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Sunday, December 1, 2024
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EXECUTION MATTERS: Options Trading in Focus

By
Editorial Staff
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Johan Sandblom, Lime Trading

(EXECUTION MATTERS is a Traders Magazine content series focused on the topics most important to traders and technologists in US equities and options markets. EXECUTION MATTERS is produced in collaboration with Lime Trading Corp.)

The US options market continues to be a dynamic growth story that has the attention of traders, brokers, trading venues, and infrastructure technology providers. 

Average daily options volume reached 47.4 million contracts in September, up 7.5% from the year-prior period, according to Options Clearing Corp. data, and 2024 is on pace to be a record year. Options market developments in the news recently include an academic research report about retail options trade execution, and IEX Group’s announcement that it plans to launch what would be the 19th US options exchange. 

The sustained strength in options trading has been largely driven by retail participation, which increased from about 35% of the market pre-pandemic to 40-45% since then. Post-pandemic data “suggests that substantial retail options trading is here for the foreseeable future,” Steven W. Poser, Director of Research at NYSE said in a December 2023 report. 

Providers of options trading infrastructure have taken notice. “Retail is becoming smarter,” said Johan Sandblom, President and Head of Business Development at Lime Trading, an agency-only broker-dealer providing market access to the U.S. equities and options markets. “Product innovations such as shorter maturities and multi-leg orders, combined with more educated and savvier investors have contributed to the recent upswing in volume of options trading.”

Johan Sandblom, Lime Trading
Johan Sandblom, Lime Trading

“For many investors, trading options isn’t an alternative but an addition to their traditional equity portfolios,” Sandblom continued. “That is why we make it easy to trade both asset classes through a single API (application programming interface). We want our traders to be able to focus on their strategy, so we design our tech to make it easier for them to do just that.”  

Options trading was a key topic discussed at the Security Traders Association’s 91st Annual Market Structure Conference, which was held last month in Orlando, Florida. 

In the Listed Options: They’re Everywhere panel on Sept. 19, it was noted that in the past five years, there has been strong growth in the use of options by self-directed investors, which can be attributed both to the robust trading platforms accessible to these investors, as well as more widespread investor education. The breadth of the options trading client base has expanded, and clients are increasingly trading in all market conditions. 

With regard to the options market ecosystem and operational complexities, the panel noted that there is a network of market makers who make continuous, two-sided quotes in one million instruments across 18 exchanges; a community of prime brokers who provide financing; and sophisticated electronic brokers that provide efficient, low-cost market access for retail and institutional clients. 

As for what’s next, the panel cited short-dated options on single stocks, as well as expanded trading hours are on the horizon. The market moves fast and the evolution of options is moving fast as well, panelists said; in the near future it might make sense to slow down new initiatives to ensure the proper infrastructure and protections are in place. 

The options market was also discussed in the Continued Democratization of Retail Investing panel at STA on Sept. 18. That panel noted that innovation in the options market has been a significant factor in improving the retail trading experience, and the industry needs to meet the continued demand for short-dated options and expanded trading hours in order to sustain that momentum.

Looking ahead to potential market volatility from the upcoming election and changes in federal rates, growth in retail investing will undoubtedly play a critical role in shaping how traders adapt and thrive in this evolving landscape.

Margin Optimization Back in Focus for Derivatives Market

By
Anna Lyudvig
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Stephen Bruel, Coalition Greenwich
Stephen Bruel, Coalition Greenwich

Derivatives market participants have renewed their focus on capital and margin optimization in response to the high cost of capital and the regulatory push toward central clearing, according to Coalition Greenwich.

According to its recent report The Portfolio Margining Imperative for Interest-Rate Derivatives, the largest opportunity for margin optimization remains largely untapped.

Stephen Bruel, Coalition Greenwich
Stephen Bruel, Coalition Greenwich

“Netting of futures and swaps risk in a single clearinghouse would also reduce the potential for market participants being stopped out due to margin increases from volatility spikes,” said Stephen Bruel, Senior Analyst at Coalition Greenwich Market Structure & Technology and author of the report.

“Not only would individual trading entities benefit, but the financial system would see an improvement in risk efficiency,” he said.

“Limited portfolio margining opportunities are available to market participants today, reducing portfolio margining efficiency and scale. As such, portfolio margining has room to grow,” Bruel added.

Margin requirements can be safely reduced when offsetting positions within a firm’s portfolio are held at the same clearinghouse. However, today’s competitive landscape has largely kept U.S. dollar denominated swaps and futures tied to U.S. Treasury and SOFR rates separate.

Higher capital costs have compelled derivatives market participants to be more strategic about how they optimize their margin obligations, driving changes to where they trade and how and where they clear the instruments, Bruel said.

Banks interviewed recently by Coalition Greenwich say “capital efficiency through netting and margin optimization” has become an important factor in how they measure their relationships with central clearinghouses (CCPs).

Bruel said that USD swaps and USD interest-rate futures have been cleared separately for as long as clearing for those products has existed.

He noted that FMX, which already provides a platform for cash UST and FX execution, recently launched its futures exchange for SOFR futures, with UST to follow in Q1 2025. 

