Post-Trade Data Consolidation in the UK

Transcription

1 /18 Focus: Equity Markets Post-Mifid Source: Getty Images the markit magazine Spring 2010

2 Focus: Equity Markets Post-Mifid /19 Two years on from the introduction of Mifid and there are still grumbles about the lack of transparency of post-trade data in Europe. Sophia Kandylaki, director equities and Marcus Schüler, head of regulatory affairs, managing director at Markit explain which underlying issues need to be addressed to prepare the ground for a consolidated post-trade data solution Let us gather and consolidate The introduction of the Markets in Financial Instruments Directive (Mifid) in November 2007 had a significant impact on the functioning of the European equity markets, both from an execution and from a data perspective. Today, most market participants would describe the directive as a success insofar it created more competition between execution venues, encouraged the creation of new trading platforms such as BATS, Chi-X, Liquidnet, POSIT and Turquoise and as a consequence delivered the desired benefits of reduced trading costs. On the other hand, while some initial teething issues were resolved, complaints about the reduced transparency of the European equity markets post-mifid, particularly from the UK buy side, have not abated. Stakeholders have spent a considerable amount of time identifying the causes of these transparency concerns and how best to address them. Some have called for the mandatory introduction of a consolidated tape, a mechanism that has existed in the US since 1975 that aggregates trades from different execution and reporting venues to make the dataset available to the market at a reasonable cost. Others go as far as describing Mifid as a failure and demand the return of concentration Spring 2010 the markit magazine

3 /20 Focus: Equity Markets Post-Mifid rules where all trading occurs only on the incumbent exchange. However, none of these proposals could resolve the current transparency concerns. Post-trade data consolidation can only be successfully achieved after building strong foundations by tackling the issues related to the quality, the availability and the cost of data. If all stakeholders work together, based on a roadmap and deliverables set by regulators, a post-trade transparency regime facilitating useful consolidation for the European equity markets can become a reality before the end of What are the real issues? It seems as if the actual consolidation of data does not represent the major hurdle since a number of data vendors such as Bloomberg, Fidessa and Thomson Reuters already offer consolidation solutions to a certain extent. However, according to critics, these solutions do not seem to provide satisfactory results and previous attempts to create more formally a post-trade consolidated tape have failed. That said, it is evident that simply mandating a consolidator will not yield any tangible results and that one has to address a number of underlying How to Achieve Post-trade Data Consolidation Data consolidation Cost of data / consolidated tape Data formatting Reporting obligations Data quality and granularity Pre- and post-trade data unbundling Source: Markit Sophia Kandylaki, director equities, Markit issues first before even considering the actual consolidation of post-trade data. These underlying issues are the quality, the formatting and the cost of data, as well as the interpretation of reporting requirements. Data quality The launch of Mifid in Europe fundamentally changed the data landscape with 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Level of consolidation Meaningful, high-quality, consolidated set of post-trade data trades being publicly reported subject to the newly-introduced supranational principles rather than following the established national exchange rulebooks. One of the trade reporting principles that preoccupied the industry throughout 2008 and most of 2009 was the right for investment firms to delay the publication of certain large trade reports by a specific length of time, in order to allow firms to reduce their risk position to a trade without showing their exposure to the rest of the market. The delay depends on the trade s size in relation to the stock s average daily turnover and is based on parameters that are numerical, specific and thus easy to implement. However, it could also be argued that the application of delayed publication should be justified by the economics of the trade, implying that when not at risk or when dealing on its own account, a firm should publish the trade report in real time, irrespective of the trade s size. Although this is a somewhat subjective principle, market participants have over the past two years established a strong focus on their trade reporting practices which resulted in the reduction of deferred trade publication from around 40 per cent in early 2008 to below 20 per cent of total over-the-counter (OTC) turnover today, according to data from Markit BOAT. As the issue of unnecessary reporting delays has now been addressed, one must wonder what other issues need to be resolved in order to improve the quality of the data. Even though the obligation to report a trade lies with the individual investment firms, the vast majority use centralised platforms that facilitate trade publication on their behalf. The most widelyused OTC equity trade publication platforms are operated by the London Stock Exchange, Markit BOAT, Nasdaq OMX and NYSE Euronext. Providers that wish to operate trade publication venues in the UK need to become authorised Trade Data Monitors (TDM) and comply with the minimum standards that were defined by the UK Financial Services Authority (FSA) to ensure that the published trade data is monitored the markit magazine Spring 2010

