Regulatory technology, or, as it has become known, regtech, is a burgeoning sub-sector of the electronic financial derivatives industry that has become very much a cornerstone of corporate governance since in the lengthy advent of MiFID II, which is scheduled to be fully implemented by the European Securities and Markets Authority in January The amount and nature of the reported data must be published and be made available for public viewing on a quarterly basis, hence it will be quite apparent as to which venue is conducting what type of order flow.
It may not appear very significant to retail FX brokerages or their institutional liquidity providers in markets outside China, where most traders are operating their own accounts manually, or are using a copy trading system which also does not qualify as an algorithmic trading method. A firm engaging in algorithmic trading or providing direct electronic access must notify its Member State competent authority and that of the trading venue of which it is a member.
This information can be shared with the Member State competent authority of the trading venue. The firm must also keep records to enable the Member State competent authority to monitor its compliance with these requirements.
On one hand, this makes sense and appears to be an evolution of current rulings, however it will be of interest to see how this affects FX dark pools, many of the larger examples of which are owned and operated via interbank single dealer platforms, such as the UBS MTF, which is a non-displayed multilateral trading facility operated by the bank that provides anonymous diverse liquidity to members and has been the bugbear of the US regulatory authorities — notably the CFTC — recently.
Indeed, interbank dealers use such dark liquidity for many purposes, including to gain an advantageous position at the top of the liquidity distribution spectrum to diversify their risk and provision, and to strengthen their position. Each non-member trader will be subject to risk controls, regulator registration and testing regimes. If those are not adhered to, trading futures algorithmically will not be permitted. This should be a matter of concern for firms relying heavily on introducing brokers that provide portfolio management services, and also should be of interest to copy trading and social trading companies.
Specifically there are concerns over the high order cancellation rate, increased risk of overloading systems, increased volatility, the ability of algorithmic traders to withdraw liquidity at any time and insufficient supervision by competent authorities.
If MiFID II requires all organized trading facilities OTFs , multilateral trading facilities MTFs and trading venues RMs to publish full trade information on a real time basis will be mandatory, thus causing firms to have to make their most valuable asset — their hard earned client base — visible to every individual or entity that looks at publicly available trade reports, along with how prices were calculated, how trades were executed, and whether they were executed correctly with no waiting to see if the outcome can benefit the broker rather than the client, then why are banks allowed to conduct last look practices?
Last look execution is not regarded with fondness by most OTC market participants. Whilst not a mandatory implementation, EBS stated at the time that it took this action as a result of feedback and demand from corporate clients.
This is indeed all very well, however major banks are creating a double edged sword with regard to execution and provision of Tier 1 liquidity. However, electronic spot FX market-making is a highly competitive industry and for the reasons set out above it necessarily exposes the liquidity provider to the risk of trading on incorrect pricing.
Barclays maintains that last look functionality is used to protect against these risks and allows liquidity providers to show considerably tighter electronically streamed prices than they otherwise could — something that the bank considers beneficial to every user of electronic FX trading platforms.
In one high-profile case, a global bank used its spot FX trading platform to reject unprofitable trades. After a regulatory settlement, the bank posted detailed disclosures on its web site and also paid a steep fine, setting a precedent that could impact other banks, brokers and market-making firms. Clients can then manage post-trade workflows to combine, split and roll-out completed orders.
Furthermore, there is complete anonymity for the client as counterparties on external markets only see the Barclays name. Barclays manages all the technology aspects for clients, such as the maintenance of multiple connections to multiple venues, without passing on fixed costs. Whilst this is just one example, it is not uncommon for interbank dealers with large FX market share by volume to operate similarly.
Most certainly it appears that one rule applies for one side of the execution chain and another for the priveleged market makers at the top. As MiFID II looms, retail FX firms have to consider their approach to regulatory technology and structure, in order that they can comply with trade reporting and repository requirements and the means by which firms must design their topography.
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