Regulation and Market Structure Dominate Thought at Sifma

Among the usual suspects for conference season ─ cloud, Big Data, as-a-service and other areas ─ market structure, or the future form thereof, is on most people's minds at this year's Sifma conference in New York.
It's not the most surprising revelation, given the regulatory backdrop to which the industry is operating in at the moment. In Europe, the Markets in Financial Instruments Directive (Mifid) continues to exert its influence, while frustration threatens to boil over in the US at the ongoing lack of direction from regulators over the Dodd-Frank Act.

Both Sides
Being primarily European in both location and focus, it's been interesting for me to hear what people have been saying about continental regs from a US perspective. Take the oversight of central securities depositories (CSDs), for instance, and the drive toward T+2 in settlement cycles across Europe. One regulatory specialist from a well-established vendor I spoke to pointed to Europe as a test bed for what's happening in the States, and discussions over Target2Securities, the pan-continental settlement platform in development by the European Central Bank and others, also suggest that a pattern may be forming in Europe that's likely to be repeated in the US. Naturally, T+1 and even T+0 are continually mooted as possibilities, but given obstacles that even technology can't overcome, such as time zones, there's still a way to go on this. However, T+2 seems increasingly inevitable, and more importantly, can be accomplished with relative ease.

Structural Deficit
However, the most interesting and common points that I've heard raised between participants, vendors and analysts have been around what they see as the inevitable reformation of market structure. This is in specific reference to fixed-income markets, where Title VII provisions in the US, the establishment of swap execution facilities (SEFs), and the reorganization of capital markets affected thereby, are conversant topics.

Take SEFs in US treasuries, for instance. It's common knowledge that the sell-side market-makers are the gatekeepers for access to the papers offered. While retail investors can buy directly from web portals, it's the access and inventory supplied by them, to inter-dealer brokers, who in turn lend their memberships to the high-frequency traders (HFT), that makes it the most liquid fixed-income segment. Inter-dealer brokers can't afford to alienate the market-makers, of course, so attempting to reach the other branches of liquidity serviced by them ─ the institutional investors and the retail banks ─ is a faux pas of tremendous proportions. The traditional banks who act as market-makers, though, are highly regulated in what they can and can't do regarding the operation of SEFs, so the paradigm as it stands is looking likely to undergo significant transformation.
Other areas redefine the way in which traditional branches of the capital markets operate. The direct posting of margins and collateral from the buy side to central counterparties, the commissions now likely in advance of that, and the disallowance of asset rehypothecation are all leading to a rethink of not just structure in a market, but what instruments are even traded. Meanwhile, capital adequacy requirements on the part of sell-side institutions are forcing a reduction in the inventory held, in turn having ramifications on liquidity and other areas.

The Innovation Crunch
It's not hard to see that everyone is stretched, this year. Conferences in both London, and Sifma in New York, are noticeably sparser than in previous years. A conversation that I had with a representative from a major multinational connectivity company highlighted that everyone's budgets are shrinking, and that people are treading water.
One final point that came across quite strongly in discussions with hardware providers, software vendors and impromptu conversations on the floor, was on the lack of innovation within financial services technology of late. Whereas our discussions around Big Data, for instance, are just starting to turn to analysis and pro-activity as opposed to reactivity, conferences in different industries are yielding the real thought leadership and forward drives. One industry specialist used the example of datacenters to illustrate his point: Five years ago, pharma, defense and other sectors looked at financial services and analyzed how we went about technological innovation. Now, according to those sectors, finance has been left in the dust, he says.
So, what are the causes? Shrinking budgets are evident, of course, but big firms are still engaging in initiatives such as creating their own programming languages, private infrastructure, and intelligent aggregation of data, such as Markit's desktop platform for credit-default swaps and other areas commonly perceived as opaque. Vague regulation was the point it kept coming back to, and the lack of technicality on the part of said regulators - even if the Commodity Futures Trading Commission is making steps to change that.

One regulatory specialist from a well-established vendor I spoke to pointed to Europe as a test bed for what's happening in the States, and discussions over Target2Securities, the pan-continental settlement platform in development by the European Central Bank and others, also suggest that a pattern may be forming in Europe that's likely to be repeated in the US.

Brave New World
While it's not the rosiest time to be in financial services, it's also exciting. New technologies are driving reform and reaction, even if the innovation isn't on a par with other sectors. Regulation, while perceived as overbearing and inchoate, is driving the single most important reform of the market economy, possibly in history. Times are tough times, yes, but at Sifma 2012, they're also interesting.