In search of FX liquidity

Foreign exchange (FX) is one of the world’s most liquid markets, with around USD 5 trillion exchanged across borders every day.

However, there is a perception in the market that liquidity is on the wane.

This is not necessarily true, according to David Puth, CEO of CLS. Speaking to Euromoney, he said “There is a tendency for market participants to believe that liquidity was better in the past. From what we see at CLS, liquidity appears to be very strong. It is, however, different, with liquidity widely dispersed over a number of different trading venues.”

The pessimism may in part be as a result of the increasing difficulty in defining exactly what liquidity means in the modern market, and measuring it accurately.

This was one of the questions which a recent report on liquidity in the Americas from the Bank of International Settlements (BIS) attempted to address.

Traditional liquidity metrics, such as cost metrics, quantity metrics and trade impact, have their uses, but the report finds that none are a perfect way to measure liquidity in the modern market.

This is important because one thing which is clear is that the modern FX market is becoming increasingly complex, making understanding liquidity more difficult.

The market, like many others, is fragmenting as electrification proliferates the number of trading venues and sell side participants put more emphasis on internalising trades.

Whether this fragmentation is having an impact on traders ability to trade, remains an open question.

The BIS report indicates that fragmentation does appear to be having some impact on liquidity measures, particularly when it comes to periods of market stress.

It gives examples such as the 2016 British EU referendum and flash crashes, where traditional liquidity metrics appear to have been impacted across a number of currency pairs, at least over the short term.

Dan Marcus, CEO of ParFX, points out that sometimes individual metrics don’t always give the full picture. “It may be the case that volumes are down from where they were… [However] on ParFX we do not see evidence of a problem with market depth or the ability for traders, who need to trade, fill orders.”

This is in part because, while technology is driving fragmentation, it is also creating opportunities to aggregate liquidity in more efficient ways.

“Buy-side traders have responded [to FX market fragmentation] by turning to algorithms and taking on more execution risk themselves”, says Pragma’s CEO David Mechner.

Liquidity is the lifeblood of the FX market, it is vital that the market can measure it in a way which gives an accurate representation of what it is like to trade. One solution, suggested by Mechner, is a consolidated tape, much like in equities. Until then, the market should think carefully about the metrics used to measure the market and ensure they are fit for purpose.

Mosaic Smart Data named Best Use of Data and Analytics Innovation at the 2017 FStech Awards

Data analytics technology specialist Mosaic Smart Data has won the Best Use of Data and Analytics award at the annual FStech Awards, held in London on Thursday 23rd March.

Regulatory changes and advances in technology are revolutionising fixed income, currencies and commodities (FICC) markets and driving the need for intelligent data analytics and reporting.

MSX delivers a next generation data analytics platform for FICC market participants. By delivering the insights and real-time intelligence they need to harness exponentially increasing data as well as meeting regulatory requirements, it enables trading and sales teams to significantly enhance their workflow productivity.

The platform standardises and aggregates multiple data sets to enhance audit trails and reporting, enabling banks to comply with mounting regulatory requirements.

Mosaic has fully integrated predictive analytics into MSX, enabling financial institutions to more accurately determine future market activity based on sophisticated algorithms and historical data.

After collecting the award, Matthew Hodgson, CEO and Founder of Mosaic Smart Data, said: “In today’s digital world, banks need to have a deep understanding of the business they are handling in real time. The data is there, but it needs to be standardised and have intelligent analytics applied to it. It is an incredibly intensive undertaking which requires both innovative technology and thorough insight into the bank’s business needs.”

Read more about this story at Mosaic Smart Data’s website here.

Adherence to FX Global Code will reform conduct and behaviour

As we near the final stages of the development of the foreign exchange (FX) Global Code, the ACI Financial Markets Association (ACIFMA) is leading efforts to support education and adherence. We will start by making commitment to the Code mandatory for ACIFMA members, and encourage members to prove their adherence in future. This could prove to be a turning point in reforming conduct and behaviour in foreign exchange, writes Brigid Taylor in FX Week.

As a member of the MPG, ACIFMA has both contributed and witnessed the extent to which market participants and policymakers have engaged, discussed, debated and worked together in the best interests of the wider market. This is an industry that transacts more than USD5 trillion of currencies across borders every single day. Its ability to operate smoothly is crucial to the international economy.

There was of course a broad range of views on how best to address a series of topics, such as governance, information sharing, last look and pre-hedging. An array of views is expected in any large consultation, but consensus has been achieved with the best interests of the market in mind.

The final Code will, in my view, outline principles and guidance that is effective, appropriate and strike the right balance. I expect it to act as an essential reference for market participants when conducting business in the wholesale FX markets and when developing and reviewing internal procedures.

Hardwiring adherence – the third objective

This brings us to the final objective set out at the beginning of the process: develop proposals to promote and incentivise adherence to the Code.

For this to happen, it is essential that individuals (i) commit to adhering to the Code; (ii) receive the appropriate training and education so they are clear on what is expected and understand how to comply; and (iii) sign up to a solution where senior managers are able to observe and address any training and educational gaps amongst their subordinates.

This is where the ACI Financial Markets Association (ACIFMA) can play a central role. With a track record in delivering training, education, attestation and best practice principles that stretches back more than half a century, we represent more than 9000 individuals in 60+ countries.

There are several ways we intend to achieve this. Firstly, we will make it a prerequisite for individuals to commit to adhering to the FX Global Code as part of their membership. This means a meaningful proportion of the market – over 9,000 FX professionals around the world – will sign up immediately after the code is launched and commit to understanding, implementing and abiding by the new principles.

There is an urgent need to restore ethics in financial markets and the FX market is aware of its responsibilities to its clients and stakeholders. The significance of the enormous effort undertaken over the past three years should not be underestimated; to date, the level of leadership and engagement has been exemplary. I expect the FX Global Code to be a turning point in reforming conduct and behaviour in foreign exchange and develop a renewed sense of trust in this important sector of any economy.

To read the full article by Brigid, please visit the FX Week website here.

Can we hardwire trust into our financial systems? SxSW Tech Briefing

This year there were no big headline tech launches to speak of which is unusual for an event which in years gone by saw the launch of Twitter and Foursquare, to take but two.

But this year, the tone and content was quite different. The changing political landscape loomed large, chiefly with the ‘tech under Trump’ work stream but also with keynote speeches from Joe Biden and Corey Booker.

For 2017, the recurring theme was on a pervasive lack of trust and transparency between individuals and organisations, as well as between society and its governments.

Various barometers of sentiment reveal that we are at a historical low for trust in institutions such as banks and the media.

Four panels and presentations focused on the technology variously known as Blockchain or Distributed Ledger and how it can be applied to hardwire and build trust into our systems and interactions.

Discussions ranged from how this tech enables individual contribution, makes it easy to collaborate, decentralises power and creates hope for increasing equality.

There were hands-on workshops and introductions to some of the protocols, coding and design challenges in creating distributed data structures.

As a recap on ‘Blockchain’, it is effectively a record of assets, or any other kind of content, that is shared, replicated and encrypted so it becomes a verified and immutable source of truth. The blocks can’t be modified, but can be viewed, meaning a huge benefit lies in the added trust and transparency that provides.

Dr Tomicah Tillemann, of New America’s Bretton Woods II program is working with his team to apply the principles of blockchain to the US land registry system.

Speaking at SxSW he commented: “Institutions right now provide the facts at the foundation of our reality. I know there’s a land registry somewhere that says I own my house. I swipe my card because I know the bank will transfer the right money for me. As soon as people lose confidence, those systems start to break down really quickly.

“The exciting thing about blockchain is that it has the potential to create a layer of authentication and validation that can’t be tampered with. It’s a layer of reality locked in mathematically, and it’s locked in permanently, which is something we’ve never had before.”

IBM was also in attendance, focusing on the wider potential application of blockchain, announcing a blockchain solution with shipping container giant Maersk to track shipping containers across the world

With over 90% of goods in global trade carried by the ocean shipping industry each year, there are clear benefits to enhancing transparency and sharing information.

From the exchange of money between two parties, to documenting how goods move through a supply chain, and the making of contractual agreements, there are significant savings to be had in terms of cost and time as well as the potential to reduce risk and increase trust.

Algo trading on the rise as Pragma establishes European presence

The decision by Pragma to set up a base in London shows how the UK’s capital remains the natural hub for algorithmic currency trading despite the UK’s looming exit from the European Union.

While the debate about the future of London in a post-Brexit environment continues to rage on, there are many who continue to recognise the role of London at the centre of the USD5 trillion currency market.

Algorithmic trading in particular continues to rise in popularity. A report from Greenwich Associates found that the proportion of volume-weighted FX trading executed algorithmically has increased two and a half times in the past three years.

This trend was further highlighted by Pragma Securities, the multi-asset class provider of algorithmic solutions, which established a new connectivity presence in London to service its growing international client base.

London currently accounts for more than a third of all currency trading activity globally, according to the BIS. In a news article in FX Week, David Mechner, CEO of Pragma, expressed confidence in London and its role at the centre of European and international financial markets.

“Equinix’s LD6 site offers Pragma360 clients access to state-of-the art technology and the largest ecosystem for foreign exchange trading globally.

“The banks we service need state-of-the-art trading capabilities for their traders, and buy-side and corporate clients, making LD6 a natural fit.”

Pragma is not alone in its bullishness on London’s future, and it is clear that maintaining a data centre presence remains crucial to an institution’s trading operations, particularly for FX trading. The Financial Times recently reported on Dutch data centre operator Interxion’s £30m investment in its site in London’s Brick Lane.

Curtis Pfeiffer, Chief Business Officer at Pragma, also highlighted the benefits of proximity to London and risks of leaving London’s FX ecosystem.

“We are moving forward with this large capital expenditure because London, as the largest FX trading centre in the world, hosts the largest datacentre ecosystem for low-latency FX trading applications and we do not see that changing any time soon,” said Curtis.

“Institutions will be reluctant to leave the data centre ecosystem in London, which has increased in size significantly over the last 10 years as a result of a network effect – everyone wants their trading servers to be where everyone else’s are. By leaving that ecosystem, a firm could disadvantage themselves and their clients.”