FMX will not directly clear the trades; rather, they have entered into a partnership with the London Stock Exchange Group’s LCH, who will clear the trades through LCH’s Listed Rates service.

A partnership between FMX and LCH is aimed directly at the costs associated with these fragmented margin pools and has reignited the cross-margining discussion amongst market participants.

Bruel said that FMX’s 10 current partners include the largest banks and market makers, and 7 of the 8 largest futures commission merchants (FCMs). 

“Given CME’s current market share as sole incumbent in U.S. rate futures, differentiation in margin efficiency becomes paramount for FMX or anyone hoping to compete,” he said.

According to the report, interest-rate derivatives posted margin has increased by 108% since 2017, reaching $331.8 billion as of the end of 2023.

The CME is the primary clearer of U.S. rate futures and, thus, holds a majority of that margin, with no U.S. rate futures margin held at LCH prior to the FMX launch (the FMX partnership is LCH’s first foray into U.S. rate futures), according to the report.

“Portfolio margining at scale between offsetting U.S. rate futures and USD (and non-USD) swaps would free up significant capital for other uses,” Bruel commented.

He added that reducing margin obligations post-trade is beneficial; knowing the optimal path to maximize potential offsets before you trade will help achieve those benefits. 

“Large entities could have a substantial number of positions spread across multiple clearing members.” he said. 

“Regardless of the instrument type, derivatives traders therefore seek to know the margin implications of a new trade before they decide on the trade path, so they can act accordingly,” he said.

“Embedding tools such as LCH’s Rates Margin Calculator or CME’s Margin Calculator can help evaluate potential margin benefits through what-if analyses for incremental trades, including across swaps and futures. Reviewed pre-trade, this helps control margin costs. Approaching the margin issue from a pre-trade, trade, and post-trade perspective will provide the greatest benefits,” he added.

Bruel said that competition and choice are critical in financial services.

“But the launch of FMX and its partnership with LCH should lead market participants to refocus their efforts on margin efficiency in hopes of freeing ever-valuable capital to where it is most needed,” he said.

Shifting the Landscape: 8 Takeaways from the 91st Annual STA Market Structure Conference

By
STA
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Jim Toes, STA

By Jim Toes, President & CEO, STA

Jim Toes, STA
Jim Toes

Last month’s STA Market Structure Conference, titled “Shifting the Landscape”, promised in-depth discussions of the most pressing issues reshaping the financial services industry. Over three days in Orlando, the panelists delivered, diving into topics from demographic and asset class trends to the implications of SEC regulation.

Read on for 8 takeaways from the program, including perspectives from exchanges, trading firms, regulatory officials and beyond.

1. The retail trading community grows increasingly sophisticated. Today’s retail investors have evolved into highly active, educated participants in the financial markets, driven by better access to tools and resources. Significantly, innovations like 401(k) rollovers and self-directed accounts have enabled retail traders to diversify their portfolios. The “Continued Democratization of Retail Investing” panel focused the transformative impact of technology on democratizing market access.

“Retail traders have demanded better and better tools and are now actively managing their portfolios around headlines and major events,” said Webull Financial’s Arianne Adams.

2. ETFs are bringing institutional management to retail investors. With the rise of new products and new strategies, ETFs have seen a surge in adoption. A decade ago, individual investors would have struggled to secure downside protection or enhanced yield, but with the increasing sophistication of the retail community, they are now flocking to vehicles that enable such approaches. The market has grown accordingly. “A total of 46 firms have launched an ETF in 2024 that never had before – that’s more than one a week,” said Douglas Yones of NYSE. “The numbers are there. Now they need partners and people to help them efficiently navigate the market. The next era of ETFs is here.”

3. Options continue to explode. The options-focused panel discussed the rapid innovation occurring within this market. Retail demand has surged, while institutions are focusing on initiatives like options-driven ETF structures and dedicated risk models for this asset class. Panelists agreed that while a more measured pace may be appropriate, there is a continued need for evolution, creating competing incentives. “One place I think we’re heading: if listed options don’t provide more strikes and expirations, people are going to move to flex options or OTC options,” said Jennifer Setzenfand of Federated Hermes. “It just underscores the need for evolution in the listed options space.”

4. “Wall Street South” continues to gain momentum. With numerous financial institutions opening offices in the area, South Florida shows true promise as the nation’s next major financial hub. Former Florida Governor Jeb Bush and Miami International Holdings Chairman and CEO

Thomas P. Gallagher discussed the developments that have made the state a key industry player, with Gallagher sharing MIAX’s plans to open a trading floor in Q2 2025.

“The dream for me, for the state of Florida, was developing a closer connection to the financial services industry by having a vibrant exchange in our community,” Bush said.

5. The SEC rulemaking process has evolved significantly. The presence of industry regulators is always a highlight of the conference. This year’s program featured former SEC Commissioner Dan Gallagher and former Director, Division of Trading and Markets Brett Redfearn, both of whom expressed certain misgivings regarding recent regulatory priorities. Gallagher stated his concerns about the commission’s approach to payment for order flow, while Redfearn offered his perspective on the overall evolution of SEC rulemaking. “We passed rules when I was with the SEC that were approved and upheld in court and then ignored by the new SEC administration – or they cherry-picked parts to ignore,” said Redfearn. “I think that is a dangerous precedent.”

