OVERCOMING REGULATORY HURDLES.
Michael Horan, Head of Trading and Scott Coey, Managing Director & Head of Broker Dealer Services EMEA at Pershing, a BNY Mellon company explain the ongoing impact of legislation and the operating models needed to respond.
There has been a trend to integrate the different dealing desks, why has Pershing decided not to?
Michael Horan: We are a multi-asset class dealing desk – equities, fixed income and FX – but we have dedicated teams trading all three. The reason is that integrating the desks can lead to ‘juniorisation’ meaning you have traders who can work across a range of asset classes but are masters of none. We like to have experts in their field and for us the most important thing is to offer a multi-trading offering. The other issue is that at the moment there are no order management systems (OMS) that can trade all three together. For example, we use Bloomberg for fixed income, Realtick for equities and Dean for FX.
What regulations have had the most impact on the industry and Pershing?
Michael Horan: The Market Abuse Regulation (MAR), which is coming up imminently, is having an impact on our trading services business because it is turning a directive into regulation which means everyone has to implement it. There are a lot of firms running around making sure they are ready. We have already implemented Liquidmetrix surveillance systems that spot nefarious activities such as layering, spoofing, reference price manipulation etc.
MiFID II is another key regulation that will impact both our trading and post-trade services. The industry may have breathed a sigh of relief because of the delay until 2018 but firms should start preparing now even if there is more time. From a trading perspective, there is a small difference in MiFID II in the wording of best execution. It has changed from firms being obliged to take ‘all reasonable steps’ to achieve the best possible results for their clients under MiFID I to being required to take ‘all sufficient steps.’ This will catch out firms who do not do enough to prove and monitor best execution, but again we are well prepared.
What impact do you think unbundling will have on research?
Michael Horan: There is a view that it will have a negative impact but I think broker dealers that are nimble enough will be able to adjust and it will give them an opportunity to diversify their offering. For example, they could specialise in certain areas such as Asia or mining. However, they will have to restructure the way research is paid for. The common response is that they already have commission sharing arrangements in place, but the whole point of MiFID II is to change the reliance on execution. They have to not only separate the payment but also offer a better price for the research.
We might also see wealth management funds set up their own research function instead of relying on the broker dealer because their end client will not want to pay for it.
Scott Coey: I think one of the unintended consequences of research unbundling is that broker firms that cover stocks below the FTSE 250 may choose to no longer cover them, because the revenue they receive for providing research is a prime driver for covering these stocks.
What impact do you think MiFID II and other regulations have had on fixed income markets?
Michael Horan: One of the challenges is market conditions in that issuance is rising, because of the interest rate environment and monetary policy by the different central banks, while liquidity is going down. This is because investment banks are no longer as active in the market due to capital controls under Basel III. Although the push to on-platform trading is designed to attract more players and facilitate the search for liquidity, the buyside’s buy and hold strategy will have an impact on liquidity, despite the greater activity in issuance.
What about the caps on dark pools?
Michael Horan: I think it will be a greater challenge for the stock exchanges, MTFs and investment banks that have dark pools. I think the lit markets will absorb these trades. However, LSE wrote a paper that stated 99 out of the FTSE 100 stocks would be banned from dark trading because they are using the reference price waiver or negotiated price which are subject to the caps.
How are broker dealers changing their business models and what are the challenges?
Scott Coey: The cost of compliance is one of the greatest challenges. A study by Oliver Wyman – The State of the Financial Services Industry, published last year – shows that this cost will increase by 50% per employee. The result is that banks are looking more closely at their operations to see where they can differentiate themselves and add value. Outside of research and origination, there is really nothing else that gives them a unique selling point. Trading, clearing and settlement and asset servicing have become too commoditised and they want to move away from these huge fixed costs.
Is this a trend with larger banks as well as small to medium sized institutions?
Scott Coey: It has been an evolution but over the past couple years we have seen the larger broker dealers look at outsourcing because of the stricter capital requirements under Basel III. They are not meeting their hurdle rates in terms of return on investment and they realise they are spread too thin across their offerings. They are taking the decision to go back to their core offerings and also to have areas of specialisation.
Michael Horan: The other driver is that different divisions now have to stand alone, on their own two feet, and cannot be subsidised. This is also driving banks to outsource different parts of their business.
What type of solutions are Pershing providing clients to cope with all these changes?
Scott Coey: Our aim is to help our clients make better decisions and we see ourselves more as a partner working together rather than a supplier. We offer front, middle and back office solutions across the full trading lifecycle including execution, clearing and settlement, pre- and post-trade analysis, reporting and custody. It provides our clients with economies of scale as well as flexibility to adapt to market changes.
Scott Coey is Managing Director and EMEA Head of Broker-Dealer Services at Pershing. Previously, he was a principle consultant at Detica, managing investment and private banking projects in London, Geneva and New York, as well as serving as a spokesperson on industry developments such as MiFID and exchange consolidation. Coey also worked at The London Stock Exchange, where he held a number of senior strategic business development and project management roles, and ran the European Institutional Relationship Management team.
Michael Horan is Director and Head of Trading Services of Pershing Limited, with overall management responsibility for the firm’s global equity and foreign exchange trading desks. Prior to joining the firm, he was Head of the Foreign Exchange desk at FLG Group, providing execution-only FX services for both private and corporate clients. He also spent five years with Instinet and before that was a trader at Tullet & Tokyo and ABN AMRO Hoare Govett.