Algo trading and interest in emerging market currencies will grow in 2017 driven by hunt for FX liquidity

Traders at across both buy and sell side are reporting that they plan to make more use of computer algorithms to trade FX in 2017 and are also setting their sights on traditionally less-traded currencies.

This matters. Foreign exchange – or FX – is the world’s largest and most liquid market, with around USD 5 trillion exchanged every day across borders.

FX underpins global trade and commerce, allowing countries, companies and institutions to trade, hedge and transfer risk.

Now a survey of over 200 FX trading institutions reveals that while 12% currently use algorithms, 38% plan to increase their use of algos in 2017.

JPMorgan believes 2017 is going to be “a watershed year for algo usage”.

In terms of currency mix, traders currently spend 70% of their time trading the major G10 currencies – including EUR, USD, GBP and JPY – and 26% in emerging markets.

This looks set to change in 2017 with 15% planning to increase their use of G10 currencies this year, with 32% planning to trade more emerging market* currencies as their liquidity continue to improve and they therefore become increasingly more attractive to trade.

So it’s no longer just about speed and a race to the bottom to be first in and out of the market – so called ‘bad algos’ beating everyone to the punchbowl.

The unifying theme of both the rise of the machines and the renewed interest in traditionally ‘less traded’ currencies is the search for liquidity in an increasingly fragmented and competitive market.

Algos can monitor and act across multiple venues, markets and currency pairs to flag opportunity or alert to risk.

Likewise, an uncertain macro-economic outlook plus improving liquidity makes trading in less-traded pairs much more attractive.

As the first signs of Donald Trump’s victory in U.S. presidential elections emerged the largest increase in currency pair activity was the U.S. dollar traded against the Mexican peso (USD/MXN), 63 times normal levels in the hour following the result.,

By way of comparison, spikes were also registered across the major currency pairs with input volumes ten times normal levels for EUR/USD for that hour, followed by USD/JPY and GBP/USD.

Turning to FX instrument type,40% of FX traders report that they plan to use more options in 2017, with a corresponding increase in cash, swaps and NDFs as hedging tools in an uncertain political and economic environment.

*On the whole at Chatsworth we’re not so keen on the term ‘emerging markets’ which is largely subjective and frequently inaccurate as many ‘emerged’ long ago.

The FX market’s six-month health check is due this week

The Bank of England releases FX trading data from the market for the six months to October last year. That covers a bouncy few months to say the least.

This data set will cover the Brexit vote and the not-entirely-event-free run up to the US election so we’ll be interesting to see what happened with dollar-peso volumes and Sterling which continues to be buffeted by the winds or Brexit and a significant degree of political and economic uncertainty.

These are unprecedented times for the flow and trade of global currencies and the structure of one of the world’s largest and most liquid markets.

The public face of the market has focussed on the conduct of some traders remains in the spotlight following a series of high profile legal cases over alleged malfeasance.

Much of this is being addressed through the Global Foreign Exchange Code of Conduct, led by the Bank for International Settlements.

But it is the changing role of the banks and the funds as makers and takers – the shape-shifting of the formerly API prop traders towards market maker status that, in our view, has delivered the most significant structural change.

Once dominated by the largest global banks, the growth of electronic trading has made it easier for relatively smaller financial firms to become directly involved in currency trading. Access to the market and competing trading venues have exacerbated this process.

Concurrently, regulation has limited the risk these banks can carry on their books, making them more selective about how and with whom they trade.

Currency trading continues to be dominated by what are euphemistically described as “other financial institutions”

This category includes smaller commercial and investment banks, as well as buy-side firms like pension funds, mutual funds and hedge funds. In other words, not the banks.

Broadly, volumes of late have been lower with overall daily turnover declining to around USD 5.1 trillion in April 2016, from USD 5.3 trillion three years ago.

But the there has been a significant uptick in currency market volatility has increased over the past few years.

All eyes on Tuesday to see how the market fared through the events of the latter part of 2016. Expect a few surprises.

David Rutter: 2017 the year of blockchain delivery

In the long history of humankind, those who learned to collaborate and improvise most effectively have prevailed, says David Rutter, CEO of R3.

Darwin’s point holds true. Critical mass, momentum and co-operation are absolutely essential if we are to transform financial services and the communications and transactional framework we rely on.

This was our rationale for bringing banks together to jointly develop distributed ledger technology for the financial services industry from day one.

In R3 we have created a fast moving financial technology product company with an ownership structure which provides a balanced governance, combined with the leadership and stewardship of the best technologists in their respective fields.

The spaghetti junction of shared legacy infrastructure as well as individual front, middle and back office systems is testament to the resulting mess when banks disappear into development silos.

The overall cost of maintaining this legacy infrastructure is incalculable and there is risk around every corner, embedded into the old Cobol and Fortran code under the layers of many of those systems.

That is why we came together with an initial group of nine banks in September 2015 to create R3. A highly experienced and effective technology team was assembled and ready for action two months later.

Fast forward a year and there are now over 75 members of the R3 group – with two additions in the last week alone – working together on a diverse array of projects and developing technology to address some of the most serious pain points affecting the industry.

There is no secret. We hired the best, assembled and activated a powerful and engaged membership base and connected them together to leverage the network effect distributed ledger technology delivers.

Together, we have designed, built and launched Corda, the open-source release distributed ledger platform which will set the standard for this technology in global financial markets.

This is the only platform designed by and for its users and represents the world’s largest collaborative distributed ledger effort in financial services. It is unique and it is a landmark moment for the market.

Distributed ledger technology will have such phenomenally powerful network effects that it is hard to imagine serious institutions deploying base-layer ledger software that is anything other than fully and wholeheartedly open.

The response and engagement with Corda has been exceptional and only a few weeks after open sourcing the platform we have already had a vast number of contributions from the public developer community.

Amidst the excitement of the Corda roll-out, it’s hard to ignore the running commentary on the progress of our fundraising programme.

The motivation and accuracy behind some of the noise has sometimes been questionable, but such is the nature of working on such high-profile projects. It’s a complement to be discussed and we are very happy with constructive criticism, but better when the discussion is informed and accurate.

We have always expected the make-up of the consortium to change over time – our member base is so large and so diverse, it would be unrealistic not to expect some institutions’ priorities, resources and focus to travel in different directions.

We have new members joining the project all the time and some banks may choose to change the way in which they engage with us as we move forward, but the critical mass we have built over the last year means members can be confident they are investing in developing industry standard solutions that will be the building blocks of the new financial services infrastructure.

The financial institutions that have shown the vision to join R3 are by that very action ensuring the technology we adopt is built using common code and protocols, ensuring seamless interoperability and integration.

This is a direct hedge against the risk of replicating the disjointed infrastructure financial markets are forced to operate on today.

We remain focused on perfecting Corda and looking ahead to our objectives and deliverables for 2017 working together with our members.

We are on the cusp of a new era in financial technology, and over the next year banks will begin to reap the benefits that have been promised to them since the financial services industry recognized this technology’s potential to deliver efficiency, lower risk, security and cost reductions.

Let’s be clear: the power of distributed ledger technology lies in its network effect – and that goes for the build as much as the usage. The past few years were characterized by blockchain hype. Leveraging the combined power and expertise of our diverse and growing group of members, R3 will make 2017 the year of blockchain delivery.

Post-result: input volumes submitted to CLS

Input volumes1 submitted to CLS

CLS witnessed increased levels of FX trading activity during the announcement of US election results, with particular spikes in activity between 02:00 – 03:00 GMT when the results for key swing states were announced (input volumes were 7 times normal levels for that hour). This heightened activity continued following the confirmation of Republican candidate Donald Trump as president between 08:00 – 09:00 GMT, when input volumes were more than double normal levels for that hour. 

Significant spikes were registered across currency pairs between 02:00 and 03:00 GMT, with input volumes ten times normal levels for EUR/USD for that hour, followed by USD/JPY and GBP/USD (nine times and five times respectively).

The largest increase in currency pair activity was the US dollar traded against the Mexican peso (USD/MXN), 63 times normal levels for that hour.

A full breakdown can be found below.

Between 02:00-03:00 (GMT), CLS total input volumes increased significantly to 199,030 compared to a YTD average for that hour of 28,829 i.e. volumes were 6.9 times normal levels.

For the same period, the input volumes for the top five most traded currency pairs and the USD/MXN were as follows:

Currency pair

input volume for 02:00-03:00 (GMT)

YTD average input for 02:00-03:00 (GMT)

input as multiple of average

EUR/USD

33,675

3,226

10.4

USD/JPY

75,575

8,598

8.8

GBP/USD

6,732

1,436

4.7

AUD/USD

18,220

4,461

4.1

USD/CAD

8,177

1,049

7.8

USD/MXN

8,803

139

63.3

Between 08:00-09:00 (GMT), CLS total input volumes increased significantly to 150,487 compared to a YTD average for that hour of 66,983 i.e. volumes were 2.2 times normal levels.

For the same period, the input volumes for the top five most traded currency pairs and the USD/MXN were as follows:

 Currency pair

input volume for 08:00-09:00 (GMT)

YTD average input volume for 08:00-09:00 (GMT)

input as multiple of average

EUR/USD

36,867

14,985

2.5

USD/JPY

38,946

10,991

3.5

GBP/USD

8,797

6,233

1.4

AUD/USD

11,347

6,024

1.9

USD/CAD

6,578

3,054

2.2

USD/MXN

4,458

651

6.8

 

1 Input volumes are the number of instructions received by CLS for future settlement combining the settlement and aggregation services. 

CLS Data: CLS makes aggregated FX trade data available to subscribers through Quandl, a data platform for economic and financial data. Data is available for subscription in the form of three separate reports, showing activity by hour, day or month. The data reports contain trade volume in terms of both the number of trades and the total value in USD. The data is aggregated by trade instrument (spot, swap and outright forward) and currency pair. Visit the Quandl website to find out more.

 

 

Disruptive HFT: Legislation, taxation or industry solution?

High-frequency traders are in the news again…

In financial markets, it’s not uncommon to hear whispers about high-frequency traders (HFT), and their so-called ‘bad behavior’. Amongst the chatter, officials are busy pounding their gavel as they race to govern HFTs.

