Regulatory Tsunami – Right Here and Now
Brace, brace, brace.
That’s the cry often heard from ships as they prepare to face an impact whether it be incoming enemy fire, contact with another ship or a fierce storm and seas.
No matter which direction the brokerage industry looks, there’s the proverbial tidal wave of regulation and/or compliance issues it is faced with from the regulators. And while these new regulations were once viewed as out there and somewhere, the regulations are now coming home to roost.
Whether it is the recently inaugurated Tick Pilot, the Consolidated Audit Trail, Order Handling Disclosures, or the implementation of MiFID II and the unbundling of research payments from executions, brokers are faced with a more complicated and costly market structure. While the cost of compliance is always factored into trading and any trading environment, new regulations and compliance becomes even harder when US equity commissions haven’t risen, nor expected in the future to offset these costs. Not to mention many firms are being forced to make due with less staff – yesterday’s trader likely focused on outright trading but now wears the dual hat of trader and some other role.
So what is a broker to do? Or how does a firm do it? And what about the exchanges, how do they cope?
Several head traders at brokers throughout the country said they’d be relying on their vendors to help them keep manage new regulations and assistance in compliance. Traders after all want to trade, not worry about re-programming algorithms and smart order routers and interpreting legalese.
“With all the regulation we’re facing, I’m looking to my vendors to keep me out of trouble and in compliance,” one regional head trader said. “The vendors are the pros at this and I’m going to leave them to do their job. And in the meantime, I’m going to do mine and trade.”
Another head trader made the same argument.
“Regulation and mandates from the powers that be are coming at me from a lot of directions and with limited human resources I have to turn it over to my vendors and their solutions,” he said. “They’ve specialized themselves in these unique areas and can help me do my job better. So why wouldn’t I use them?”
Case in point is the upcoming Tick Pilot, which began this week. Tethys Technology noted in a recent commentary that while the US pilot is just getting underway, the same concept or some form of it is being implemented or tested in various markets around the world. Japan and about 20 other jurisdictions have liquidity based varying tick size regime. Some markets do not allow native hidden orders (e.g. Hong Kong). Markets such as Germany require minimum order sizes and display quantities and thus discourage iceberg orders. Futures markets do not allow off-exchange trading and some of them prohibit internal crosses.
In looking at this, vendors such as Tethys, Fidessa and others are ready to assist the brokers and leave them free to trade. As one broker said, “The cost of reprogramming my algos for 50 or so markets on my own is not only cost-prohibitive, but also too time-consuming.”
Also, the upcoming implementation of MiFID II which will mandate the separation of commission payments from actual trade executions or unbundling. This change upends the traditional way research has been paid for and provided. Again, for brokers who trade internationally the changes and cost of compliance between geographies can be daunting and time consuming, not to mention altering the sell side’s bottom line. The solution, let the vendors assist.
At one panel at the recent 83rd Annual STA Market Structure Conference, the cost of compliance was a central point of interest among attendees. One executive at a larger broker said that complying in the current regulatory environment is akin to trying to hit a moving target. As such, the cost of compliance is high. He added that many sell-side firms have adopted a culture of compliance and that while that helps restore market integrity and confidence, running a brokerage in this type of environment is a challenge.
And the sell side is not alone in facing these challenges or costs. The exchanges, despite their diversified business models and multiple cash streams, are also girding up to meet the changing regulatory landscape. NYSE Group, a unit of IntercontinentalExchange, told Markets Media that as markets evolve and become more complex, the regulatory landscape also needs to keep pace.
“NYSE dedicates significant resources to implement exchange-specific and market-wide initiatives to protect all market participants,” the exchange wrote in a statement. ”Recently, we brought the function of exchange surveillance in-house and is both growing our NYSE Regulations team and investing in state-of-the-art surveillance systems to give us the flexibility to adapt to the dynamic operating environment.”
And NYSE wasn’t alone. IEX, the U.S.’s newest stock exchange also chimed in on the matter.
Claudia Crowley, IEX’s chief regulatory officer said the nascent exchange has an experienced staff in place with extensive expertise managing and implementing regulatory compliance requirements at exchanges and broker-dealers, and a nimble process for allocating resources to new rules that most impact its operations.
“We also had the benefit of building the IEX team and exchange during just the last four years, so we were able to factor regulatory requirements for processes and technology — such as Reg SCI — into the design of our market,” she added. “While new regulations of course impose resource burdens, exchanges should be held to higher standards due to their public responsibilities and impact on market integrity.”
John Ramsay, IEX’s chief market policy officer added that the additional costs associated with increased regulatory compliance does pose unique challenges for the brokers and exchanges alike.
“We can see how rising compliance costs can create extra financial pressure for market participants — we’re trying to offset that by challenging exchange practices of squeezing their members with constantly rising fees for tiered access and market data,” Ramsay said.
Regardless of who one spoke with, all agreed that the never-ending wave of new regulations is sure to test the mettle of the market – no matter where one fell in the market structure.
“We’re all bracing for this,” said a head trader in the Midwest. “We’re just preparing the best we can and taking everything in stride.”
Still, perhaps a life jacket might be in order.
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