11.02.2011
By Terry Flanagan

Innovation vs. Regulation

Market participants are wary of over-regulation negatively impacting product innovation.

“Is the industry ready to have innovation stifled at the expense of running products through an approval process for regulators? I’m not sure we’re ready to see something like that,” said Robert Hegarty, managing director and global head of market structure at Thomson Reuters during the FPL Americas Trading Conference. “The desire by the regulators is there, but practical implementation is a ways off. There’s too much of a divide with regulators trying to keep up with the marketplace and what we are trying to bring.”

Following the events of the “flash crash,” regulators are as stringent as ever as many investors lose confidence in the markets.

“Like it or not, that flash crash killed confidence in the markets,” added Hegarty. “Not just retail, but the traditional buy-side as well. We have to look at that. Every time we make a rule, we have to look at the systemic effects.

The first thing that regulators need to do is understand the way the markets work and how participants interact with one another.

“The regulators have a view of the result they want, but what they find difficult is that the system is complex,” said Kevin Houstoun, chairman and founder of Rapid Addition. “There’s a lot of moving parts. It’s the interaction of things, such as two algorithms interacting with each other. The problem of trying to have results-based regulation is that you have results in mind, but what you need are tighter regulations. Once you see how new regulations affect the system, you see that this doesn’t affect it the way you want, and you further modify it. This creates regulatory uncertainty.”

Market participants believe that exchanges can help to bear some of the burden of improving the market structure through the offering of testing sessions.

“It would be nice if exchanges made live testing environments where people can come in on weekends and see how algorithms interact with each other, like live test sessions,” said Thomas Chippas, managing director and global head of quantitative prime services at Barclays Capital.

The idea is for exchanges or other trading venues to essentially offer practice sessions for algorithms to be tested in a simulated environment. This way, the sell-side can see how their newly developed algorithms work in a variety of different situations, and how they interact with others, so that any further mishaps can be avoided in the future.

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