The HFT community has, rightly or wrongly, developed somewhat of a reputation problem and is firmly in the crosshairs of international regulators seeking to crack down on what they see as nefarious behaviour.

However, with no international body coordinating efforts, there is a divergence appearing in different international regions, with a variety of different measures being proposed.

Presidential candidate Hillary Clinton has long called for a tax on high frequency trading transactions during her campaign. In recent weeks, however, the Japanese Financial Services Agency (FSA) reignited the debate over how officials should handle the growing presence of HFT in public markets. With the practice accounting for about 70% of all order flow on the Tokyo Stock Exchange in 2016, the regulator has proposed plans that would require HFT to register their risk management measures.

More recently, a report from Bundesbank analysed HFT patterns in Germany’s stock and bond markets and suggested, amongst other recommendations, a trading delay or ‘speed bump’ that could reduce the incentive for some market participants to engage in a technological arms race.

But in a twist of events, the European Central Bank’s report on Tuesday arrived at a different conclusion, suggesting the best way to monitor HFT was to use existing tools provided by the industry instead of rigorous rules.

Both reports agree that HFTs boost liquidity, making it easier for investors to buy or sell an asset. Contrary to the ‘Flash Boys’ image, academics have produced research reiterating this view and highlighting how HFTs reduce trading costs, improve market depth and stability. Jonathan Brogaard, a professor at the University of Washington, told Bloomberg: “as a whole, the literature strongly supports HFTs being a net positive.”

Despite this, the debate rages on: should there be greater regulation? Is that really the best approach, or can market-led solutions provide the answer?

In recent years, industry-led solutions have certainly become increasingly prominent. In spot foreign exchange, for example, an electronic spot FX platform called ParFX has employed a number of tools, including a randomised pause on all order submissions, amendments and cancellations, to prevent disruptive trading.

Dan Marcus, CEO of ParFX, shares the view that the market can create its own solutions. “Rather than an ineffective and expensive cure in the form of legislation or taxation on trades, which will take years to implement and almost certainly result in regulatory arbitrage, a proactive preventative, market-led solution is required.”

With other trading venues such as IEX and Chicago Stock Exchange adopting “speed bumps”, this idea certainly seems to be gaining momentum.

So what’s the right answer? Should we increase regulation? Implement a “speed bump”? Impose a tax on transactions, as suggested by Hillary Clinton? Looks like the jury is still out for now.

Regulators seek further transparency for the US Treasuries market

As the Fed marks its second annual conference on the evolving structure of the US Treasury market, there has been much debate over the future of the $13tn bond market.

The conference was established following the now infamous flash crash in US Treasuries on October 15 2014, which saw enormous swings in the 10-year benchmark – causing a major upset and soul-searching about the structure of the market.

A particular topic that caught the interest of market participants during this year’s conference was trade reporting. At present, there is no requirement to report trades involving US Treasuries, unlike corporate bonds or equity markets. However, in a bid to bring further transparency to the market, Antonio Weiss, counsellor to the secretary of the US Treasury, has now called for trades to be publicly reported.

Mary Jo White, Chair of the Securities and Exchange Commission (SEC) echoed the sentiment, arguing that regulators needed “full access” to trading data, and firms buying and selling Treasuries for proprietary reasons should register as dealers.

Understandably, this has stirred up significant debate amongst market participants. As the world’s largest debt market, the US Treasury plays a major role in the cost of government finance, so any changes to how the market is governed will likely cause concern about unintended consequences.

Whilst many market participants appear to be in agreement about providing further information to regulators and increasing transparency, several banks have warned that, depending on how quickly trades are reported, it may disrupt the effective functioning of the market.

One specific concern relates to competitors potentially using this information to gain an advantage and move markets against them. Such behaviour could have a particularly hard impact when trading in large block sizes.

Reforming a market as critical as US Treasuries is no small task and it is clear that regulators are still in the early stages of this process. Perhaps by next year’s conference there will be further clarity as to the road ahead.

A milestone for electronic trading – but what’s next?

Monday, 26 October 1986 marked a momentous day for London’s financial markets. 30 years ago brokers abandoned physical trading floors in favour of computer-based stock trading, which heralded a new dawn in trading and financial markets. This programme of deregulation later became known as ‘The Big Bang’.

Led by a major Government initiative and supported by many of the biggest banks, which recognised the opportunities this presented, the industry experienced unprecedented growth in stocks, bonds, currencies and other financial products over the next two decades.

While few could have predicted how influential technology would play at the very heart of financial markets, the perennial question remains; how will it influence the markets over the next 30 years?

Electronic trading fuelled the expansion of the global financial services industry, connecting new and existing markets with a wider range of financial institutions and reducing barriers and the cost of trading for all.

Regrettably it also helped create the very conditions that would lead to a global systemic financial crisis in 2007/08 – a major turning point for the industry.

But every cloud has a silver lining and the difficult events of that period paved the way for the wholesale reform of financial markets; greater regulation and innovation surrounding electronic markets shaped the way in which counterparties interact, clear, settle and report transactions.

Dodd Frank, Volcker Rule and MiFID II, amongst others, sought to introduce greater transparency, risk mitigation and accountability. Central clearing, trade reporting and more stringent Know Your Customer (KYC) requirements have been among the central planks of the new trading architecture, allowing regulators to better monitor behaviour and risk.

This instigated significant advances in state-of-the-art trading technology such as distributed ledger technology, big data, AI and algorithmic trading. The latter enabled financial institutions to automate a number of trading processes that previously required manual intervention – from price discovery and trade execution to payment netting, post-trade processing and reporting.

So what does the future hold?

Any response to a question exploring the future of trading technology day is likely to involve the word ‘blockchain’. The nascent technology is already on the verge of transforming the way in which the financial services industry operates.

The technology has been touted as transformative in a number of areas, from capital markets trading to trade finance. To this end, R3, a global consortium behind the development and application of distributed ledger technology in financial markets, is making the source code platform for Corda publicly available, paving the way for it to become the industry standard.

But beyond the integration of emerging technology, trading systems and processes are also adapting to evolving regulatory conditions and market structure.

The growth of all-to-all trading is a reflection of changing market conditions, as non-banks play an increasingly important role as providers, rather than simply consumers of liquidity.

Elixium, a new all-to-all marketplace for the repo market, recently hit the headlines after developing a pioneering model that facilitates direct access to a much wider base of market participants.

While it is difficult to paint a comprehensive picture of electronic trading in five or even 10 years’ time, it is likely that emerging technologies such as blockchain and evolving market structures will have a big part to play.

The foundations are being put in place for technology to be at the heart of the next Big Bang.

Open sourcing blockchain – setting the industry standard

As of November 2016, any institution that wants to develop applications using distributed ledger technology, will be able to do so on R3’s distributed ledger platform, Corda.

The global consortium behind the development and application of distributed ledger technology in financial markets is making the source code platform for Corda publicly available, potentially paving the way for it to become the industry standard.

R3’s goal from the beginning was to deliver a distributed ledger solution that was open source, so as to allow the entire financial services industry to benefit and learn from its work. As the programme develops, it is evident that applications ought to be built on a common, unified platform to avoid any issues that may result from a fragmented approach.

The power of this technology lies in its network effect; therefore the consortium model, as utilised by R3, is the ideal method to get it off the drawing board and into the wholesale financial markets. By making Corda open source at a time when many participants are still at nascent stages of developing proof-of-concepts and use-cases, R3 provides a standardised environment in which to ensure these applications are scalable, interoperable and secure.

The consortium approach has repeatedly proved successful in financial markets. One of the best examples is CLS, built with a single technology provider with the backing of a consortium of banks and regulators. It was set up to mitigate a very real issue in the FX market – namely settlement risk. 15 years later it still performs a critical role in maintaining trust and stability in the currency market.

Will R3 become the next market infrastructure? The seeds are certainly being sown for this to occur as the consortium continues to strengthen its diverse membership and move ever closer to introducing practical applications for distributed ledgers.

BBC Newsnight review: Antony Jenkins on banks and the fintech sector

Antony Jenkins, former CEO of Barclays, appeared on BBC Newsnight this week to share his views on the current state of the banking sector and provide an interesting appraisal of the fintech industry and its threat to the status quo.

His short feature piece outlined the structural issues in the banking sector and why advances in technology could render these institutions redundant over the next 20 years.

Central to his argument was the potential for distributed ledger technology to reform the way in which transactions are handled and recorded by financial institutions, making the process faster, cheaper and more transparent for all.

The technology has been touted as transformative for a number of areas from capital markets trading to trade finance. But while Jenkins positioned distributed ledger technology as a direct threat to the banking sector – the reality is a little more nuanced – with a number of banks working to find new practical applications for the technology.

For example, R3, a fintech firm developing distributed ledger technology for financial markets, has already signed up over 70 banks to its consortium.

But Jenkins also covered peer-to-peer lending as an example of how banks are facing the increasing risk of disintermediation by fintech firms, which directly match borrowers with lenders to secure a better deal for both parties.

The model has become particularly prominent in the retail foreign exchange market, where providers such as Transferwise connect investors directly, thus avoiding bank fees and the risk of unfavourable exchange rates on smaller value transactions.

 The feature was first broadcast on the 19th October and can be viewed on BBC iPlayer

 

 

Regtech: tapping into the compliance goldrush

Regtech has emerged as the golden child of the fintech age. The sector has already proved pivotal to aiding regulatory compliance and is increasingly focusing on artificial intelligence (AI) to alleviate what has become a notoriously resource-intensive activity for banks and the buy-side.

With huge fines levied on banks and other institutions that fail to meet regulatory standards hitting the headlines on a regular basis – the issue of compliance is now very much front and centre of the agenda.

Perhaps unsurprisingly, compliance budgets have spiralled. According to the Financial Times, big banks such as HSBC, Deutsche Bank and JPMorgan spend well over $1bn a year each on regulatory compliance and controls, with BBVA estimating that, on average, institutions have 10 to 15 per cent of their staff dedicated to this area.

