Sense and Sensitivity

Much of our coverage recently has been focused on clearing and settlement, given the central counterparty (CCP) rules from the European Securities and Markets Authority (ESMA), incoming reform over the trading of derivatives in the US and the EU, as well as Central Securities Depository (CSD) regulation earlier this year. Indeed, I've read so many articles and long, unwieldy regulatory documents of late that Swap Execution Facility (SEF) is permanently tattooed on the inside of my eyelids. I've even started creating acronyms in text messages to friends and family, much to their perpetual amusement (read chagrin).

The Futures and Options Association (FOA) guidelines last week, then, gave a slight breath of fresh air in a way. That's not because the issues aren't complex, of course, they are. But in FOA's detailed recommendations to its members, a thread of common sense permeated the document, something that I discussed with them in a late-afternoon phone call that day.

After all, while kill switches and their working may be more difficult to implement in practice, the basic idea in and of itself screams with an overriding sense of obviousness. Venues should of course be able to kill destructive, glitch and rogue algorithms along with the firm that activates them; the intricacies can be worked out later. Likewise, any orders routed to a market should have to go through pre-trade risk controls, and said controls should be married up with the post-trade process as well. Taking electronic trading as a whole, rather than focusing on specific practices within it such as algorithmic or high-frequency trading is sensible, it mitigates the risk of regulatory loopholes that can potentially be destructive or damaging.

Overwatch
All of these, naturally, are things that have been already thought about and to an extent implemented. FOA couldn't speak for its entire membership, which includes venues, banks, prop trading firms and vendors, but said that some of what it's published is already going on.

Some areas are bound to raise eyebrows, though. The ESMA guidelines on overwatch regarding service providers, for instance, seem sensible on the surface. Quite rightly, firms should have a rigorous diligence and review process for the services they receive. But in the same way, they shouldn't regulate-by-proxy. Independent software vendors (ISVs) and software providers, on the whole, are not regulated entities. But the function they serve and the products they create are used to implement activities which are regulated. It's all well and good saying that firms should have some sort of oversight process to ensure that the vendors they use are ESMA-compliant, but you can understand that there are some grumblings, legal ones at that, where this is seen as back door regulation.

Regulation is a difficult balancing act, we all know this. The competent authorities have to ensure a stable and fair market while also keeping it loose enough to operate freely. But that doesn't mean their services should be subcontracted out, forcibly, to the cost of participants.

Essentially, if a technology service is important enough to be mentioned in a policy document and have strictures regarding its effective operation, it should probably be overseen by the regulator. Not by a bank, or a broker, or a principal trading firm which has its own compliance issues to worry about.

Sensitivity
This is where the second part comes in, rather than being a strange and disturbing 50-Shades-of-Fi-Tech amalgam. Regulation is a difficult balancing act, we all know this. The competent authorities have to ensure a stable and fair market while also keeping it loose enough to operate freely. But that doesn't mean their services should be subcontracted out, forcibly, to the cost of participants.

Common sense is a laudable goal, but that has to be coupled with a more intellectual understanding of the ramifications. Arguably, this lesson should have been learned after the first iteration of the Markets in Financial Instruments Directive, the holes in which regulators are now rushing, legally, politically and technically, to close now while potentially storing up further problems for the future.

If you'd like to talk about regulation, over-reach, or if you're a vendor concerned about potentially being in breach, I'd like to hear from you. Give me a call on +44207 316 9811, or send an e-mail to james.rundle@incisivemedia.com and we'll have a chat.