I have been away in the wilds of Australia for a week so a little rusty on what’s hot, but something did catch my eye as I was waiting for my flight home yesterday – yet another realisation by US authorities that they may have got something wrong in their post-GFC rush to regulate everything markets. They are right to review the rule in question, my only hope is that regulators the world over that followed the US initially, conduct the same review, because what these markets need is transparency of action, not of market order.
It has been reported by Bloomberg News that the US Commodity Futures Trading Commission (CFTC) is considering implementing a 48-hour delay on the reporting of large swap trades. I can’t remember the first time I argued against the publication of trades, but it was a long while ago, and I suspect the only reason that the CFTC and, apparently, other US authorities, are moving now is because large asset managers are getting on their case. Perhaps this is one upside of the buy side assuming more risk, although who’d have thought that segment would be uncomfortable with trying to get out of a large lump of risk given to them in a less than secure information environment – it’s not like the banks had to do that in the past…
Whilst I can understand the authorities’ desire to impose some controls on the swaps market post-GFC, the fact is this rule in particular has also become victim to the law of unintended consequences. Other rules have seen execution risk shift to the buy side as banks can no longer cost-effectively hold large inventory or warehouse large risk and one result of this has been the rise of the algo – and the breaking down of large trades.
The market intelligence capabilities of too many firms are now so good that algo executions are being spotted earlier and earlier – there are, after all, only a few different strategies that can be employed – just look at the sluggish take up of algos in FX. So it’s bad enough that firms’ larger orders are more vulnerable to signalling risk, they certainly don’t need “help” from the regulators publishing their trades within minutes of execution.
I should stress I have no problem with trades being reported to regulators, as markets become more complex and fragmented, an accurately time-stamped trade report is vital to any investigation that may be required, but I don’t see why these trades need to be made public for everyone. What benefit is there to various players in the industry? The execution desk gets slippage thanks to signalling risk, firms that have done nothing more than build a tech stack to enable them to legally front run orders get oil for that machinery and the rest of us? Well it doesn’t matter does it?
I wonder if this is another manifestation of the “every child wins a prize” syndrome? Actually (and this is only for UK readers of a certain age) it’s what I would call the “Bullseye” approach.
To explain to non-British quiz show of the 1980s addicts, the game show Bullseye would have a final challenge and if, as happened quite a lot, the contestants failed, the host, the always affable Jim Bowen, would end by saying “Come and have a look at what you would have won” (brilliantly, it seemed whenever two contestants from the very centre of Britain won, it would be a boat!). This is what trade reporting is to most people. It’s saying, “well if you had wanted to sell at that time there was a trade that could have helped you make your decision” – in other words, it’s nonsense.
The whole idea of markets is that people trade when they want to trade. The decision-making process is different for most people and I remain against firms who gain an advantage through speed alone. But to say that every trader should have access to every order in the market, even if it is only 20% executed always has been, and always will be, ridiculous. It’s la-la land thinking, the regulators are effectively saying, “we will show you every order and trade out there, but we trust you not to use the information to trade yourself”. It’s a regulation that breeds poor practice and encourages people to step into grey territory. After all, if you are pondering buying a swap contract and you see a large sell order on the exchange, you will probably wait and see what happens in the hope of getting in a better level. So it is with trade reporting, if you see a large sell go through, quite often you will wait to see if there is any more before trading – execution timing is all about risk-reward, in these circumstances the (potential) reward has the upper hand.
So well done to the CFTC and FINRA for apparently realising that this aspect of regulation has made markets less fair and harder for genuine large interest to trade in. It is part of what seems to be an extensive roll back of rules imposed in the early part of the last decade in the US, most of which have been sensible reversals.
The big problem we have, however, is that other authorities seem less interested in understanding where the rules have created problems, rather they are intent on showing how tough they are on market practitioners – even if they haven’t done wrong. What is needed is for these regulators to take a lead from the US and re-assess conditions in their markets (and indeed global markets).
The financial industry is far from perfect and sensible rules that make markets fairer are imperative, so this should not be read as a call for a free-for-all. That is not to say that regulatory mistakes should not be rectified and as I look at it, an environment in which risk absorption has become difficult, if not impossible, and that has created the conditions for order execution to be split over a long period of time, thus raising signalling risk, is a huge error – and it needs changing now.