Thomson Reuters’ seventh annual Cost of Compliance Survey served to confirm the issue. “More than two-thirds of firms (69 percent) are expecting an increase in their compliance budget this year with 15 percent expecting significantly more.  Systemically important financial market utilities (G-SIFIs) are expecting a similar increase in compliance team budgets with 17 percent expecting a significantly higher budget.”

And this is only expected to increase, with major pieces of legislation such as MiFID II set to come into force in 2018. Reporting, internal controls and governance and derivatives reforms are all on the agenda posing challenges for cost-conscious institutions already focusing on keeping up-to-date with the latest technology.

A report from the Institute of International Finance (IFF) identified seven key areas where regtech should be utilised to solve compliance problems.

  1. Risk data aggregation
  2. Modelling scenario analysis
  3. A bottleneck in monitoring payments transactions
  4. Identification of clients and legal persons
  5. Monitoring a financial institutions’ internal culture and behaviour
  6. Trading in financial markets
  7. Identifying new regulations

This fledgling industry has responded proactively – innovating around a number of key areas such as cloud computing, blockchain, machine learning, APIs and cryptography.

Real-time automated trade monitoring, driven by AI, has also become a key tool for banks and the buy-side to evaluate trading behaviour and quickly identify abnormalities. And the principal is increasingly being applied to automated trading strategies as well.

But as the Financial Times note in a recent piece on the regtech sector, the real value delivered by providers is in “modelling, scenario analysis and forecasting”. But sometimes, this is easier said than done with the UK’s imminent exit from the European Union is set to complicate compliance matters further.

With a myriad of upcoming regulatory measures under MiFID II, Basel III and AIFMID likely to translate into growing demand for regtech solutions that will enable financial institutions to focus on their core business – it is certainly a sector worth watching closely.

 

 

 

 

 

 

 

 

Russian institutions flock to join R3 consortium

Payment processor QIWI becomes the first Russian company to join the consortium’s global network.

R3, the global blockchain consortium behind the development and application of distributed ledger technology in financial markets, has expanded its membership with the addition of its first Russian member.

QiWi’s online payment system is one of the most widely used payment systems in Russia. It is used to make online purchases and pay for loans, mobile bills, and even home utilities, and offers terminals where users can make payments as they would on their mobile device.

QIWI is a payment services provider and the first Russian institution to collaborate with R3. It has long recognized the benefits of blockchain technology; earlier in July, the firm expressed interest in joining the blockchain consortium created by the Central Bank of Russia.

“Our goal with R3 is to explore this emerging technology space as we shape the future of payments and transactions throughout collaborative research with other members of the consortium,” says Sergey Solonin, QIWI’s chief executive officer. “We believe that blockchain projects that we are currently working on can be applied on one of the R3 platforms and have great potential to be favorably perceived by regulated financial institutions.”

The firm joins over 60 leading financial institutions, who collaborate in R3’s lab environment, R3’s Lab and Research Centre.

David Rutter, CEO of R3, said “The addition of QIWI is a further milestone for R3 … as we expand our network of consortium members and continue to develop truly global applications for this groundbreaking technology.”

Illuminating Markets – a vision for cash and collateral management

Roberto Verrillo, Head of Strategy and Markets at Elixium, outlines his view on the key issues in the repo and collateral market.

Changes to the regulatory environment that have already taken place, and those that will occur over the next few years, have put us on a path that will change the industry forever. The impact on how the industry executes its business has been fundamentally changed.

The result of these changes has been an almost uniform decline in profitability for investment banks. Many operations have already begun efforts to re-structure large areas of their business to maintain return on equity (ROE) levels that are acceptable to their shareholders. This process will continue for several years yet.

I suggest reading ICMA’s excellent report written by Andy Hill “Perspectives from the eye of the storm” for more information about the current and future evolution of the repo market.

Basel III significantly increases the cost of doing business, taxing risk and market-making via increased capital requirements and increasing the cost to certain activities by requiring higher quality and amounts of capital. (See leverage ratio and liquidity coverage/net stable funding ratio -Basel III[1]). The more balance sheet intensive a particular business area is, the higher the “hurdle rate” for returns should be. In this regard market making (via capital costs for holding positions) and repo stand out.

Many firms have not yet implemented an exhaustive study of what these hurdle rates ought to be. These are not standard across the industry but are firm specific and are calculated using varying inputs particular to each individual institution and their relevant regulatory requirements. Ultimately these metrics will decide what each institution’s balance sheet will be and the required ROE.

We believe that as this process of re-pricing and charging business areas for the regulatory cost of partaking in certain businesses (and transactions) progresses, the market will find many more institutions cutting back and re-structuring their current business models, or simply pulling out of certain markets or product lines altogether.

NSFR (Net Stable Funding Requirement) rules under Basel III are calibrated such that longer-term liabilities are assumed to be more stable than short term liabilities. This will lead to greater demand for longer dated deposits, particularly corporate deposits which are treated favourably for banks under the rules.

NSFR provides for different, Available Stable Funding (ASF) and Required Stable Funding (RSF), weightings depending on the type of counterparty and the residual maturity of the transaction. This will make many financing transactions that are still viable under current regulatory capital treatment extremely onerous. Fifty percent RSF weightings will be applied to all loans (including reverse-repos) to non-banks, regardless of the residual maturity of the transaction, and independent of the underlying asset. In other words, this would mean that all reverse-repos with non-banks under one-year maturity would require the provision of stable funding against 50% of the value of the reverse-repo. For example, a bank transacting a $100 million overnight reverse in AAA government bonds with an insurance company or hedge fund would carry a requirement for $50 million of (long term) stable funding, even if this reverse was match-funded by repo.

The FRTB (Fundamental Review of the Trading Book) due to be implemented in local regulation by 2019, is a supervisory framework for the next generation of market risk regulatory capital rules for international banks. It will add further granularity to this process by identifying how profitable each business is within an institution at a “desk Level”.

It will also overhaul the standardised approach to market risk, forcing big banks to calculate and report it for the first time, radically altering the way that modelling approval is granted and policed, Value-at-risk (VAR) will be replaced with expected shortfall (ES) as the standard risk measure, redefining the boundary between banking and trading books. Approval by the regulator will be required, at a desk level, for banks to operate using their own internal models.

An ISDA study of 21 sample Banks concluded that, as a result of FRTB implementation, the overall increase in market risk capital, would be between 1.5x and 2.4x compared to current levels.

Current implication for repo

The cost of providing balance sheet to customers that may simply require a home for their cash has become increasingly prohibitive, leaving some banks having to turn away short term deposits/repo’s and/or charge what might look like unreasonable costs for either accepting said deposits or only offering the facility to clients from whom they generate revenue on other products as part of a wider relationship.

Because of this lack of willingness to, or difficulty in, pricing collateral transactions, many of these transactions have become economically unviable. Backward-dated pricing and resulting dysfunctional collateral markets are in evidence not only during reporting periods such as month, quarter, half and year end, but increasingly over a “normal” date run – volumes and liquidity are both showing signs of drying up.

“Previously, business lines might have been kept as part of the core business strategy, even if they did not meet the hurdle rate for returns. But in time banks will become more ruthless and cost aware about whether these activities can be a valid part of a long-term business model.

“Repo, as a standalone product, is no longer profitable. Repo desks have gone from being profit centres to cost centres. This has already happened; whether yet realised or not” – Andy Hill -ICMA.

“The provision of repo pricing and liquidity by banks has become more of a value-added service for clients, largely subsidised by other, more profitable businesses. “ ICMA quarterly report Q4 2015 – pages 25-28.”

Improving efficiency

There has been an exodus of banks from non-core businesses, but even in areas where they remain active, banks can make significant cost savings by accessing liquidity pool providers (such as Elixium) for distribution.

Harmonisation of settlement

Basel rules are implemented as the Capital Requirements Directive in Europe and the specific capital requirements for EU firms are based on their MiFID permissions.

There is increasing interest secured financing transactions, with the market moving from unsecured to secured financing and impending enactment of regulation surrounding the margining of OTC products. There is a stream of regulation that will have a significant impact on collateralised markets which involves harmonisation of settlement discipline regimes across Europe. The industry will have to identify an efficient operating model to manage these changes.

“4.6 Market access and interoperability

Activity description

The activity covers market practices or legislation that obligate or restrict the settlement of (stock exchange and/or central counterparty-cleared) transactions in a specific issuer CSD. The consequence for foreign investors, custodians and/or investor CSDs in such (issuer) markets is that access to settlement flows is restricted owing to the unfair competitive advantages established in those issuer markets. The restriction implies that entities wishing to offer settlement services on these securities need to become participants in the issuer CSD or central counterparty.”

Page 46 ECB Harmonisation Progress Report 13/04/15

http://www.ecb.europa.eu/paym/t2s/progress/pdf/ag/fifth_harmonisation_progress_report_2015_04.pdf?986629e468a824c5d0069151574ead5c

In an environment of litigation and lawsuits is it reasonable to suggest to pension funds, hedge funds, sovereign wealth funds asset managers, CCPs, corporate treasurers, local authorities and other government entities such as public utilities should be precluded from access to a transparent trading facility for the re-investment of their short end cash and or securities or for sourcing collateral/margin?

http://www.reuters.com/article/2015/11/26/interestrateswaps-lawsuit-idUSL1N13K2IE20151126

In Europe, EMIR sets out a legislative framework for Central Counterparties (CCPs), trade repositories and OTC derivatives. This framework includes new requirements covering capital requirements, risk managements and organisation.

MiFID2 will be introduced with a view to de-restricting market access on a non-discriminatory basis. There is a requirement for Multilateral Trading Facilities to implement non-discriminatory rules regarding access to its facility.

MiFID2 introduces additional pre and post-trade transparency requirements for a number of financial instruments, these proposals aim to create a level playing field for the regulation of all organised trading. The trading obligation in Europe will be introduced in the Markets in Financial Instruments Regulation (MiFIR).

Mandatory Swaps Margining and the effect of Mandatory Swaps clearing on collateral markets;

Initial Margin (IM) and Variation Margin (VM) for uncleared OTC derivatives will be phased in from September 2016 through to June 2021. The US will start IM from September 2016 for the largest of counterparties but the EU has delayed the start of IM until June next year.

