Max Bowie: Fighting Fragmentation: The Rising Cost of Connecting the Dots

The financial markets have long dealt with fragmented marketplaces and data sources, consolidating market data from multiple trading venues, vendors and regions. Not only is this expensive, but the more complex the marketplace, the more complex the process of capturing data, making it more likely that multiple, fragmented instances of data emerge, making it harder for regulators and traders to obtain a single, accurate view of the markets in which they operate.

The systemic risks of over-the-counter (OTC) derivatives have prompted regulators to begin shifting these instruments onto centrally cleared, exchange-like platforms—swap execution facilities (SEFs). These SEFs create a standardized—and inherently safer—trading environment, though not everyone is looking forward to the lower returns that accompany lower risk. But on their own, a plethora of new exchange-like venues churning out exchange-like volumes of trade data would create new burdens on firms and regulators alike—not only more and higher-frequency derivatives data, requiring infrastructure capacity upgrades, but also the need to connect to every venue to obtain data to assemble a workable view of the marketplace to support their trading and market oversight functions, respectively.

Hence, Dodd–Frank includes a provision for the creation of swap data repositories (SDRs) of cleared and un-cleared swaps trades. At present, four SDR applications are pending in the US, with CME Group, the Depository Trust and Clearing Corp., and IntercontinentalExchange’s ICE Trade Vault having already received provisional approval.

But competition among trade data repositories and indemnification provisions around data-sharing between repositories may lead to the creation of more national and regional repositories, increasing data fragmentation and the burden on those needing to collect data. Larry Thompson, general counsel for the DTCC—which recently received approval to operate a Japanese repository—argued this point to the US House Committee on Agriculture last month, while speakers on a recent panel organized by sibling publication Risk magazine in Johannesburg warned that multiple repositories increases the burden on regulators, and that market participants prefer a simpler scenario with fewer repositories. Elsewhere, for example, the Australian Securities and Investments Commission has just begun a consultation process for establishing its own trade data repository regime.

In the US equities markets, the Securities and Exchange Commission (SEC) is currently enlisting potential providers of a Consolidated Audit Trail of information, to help it analyze market events such as the 2010 Flash Crash or instances of suspected market manipulation. For market participants, fragmentation is addressed by Regulation NMS, which ensures best execution by routing orders to the market with the best price available, regardless of where the order was originally placed. And to ease the burden of aggregating data on these markets, the Consolidated Tape Association and UTP SIP Plan utilities create consolidated tapes of quote and trade data from US equities exchanges—though subscribers to these feeds were recently confronted with new fees that simplify administration, but also increase many fees by significant percentages.

The more complex the marketplace, the more complex the process of capturing data, making it more likely that multiple, fragmented instances of data emerge.

Pan-European Pandemonium
In contrast, the European Commission (EC) mandates best execution but has thus far stopped short of mandating a tape of pan-European quote data to support it, though efforts are under way to produce an industry-led solution of competing tapes. However, there are signs that the EC is becoming impatient with this process and may hold a tender to appoint a single tape provider, creating uncertainty among those already involved in tape initiatives. For example, The COBA Project, an independent organization dedicated to creating a European consolidated tape, recently disbanded after its backers withdrew support because the mixed messages from regulators discouraged other market operators from supporting the initiative—ironically, restoring the status quo of fragmented initiatives that the EC no doubt sought to avoid.