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Upcoming Regulation: Changing The Trading Technology Landscape

By Sacha Fellica, Global Product Manager, Sales and Trading, Bloomberg

After the crisis of 2008 a host of new regulation has been introduced and has driven many of the changes in the trading technology arena. This article examines how the upcoming MiFID II and recent regulation such as the Market Abuse Directive (MADII) and Market Abuse Regulation (MAR) will continue to drive this change. Particular attention will be paid to potential implementation challenges that these pieces of regulation will bring and some suggested solutions will also be presented.

Best execution under MiFID II

A key focus for the regulators post MiFID II will be monitoring how market Sacha-Fellica-Crop1participants will comply with their obligation to provide best execution to their clients. MiFID II does not steer away from MiFID as it pertains to the “best ex” obligation but does offer a step up in the wording asking participants to take “sufficient” instead of “reasonable” steps to provide best ex. Therefore the focus on the multi-factor approach (price, cost, speed, likelihood of execution and settlement, size and any other relevant consideration) will still stand. It is also clear that particular attention will be paid on how best ex is applied to non-Equity asset classes such as FX, Fixed Income, Derivatives and Contract-Based Instruments.
Market participants will be required to develop easily accessible best ex policies and clearly communicate these to clients. Regulators appear to be eager to ensure that appropriate best ex monitoring is in place and that the results of the monitoring process are fed back into the way in which firms run their business. For example the UK regulator, the FCA, which has been very active in driving the best ex agenda, during their Thematic Review published last year,[1] concluded that ‘most firms are not doing enough to deliver best execution through adequate management focus, front-office business practices or supporting controls’.
This means that from an implementation perspective regulated firms have their work cut-out; they will have to address the shortcomings highlighted by the regulator and also enhance their best ex framework to be multi-asset if this is not in place already. From a data consumption perspective the new best ex framework will substantially increase the amount of data that will have to be captured and analysed. Sub optimally implemented TCA processes will be therefore placed under substantial strain from the new requirements. It is therefore reasonable to expect that a significant part of the MiFID II implementation costs will be directed to solve the data problem that the new best ex framework will offer. Unresolved issues such as the lack of a European Consolidated Tape will continue to impact the quality and cost of implementing a TCA process for Equities and the renewed focused of providing best ex for asset classes that lack price transparency will bring new challenges.
The regulators will carefully scrutinise how firms implement their best ex process and integrate its results to their core business. Therefore it will be critical that firms will work hard on enhancing the integration between their OMS and TCA system. This will help dramatically towards improving the outcome of the TCA process and its ease of use whilst seamlessly integrating its results with the OMS where the core business is managed. Because of the strong focus on best ex outside of Equities, the new framework will have to thoroughly support other asset classes. Therefore from a data perspective it will be important to obtain and create reference prices from all available sources (RFQ systems, leading composites such as WM for FX and CBBT for Fixed Income or modelled prices for very illiquid instruments).
As it pertains to the accessibility of the results and the disclosure of the best ex policies to clients, a suggestion would be to move to easily accessible and consumable reporting formats such as portals instead of static pdfs or printouts. This will help dramatically a firm to explain and summarize to its clients, how venues are selected, what execution strategies are employed and how the firm generally monitors TCA.
Standards such as FIX should be used wherever appropriate in order to bring the cost of implementation down. Prime examples of how FIX can be used to drive costs can be found in the Market Model Topology (MMT), very relevant for TCA reporting in that it harmonises condition codes across venues, and the now widely utilised tag 30 (Last Market) and tag 851 (Liquidity Indicator).