Clearing banks that traditionally put up money to support default funds within CCP’s are increasingly reluctant to do so as they have to hold a significant amount of capital on their balance sheet to support this business.

Variation margin to CCPs must be in the form of cash – there is a need for collateral to cash transformation and the size of the potential problem cannot be underestimated as banks step away from providing balance sheet to support short dated, low margin repo activity.

CCPs are working to engage buyside counterparties via differing initiatives be they sponsored or direct CCP membership.

It is envisaged that mandatory swaps clearing in Europe could create unprecedented demand for high quality liquid assets (HQLA) and its transformation, for use in initial and variation margining of swaps.

Eventually CCPs may offer cross-netting capabilities across a range of products.

Elixium – re-engineering collateral markets.

Elixium is an all to all collateral trading platform that addresses the current fragmentary nature of the market.

Standardised processes and protocols facilitate a transparent, efficient marketplace that simplifies the process of ‎rapid counterparty diversification amongst all institutions seeking to raise cash or collateral.

Connecting traditional players with new entrants and addressing the growing demand and supply of cash and collateral presents an exciting opportunity for Elixium.

The repo and collateral market is a critical source of funding for many institutions but remains balance sheet intensive. As institutions come under pressure as a result of regulatory changes such as the Liquidity Coverage Ratio and Net Stable Funding Ratio, a reduction in balance sheets has impacted the depth and cost of liquidity available.

It is broadly accepted that the market will see more buy-side entrants, and all-to-all trading. The Elixium all-to-all marketplace has been developed specifically to facilitate access to a much wider counterparty base, which previously, have been restricted from direct participation by overly complicated legal and restrictive trading structures.

Legacy trading models are no longer as relevant in today’s market as they once were. As regulation creates new challenges and reshapes the traditional repo market-making model, stakeholders are trying to adapt and innovate both to meet those challenges and to exploit potential new opportunities.

Roberto Verrillo is head of strategy and markets at Elixium.

[1] Basel III is the global framework of principals that are agreed internationally which local regulators are consequently expected to implement into local law. It is worth noting that the US and EU are not 100% aligned on leverage ratio. (See CRD IV for the EU rules)

Currency trading volumes bounce back in September

After August’s annual slowdown, currency trading activity bounced back to almost USD5 trillion in September.

Currency trading activity rose strongly in September, according to the largest provider of settlement services in the global foreign exchange market.

Data from CLS showed a 17.5% month-on-month increase in the number of trade instructions submitted in September, reaching 1,038,025. The value of these trades equated to just shy of USD5 trillion, an increase of 6.6%.

September’s data indicated it was also the second busiest month for CLS in 2016, second only to June’s peak of USD5.19 trillion. The data also showed a 3.7% increase from September 2015, when trading activity totaled USD4.81 trillion.

While the increase mirrors a similar trend observed across many of the major trading platforms last month, CLS’s data provides the most accurate and comprehensive snapshot of activity in a given month – encompassing data from 18 global currencies and approximately 21,000 trading entities around the world.

screen-shot-2016-10-14-at-13-02-09

British Pound Remains on the Defensive After Flash Crash

Sterling remained under pressure at the start of the trading week following last week’s so-called “flash crash”. Sterling faces a potentially tumultuous week ahead as Prime Minister Theresa May heads to Denmark and the Netherlands for bilateral talks with Prime Ministers Rasmussen and Rutte ahead of this month’s EU leaders’ summit. Increasingly fiery rhetoric on both sides of the English Channel has already exploded in epic fashion and may do so again.

The economic calendar is in quiet in European and US hours, leaving the markets to digest recent price action ahead of this week’s headline event risk. Knee-jerk volatility remains a risk however. Bild reported that Deutsche Bank failed to secure a penalty reduction deal with US regulators, which may rekindle insolvency fears and bleed into broader market sentiment. S&P 500 futures are pointing upward however, hinting investors’ mood is relatively chipper for the time being.

The anti-risk Yen traded higher as US-listed Nikkei 225 futures declined in overnight trade. Japanese markets are closed for a holiday. The move may have followed comments from BOJ Governor Kuroda over the weekend, who said the central bank may delay hitting the inflation target until 2018. The remarks may have stoked recent skepticism about the efficacy of the central bank’s stimulus efforts.

The Canadian Dollar recovered in a move that appeared to be corrective after Friday’s broad-based selloff. The Loonie fell against all of its major counterparts alongside crude oil prices in a move that seemed linked to Russia signaling it would not reach a deal with OPEC to cut back output at a meeting in Istanbul this week.

FX industry reacts to Sterling flash crash

Speculation has mounted since Friday’s flash crash as industry commentators and counterparties alike continue to analyse the potential causes for a sudden six percent plunge in the price of the pound. While uncertainty is likely to remain in the near-term, the lack of a clear consensus about what triggered a sudden fall and subsequent recovery in Sterling has caused concern for many.

The market event followed revelations of French President, Francois Hollande’s intention to negotiate a hard bargain with the UK over Brexit – leading to further weakness in the currency. But while some pointed the finger at macroeconomic conditions or political rhetoric, others laid the blame at the door of high speed trading algorithms – a growing feature of foreign exchange markets.

While the causes are yet to be determined, it is not an event officials are taking lightly. Mark Carney, Governor of the Bank of England (BoE) has already announced an inquiry to examine the possible causes. While the Central Bank is expected to report back in the coming months, the market is rife with speculation.

JP Morgan’s Flow and Liquidity team referred to the ability of high speed trading to determine market conditions without the presence of major contributory factors. “A step change following a significant event such the Brexit referendum or the SNB’s abandonment of its peg is not problematic as it represents a natural market resetting. But a step change triggered by an order flow is more problematic and in our opinion reflective of how vulnerable market liquidity is in FX markets also.”

The bank’s team also highlighted the issues surrounding liquidity provision in periods of market stress. “HFTs have a higher incentive to withdraw from their market-making role in periods when volatility rises abruptly as they are reluctant to subject themselves to the risk of large price moves.”

The comments reflect the ongoing debate about speed in wholesale markets. Advocates, typically led by groups such as The Modern Markets initiative, reference the narrowing of bid-ask spreads across a number of asset classes and the ability for high speed trading firms to provide liquidity at a time when banks face capacity issues.

Yet, others, such as BofAML summarise the opposing position. “Market fragility is increasing as phantom liquidity creates the illusion of stability. While on the surface, traditional measures such as bid-ask spreads in FX have indeed narrowed in the past couple of years, our volume-based analysis shows market liquidity has materially worsened. We find the market impact of a given volume is now 60% greater than in 2014. Notably, the frequency and amplitude of outsized volatility events has also increased.”

However, others are focusing instead on wider economic conditions in the UK. Themos Fiotakis, Global Co-Head FX & Rates Strategy at UBS Investment Bank, neatly summarised the differences of opinion across the market for the Financial Times. “Often, a depreciating currency is linked to a country’s declining economic prosperity. So it is not surprising that, to some, the ongoing depreciation of sterling against the euro can be viewed a precursor of dire times ahead. For others, it is merely a market miscalculation that will correct when the benefits of leaving the EU become visible.”

The publication of the BoE’s investigative report in the coming months should bring some clarity. Its release will be keenly anticipated.

As investment in fintech goes billion-dollar stratospheric, there’s an ancient principle uniting the source code

Back in 350 B.C., Aristotle observed that assigning monetary value to an otherwise insignificant thing – such as a coin – could only happen because of the human capacity for trust.

He noted that through their trading relationships, people had evolved a natural, psychological capacity to place trust in each other, as part of a trading exchange.

Today, it is well documented that trust is low in, and across, financial markets. A culture of excess, charges of lax compliance and regulation and the behavior of some has caused enormous reputational, political and societal damage.

Maintaining trust across increasingly digitalised wholesale markets has proved to be expensive, time-consuming, and inefficient.

Emerging financial technology (fintech), however, has the potential to bridge this divide.

Financial technology has been the breakout investment and research success story of the past few years. Investment in fintech is expected to accelerate to over $150 billion over the next five years, with over $50 billion already invested in roughly 2,500 in technology companies.

This includes over $1.4bn invested to explore the application of blockchain and distributed ledger technology to wholesale markets.

Financial technology has the capacity to hardwire trust into systems which do not disrupt, but instead supplant duplicative, inefficient processes.

Auditable, traceable electronic trails, smart analytics, next generation API, artificial intelligence and advancements in crypto-security offer additional resilience, trading and reporting capabilities.

But it is the potential for blockchain and distributed ledger technology to replace physical middlemen with mathematics which is the real reason this technology matters – proving the authenticity of records, content, and transactions across institutional boundaries – effectively automating trust between counterparties.

China already plans to use blockchain for social security payments while Australia had indicated it sees blockchain as a suitable application to run its voting systems.

A recent poll of tier 1 bank CEOs, CTOs and trading desk heads agreed that ‘integrated, applied technology’ offers a great opportunity to control costs and improve performance, ahead of ‘talent management’, and only just behind ‘effective leadership’ at 98%.

A similar percentage (88%) predict their organisation will increase or maintain their fintech investment over the next three years.

Financial markets today consist of people and technology, cemented by trust in the integrity and resiliency of a market, its physical operation and those using it to trade, invest or exchange risk.

So is fintech riding in on a white charger to solve every aspect of malfeasance in financial markets?

Not exactly. In fact, it cuts both ways and there is an equal challenge to avoid the impression and the reality of an all-out fintech arms race, where technological advantage buys financial advantage, say through super-fast market data at a premium, to take one example.

The banks are in a tough spot right now. Pressure is everywhere and they have to do more with less, faster and more efficiently.

Just recently a number of leading market-making banks got together to discuss how they could share their middle office functions as part of a drive to cut costs associated with the custodian function.

There is so much that is ripe for renewal and there are short and long term investment decisions to be made. The smart CEO is listening to his CTO and CIO very closely indeed.

Finally, a word on the financial transgressions of the past. It is ironic that the guilty were damned by technology; the smoking evidence of malfeasance was enshrined in reams of Bloomberg chats, preserved for the law in that iconic font (Blpu for the graphic designers out there).

It is of course an error to ascribe absolute moral imperative or a conscious policing function to any electronic system.

