May 2010

TRADING: trade optimists on regulatory change

Funds Europe talks to a selection of fund-manager dealing heads and finds that regulatory change, such as Mifid, has been largely successful

RCM Allianz Global Investors
Christoph Mast
Managing Director and
Global Head of Trading
What is the biggest risk issue facing buy-side dealers?   “As far as risks are concerned the recent developments have led to change in sentiment. In the past, for a buy-side trader the risks of dealing the wrong size or side were quite significant given the technological hurdles the desks were facing. Those trading errors have vanished to a large extent since using the electronic pipes to the brokers/markets.

With these technological developments the dependence on the order management system and a working IT support function is certainly one huge potential risk factor. The order management system needs to be reliable in order to reduce risks for the desk such as overseeing limits, account restrictions and portfolio managers’ instructions. Another one is the counterparty risk management. As we have learned from the Lehman Brothers experience, even a delivery-versus-payment agreement leaves some counterparty risk.”

Do you welcome more central clearing for derivatives? Will the benefit of reduced risk outweigh the disadvantage of increased cost?    “Absolutely. Higher transparency and lower operational and counterparty risks are a clear benefit and it is far from certain that it will come at a higher cost given the current cost of OTC operations. Listed contracts are cheaper to process which should outweigh the fees charged.”
Axa Investment Managers
Paul Squires
Head of Trading
Has Mifid been a success or a failure so far?   “It is difficult to pinpoint cause and effect, but one of the positive impacts is that Mifid created competition to the primary exchanges which has driven down the cost of trading. On the negative side, the fragmentation of liquidity has had less favourable implications for trade reporting
.
The limited options that faced brokers in the pre-Mifid era were broken down and they had much more freedom as to where they reported their trades. From a broker’s point of view, the cost of trade reporting went down but for us, as buy-side traders, we did not have access to information which is very important. So while Mifid has created a new secondary market to compete with the primary exchanges, it is more expensive and unreliable to get any information from this section of the market.”

How has Mifid affected the relationship between buy-side dealers and their brokers?    “We have relationships with over 150 brokers but there are only around 50 of those brokers that are able to access all the MTFs. The problem is knowing which of these 50 brokers are genuinely accessing all of the available venues for my orders.

A number of brokers offer FIX tags but these tags cost money and you have to install the right system to receive the feed. Instead we have asked for a monthly breakdown of all trades – how many went to MTFs, how many were crossed internally etc. But of the 20 brokers we asked, only two could supply us with that data. Either it’s too difficult for them to correlate information or we should be suspicious of those that do provide the data [due to a lack of transparency].”

What is the biggest risk issue facing buy-side dealers?   “As far as risks are concerned the recent developments have led to change in sentiment. In the past, for a buy-side trader the risks of dealing the wrong size or side were quite significant given the technological hurdles the desks were facing. Those trading errors have vanished to a large extent since using the electronic pipes to the brokers/markets.

With these technological developments the dependence on the order management system and a working IT support function is certainly one huge potential risk factor. The order management system needs to be reliable in order to reduce risks for the desk such as overseeing limits, account restrictions and portfolio managers’ instructions. Another one is the counterparty risk management. As we have learned from the Lehman Brothers experience, even a delivery-versus-payment agreement leaves some counterparty risk.”

Do you welcome more central clearing for derivatives? Will the benefit of reduced risk outweigh the disadvantage of increased cost?
“Absolutely. Higher transparency and lower operational and counterparty risks are a clear benefit and it is far from certain that it will come at a higher cost given the current cost of OTC operations. Listed contracts are cheaper to process which should outweigh the fees charged.”
Invesco
Mark Harding
Head of EMEA Equity Dealing
What changes, if any, has the financial crisis had on your trading desk in terms of risk management?    “Even before the financial crisis we had been looking at ways of tightening our approach to counterparty risk. The new broker take-on approach was always rigorous but we have initiated an improved process for ongoing reviews.

The process involves an annual review of counterparties that includes a regulatory background check, a review of the latest financial statements, an updated credit rating and confirmation from the broker that they have successfully tested their BCP over the intervening period. In addition to this we review the credit ratings of counterparties on a monthly basis, picking up if there have been
any significant changes from one month to the next which warrant further investigation.”
Ignis Asset Management
Besty Anderson
Head of Centralised Dealing
Is it too early to say whether Mifid been a success or a failure so far?   “I think Mifid has been a success so far. The increased competition and choice it has introduced has enhanced our ability to access liquidity and, to a certain extent, it has lowered our trading costs. I know that the lack of central clearing has added some cost, but overall I think we have seen a reduction.

It’s probably too early to say whether it has gone far enough yet. Mifid is currently under review and we don’t know yet how that will pan out. It’s clear that Mifid II needs to go further but not so far that we become stifled by over regulation. The search for liquidity has always been our biggest challenge on the desk and Mifid has allowed us to access a greater number of venues and we now have greater choice of how to execute, where to execute and with whom.

What changes, if any, has the financial crisis had on your trading desk in terms of risk management?    “We have always had an integrated approach to risk. From the beginning (1999), I’ve been a member of our counterparty risk committee (CRC).  I highlight the nuances of trading in certain instruments and the importance of regional idiosyncracies when considering counterparty relationships and appropriate risk.

What has changed is that we have increasingly added additional criteria into our counterparty approval and review process – for example, CDS spreads, the parentage of the underlying entities and the probability of default. We now overlay the considerations of the CRC with those from our dedicated credit committee.  We are also much more aware of the fact that it is important to know the risks within each of our counterparty relationships across the whole organisation and for every asset class, so there is a greater granularity and at the same time, a holistic approach to risk across the business.”