4 Focus: Equity Markets Post-Mifid /21 Minimum trade data monitoring standards should be applied equally to publication venues across Europe in order to create a level playing field and promote confidence in the quality of the OTC post-trade equity data. Marcus Schüler, head of regulatory affairs, managing director, Markit for errors and is reliable. TDMs may be subject to external audits and need to provide evidence of all measures they have put in place to warrant data quality. Data validation and verification controls for TDMs range from static data checks to automated real-time trade checks. The latter specifically ensure that the dataset is free from unjustified price or quantity spikes that could be caused by incorrect decimal places or erroneous currencies. Some TDMs, such as Markit BOAT, the reporting platform that currently captures 24 per cent of the overall European equity market volume, have taken this a step further and have built feedback loops with defined escalation points to compliance officers and business managers in addition to automated real-time exception messages. This is all substantiated by reference to statistical data quality reports produced on a weekly basis. However, while the FSA s TDM regime has ensured that minimum data quality controls are enforced and that more sophisticated controls are constantly being introduced for platforms that operate in the UK, this regime does not apply across Europe. This has a detrimental impact on the overall quality of European equity trade data. For example, certain reporting venues often print their trades without an execution date and time or the reported quantity is exaggerated by millions of shares because of an incorrect decimal place. That said, it seems clear that minimum trade data monitoring standards should be applied equally to publication venues across Europe in order to create a level playing field and promote confidence in the quality of the OTC post-trade equity data. Data format Once the quality of post-trade data has been assured, one has to examine how the data is published and represented to the end user. As a rule of thumb, data needs to be uniform, consistent and subjected to normalisation to make it consolidatable. Prior to Mifid, each venue would determine the level of granularity of its dataset individually, often reflecting trading strategies and the preferences of end users in that particular market. Post-Mifid this resulted in a Babel-like confusion with a multitude of different trade data publication formats being employed across the European execution and publication venues. Condition codes, or flags, are prominent examples of this issue. Condition codes are prefixes that are attached to a trade report providing different levels of relevant information. For example: The trade report in question represents an amendment or a cancellation to a previous trade report and is not a new trade; The trade report has been delayed in line with the Mifid deferred publication matrix; or The trade price is away from prevailing market conditions. Consistent use and appropriate interpretation of condition codes are necessary when attempting to calculate total volumes traded, to represent the total size of the market, or to determine which prices are relevant for the process of price formation. However, more than 200 different condition codes are currently used by European publication venues. Some Spring 2010 the markit magazine

5 /22 Focus: Equity Markets Post-Mifid Interpretation of Reporting Obligations Type of trade Reporting practices Appropriate approach Broker executes order of 100 shares OTC on an agency basis as riskless principal Broker executes a client order for 100 shares. Order is broken down into: One regulated market (RM) trade for 80 shares One multilateral trading facility (MTF) trade for 20 shares Source: UK Financial Services Authority (FSA) venues publish as few as a single condition code while others use as many as 80 different ones. As if this wasn t enough, market data vendors have introduced their own additional condition codes in their efforts to normalise data. Therefore, a meaningful consolidation of trade reports with attached condition codes cannot be achieved today and the issue can only be resolved if regulators can bring all stakeholders to one table to set a common goal. Another question that needs to be answered when analysing post-trade data is which portion of the trading activity represents price forming flow or trading activity that can be included in the Transaction Cost Analysis (TCA) process. For example, is a broker-tobroker give-up or a guaranteed volumeweighted average price (VWAP) trade report relevant for TCA purposes and, if not, should it be flagged as such? Although there are currently no requirements to flag these trade reports, the industry needs to advance its efforts of defining the parameters of what price forming flow consists of to harmonise the formatting of the data. the markit magazine Spring 2010 Broker reports market-side trade to OTC reporting venue Broker reports client-side trade to OTC reporting venue Market sees total volume of 200 shares RM publishes on-market trade of 80 shares MTF publishes on-market trade of 20 shares Broker reports trade of 100 shares at average price Market sees total volume of 200 shares at three different prices Broker should not report the client-side leg of the trade Broker should not publish client-side leg of the trade or average ticket price A further relevant issue relates to the fact that investment firms in some member states have chosen to publish their trading activity on institutional websites. This form of publication complicates access and prevents their data from being consolidated into vendor terminals or data feeds. As this practice hinders the emergence of a consolidated tape with comprehensive coverage, it should arguably no longer be accepted by the authorities. Interpretation of reporting requirements Input and output data of trade reporting services will be determined by both market and regulatory requirements. Unless these requirements are simple and specific, they run the risk of being subject to differing interpretations, resulting in the publication of data that is not comparable and can distort the picture of the European equity markets. Post-Mifid equity trading volumes have been heavily scrutinised as potentially being inflated because of double counting. This criticism stems from the lack of clarity around trade reporting obligations, especially in transactions involving a chain of firms or agency trades with no risk involved. To avoid the risk of underreporting, the general practice followed by investment firms was if in doubt, report. The FSA Market Watch No. 32 attempted to provide guidance using unambiguous cases that detailed exactly how firms should report when trading in different capacities. It tackled a variety of questions that arose following Mifid and aimed to harmonise the interpretation of firms reporting obligations. The FSA s paper addressed the most frequently asked questions and built a Consistent use and appropriate interpretation of condition codes are necessary when attempting to calculate total volumes traded, to represent the total size of the market, or to determine which prices are relevant for the process of price formation.