Those are human preserves which need to come from leadership and culture, but financial technology is the agent of delivery – it can only facilitate.

Confucius, another smart guy you may have seen quoted on motivational social media posts, said a ruler needs three things – weapons, food, and trust; if he has to give up any of these, weapons go first, then food.

Without trust we cannot stand. It is time to hard code it into our financial system.

The author is the principal of Chatsworth, a London and New York-based consultancy with a focus on the financial technology sector.

MiFID II costs mount as industry navigates uncertain future

A report analysing regulatory compliance has put the projected cost of MiFID II at $2.1 billion for the financial services industry in 2017 alone.

The report from HIS Markit and Expand, a Boston Consultancy Group company, provides the industry with fresh insight into how the sprawling package of reforms will affect financial institutions in Europe.

Upon its expected introduction in 2018, MiFID II will increase trade reporting requirements on multiple asset classes, accelerate the transition of OTC derivatives onto regulated electronic venues to reduce bilateral risk, while increasing both investor protection and market transparency with a series of measures.

Yet, such a comprehensive piece of legislation comes at an uncertain time for the financial services sector in Europe, as the UK’s future role and access to the single market is yet to be determined.

With many financial institutions in the UK firmly established in mainland Europe, with offices in financial centres such as Frankfurt, Amsterdam and Paris, the risk of a two-tiered regulatory framework poses real operational issues.

In order to gain insight from the market regarding the proposed compliance obligations, the FCA recently published a consultation paper on MiFID II, which outlined some of the organisation’s key priorities.

Andrew Bailey, chief executive at the FCA highlighted the following areas of focus:

“Strengthening consumer protection is one of the key aims of MiFID II and this aligns with, and advances, our own statutory objectives. The changes to rules we are proposing today reflect key themes that we have worked on in both retail and wholesale markets over recent years to promote competition and market integrity.”

However, Bailey also reiterated the need for institutions to comply with both UK and EU financial regulation:

“As we said in our statement following the EU referendum result, firms must continue to abide by their obligations under UK law including those derived from EU law. They must continue with implementation plans for legislation that is still to come into effect, of which MiFID II is one such example.”

Rise of ‘regtech’

In today’s cost-cutting environment, the growing cost of compliance has become a major issue for banks and the buy-side. A Thomson Reuters report analysing the current regulatory landscape in 2015 identified that 69 percent of respondents expect the cost of compliance to rise.

The report notes: “Regulatory matters are consuming disproportionate amounts of board time, from correcting non-compliance and preventing further sanctions to implementing structural changes to meet new rules.”

However, this increased focus has led to the rise of ‘regtech’ a subset of the growing fintech sector. The ability to develop innovative ways to comply with incoming regulation in an effective and cost-efficient manner enables firms to secure a competitive advantage.

The market is also poised for future growth, with more than two-thirds of firms that took part in the same Reuters study (68 percent) expecting an increase in their compliance budget last year with 19 percent expecting significantly more.

Those keen to differentiate themselves from the competition in a cost-sensitive environment are already looking at compliance as a means to secure an advantage.

Partnering with ‘regtech’ firms and building technology and operations around future regulations are likely to yield tangible results. But with uncertainty hovering in the air – it is easier said than done.

Rumours of a flash crash as FX markets experience high volatility

Sterling plunged by around 6 percent in two minutes in Asia trading this morning before recovering as rumours about a flash crash or fat finger trade spread. And we’ve still got US employment data to come. Happy Friday.

Sterling sank in early Asian trade, at one point losing as much as 7.5 percent against an average of its top counterparts following an article in the Financial Times quoting Francois Hollande.

Referring to the outcome of the Brexit referendum and recent strong-worded rhetoric from UK Prime Minister Theresa May, the French President argued that the EU must be as tough as possible on the UK.

Thin liquidity before the trading open on most Asian bourses probably amplified the move. The magnitude of the drop and the violent recovery thereafter – prices erased more than three quarters of the move within 10 minutes – suggests this is not the whole story however.

There is currently rampant speculation that trading algorithms have compounded volatility. Shellshock after the Pound fiasco appeared to translate into wider risk aversion overnight.

The sentiment-linked Australian, Canadian and New Zealand Dollars tracked Asian stock benchmarks and S&P 500 futures downward, with the Kiwi underperforming amid swelling RBNZ easing speculation. Markets now price the probability of a rate cut at next month’s policy meeting at 66 percent. The anti-risk Japanese Yen and US Dollar outperformed.

Later today, the greenback may continue to build higher as US Employment data is released. The economy is expected to have added 175k jobs in September, up from 151k in the prior month. An increase of more than 143k would keep the three-month average at 190k, a threshold identified by Fed Chair Yellen as supportive of a rate hike in 2016.

This seems to mean that anything short of deep disappointment will reinforce already swelling tightening probability. The priced-in chance of an increase in December is now at 63.6 percent.

R3 expands blockchain testing to bond markets, reference data and syndicated loans

 It’s been a busy week for R3 CEV. The blockchain consortium has partnered with Credit Suisse, Intel and Axoni to advance the use of distributed ledger technology in real world use-cases.

As the financial services industry rushes to integrate the nascent technology, blockchain to a variety of markets and applications, we take a look at how a single shared ledger for financial transactions could enhance US Treasury trading, the reference data industry and syndicated loans space.

Bond Markets

The R3 consortium has successfully completed blockchain testing for bond trading in partnership with Intel. The test, which involved eight banks including HSBC and State Street, enabled trading, matching and settlement of US Treasury bonds, as well as automated coupon payments and redemption.

The initiative is intended to simplify and standardise protocols and processes in the US Treasuries trading, a market that has become increasingly complex of late, as noted in a recent Fintech Focus article. In the clearing arena for example, challenges persist. While the Fixed Income Clearing Corporation (FICC) acts as a central counterparty for its membership, non-bank firms often don’t qualify for membership and if they do, find FICC membership costs prohibitive, opting instead for bilateral settlement outside the CCP model.

Syndicated Loans

 Symbiont and data provider Ipreo have joined Credit Suisse in utilising R3’s Lab and Research Centre to test how distributed ledger could be used in the syndicated loans market. By connecting agent banks via a blockchain, the initiative is expected to achieve faster and more secure settlement in the loans market.

The user benefits are clear and demonstrate the value distributed ledger technology can deliver in a wide variety of fields. Loan investors will have direct access to an authoritative system of records for syndicated loan data, a process that will reduce manual reviews, data re-entry and systems reconciliation.

 At present, the syndicated loans market requires each participants involved in a transaction to maintain its own separate lending system. By adopting blockchain technology, loan processing can be done exclusively on a shared distributed ledger – minimising middle and back office operations.

 Reference Data Market

R3 CEV has also announced a collaboration with capital markets technology provider Axoni, to test how blockchain technology can be used to enhance the reference data market. The project, which also involves Alliance Bernstein, Citi, Credit Suisse and HSBC is the latest example of how the financial services industry is finding new applications for the technology.

Reference data has become a real issue in financial markets of late as it accounts for up to 70% of the data used in transactions, but continues to be supported by legacy technology that often requires manual processing and constant upkeep. With reference data adding significantly to operational costs and ultimately affecting the bottom line for cost conscious institutions; it is a market ripe for innovation.

Moreover, as the market continues to grapple with regulatory measures designed to ensure firms manage and maintain the quality and accuracy of their reference data, many are now exploring the possibility of streamlining the process via a distributed ledger.

While those institutions developing blockchain solutions may have passed the proof of concept test, the need to tailor this technology to a variety of different use cases now presents the next challenge.

Standardised netting of FX payments moves closer to reality

In a guest post for Fintech Focus, David Puth, CEO of CLS, explains how standardised netting of payments can deliver greater efficiencies for the foreign exchange market.

Leaders from the financial services and technology industries are descending on the Sibos conference in Geneva this week. This annual gathering of the buy-side and sell-side, fintechs and transaction banking specialists showcases the very best in technology, innovation and ideas that ensure financial technology continues to shape the way business, finance and commerce operates.

While some areas of financial markets and technology have undergone significant development over a number of years, there is clearly an opportunity for post-trade partners to do more – including in foreign exchange (FX). CLS sits at the heart of this market and sees approximately USD5 trillion of payment instructions settle through our core service every day.

In the search for ever more ways to improve liquidity and efficiency, we are focused on innovation centering on the payment efficiency of our clients’ underlying supporting infrastructure. For traders in a market of such size and scale, efficient netting of payments can have a significant impact on intra-day liquidity demands and an institution’s overall ability to effectively manage risk.

The inception of CLS in 2002 addressed many of these issues for institutions that use our services. Our role is to protect our settlement members, 66 of the world’s leading financial institutions, and 21,000 of their clients, from the most significant risk in the FX market – settlement risk.

Time for innovation

However, not all currencies or market participants access our core settlement service. And while some participants are currently capable of bilateral payment netting for trades not settled in CLS, this practice is not universally adopted. Various bespoke approaches to payment netting lack standardisation, scalability, and efficiency, which in turn increase operational risk. Therefore, many institutions limit their payment netting activities to their larger counterparties.

In addition, many FX market participants across the buy-side and sell-side do not use bilateral payment netting and instead settle a significant portion of their non-CLS trades on a gross basis. Gross settlement without netting requires access to deep liquidity, which requires institutions to allocate more collateral and capital.

To address this gap in the market, we are working closely with the global FX market community to develop CLS Netting, a standardised, bilateral payment netting solution for all market participants, regardless of whether or not they currently have access to CLS.

Netting already forms a crucial part of our settlement offering and the facilitation of standardised netting for a wider group of institutions will significantly improve the way currency payments are netted across the globe, with tangible benefits for clients.

Participants will be able to submit FX instructions for six products and 24 currencies. In addition to the 18 currencies CLS currently settles, we will offer payment netting for the Chinese renminbi (offshore), Czech koruna, Polish zloty, Russian rubble, Thai baht and Turkish lira.

