A raft of incoming regulatory initiatives globally is turning sharp focus on improving transparency and oversight in derivatives trading systems. The consistency of message to market practitioners from different regulatory jurisdictions is to be applauded. But with the cost of compliance counted in millions of dollars per firm, there are concerns that market participants are facing regulatory overload.
Across the regulatory board, emerging initiatives are stressing the need for firms to have in place additional layers of protection against trading disruptions due to system glitches, for instance adding requirements for platform testing. They are emphasising proper pre-trade risk controls to ensure unauthorised trading is minimised. And – under the guise of ensuring best execution for clients and stakeholders – they are requiring unprecedented levels of trade reporting and other transparency measures that will help firms prove adherence to their own best-x policies.
Today, a global player in derivatives markets faces substantial regulatory initiatives in North America, Europe and the Asia-Pacific region. In North America, all eyes are currently on the US Commodity Futures Trading Commission’s (CFTC) Regulation Automated Trading (Reg AT), which mandates a broad range of measures to ensure FCMs and proprietary trading firms invest adequately in maintaining systems and trading records.
In Europe, the EU’s Markets in Financial Instruments Directive II (and Regulation) (MiFID II/MiFIR) are taking a similar approach to Reg AT. Specifically, the European regulations are seeking to ensure firms put proper pre-trade risk controls in place and test trading systems and algorithms before putting them into production. MiFID II also has onerous record-keeping requirements that may mean firms need to retain records for as long as seven years.
Finally, in Asia-Pacific, practitioners are facing a more fragmented picture. In China, the Shanghai and Chinese futures exchanges have published guidelines for the use of trading algorithms in a bid to prevent a repetition of market disruptions in the summer of 2015. Meanwhile, the Singapore Exchange – a major derivatives trading hub – is advocating a principal-based approach to pre-trade risk.
Observers point out that many large futures commissions merchants (FCMs) and other derivatives markets players already have much of the technology they need to comply with these new regulations. But many other practitioners – smaller FCMs, proprietary trading firms and floor traders – are less prepared, and are in line to suffer the most pain.
TABB Group has estimated the cost per-firm of complying with Reg AT alone at approximately $1.5 million. The research group reckons around 300 participants are likely to be affected by the new measures, putting overall industry cost at around $450 million. Meanwhile, by its own reckoning, the EU has forecast MiFID II/MiFIR will cost the industry up to €732 million in one-time costs plus €586 million in annual maintenance. And those figures were published back in 2014, before a year-long delay and numerous changes to the final requirement spec added to the overall cost.
What’s clear is that firms need to understand their obligations, and not merely in their ‘home’ jurisdictions. Growing complexity of markets means that firms may be operating in multiple global markets, and will need to ensure they adhere to local rules and regulations.
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