6 Focus: Equity Markets Post-Mifid /23 The provision of pre- and post-trade data in unbundled form is a necessary precondition for the creation of an affordable consolidated post-trade tape in European equity markets. for the creation of an affordable consolidated post-trade tape in European equity markets. However, even after unbundling preand post-trade data, the total cost of a European consolidated tape might still be too high. To facilitate consolidated transparency in the European equity markets at an affordable cost, reporting venues and exchanges might therefore need to be encouraged to reduce the fees they charge for post-trade data. While at first glance this does not seem desirable from their perspective, one must realise that the distribution of a consolidated tape at a reasonable price point of, for example 80, might still overall be beneficial for most publication venues as this efficient form of distribution will most likely result in increased end user adoption. sensible foundation for the more detailed review that is currently being performed by the regulators. Most importantly, it has demonstrated that a consultative, rather than punitive or prescriptive, approach will often yield better results far more quickly. In this case, the industry worked with the regulator to define the working standards and agreed on principles that would commonly apply across all investment firms. Market participants delivered against a timetable that was set by the FSA and ensured that their full attention was devoted to this effort. The regulator communicated these principles by publishing guidance on best practice and made itself available for a second round of consultation where any further discrepancies will be addressed. Unfortunately, the success of this initiative is limited to the UK. Similarly, only UK-regulated TDMs would be expected to monitor their data against these guidelines and pan-european post-trade data continues to be published subject to different trigger points. Arguably, only once the definition of transaction has been harmonised will it be possible to achieve consensus on the interpretation of reporting firms obligations. Cost of data Last, but not least, another significant hurdle that needs to be overcome to lay the foundation for the successful creation of a consolidated tape is the cost of real-time post-trade data. To create a consolidated tape, one must gain access to all the data that is published by the different reporting venues, i.e. exchanges, multilateral trading facilities (MTFs) and TDMs. When adding up all the fees that are charged by these various venues for their respective portion of European equity data, one would currently be charged more than 500 per user per month, an amount that seems out of proportion compared with the US. One major contributor to this high cost is the fact that in Europe so-called Level 1 data that is provided by the exchanges will include both post and pre-trade data. As these two different sets of data are typically offered only as a package, one will incur a higher charge in order to access the posttrade data that is needed for the creation of a consolidated tape. It seems quite clear therefore that the provision of pre- and post-trade data in unbundled form is a necessary pre-condition Lessons learned The fragmentation of the European posttrade equity data which was caused by the introduction of Mifid more than two years ago so far has not been fully addressed and put the success of the whole project in question. Much work will be required from regulators and market participants to make European post-trade equity data consolidatable to create truly useful transparency. It is noteworthy that this problem has occurred in the equity asset class, one of the simplest financial products. When debating the extension of Mifid to other asset classes, one should therefore prefer solutions that would facilitate competition in trading but would not suffer from data fragmentation. Alternatively, where one cannot avoid the fragmentation of data, one should consider from the start how it can be addressed in order to secure the creation of truly useful transparency. While some observers compare the current post-trade transparency situation in European equity markets to the tale of Humpty Dumpty, if all stakeholders work together on the basis of a roadmap set by the regulators, there is a chance to turn it into an episode of Bob the Builder instead: Can we fix it? Yes, we can! Spring 2010 the markit magazine