CLS Netting will standardise bilateral matching and payment netting in these currencies, manage payment netting positions through a single interface and enable automated reconciliation. This will decrease the volume of payments manually initiated, resulting in fewer late or failed payments.*

The strong appetite for a globally standardised netting service is demonstrated by the desire of leading international financial institutions to become early adopters. So far, 14 have committed to work with CLS, including: Banco Actinver, Bank of America, Bank of China – Hong Kong, Bank of Tokyo-Mitsubishi UFJ, Citibank, FirstRand, Goldman Sachs, Goldman Sachs Asset Management, HSBC, Intesa Sanpaolo, JPMorgan Chase, Morgan Stanley, Neuberger Berman, Northern Trust – with others joining this group in due course.

Use of distributed ledger technology

The speed at which technological innovations are developing leads us to focus our efforts on those post-trade processes where change is possible. Our goal is to continue to expand and develop the service with new currencies, products, and technologies, and the adoption of distributed ledger technology (DLT) will be central to this.

In addition to submitting FX instructions over existing SWIFT-based channels, participants will have the option of connecting directly to CLS Netting via a highly secure, permissioned distributed ledger, administered by CLS.

As a founding member of the Linux Foundation’s Hyperledger Project, we have long acknowledged the benefits of distributed ledger technology and have worked diligently over the past 12 months to explore how DLT can be used to improve efficiencies, security, and resilience in the global FX community.

It is crucial that the basic fabric of any distributed ledger technology we use for the CLS Netting platform adheres to high standards and resilience. We will incorporate DLT capabilities in a way that is meaningful to our members and participants, and we believe it has enormous potential.

To facilitate broad adoption amongst industry participants, we will collaborate with IBM to develop the underlying technology, which will be based on the Hyperledger fabric rather than a proprietary solution. IBM is a key member of the Hyperledger Project and has been a partner of CLS since our inception. Our partnership creates the foundation for new technology that can be applied not only to CLS, but more broadly across the financial industry.

 

Cybersecurity: could a global standard be the answer?

A committee of central bankers are working with the Bank for International Settlement (BIS) to explore ways of tackling the threat cybersecurity poses for the financial services industry – in the first initiative designed to set a global common standard.

With cyber attacks against financial services firms continuing to escalate, the need to standardise best practice across the industry has becoming a pressing issue for many.

According to a PWC report, in 2015, 38% more security incidents were detected than the previous year, while theft of hard intellectual property increased 56% in 2015.

As the volume and severity of security breaches increases, regulatory organisations and governments are also voicing concern. The FCA recently reported a huge spike in the number of reported incidents, from just five in 2014 to 75 in 2015. While these numbers are likely to only touch the tip of the iceberg when compared to those attacks that go unreported – the statistics still present a worrying trend.

New York Gov. Andrew Cuomo has also proposed cyber security regulations for banks, which would increase the onus on technology departments to invest in cyber protections. The prospect of mandated investment in cyber security comes at a difficult time for the banks, as they grapple with compliance issues and growth in competition from non-bank firms.

Yet, many institutions are already taking proactive measures. A 24% rise in security budgets split across a number of initiatives designed to mitigate the risk of cybersecurity breaches, such as employee awareness programmes and enhanced monitoring tools, appears to be paying dividends. PWC noted a 5% decline in financial losses associated with cyber attacks in a year-on-year comparison.

However, the absence of a common standard has led to discrepancies in the ability for some financial institutions to handle online attacks, something that has become particularly apparent in developing economies across Asia.

With up to 90% of Asia-Pacific companies targeted by cyber-attacks this year, a 76% rise from the year before, many firms are playing a high price for breaches online.  $81.3bn out of a global total of $315bn was lost to cyber-attacks in the region exceeding those in North America and the EU by about $20bn.

Yet, the consequences of a security breach are also reputational. With many financial services firms acting as custodian for sensitive  information – the need to stop data from entering the wrong hands is a critical issue.

But there is now growing recognition that a proactive, cross border response is required. Recent attacks affecting Bangladesh, the Philippines, Taiwan, Thailand, Vietnam, and Japan, have prompted officials to gather in Singapore next month to discuss how these economies can mitigate the impact of cyberattacks.

Already this year, Japan has made proactive moves to introduce reforms that will allow the country’s banks to invest directly in technology to defend against cyber-attacks.

While national programmes designed to increase cybersecurity is certainly a step in the right direction, the need for a common global standard should not be underestimated.

Much like the global Code of Conduct for the foreign exchange market, also spearheaded by the BIS, a solution must be universal in its application to instigate comprehensive, rather than siloed progress.

BIS FX Code of Conduct Offers Reasons For Optimism

Chris Salmon, Executive Director of Markets at The Bank of England, highlights the reasons to be optimistic about the new FX Code of Conduct, which will launch in London next May.

The BIS Code of Conduct is arguably one of the largest, most ambitious and comprehensive efforts to introduce globally-accepted standards and guidelines to govern conduct and behaviour in the foreign exchange market.

Initiated in 2015 by the Bank for International Settlements (BIS), it is designed to establish a single, global code of conduct for the wholesale FX market and promote greater adherence.

The process is well advanced and remains on track to launch in May 2017, according to Chris Salmon, Executive Director, Markets, Bank of England. As a senior official at the UK’s Central Bank, he is actively involved in the development of the Code. His speech at the ACI Financial Markets Association in London provided great insight into why global regulators and market participants remain positive about the final Code.

Chris Salmon highlighted four reasons for optimism. The first is the substance of the Code itself. It will directly address the complexity of the FX market and provide guidance where it is necessary, he says.

Secondly, he reiterated the importance of keeping the Code up to date. Its completion in just two years means it should be relevant for today’s market when published. Importantly, he adds, the new Code will not be allowed to stagnate; the BIS is committed to developing an appropriate review mechanism so that the Code stays up to date and evolves as the market evolves.

Third, the process for developing the Code is inclusive and unprecedented in many ways. The Code will apply to the buy-side, sell-side, non-bank participants, trading platforms and other market infrastructure providers. Therefore, there is engagement from all types of key market participants, including 40 members of the Market Participants Group (MPG), chaired by CLS CEO David Puth, and regional FX Committees. This ensures the final Code will get buy-in from a wide range of diverse market participants.

Lastly, he highlighted how the Code is one of a suite of important initiatives that have launched in recent years to improve conduct in FICC markets. Initiatives such as the FICC Market Standards Board, created as a direct consequence of the Fair and Effective Markets Review, and UK Senior Managers and Certification Regime, soon to be extended beyond banks to all FCA authorised firms, will aim to raise standards of market conduct by strengthening the accountabilities of senior management. These initiatives, combined with a greater focus on conduct, create a supportive environment for the objectives of the Code.

While this will be received well by the FX market, he also cautions that the Code will only rebuild trust if it is actively used by market participants and drives a market-wide shift in culture and attitudes – one that embeds behavioural norms that are consistent with both the letter and spirit of the Code.

This type of cultural shift is not something that can be mandated; ultimately, that change must come from the industry. Firms that assimilate the Code fully are likely to benefit, over time, from greater trust in the marketplace, a stronger reputation, and a higher long term franchise value.

Individually, firms and senior personnel should start considering the steps they will take to support the Code. In a world where competition for market share remains fierce, winning the trust of clients matters financially.

To this end, Mr Salmon recommends three elements be put in place to realise the benefits of the Code.

First, the Code needs to be embedded in firms’ practices, training and education; second, firms should have the right policies and procedures in place to ensure that they are able to monitor how successfully they have embedded the Code; and third, firms should be able to demonstrate publicly that their behaviour and practices in the FX market are in line with the Code’s principles.

The first phase of the Code was well received by the FX industry, and there is no doubt that the widespread use of a common public attestation could be a powerful tool. It would provide a strong signal of a firm’s commitment to following good practices and rules that are applied internationally across borders.

The launch of the second phase will be an important milestone in the industry’s efforts to reaffirm trust in the FX market. It is no secret that all has not been well in FX or FICC markets more generally; the completion of the Code of Conduct, and its application amongst individual firms, will send the right signal to clients, regulators and employees.

The full speech by Chris Salmon can be found here.

Blockchain set to streamline reference data market

Blockchain consortium R3 CEV have announced a collaboration with capital markets technology provider Axoni, to test how blockchain technology can be used to enhance the reference data market. The project, which also involves Alliance Bernstein, Citi, Credit Suisse and HSBC is the latest example of how the financial services industry is finding new applications for the technology.

Reference data has become a real issue in financial markets of late as it accounts for up to 70% of the data used in transactions, but continues to be supported by legacy technology that often requires manual processing and constant upkeep. With reference data adding significantly to operational costs and ultimately affecting the bottom line for cost conscious institutions; it is a market ripe for innovation. 

Moreover, as the market continues to grapple with regulatory measures designed to ensure firms manage and maintain the quality and accuracy of their reference data, many are now exploring the possibility of streamlining the process via a distributed ledger. 

In partnership with Axoni, R3 CEV recently completed a multi-month proof of concept (PoC) exercise, coordinated by Credit Suisse. The prototype was created using Axoni Core to simulate the management of reference data on the blockchain, and also inform corporate bond issuance. The technology enabled participants to interact with reference data after issuance, with any proposed changes requiring validation by the underwriter to ensure the ledger provided a single, unchangeable record of all data related to the bond.

David Rutter, CEO of R3, comments: “Quality of data has become a crucial issue for financial institutions in today’s markets. Unfortunately, their middle and back offices rely on legacy systems and processes – often manual – to manage and repair unclear, inaccurate reference data. Distributed ledger technology – which allows financial institutions to push these functions to a cloud environment – removes the need to reconcile multiple copies of data, providing a sophisticated and agile solution to the headaches currently caused by these legacy systems and processes.”

Whilst the study of distributed ledger technology’s application to reference data is still in its early stages, this project marks the first step in testing its potential.  

What to expect at SIBOS 2016

With over 8,000 business leaders set to descend on Geneva for the annual SIBOS conference next week, this year’s event comes at a poignant time for the industry.

More than 200 exhibitions and hundreds of conference sessions will take place over four days, bringing together decision makers from banks, market infrastructure providers, multinational corporations and technology vendors.

With the industry continuing to grapple with a number of developing issues, from the emergence of disruptive technology and the ongoing impact of regulation and cyber crime to the potential implication of a Brexit, there is plenty to talk about.

