FinReg: Game, Set, Match

Terry Flanagan

A 20-year tennis match has taken place between trading technology and regulation, and regulation has lately been serving up aces.

Bob Sloan, founder of S3 Partners, a provider of financial analytics to banks and asset management firms, said in the keynote presentation at Markets Media’s Global Markets Summit New York on Nov. 20 that up until the financial crisis, technology has been able to match regulations point for point, but post-2008 the game has tilted in favor of regulations.

“Beginning in the late 1990s, when the order handling rules were enacted in response to the SOES (Small Order Execution System) bandits, regulations were reacting to technology,” Sloan said. “ECNs resulted in Reg ATS, smart order routing led to decimalization, algorithms and dark pools led to Reg NMS.”

In the six years since the financial crisis, there have been major regulations on bank bailouts (TARP), OTC derivatives (Dodd-Frank), prohibitions on prop trading by banks (Volcker Rule), hedge funds (AIFMD), and bank liquidity (Basel III), yet technology has failed to keep pace.

The problem, according to Sloan, is essentially one of data management. He suggests picturing market structure as an hourglass. At the top of the hourglass are some 20,000 long-only pension funds and mutual funds, who deposit their assets with an agent (custodial) bank. At the bottom of the hourglass, are 5,000 or so hedge funds who deposit all their assets with a prime broker.

The agent banks and the prime brokers are basically swapping positions back and forth trying to get the best price discovery. This is where most of the costs get built in. What’s needed is a way to clear up this Big Data logjam.

S3’s counter-party intel analytics platform performs this task. Just as the FIX protocol has enabled algorithmic and high-speed trading, S3’s PIX (Prime Information Exchange) protocol is automating the management of data in the prime services world. PIX captures and standardizes prime, custody, swap and contractual data.

“Until you standardize that data, you cannot get technology to work to where you can bring the costs down to the transactional level,” said Sloan. Most of S3’s clients save 3 to 5 hours a day using Blacklight, he added.

In equities trading, it used to be that the clearing/financing cost versus the trading/commission cost were basically separate universes, Sloan said. What regulation does is throw them together. Part of executing a trading strategy will be to understand where that buy or sell order winds up, and the capital charges associated with it.

“Because capital charges can be many times the commission cost or the market impact of buying or selling a security, we might see part of a trader’s decision making process to be understanding these costs in a much more granular way,” Sloan said.

Featured image via iStock

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