Hurry up, Take Your Time

The Buck Stops At The Brokerage

In Key West there is a famous cat show on the waterfront at sunset where the trainer (yes, cats can be trained) gives his performers their signals and they rush to slowly do his bidding. He says to them, often: "Hurry up, take your time." Such is the nature of cats.

Regulating the financial markets seems rather like herding cats; trying to figure out the legal angles and ramifications to a raft of new regulations while trying to consult with market participants and coordinate between other financial regimes and placate well-meaning politicians is a recipe for confusion.

After the May 6th, 2010 flash crash there was a three month period where the regulators learned just how much they didn't know, said Miranda Mizen, Principal at TABB Group at a Market Surveillance Seminar on February 22, co-sponsored by Progress Software. And this was after nearly two years of delving into financial market practices in order to reform regulations following the credit crisis. The result of all of these events has been a slew of new regulations, all of which require new or different surveillance programs in order to succeed.

During the intricate dance between market participants and regulators it becomes clear that there needs to be some common ground from which to start. That common ground lies with brokers, concluded Mizen, author of the paper entitled Dynamic Surveillance: Detection, Prevention and Deterrence.

She noted that brokers are sitting square in the middle between client order flow and trading venues. They are the major intermediaries, handling both order flow and information which allows them a top-down view of the markets. This view could help to fill some of the gaps that regulators need to fill.

The Securities and Exchange Commission has intimated that the buck stops with senior executives at big brokerage houses and operational risk executives, who must prove that they have adequate procedures in place to prevent market abuse. This fate was pretty much sealed when the SEC agreed to propose the Market Access Rule last year, which would effectively prohibit broker-dealers from providing customers with naked access to an exchange or ECN.

The Market Access Rule mandates real-time risk controls for brokerage clients, but it is only part of the struggles that brokers face. They have to deal with market structure changes such as the introduction of swap execution facilities, regulations in new asset classes and geographies, and regulators' demands for more detailed trade information. The rise of social networks, often used for trading discussions, adds another dimension to monitoring challenges. Plus, their efforts toward surveillance and market monitoring must be deemed "appropriate" by the authorities.

And the sellside will be happy to know that the buyside wants these types of control in place. Mizen's report pointed to recent interviews with asset managers in Europe, 85% of whom said that performance monitoring of their order flow is their top requirement when using algorithms and direct market access. This includes preventing fat finger trades, algos gone wild and market abuse.

No one wants to inadvertently kick the first domino that causes the whole line of dominoes to fall across the market, and most market participants are terrified of being the ones whose algorithm goes rogue. Technology is one - big - part of the solution. But procedures, processes and controls are also important elements of risk evaluation. Best execution and surveillance have to work together to be effective.

-Dan