6. 24-hour trading appears inevitable. On Friday morning, panelists from Blue Ocean Technologies, Imperative Execution, Liquidnet and OTC Markets took the stage to discuss the roles of their respective venues, which offer distinct value propositions to market participants, in the wider marketplace. One theme they discussed (which came up several other times during the program) was the seeming inevitability of 24-hour trading. Bryan Hyndman, CEO and President of Blue Ocean, stated that progress has been measured, yet undeniable. “An exchange will definitely follow our success in overnight trading,” he said. “But right now, you don’t have the SIP operating 24 hours and trade reporting is batched. Things are evolving, though. DTCC used to open at 4 am, and now it’s 1:30 am. In a few years, it will be 24/5.”

7. Cybercrime has become a potent threat to market security. Thanks to rapidly evolving technologies, cybercrime has evolved into a highly sophisticated business, posing significant threats to financial market resilience. In a fireside chat, Bryan Smith of FINRA, former FBI Section Chief of Cyber Criminal Operations, cited malware, infrastructure and money laundering as being among the principal challenges. He also cited the vast underreporting of attacks as a key issue in cybercrime enforcement. “When the FBI infiltrated a major cybercrime network for seven months, we could see all the victims, past and present,” said Smith. “Only 20% to 25% of the cybercrime victims actually reported the attacks.” Smith explained that by reporting concerns to FINRA or to law enforcement, firms may be able to receive guidance, assistance, and referrals to potential resources that could help address their issues. Additionally, Smith described FINRA as being “open for business” and willing to actively engage with firms to provide support.

8. Mentorship is vital to career growth. The conference also featured the 9th Annual STA Women in Finance Symposium, where Patty Schuler of BOX Options Markets received the 2024 Woman Mentor of the Year Award. She spoke on lessons learned from her career and the industry’s progress toward diversity, encouraging her fellow female professionals to embrace the wisdom of those above them and invest in the ones who follow.

“I truly believe that mentoring is about passing on your knowledge and legacy to the next generation,” Schuler said. “The best way to thank a mentor is to pay it forward and become a mentor yourself. We must all remember to thank those who have made a difference in our lives.”

US ETF Assets Reach $10 Trillion

By
Press Release
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ETF Exchange traded fund Trading Investment Business finance concept on virtual screen

ETFGI, a prominent independent research and consultancy firm specializing in providing subscription research on trends in the global ETFs industry, reported assets invested in the ETFs industry in the United States reached a new record high of US$10 trillion at the end of September. 

During September the ETFs industry in the United States gathered net inflows of US$97.29 billion, bringing year-to-date net inflows to a record US$740.81 billion, according to ETFGI’s September 2024 US ETFs and ETPs industry landscape insights report, the monthly report which is part of an annual paid-for research subscription service. (All dollar values in USD unless otherwise noted.)

Highlights

  • Assets invested in the ETFs industry in the United States reached a record of $10 Tn at the end of September beating the previous record of $9.74 Tn at the end of August 2024.
  • Assets have increased 23.2% YTD in 2024, going from $8.11 Tn at end of 2023 to $10 Tn.
  • Net inflows of $97.29 Bn in September 2024.
  • YTD net inflows of $740.81 Bn are the highest on record, followed by YTD net inflows of $650.04 Bn for 2021 and the third highest recorded YTD net inflows are of $412.07 Bn in 2022.
  • 29th month of consecutive net inflows.

“The S&P 500 index increased by 2.14% in September and is up by 22.08% year-to-date in 2024. The developed market index excluding the US increased by 1.26% in September and is up 12.53% YTD in 2024.  Hong Kong (up 16.51%) and Singapore (up 7.43%) saw the largest increases amongst the developed markets in September. The emerging market index increased by 7.72% during September and is up 19.45% YTD in 2024. China (up 23.89%) and Thailand (up 12.43%) saw the largest increases amongst emerging markets in September.” According to Deborah Fuhr, managing partner, founder, and owner of ETFGI.

Growth in assets invested in the ETFs industry in the United States as of the end of September

The ETFs industry in the United States had 3,775 products, assets of US$10.00 trillion, from 341 providers listed on 3 exchanges.

During September, ETFs gathered net inflows of $97.29 Bn. Equity ETFs gathered net inflows of $49.24 Bn during September, bringing YTD net inflows to $337.90 Bn, much higher than the $141.78 Bn in YTD net inflows in 2023. Fixed income ETFs had net inflows of $15.61 Bn during September, bringing YTD net inflows to $145.15 Bn, higher than the $116.99 Bn in YTD net inflows in 2023. Commodities ETFs reported net inflows of $1.52 Bn during September, bringing YTD net outflows to $9.17 Mn, higher than the $7.78 Bn in YTD net outflows in 2023. Active ETFs attracted net inflows of $26.49 Bn during the month, gathering YTD net inflows of $206.66 Bn, much higher than the $86.10 Bn in net inflows YTD in 2023.

Substantial inflows can be attributed to the top 20 ETF‘s by net new assets, which collectively gathered $61.63 Bn in September. SPDR S&P 500 ETF Trust (SPY US) gathered $17.89 Bn, the largest individual net inflow.

