James Rundle: The Devil in the Details

Regulators have been in the headlines for many reasons lately, and not all of them encouraging. The final deadline for the acceptance of comments on the Volcker Rule banning prop trading, for instance, generated a flurry of comment pieces, themselves generated by the flurry of comments received at the eleventh hour.

To call the response to Volcker a flurry underestimates the sheer scale of the comments received by the Securities and Exchange Commission (SEC). I spoke with a former New York Fed staff attorney shortly after the deadline, who said that the regulators had received around 15,000 separate pieces of comment, and not all of them were the standard 10 to 20 pages long. The submission by interest group Occupy the SEC, for instance, was 350 pages long. The problem with working through high-profile rules such as the Volcker Rule, though, doesn’t just come from balancing political will with public opinion. As the lawyer pointed out, the regulators also have to deal with each other—in this case, five separate bodies—and form a cohesive arrangement among disparate interests.

Time Flies
Volcker is provisionally scheduled to take effect on July 21—an ambitious timeframe to sift through the sentiment received, and implement any final regulation. Stress points have come not only from US-resident banks, which claim it will be impossible to put effective technological and operational systems for compliance in place by then, but also by extraterritorial entities that are challenging what they see as an overextension of legislative power by the US. Canadian banks are worried that their non-US operations will now be subjected to oversight by a foreign regulator, and some are concerned that Volcker, in its present form, will contravene previous intra-sovereign treaties such as the North American Free Trade Agreement.

The regulators have to be seen to move quickly while still taking into consideration the complexity of the financial services industry and any unintended consequences. They also have to balance the fact that technology development, such as what has facilitated the growth and reach of tier-one banks, continues apace, and unless stringent deadlines are set for enactment and compliance, there’s no guarantee of efficacy.

Rules of Engagement
The criticism of supervisory authorities is that they cannot understand that complexity, as they don’t live and breathe the world of capital markets on a day-to-day basis. A hard-and-fast definition of high-frequency trading (HFT), for instance, still eludes many, and results in excessive lobbying and stalling over rules to rein it in.

Sell-side firms need to look at their infrastructure at a granular level, such as their data operations, and prepare for change.

This is slowly set to change, though. The US Commodity Futures Trading Commission (CFTC) has established a subcommittee to look at HFT and algorithmic trading with the express purpose of defining it, as a precursor to regulatory movement. Governmental studies such as those from the UK’s Foresight group, and the Swedish regulatory body Finansinspektionen about the practice are beginning to develop a more mature view of what HFT entails, and its relationship to both liquidity and market stability. Regulators are becoming more conversant, informed, and efficient in their rulemaking as well as their understanding of the arcane arts.

The global financial services community may all seek to postpone or eliminate Volcker and similar regulations, but it’s clear that the regulators are moving ahead. Indeed, they have to, or risk it becoming irrelevant before it’s even finalized. The industry should aim to be more anticipatory than reactionary—it’s simply not going to go away, and regulators are becoming more adept at keeping pace. Sell-side firms need to take the time they have to look at their infrastructure at a granular level, such as their data operations, and prepare for change. Implementing technology changes for segregation and even outright separation takes time, which is in short supply these days.