envisaged and enacted regulations (e.g. MiFID/MiFIR, EMIR, EU Index Consultation) on trading, clearing and settlement of financial instruments and index products as well as derivatives are an important element to strengthen the European securities markets. Our members support well balanced regulatory initiatives in these areas at both the European and national level in order to restore investor confidence, reduce systemic risk and to improve financial stability. BVI is in close cooperation with all relevant stakeholders and regulators in order to improve the regulatory framework in the pre- and post-trade environment.
We recognise that the new regulatory framework will put pressure on all market participants (e.g. asset management companies) to streamline and automate even more their operational workflows in the front, middle and back office. Therefore we welcome improvements in automation that are based on standards, such as the FIX Protocol.
Retain the pre-trade transparency waivers
Asset managers need to retain the ability to execute large block orders on behalf of institutional investors without creating a market impact in terms of liquidity or price. Long term investing institutional investors (e.g. pension funds) are vulnerable to the constant risk that other market participants (e.g. High Frequency Traders (HFT)) will identify their block orders and “front run” them.
The German investment fund industry needs pre-trade transparency waivers in order to protect institutional investors.
Besides a large in-scale waiver we also fight for the retention of the reference price waiver. The reference price waiver is necessary to allow the broker working on behalf of the asset manager to split (without creating too much of a market impact) a large order in the course of the trade execution.
If the investment fund industry could not rely on this kind of waiver going forward, asset managers would not be able to place block orders in the market because of the risk of the orders becoming public. Investment managers would need to split each order into very small size transactions to avoid the signalling risk. But the average trade size and the corresponding liquidity for larger orders has already diminished a lot in the lit markets due to excessive high frequency trading.
Proper differentiation between high frequency and algorithmic trading and minimum resting times
The German Ministry of Finance has proposed a national law on high frequency trading prior to the implementation of MiFID /MiFIR .
Asset managers are not HFT and do not use investment funds in order to generate profits through HFT strategies. However, they optimise the performance of their investment fund by also using algorithmic trading strategies, e.g. to automatically rebalance an index-linked portfolio once or twice a day.
Because asset managers, like most banks, are not engaged in HFT, we request that the German regulator differentiates between algorithmic and high frequency trading on the basis of the HFT definition of the European Parliament dd. 26 October 2012. According to the EU Parliament an HFT trading strategy is a trading strategy for dealing on own account in a financial instrument which involves HFT trading and which has at least two of the following characteristics:
(i) it uses co-location facilities, direct market access or proximity hosting;
(ii) it relates to a daily portfolio turnover of at least 50%;
(iii) the proportion of orders cancelled (including partial cancellations) exceeds 20%;
(iv) the majority of positions taken are unwound within the same day.
(v) over 50% of the orders or transactions made on trading venues offering discounts or rebates to orders which provide liquidity are eligible for such rebates.
Usage of Pre-LEIs in the EMIR reporting obligation
The European Market Infrastructure Regulation (EMIR) introduces new regulatory obligations for all participants in the OTC derivative markets. One important pillar of the EMIR regulation is the obligation to report all transactions to trade repositories. The identification of all market participants shall be made through the Legal Entity Identifier (LEI). As the LEI system is not expected to be operational before 2014 we hope that the EU will endorse an interim solution which allows the use of a so-called pre-LEI identifier issued by FSB approved operators such as DTCC/SWIFT (CICI) or WM-Datenservice. If no final LEI or interim LEI is available, the market participants would have to use the BIC Code for the identification of the counterparties. In total we calculate that more than 100,000 entities in the EU need identifiers for EMIR reporting, including 30,000 investment funds/asset managers, 55,000 pension funds, 9,000 companies listed on the European stock exchanges and more than 5,000 insurance companies that are likely users of derivatives but which are currently not part of the BIC universe. These entities would have to register a BIC Code. However, using the BIC means doubling the cost for each company by requiring registration now for the BIC, and at a later stage for the global LEI. It is not fair to require from most of the market participants outside the credit institution sector to go through the time and effort of double self registration. The unnecessary double registration will damage support for the global LEI system in the market place.
LiBOR manipulation – Regulation of index providers
Due to the LiBOR scandal, the EU Commission started a consultation on the possible regulation of index and benchmark providers. We support the initiative of the EU Commission to regulate the production and use of indices in the financial services industry. A new regulatory framework for index providers is essential in order to restore investor confidence in the market and improve financial stability. In particular, full daily transparency of the index, weightings, constituents and contributors would enable all market participants or their service providers to check the correct calculation of an index. This is the best protection against market manipulation attempts going forward.
Many financial indices are based on market capitalisation, but increasingly, market participants use strategy indices which are based on economic fundamentals or on a risk/return profile. That market segment needs to be distinguished from customised/bespoke indices that are created and customised either by the provider of the basic market index or by a third party (e.g. an asset manager) on the request of one or a very limited number of market participants and according to the specification of market participants. Such individually agreed indices should be considered out of scope of the debate at hand and of any regulatory discussion as the implement only a specific risk/return profile of an institutional investor (e.g. an insurance company hedging interest rate risk on the based portfolio). Only market or strategy indices which are created for a large number of users should be in the focus of the potential regulation of index providers.

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