Source: ETFGI

Buy Side Recognizes Importance of Trading Algorithms

By
Anna Lyudvig
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There has been very little innovation in algorithmic trading over the past 15 years, according to Stephen Ponzio, Head of Electronic Trading, BTIG.

“There have been developments in liquidity sources – single-dealer platforms, for example – but almost nothing in terms of algorithmic functionality,” he told Traders Magazine.

Stephen Ponzio

According to Ponzio, the most interesting recent development is trajectory crossing, where executions are matched at the parent level, but only over a short horizon, such as five minutes. 

“Both sides get the average market price for the five-minute interval, which is an improvement over executing in the market. This kind of crossing is now offered by several ATS’s,” he said.

Developing better-performing variants to traditional algorithms like VWAP and POV is top-of-mind for BTIG.

Ponzio said that a lot of firms use these algorithms but do not need strict adherence to the standard schedule or rate. 

“They would be very eager to give the algorithm a bit more discretion in exchange for better performance. This is not an avenue the sell-side has explored very much,” he said. 

“Some brokers have offered VWAP with “dark overlay” which is very simplistic and does not perform well because of adverse selection,” he added.

BTIG has taken a scientific approach to the problem, modeling volume carefully to understand the difference between baseline volume and stochastic volume fluctuations, which they call “opportunistic volume.” “This is particularly important for illiquid stocks,” Ponzio said.

“We have also developed about a dozen signals that the algorithm uses to recognize conditions when a price move is likely to revert or to be sustained,” he stressed.

“These approaches are packaged into our “Opportunistic VWAP” and “Opportunistic POV” which may get a bit ahead or behind the schedule/rate in order to trade at better times and get better prices,” he added.

Performance is the key driver for several components of the BTIG’s system: “We have a proprietary design for accessing the markets, featuring semi-autonomous modules that are co-located at each of the exchanges.” 

Ponzio said that the real-time analytics are calculated using Julia, a high-performance programming language developed at MIT for use in data science and machine learning.

According to Ponzio, there is a wide range of the buy-side’s adoption of algorithms. 

Some use algorithms, but only manually, and don’t really measure performance, but instead use poor benchmarks like venue analysis, or focus only on commissions and fees, Ponzio.

Others are more sophisticated and use algorithms extensively and systematically, they add more automation and introduce randomization (“wheels”), he said.

This is really a prerequisite for measuring performance, he noted. 

“You’ll have a very difficult time measuring performance if part of your process is manual. It’s impossible to compare brokers A and B if the utilities trader always sends to A but healthcare sends to B, and one sends larger orders but tends to cancel when they go badly,” he stressed.

“To make a valid comparison (“apples to apples”), you need to remove the manual part of the process. By being more systematic, you develop an approach that is repeatable and predictable, and best of all, measurable. Now you have a data-driven process that will lead to real savings,” he said.

Ponzio said that while some people mistakenly believe algorithms have been commoditized, the more sophisticated are realizing there can be an enormous difference in performance—easily 5-10 times the commission.

Obviously, Ponzio said, computers can do things that humans are simply incapable of: “A trader cannot check 50+ venues for liquidity or detect subtle patterns in the market. A computer does these things very well, so an algorithm is the perfect solution once an objective has been determined.”

He added that an algorithm can execute basic strategies very well, but it’s not going to predict 6-hour returns. 

“That’s where the buy-side can add value to the execution process—by determining when to trade and how aggressively to trade. These are very difficult decisions to optimize, and again, should be approached systematically,” he commented.

For a firm that already uses algorithms widely, there is tremendous opportunity for further savings, Ponzio said. 

“Algorithms are not as commoditized as some people think. While behavior across brokers may be fairly standard, performance is not,” he said. 

The difference in performance between brokers can be 5-10 basis points, which is multiples of the commission, he said. 

“One basis point is $0.0050 (50 mils) on a $50-dollar stock, so we’re talking several pennies per share,” he added.

When asked about the future of the electronic trading space, Ponzio said: “I think that in this age of AI, people will finally start looking to algorithms to optimize executions, rather than trying to micromanage them.”

The past ten years has seen algorithms adding bells and whistles, but very little guidance in how to use them effectively – things like minimum fill quantity, max display size, venue blacklists and restrictions on execution rate, he said.

Traders often set values for these parameters without any real evidence for whether it will help the execution, Ponzio said

In reality, he added, different values are needed at different times and places over the course of the execution.

“It may be better to use different minimum fill quantities for different venues. It may be better to use different venues for different purposes. It may be better to trade faster at some times and slower at others. These decisions are best left to a computer, which can optimize based on data,” Ponzio said.

“This will be a welcome development for everyone – the buy-side will benefit from more efficient execution and the sell-side will be free to innovate and compete,” he concluded.

DTCC Announces Industry Sandbox to Support and Advance the Digital Asset Ecosystem

By
Press Release
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Frank La Salla, DTCC

DTCC also announces results of proof-of-concept to optimize collateral management using tokenization.

