THE FUTURE OF US FINANCIAL MARKET REGULATION

How much is too much market regulation and when does it start having a negative effect on global access?

Global change is afoot. The financial industry is currently implementing two regulatory proposals.

Both regulations will modify market governance, disrupt how the sector operates and affect access to US markets across the world. Those were some of the concerns raised at this year’s FIA Boca conference.

But first, what are the new regulations? As we explored earlier in the year, the first is Regulation Automated Trading (RegAT), a high-profile ruling being debated by the Commodity Futures Trading Commission (CFTC).

Put simply, the framework aims to increase market transparency in a controversial way. One of its main proposals is the demand that algorithmic trading firms reveal their proprietary source code to the watchdog.

As you would expect, there has been significant opposition. Back in November 2016, Walt Lukken, the President and CEO of FIA declared: “We cannot support the proposed source code provision. […] Source code deserves the same protections under the law as any other form of intellectual property.”

The CFTC countered this point a month later with the statistic that over 70% of trading in futures is now automated and thus it is necessary to modernise regulatory oversight. Which side of the industry is correct? Time will tell.

Regulation and technology is global

The other regulation being implemented is Europe’s MiFID II – an even more comprehensive change to how global markets, traders and firms are governed.

At the heart of MiFID II is the intersection of technology and regulatory power – for example, MiFID II proposes that trading firms should report trades to local regulators and algorithms should be extensively tested.

This relationship between technology and regulation is interesting to analyse.

Within the context of US market regulation, technology is both an enabler and a disruptive entity.

It provides a powerful way to govern markets effectively and the ability to improve transparency. At the same time, technological changes are responsible for many new challenges regulators have faced in recent years.

In recent weeks, the discussion between the FIA and CFTC has intensified. In a letter to President Trump, FIA asked for a pause in the regulatory structure so an adequate review can be conducted and Lukken himself calls for three pillars of reform in:

1. Smart regulation and enforcement

2. Global access

3. Promoting fair competition and innovation

Each of these pillars are worthy of discussion. We believe in fair competition, but never at the expense of innovation. For us, challenging the status quo is crucial, especially if clients are going to successfully leverage opportunities in emerging and established markets across the world.

However, as you would expect, successful market reform requires more than a few open letters to the President. It requires careful deliberation, extensive planning and open dialogue between industry groups, regulators and market sectors.

Classifying us market regulations and their impact on connectivity

Even with these factors in mind, the structure of US markets has made regulation challenging and global access an important point worth discussing.

Regulation typically falls to the SEC (U.S. Securities and Exchange Commission) and the CFTC. Both hold substantial judicatory power and each body defines which direction the markets should move in.

Their choices can sometimes be at the expense of global access and network performance for international traders.

The challenge lies in the fact that these groups must balance the interests of US-based market participants, the law and international firms that trade in heavy volumes.

Things become even more complicated because regulation typically falls under two classifications. The first is macro market governance.

These overarching, industry-wide regulations deliver market transparency, promote effective risk management and ensure competent safeguards for investors.

The second classification focuses more on transformative change. For example, new measures to limit the effects of ‘flash crashes’ or programmes that intend to deliver a better understanding of dark pool trading and alternative trading systems (ATSs).

It is common for these regulations to have a direct impact on connectivity.

Part of the ongoing struggle for US regulators is that finance is international, a point Lukken echoes:

“The data that we see from the Federal Government shows that about one-third of the volume coming into the United States markets comes from foreign participants. As we know, in talking with our counterparts in Europe, it’s about the same crossing into Europe.”

Lukken acknowledges the long-term value of enabling global access and supporting overseas investors.

Global access provides liquidity and healthy competition.

Yes, this globalisation creates new challenges, however these can also be addressed with ‘smarter regulation’.

How should ‘smarter regulation’ be defined? Lukken offers some clarity in his endorsement for greater market access. He states:

“So, for us, it is important that there is cross-border access, that we avoid duplication of rules between governments that are allowing for that access.”

There is a compelling case for regulatory caution – that is, the need to be perceptive to US trader requirements but also those global participants that invest heavily in US trading strategies, technology and connectivity.

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What awaits in the future?

Global access was a popular theme at FIA Boca this year. Many attendees were open with the challenges they face in delivering market access to local and international clients, and the role network connectivity plays in this process.

It has never been more important to have a flexible network that can adapt to market developments and changes in market access.

So, the future. What’s next? An air of caution remains in the industry, though some positivity can be drawn from Christopher Giancarlo’s recent comments, who is President Trump’s pick to lead the CFTC.

Giancarlo echoed many of the points Lukken has voiced, including the need for smarter regulation to better serve the American economy. He also voted against the proposals to extract information from HFTs.

With the political landscape still settling in the US and the CFTC awaiting its new head, much could change in the coming months.

Regulation is a constantly evolving subject and we maintain a close watch on proceedings to ensure our network evolves with the markets. There is one thing you can be sure of amidst all this change, we are here to keep you informed.

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