Monitoring and accessing liquidity under MiFID II

When focusing on liquidity issues post-MiFID II it is appropriate to consider separately the Equity and the OTC worlds. As it pertains to Equities it is clear that the dark trading caps[2], affecting trading under the Reference Price Waiver (RPW) and certain type of negotiated trades, will be the main challenges to address.
If a stock will breach any of the two caps it will be banned from trading in the dark for six months and trading for that security will have to move to lit venues. Undoubtedly this will be a significant change and whilst it is still uncertain how market participants will respond, it is clear that trading under the Large in Scale (LIS) waiver will become increasingly significant. There is a feeling that the trading caps might put an end to trading under the RPW since it will be very difficult to monitor how close a stock is approaching its limit especially on a consolidated basis. Some market participants have therefore already started to look at ways to encourage LIS trading. Noticeably the BlockDiscovery service offered by Turquoise with the use of conditional orders, the introduction of a midday auction from the LSE and the creation of the Plato Partnerships are some initiatives that have recently materialised.
From an implementation perspective it is therefore clear that it will be important to build solutions that will allow easy monitoring of block trading activity across venues. The same can be said about the use of block discovery analytics and analytics that will flag quickly and easily when a position or order qualifies to trade under the LIS waiver. Further implementation challenges will apply to algorithms which will have to be recalibrated in order to deal with the introduction of new intra-day auctions. In this case the algos’ capability of pausing from continuous trading, switching into auction and back again to continuous trading will have to be added. Moreover the algos’ participation and slicing logic will also have to be recalibrated; this is so that the execution strategies will be capable of coping with additional auctions and the opportunity of interacting with larger blocks of liquidity.
Switching to the liquidity challenges facing the OTC market, there is an on-going debate within Fixed Income which is centred around the calibration of the pre-trade transparency rules. Many institutional investors are concerned that illiquid instruments might get classified into liquid buckets under the pre-trade transparency regime. The concern is that an incorrect classification of instruments might result in additional thinning of liquidity, the surge of predatory strategies, higher costs for investors and increased market volatility. A lot of discussions are also still on-going as it pertains to what needs to be done with the publishing of individual RFQ prices. Some institutional investors are backing the idea of publish a composite average of received quotes by volume bands whilst others are in favour of the creation of a quote batching system with built-in delays for publication.

Trade surveillance under the Market Abuse Directive (MADII) and the Market Abuse Regulation (MAR)

Lastly moving on to new regulation that has been recently introduced but where there is still huge scope for system and process improvements, MADII and MAR continue to be at the forefront of the regulators’ agenda. Generally surveillance processes monitor market abuse by applying a “sampling” approach to analyse a firm’s order flow. A suggestion for improvement would be to use an exception based monitoring approach instead. This would enable a firm to monitor all of their order flow and focus only of the exceptions generated once that the surveillance process has been calibrated accordingly.
The surveillance tool should then be further enhanced to capture all relevant electronic communications (emails, voice calls, file exchanges and website visited to name a few) into a data store in order to provide point in time analytics of the exceptions highlighted by the tool. The proposed solution would allow users to reconstruct a trade and pool in every relevant piece of information that happened around that trade (communications, news, events, and so on) and offer a very powerful investigative tool. Whilst the surveillance and best ex processes are separate bringing these two closer will eventually provide further efficiencies to the users.


In conclusion regulation will continue to drive changes within trading technology over the next 2 to 3 years. From a best ex and trade surveillance perspective, it will be important to implement a multi asset TCA process and move away from a sampling approach and towards exception based surveillance. It will be critical to ensure that the results of the monitoring processes will be integrated to the core of the business as regulators will pay particular attention to this. Different challenges will impact the liquidity of Equities and OTC asset classes. For Equities trading under the Large in Scale waiver will become critical as market participants will focus heavily on trading in blocks as much as possible. For OTC asset classes such as Fixed Income the calibration of pre-trade transparency requirements will be a critical issue. Finally as an additional comment it is very apparent that the trading of OTC asset classes is becoming increasingly more electronic. This means that what has been learned from the Equity experience can be applied to OTC asset classes too. However it will not be possible to simply port Equity technology to cater for OTC trading as the nuances of the different after class will have to be accounted for.
[1] TR14/13: Best Execution and payment for order flow, July 2014: https://www.fca.org.uk/static/documents/thematic-reviews/tr14-13.pdf
[2] 4% on the amount of trading in a stock that can be carried out on any single dark pool
8% on the amount of trading in a stock that can be traded across all dark pools
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