New York/London/Hong Kong/Singapore/Sydney/Tokyo/Abu Dhabi, October 15, 2024 ‒ The Depository Trust & Clearing Corporation (DTCC), the premier post-trade market infrastructure for the global financial services industry, today announced DTCC Digital Launchpad, an industry sandbox intended to bring together financial market participants and clear the path to scalable adoption of digital assets. As an open ecosystem, DTCC Digital Launchpad will feature market participants, technology providers, and others working together to identify and collaborate on meaningful pilots that have a clear path to production.

“DTCC Digital Launchpad will unify stakeholders from nearly every corner of the financial markets to solve the challenges facing adoption of digital asset technology,” said Frank La Salla, DTCC President, CEO and Director. “As an industry-owned and governed infrastructure for the world’s largest capital markets, DTCC is uniquely suited to drive industry collaboration under the banner of a larger goal: building a digital asset ecosystem that’s as safe and sound as the one we have for traditional securities today.”

Current estimates suggest tokenization presents a monumental business opportunity, with projections stating $16 trillion dollars in tokenized securities could be on digital rails by 2030. However, adoption of this technology has stalled as the industry continues working in silos. Most digital asset initiatives today have differing and conflicting standards, controls, and operational processes, leading to a fragmented digital landscape.

“We’ve reached a critical inflection point in the adoption of digital asset technology, and DTCC is challenging the industry to rethink and reframe its siloed approach,” said Nadine Chakar, Global Head of DTCC Digital Assets. “The ultimate objective of DTCC Digital Launchpad is to bring the industry together to build production-ready, secure, and efficient digital market infrastructure and standards that will transform capital markets for generations to come.”

DTCC Digital Launchpad provides:

  • DLT infrastructure featuring capabilities from the DTCC Digital Assets product suite. These capabilities help firms address some of the industry’s biggest challenges around data, liquidity, and infrastructure, including interoperability and data harmonization
  • Robust and scalable infrastructure, enabling firms to get started on their digital asset journeys without having to build their own ecosystem
  • One platform, two objectives:
    • Industry Launchpad: An open ecosystem for broad collaboration. DTCC will publicize our prioritized pilots in Q1 2025, starting with an initial group of participants invited to co-develop these solutions. These initiatives are designed to unite the industry behind addressing critical pain points and paving the way for scalable solutions that drive industry-wide progress
    • Client Launchpad: A dedicated space to leverage comprehensive digital asset capabilities from DTCC Digital Assets. Clients can explore and develop their own innovative use cases without substantial investment. DTCC’s professional services team is on hand to offer guidance and provide product support to drive these initiatives to production

DTCC today also announced the results of a recent proof-of-concept on DTCC Digital Launchpad. Led by Japan Securities Clearing Corporation (JSCC), clearinghouse of Japan Exchange Group, the proof-of-concept explored how central counterparties (CCPs) could use tokenization to optimize the collateral management process for clearing members and their buy-side firms. In particular, it examined how margin calls and their associated processes could be automated, made more efficient and transparent for all participants using digital assets and smart contracts – or rules that automatically execute on a distributed ledger when certain conditions are met.

“JSCC is excited to share the results of our successful proof-of-concept, which demonstrated that digital assets and smart contracts technology could be leveraged to introduce operational and capital efficiencies for market participants in the collateral management process,” said JSCC President & CEO, Konuma Yasuyuki. “By leveraging DTCC’s reusable blockchain-based infrastructure, we were able to jump-start our proof-of-concept, easily issuing digital assets such as cash, stocks, and bonds without needing to develop our own infrastructure. This allowed us to shift our focus to the initiative’s impact on our own business processes.”

DTCC encourages the industry to read the results from JSCC, a key first step as the firm now invites the industry to explore how they can leverage DTCC Digital Launchpad to support large-scale initiatives in shared environments.

About DTCC

With over 50 years of experience, DTCC is the premier post-trade market infrastructure for the global financial services industry. From 20 locations around the world, DTCC, through its subsidiaries, automates, centralizes, and standardizes the processing of financial transactions, mitigating risk, increasing transparency, enhancing performance and driving efficiency for thousands of broker/dealers, custodian banks and asset managers. Industry owned and governed, the firm innovates purposefully, simplifying the complexities of clearing, settlement, asset servicing, transaction processing, trade reporting and data services across asset classes, bringing enhanced resilience and soundness to existing financial markets while advancing the digital asset ecosystem. In 2023, DTCC’s subsidiaries processed securities transactions valued at U.S. $3 quadrillion and its depository subsidiary provided custody and asset servicing for securities issues from over 150 countries and territories valued at U.S. $85 trillion. DTCC’s Global Trade Repository service, through locally registered, licensed, or approved trade repositories, processes more than 20 billion messages annually. To learn more, please visit us at www.dtcc.com or connect with us on LinkedIn, X, YouTube, Facebook, and Instagram.

Why a Shift in Regulatory Enforcement Demands a New Approach to Trade Surveillance

By
Eventus
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Joe Schifano, Eventus

In the wake of several high-profile enforcement actions in the U.S. and abroad, trade surveillance has come under intense regulatory scrutiny. In this article, Joe Schifano, Head of Global Regulatory Affairs, Eventus, explores what this shifting regulatory landscape means for firms and why it demands a different approach to trade surveillance.

Regulators are changing tack. Significant enforcement actions demonstrate an increasing focus not just on whether market abuse occurs, but whether firms’ surveillance capabilities and internal processes are fit for purpose.