The theme of this year’s event, ‘Transforming the Landscape,’ will explore issues surrounding the future of payments, securities, cash management, trade and financial crime compliance.

To help you keep track of what to look out for, we’ve picked out some key highlights from the programme agenda:

  • Cyber resilience in a changing world, Monday 26 September, 09.00 – 10.00
  • Patterns of disruption in wholesale banking, Monday 26 September 09.30 – 11.15
  • Insights on Blockchain: a panel discussion of early adopters hosted by IBM, 26 September, 11.30 – 12.00
  • When RegTech meets FinTech: the day after tomorrow – How technology disruption intersects with regulation in securities, 27 September 10.15 – 11.15
  • Fintech hubs – EMEA, 27 September, 12.45 – 13.45
  • After the Brexit, what’s next: A BRICS-it towards a multilateral financial system?, 27 September, 15.30 – 16.30
  • Machine learning – The future of compliance, 28 September, 09.00 – 10.00
  • Open API’s and the transformation of banking, 28 September, 16.30 – 17.15
  • Capital markets: Big data, big deal, 29 September, 09.00 – 10.00
  • Financial centres outside of the EU – What can the UK learn from Switzerland, 29 September, 10.15 – 11.15

Details of the full programme can be found on www.sibos.com

Derivatives industry gathers to discuss market reform, opportunities and challenges

The great and the good from London’s derivatives industry descend to FOW Regulation to discuss G20 reform, Brexit, Basel III and all things MiFID II.

More than 200 banks, brokers, vendors and buy-side participants gathered at the Grange City Hotel to find out how MiFID II and other European and international regulations will impact trading, risk management and regulatory operations in the global derivatives market.

Attendees at the 4th annual FOW Regulation conference participated in presentations, panel discussions and Q&As on the implementation of MiFID II, MAR and Basel III, the impact of Brexit, algorithmic trading, compliance and trade reporting. With representatives from regulatory bodies, banks, buy-side institutions, legal firms, technology vendors and trade bodies all offering their views, the audience was offered a broad range of views from different perspectives. MiFID II was undoubtedly the topic on everyone’s mind.

Although it remains the centrepiece of European regulatory reform, and still looks certain to be introduced in the UK, fundamental questions remain over London’s capital markets and the competitive advantage or disadvantage that Brexit will bring. The early morning panel discussed what Brexit meant for the implementation of EU regulatory reform in the UK and its interaction with Europe and the rest of the world. This was followed by a panel discussing the plethora of reforms across the world seeking to bring greater oversight, transparency and accountability to algorithmic trading.

With differing approaches and definitions in place, new rules are increasing complexity for firms in the market. The debate focused on how will Reg AT in the US impacts Europe, how to manage obligations across a global trading book, how MiFID II will transform algorithmic trading and what trading institutions should do to meet regulatory requirements. The final panel of the morning discussed the complexities of trade reporting in an increasingly automated trading environment.

The EMIR reporting requirements were introduced amid confusion from the market and reports of miss-reporting and over-reporting were rife. But this has not dampened the appetite of regulators to enforce new rules, and many expect a tougher stance to be taken with MiFID II reporting. There were also fruitful discussions around the Market Abuse Regulation regime, which came into force in July with unprecedented scope and ambition, Organised Trading Facilities (OTFs) and the increased requirements for commodity derivatives. But another prominent challenge for the derivatives industry that became clear throughout the day was the management of capital rules.

Already, a number of large FCMs have pulled out of the market and more rules, including MiFID II, CRD IV and the new IOSCO requirements, are coming down the line. Panel members and the audience discussed how this will impact liquidity and trading activity and how banks and buy-side firms can adapt. Overall, the reform of financial markets continues to gather pace and it remains the case that regulation remains at the forefront in the post-2008 regulatory environment.

The complexity of compliance in an electronic, automated environment remains a concern, but participants were also given insight into the innovation taking place amongst technology vendors and trading institutions to stay ahead of the regulatory curve. 12 months is a long time in financial services and we could be looking at a very different market in a year’s time.

FCA sets out fertile ground for fintech innovation

The fintech sector continues to grow at a rapid rate. According to a PWC report, which explored how the sector is shaping financial services around the world, over USD 50 billion has already been invested in roughly 2,500 fintech companies since 2010.  And investment is expected to accelerate to over USD 150 billion over the next three to five years.

But while the value delivered by innovative technology companies in financial services has become abundantly clear, particularly in areas such as blockchain, data analytics, machine learning and peer-to-peer trading, the industry also requires a flexible regulatory framework that facilitates growth and innovation – rather than stifling it.

As Caroline Binham notes in the Financial Times, it is an issue that the FCA appears to be handling well. In a separate EY report, the UK is singled out for its friendly regulatory stance — topping the global survey as the most fintech-friendly jurisdiction — closely followed by California and New York. The EY report recognised the progress the UK has made in securing a competitive advantage against its rivals, stating; “The UK benefits from a world leading fintech policy environment, which stems from supportive regulatory initiatives, tax incentives and government programmes.”

Clearly, a number of FCA led initiatives designed to promote innovation and market competition appear to be paying dividends. One of the most prominent examples, the ‘regulatory sandbox’ outlined in 2015 as part of Project Innovate’, enables firms to test products for compliance purposes at an early stage in order to fast track the adoption of financial technology by the market.

All this is encouraging a dynamic sector to grow further. As Matthew Hodgson, CEO of Mosaic Smart Data, noted in an article on fintech investment earlier this year, “London is almost perfectly positioned at the intersection of finance and technology. In the last 24 months, the Capital has acted as a hotbed for venture capital investment for a variety of fintech firms pioneering new technologies designed to disrupt traditional business models, but also to enhance existing ones through collaborative partnerships with established financial services providers”.

But amidst competition from tech hubs in Silicon Valley, Berlin, Hong Kong and Singapore for fintech investment and top talent, the need to provide an attractive ecosystem for new and rapidly evolving companies is not just optional, but obligatory.

As Fintech Focus noted in a piece exploring fintech investment in Asia Pacific, the region has benefited from a massive jump in financial technology investment, rising from USD 880 to nearly USD 3.5 billion in the first nine months of 2015. All this represent a serious challenge for London’s fintech scene.

While London remains ahead of its peers in the race to provide fertile conditions for innovation and growth, the threat of global competition means the capital must continue to maintain its creativity in order to retain its crown.

Bridging the divide: finance and technology

The annual P2P Financial Systems workshops (P2PFISY) for 2016 hosted by University College London (UCL) brought together academics, technologists, policy makers, regulators and fintech providers to analyse how technology is changing financial services.

The event was attended by The Bank of England (BoE) and a diverse range of experts to address questions of practical importance on: digital currencies and Blockchain technologies, P2P lending and Crowdfunding, digital money transfer,  mobile banking and mobile payments.

Victoria Cleland, Chief Cashier at BoE, outlined the latest wave of fintech activity with a particular focus on distributed ledger technologies (DLT) and the central bank digital currency (CBDC) as part of her speech ‘Fintech: Opportunities for all?

“We are undertaking more fundamental long-term research on the wide range of questions posed by the potential of a central bank-issued digital currency (CBDC). Whether a CBDC would be feasible and whether it would benefit the economy and the financial sector, over the medium term are big issues, and the answers remain far from clear. We have embarked on a multi-year research programme so that any future decision is informed with a full understanding of the implications”, Cleland said.

Cleland also noted that since 2010, more than $50bn has been invested in roughly 2,500 fintech companies’ and over 24 countries are currently investing in DLT with $1.4bn in investments over the past three years. In addition, over 90 central banks are engaged in DLT discussions and more than 60 have joined blockchain consortiums like R3CEV.

Cleland further emphasised the need to explore and understand how we define fintech and the impact it is having. “We need to understand what fintech means for the entities we regulate, how it might impact the overall safety and soundness of the financial system, and how it could alter the transmission mechanism for monetary policy.”

The pace of fintech innovation and investment has rapidly increased in recent years. PWC estimates that within the next three to five years, investments in fintech will exceed over $150bn. However, the firm also highlighted how the lines are being blurred between technology firms and traditional financial institutions in a report entitled, ‘How fintech is shaping financial services’. Accordingly to the research, 83% of the financial institutions who took part in the report believe their business are at risk of being lost to stand-alone fintech companies.

Nonetheless, there is a growing understanding that traditional financial services firms and new fintech providers can collaborate and learn from each other, rather than competing for market share.

The US Treasuries market is ripe for change but challenges persist

Trading in US Treasuries requires significant structural change – but the transition won’t be without its challenges.

The complex structure and highly regulated nature of trading in the largest and most important debt market in the world has traditionally impeded its evolution, but for the first time in a number of years, adoption of new trading technology likely to deliver real benefits for end-users is on the horizon.

The US Treasuries market has always lagged behind other markets such as equities and FX when it comes to electronic trading, however the emergence of a handful of innovative trading platforms represents a turning point for the industry.

This need for innovation has been driven by the significant liquidity challenges participants in the USD 13.4tn market have faced in recent years. As non-bank liquidity providers have emerged as major players and counterparties have become more diverse across the board, the bifurcation of trading between the dealer-to-dealer and dealer-to-client markets enforced by the current market structure has become unfit for purpose, stifling liquidity and growth.

In response to this challenge, a cluster of start-up US Treasuries trading venues such as LiquidityEdge have sought to deliver a choice of trading models that lower the barriers to entry and enable all types of institutions to participate in the market in a manner that suits their individual trading strategy.

However challenges persist, particularly in the clearing arena. In today’s market, FICC acts as a central counterparty for its membership. However, non-bank firms often don’t qualify for membership and if they do, find FICC membership costs prohibitive, opting instead for bilateral settlement outside the CCP model.

FICC volumes have decreased as non-bank firms have become more active in the market, and so the market has become vulnerable to the risks associated with trading outside of a centrally cleared environment.

While vendors deliver innovative technology solutions to the US Treasuries market’s various challenges, the relevant authorities must also play their part in addressing structural and regulatory issues such as these. Only this combined force can drive the changes required to fix one of the world’s largest and most important financial markets.