One notable case this year involved deficiencies in wash trading surveillance practices. Despite utilizing modules from its vendor, the firm struggled with excessive false positives and could not adequately justify why it selected certain surveillance modules while omitting others. The regulatory focus here was clear: firms must deploy appropriate and complete surveillance modules, tailored to detect market abuse patterns like wash trades. If certain modules are not used, firms must be able to demonstrate why these exclusions are appropriate.

Elsewhere, a large financial institution faced enforcement action for repeatedly failing to accurately report millions of swap transactions over a five-year period. These issues stemmed from data ingestion problems, where the firm’s systems failed to capture and report critical trade data. Despite being subject to a prior regulatory order for similar deficiencies, the firm had not implemented adequate controls to prevent future occurrences. This enforcement action highlights the regulatory expectation for sustained compliance efforts, especially following remediation agreements.

Similarly, a global financial firm missed surveillance of billions of orders across multiple global trading venues over a period of several years. The firm’s surveillance system failed to ingest direct-from-exchange data, leading to major gaps in trade monitoring.

Lastly, another global financial firm permitted continued placement of problematic orders near the close for months despite receiving multiple warnings from the regulator. In this case, the surveillance tool is cited for both erroneous programming and a lack of follow-up to repeated service requests from the firm.

Unpacking key enforcement trends

While all cases are unique, there are overarching trends that demonstrate where legacy surveillance systems are currently falling short.

Anecdotally, these enforcement actions collectively suggest that regulatory examiners appear increasingly focused on how firms manage internal controls and compliance procedures. This emphasizes the need for surveillance systems that can automate and enhance internal compliance reviews, helping firms stay ahead of regulatory requirements and avoid costly enforcement actions.

Yet one of the core issues across all of these enforcement cases is alert adjudication, with the process by which firms investigate and close alerts now under heightened scrutiny. Regulators are increasingly looking at whether firms can demonstrate a clear, documented process for handling surveillance alerts. The problem is that many firms are struggling with the volume of false positives, often caused by poorly configured thresholds or overly conservative alert settings.

This brings us to another area of concern: the calibration of surveillance tools. As seen in several enforcement actions, misconfiguration of surveillance tools can lead to an overwhelming number of false positives, which drain resources and hinder the ability to identify genuine market abuse.

Supervisory controls are also in the spotlight. Regulators have made it clear that firms must regularly review their surveillance processes to ensure they remain effective. In one case, a firm’s failure to capture billions of order messages over several years was traced to inadequate supervisory controls. In another, a hard-coded error in a surveillance procedure persisted for a long-time.

Empowering firms to proactively mitigate risk

As firms look to navigate heightened regulatory scrutiny in the U.S. and across other jurisdictions, firms must ensure that their surveillance systems are not only comprehensive but also flexible, auditable, and capable of handling complex trading behaviors.

This demands various capabilities across their surveillance programs to overcome ongoing challenges:

  • Automation for efficiency: Automating routine alerts allows analysts to focus on exceptions and more complex cases. For example, automatically reviewing routine alerts based on bespoke compliance logic reduces the number of false positives and cuts down on manual work.
  • Customization and flexibility: Programs must allow for flexible configuration and deep customization, enabling firms to fine-tune their surveillance thresholds according to their unique risk profiles, trading behaviors, and market conditions.
  • Real-time data ingestion and accuracy: A key issue in several cases has been the failure to capture and report data in real-time. Systems must ensure that all relevant data is captured in real-time and that there are no gaps or delays in the ingestion process. Regular system audits and fail-safes should be built into surveillance programs to prevent such issues from occurring.
  • Sustainability and audibility: The increasing regulatory focus on sustainable and auditable processes places the onus on firms to easily demonstrate their compliance efforts during regulatory audits. This requires clear audit trails, documented processes, and the ability to generate reports that show how alerts were handled from inception to closure.

Stacey Cunningham Prepared for the Unexpected at NYSE

By
Shanny Basar
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Stacey Cunningham, Advent International

At Markets Media’s inaugural Women in Finance Awards, Stacey Cunningham won the award for Excellence in Exchanges 2015 when she was chief operating officer at the New York Stock Exchange.  She went on to become the 67th president of NYSE in May 2018 and the first woman to lead the exchange since it was founded in 1792. At the end of 2021 Cunningham was succeeded in that role by another woman, Lynn Martin. Cunningham joined private equity firm Advent International as an operating partner in October 2022 and remains on the NYSE board.

Markets Media’s 10th-annual Women in Finance Awards program will be held on Thursday, November 21, at the Hard Rock Hotel.

How did you feel about receiving the award 10 years ago?

Stacey Cunningham
 Stacey Cunningham, Advent International

It was an honor to have been recognized during the inaugural Women in Finance awards, especially given all the amazing women in the industry today.

At the time, I had just stepped into the role of chief operating officer of the NYSE Group and we were in the early stages of a multi-year rollout that would completely overhaul the trading technology powering all seven of NYSE’s equity and options exchanges.

It was incredibly rewarding to see the fruits of our labor battle tested during the extreme market volatility the industry faced in the spring of 2020. Our systems scaled seamlessly as the market smashed previous activity records without looking back. Fail safes like market-wide circuit breakers and trading floor remote redundancies were used live for the first time and everything worked flawlessly.

What are you most proud of in the decade since you won your award?

I am proud of how prepared for the unexpected we were at the NYSE and the entire industry should share that pride.

Decisions made around conference room tables, at industry roundtables, and in dialogue with regulators were suddenly brought to life on a national stage. Hypotheticals instantly became reality and the industry rose to the challenge.

How do you think finance has changed in the last 10 years?

No matter how technology advances, the industry will always be about people. When you are part of an ecosystem that allows for companies and individuals to plan for and invest in their future, it is undoubtedly about people.

What are your hopes for the next decade?

I hope over the next decade there is a concerted effort to focus on telling the story of the social good our capital markets serve. As our markets continue to evolve, I also hope we recognize they must continue to be a story of shared success.

What advice would you give to the next generation of women in finance?

My advice for all men and women in finance is to focus on how to set individuals on our teams up for success. They are not all the same and have different needs and communication styles.

My advice to the next generation is to know with confidence that when you are outnumbered and have a different perspective than most around you, it makes you more valuable, not less. Be curious, ask questions, use both your mind and your voice, and never forget the importance of what you are doing.

TECH TUESDAY: Emerging Trends in ITMO Markets and the Technological Success Factors

By
Rohan Sherrard, Product Manager, Carbon, Nasdaq Financial Technology
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The global effort to combat climate change is intensifying, and with it, the demand for innovative market-based solutions known for fostering liquidity with efficiency, transparency and integrity.  At the heart of this movement lies the concept of Internationally Transferred Mitigation Outcomes (ITMOs) established under Article 6 of the Paris Agreement, which aim to reduce or remove global emissions by enabling countries to transfer verified carbon credits linked to greenhouse gas reductions. These efforts will help multiple nations achieve their climate targets within a clearly defined framework. As sovereign carbon markets evolve to incorporate ITMOs, the need for robust, secure, and efficient registry technology becomes paramount. 

The Potential of ITMO Markets

Rohan Sherrard, Nasdaq Financial Technology

As formal mechanisms established under the Paris Agreement, ITMOs have strong potential to bring standardization and structure to the exchange of carbon credits that can help accelerate liquidity creation while fostering international cooperation and support for sustainable development globally.

Several bilateral agreements have already been established to facilitate ITMO trade to date, reflecting a growing commitment to global climate mitigation efforts. Example agreements include  Switzerland’s agreement with Peru to offset a portion of CO2 emissions through projects in Peru; Switzerland, Ghana and Vanatu’s agreement to collaborate to contribute to sustainable agricultural practices in Ghana and improve access to renewal energy in Vanatu; and Japan’s agreements with Thailand, Indonesia, Vietnam and others through the Joint Credit Mechanism to improve areas like energy efficiency measures, reduce emissions via forestry and land-use projects and develop energy-efficient and industrial processes amongst other improvements.  

The structured and unified framework, with international backing, should provide ITMOs a legitimate foundation with strong governance and accountability to foster trust among participants, while driving higher demand and larger transactions than currently recognized with other market-based mechanisms.

The Role of Technology across the ITMO Lifecycle

Establishing registries with scalable and resilient technology will be crucial to the development of a robust, fast-growing ITMO market. Advanced and scalable infrastructure will be essential for managing increasing volumes, adapting to volatile market conditions and facilitating smooth ITMO transactions and cross-border transfers at scale across the ITMO lifecycle. Effective registries will provide the same sophisticated operational capabilities and qualities proven by their application in capital markets, which can help solidify an effective market structure as ITMO registries develop:

Issuance and Transfer: Efficient and transparent asset creation, issuance and transfer of sovereign carbon credits with full auditability are necessary to ensure accurate ownership and facilitation of transfer from issuing countries to acquiring countries and corporates.

Settlement: Robust and reliable ownership transfer mechanisms are critical to ensuring smooth transaction terms and accounting processes between parties to enhance trust and transparency in the market and drive further liquidity.

Custody: Safekeeping of carbon credits in a secure custody solution is critical for electronically storing and managing post-settlement events, such as the retirement of credits.

Technological Innovations to Enable the ITMO Lifecycle

Robust technological infrastructure will be essential for managing the complexities of ITMO transactions and facilitating successful cross-border transfers. Advanced solutions, such as smart contract-driven digital assets and distributed ledger technologies (DLT), offer innovative and promising solutions for creating ITMO registries. These technologies will support solutions that provide cryptographically secure and immutable records of transactions, reducing the risk of fraud and enhancing trust among market participants. Moreover, advanced data analytics and artificial intelligence can improve the accuracy and efficiency of monitoring, reporting, and verification processes, ensuring that mitigation outcomes are accurately quantified and credited.

Scalability and Resilience are Mission-Critical

As the ITMO market evolves, the scalability of ITMO registries will be essential for accommodating the growing volume of transactions as more countries and companies engage in carbon trading. Resilient technology ensures that the system can withstand cyber, volume- and volatility-based operational disruptions, maintaining the integrity and continuity of the market. Investment in robust IT infrastructure is therefore one of the most critical components for the long-term success and sustainability of the ITMO market. Solutions like Nasdaq’s robust, ISO 27001-certified and SaaS-deployed global infrastructure can provide peace of mind to market participants while helping ITMO markets meet their compliance and security needs with dynamic scalability as markets grow. 

Opportunity Ahead

The emergence of the ITMO market represents a significant evolution in the global carbon trading landscape and the importance of efficient and secure market-based carbon technology cannot be overstated. The establishment of bilateral agreements, the production of REDD+ credits and other trends in the developing ITMO markets indicate both a need for ITMO registries and a growing need for scalable, reliable, and interoperable solutions, like those provided by Nasdaq’s Financial Technology business, to support them. As nations and companies continue to collaborate and innovate, the ITMO market holds the promise of driving substantial progress in the fight against climate change, fostering a more sustainable and resilient world for future generations.

TECH TUESDAY is a weekly content series covering all aspects of capital markets technology. TECH TUESDAY is produced in collaboration with Nasdaq.

SEC Chair Gary Gensler Highlights Accomplishments

By
Anna Lyudvig
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Gary Gensler, SEC

Since taking the helm at the Securities and Exchange Commission in April 2021, Gary Gensler has initiated a wide-ranging set of rules, according to ISDA IQ.

“We’ve already proposed and adopted more than 40 items during my time here. More than three quarters of those are well into the implementation phase and have not been challenged in court,” Gensler told ISDA IQ in an interview.

SEC Chair Gary Gensler

“We recently halved the US settlement cycle for equities and corporate and municipal bonds, along with Canada and Mexico. We’ve adopted and implemented some really critical items related to corporate governance. We’ve taken some very important steps in cyber, both for companies and issuers that have material cyber events and, more recently, for individuals,” he said.

“We’ve adopted and are working with clearing houses and market participants on implementation of some key reforms in the Treasury market related to central clearing,” he said.

“We’ve addressed some of the repeated instabilities in money market funds and adopted rules last year that are still being implemented. We adopted rules on truth in advertising for registered investment companies and we have updated a 24-year old rule in that area,” he added.

ISDA IQ said that there has been an active debate about the regulation of crypto assets, and whether they should be considered as securities. When asked what is the appropriate model of regulation for this market, Chair Gensler said: “Without prejudging any one asset, it’s pretty straightforward: most crypto assets are likely to be securities and should be regulated as such.”

Gensler said there are 15,000-20,000 tokens and there’s nothing incompatible about the accounting ledger they’re stored on with the securities laws.

“The principle is consistent – it’s about making proper disclosure to investors so they can decide whether they want to buy or sell a particular crypto asset,” he said.

In July 2023, the SEC proposed rules to require broker-dealers and investment advisers to take steps to address conflicts of interest associated with the use of predictive data analytics and similar technologies. When ISDA IQ asked how the SEC is approaching the rapid development of artificial intelligence (AI), Chair Gensler replied that AI is among the most transformative technologies of our time. 

“It’s already being used in finance to protect customers from fraud, to survey markets and for compliance with anti-money laundering and sanctions regimes,” he said. 

“It’s used by traders to assess the markets, by investment advisers to set up robo-advising applications and by insurance companies for claims processing,” he said.

“It’s used by all sorts of financial institutions for opening accounts, and I think it will lead to significant changes in corporate issuance and risks and opportunities in different parts of the economy,” he added.

“Our role here at the SEC remains consistent – it’s all about making sure firms disclose the material information that is needed and that those disclosures are not misleading,” he said.

“Just as in other areas of transition, sometimes folks will exaggerate what they’re doing with this new technology, whether it’s an investment adviser bragging about the use of AI when they’re not really using it or a company that says it’s doing something but it’s not true.”

We need to beware of misleading the public in any material way – so-called AI washing. Fraud is fraud and bad actors will try to use new technologies to do bad things. That’s been true since antiquity. If firms are using an AI model, they shouldn’t think they can now do a bad thing and blame it on the model. If you deploy the model, you have a certain responsibility and obligation, particularly if you’re a fiduciary or advising people.

“If you’re using a model to front run or manipulate a market or perpetrate a fraud, there’s still a human somewhere who is responsible. Finally, we have a proposal outstanding about potential conflicts,” Gensler said.

“If you’re using an algorithm that’s putting the investment adviser or the broker-dealer into the mix of your engagement with customers, the basic concept in the US is that you’ve got to put the investor first. You must make sure the algorithm hasn’t got it the other way around by putting the investment adviser or broker-dealer first,” he said.

The three areas of focus for the SEC are AI washing, fraud and deception, and conflicts, according to Chair Gensler.

“But I also think there’s a risk that goes well beyond the US, which is that the use of AI will lead to certain fragilities in capital markets. That is why both the models and the data are likely to end up being quite centralised,” he noted. 

“We already have a system in the US where there are three large cloud providers, two of which are used by around 75% of the financial sector. There are natural economics of networks that are at play, and that is likely to also happen with AI. If everyone relies on the same model or the same data set, this could drive the market to a bad place, but that’s a challenge we all share,” he said.

The interview also discussed the Treasury market reforms, the climate-related disclosures, cross-margining arrangements, as well as the SEC’s proposal on safeguarding advisory client assets.

Read the full interview here

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