How does the European market structure compare to other regions? How do you see Europe developing in the future and what will be the main drivers for those changes?

Well, when we compare market structure regulations we are really comparing Europe and US, that have been the areas where authorities have been more active in introducing new rules. In Europe Mifid 2 will lead to profound market structure changes with the same goal as that of Dodd- Frank and the creation of SEFs that is to reduce systemic risk and increase transparency in the OTC derivatives market .

European markets will certainly be the most regulated markets in the world. So we are more regulated than in US and Mifid II will certainly broaden this gap.

In general, both US and Europe come from a prolonged period of “re-regulation”. When I graduated in college I wrote a thesis on the “deregulation in the USA” which led to the junk bonds scandal and the consequent defaults of hundreds of savings and loan associations. So, it is a fact that deregulation and re-regulation are cycles in the financial industry and finding the right balance is not easy.

The problem is that the history of financial crisis tells us that mistakes are made during the boom, not during the crash. So both regulations and monetary policies works much better if implemented during the boom, not during the panic. As it is never a good advice to plan your future during a panic attack, in the same way it is never a good practise to introduce long-term rules during financial crisis.

And this is where Europe and US usually differ more. In Europe, we have a tendency to be over-regulated because the regulatory framework tend to be led more during years of financial crisis. Conversation become soon very political, like the discussion about transparency during the negotiation process in Mifid II. Rules are introduced imagining always a worst case scenario as emergencies measures and therefore tend to be ineffective when the emergency is over.

In the U.S. the approach is somewhat different, reflecting perhaps Americans’ greater belief in markets and their stronger mistrust of regulation. The emphasis across the Atlantic has always been on finding business-friendly ways to regulate financial markets and avoid more bank failures.

All the regulatory and policy debates in the U.S. are less about modifying capital requirements and more about how to ensure that private investors rather than tax payers will pay the cost of a crash, holding that “contingent capital” which in a crash can be converted into equity.

Last but not least, the negotiation process of a new regulation is different between Europe and US. In US there is a long tradition of regulators and industry representative sitting at the same table when discussing the introduction of new rules, with the objective of understanding in advance potential negative unintended consequence s of the cats they intend to pass. I think we have less of this tradition in Europe, although it has improved significantly over the last few years as it is proven by the many consultation process that now European authorities have promoted with industry representative.

In the todays’ world, over-regulating can be a significant risk. Global companies will always look for good places where to do business, with a good mix of talent pool, tax system, regulation and bureaucracy. When jurisdictions and regulations become an arbitrage opportunity, then you  put your area at risk of losing business.

Mifid II and ETF

MiFID II brings with it positive developments for ETFs. Currently ETFs are not MiFID instruments and there are no legal requirements to make trading volumes public.

The introduction of MiFID II means that it will be easier to see the demand and liquidity within the European ETF market. MiFID II will require reporting of ETF trades for the first time. ETF issuers are one, of some might say, a small group of promoters who are looking forward to the implementation of the new post-trade disclosure rules. At the moment it is very hard to see the liquidity in European ETFs because the trading is done over the counter and trades do not hit the consolidated tape. The consolidated tape is an electronic program which will provide real-time data on volume and prices for exchange traded securities. This gives an incomplete picture of the demand and liquidity in the European ETF market. Once MiFID II is implemented, ETFs will be in scope of the new reporting obligations. It is anticipated that investors will be able to see the true depth of liquidity in European ETFs, which, based on current publicly available information, looks less liquid than the US market. ETFs trades do not currently have one home. MiFID II will enable investors to see all trading activity across the whole ETF market.

MiFID II’s general transparency requirements include pre-trade and post-trade disclosures of the details of orders submitted to and transactions conducted on a trading venue. Trading venues can be a regulated market (RM), a multilateral trading facility (MTF) or an organised trading facility (OTF)). The transaction reporting requirements means that the competent authority will have to be notified of the trade. The impact for ETFs will be the mandatory trade reporting for OTC trades and a consolidated tape. Across Europe there are 25 exchanges and ETFs are cross-listed over multiple exchanges. This means that shares on one exchange might be priced differently and it could difficult to see the total trading volume across the exchanges.

This new window into the liquidity in the ETF market will give investors a clearer picture of the market. As the liquidity of ETFs and the transparency requirements both become clearer, it is we believe very likely that ETFs will be used in a greater capacity by the securities lending market.

In the UK, the Retail Distribution Review (RDR) requirements ban payment of commission to intermediaries and supports the development of new and innovative ETFs which do not pay commission. RDR removes the incentive for an independent financial advisor to choses a financial product that pays commission. Like RDR the proposed ban on inducements under MiFID II could help considerably with the expansion of the ETF European market.

While MiFID II does bring with it positive development for ETFs it will of course bring challenges. Distributors will have stricter compliance obligations, they will have to complete target market suitability assessments and there will be increased requirements regarding the disclosure of costs.

As knowledge of ETFs increases we will see innovative products developed taking into account regulatory developments, the changing demographic of investors and their evolving risk appetite. We believe investors will become more familiar and comfortable with ETFs due to the MiFID II requirements. At the moment ETFs are used sparingly in securities lending and with the implementation of MiFID II there should be more borrowing of ETFs by the market as investors see the potential for extra income. This increased availability of non-cash collateral may be seen as an option for some investors willing to take on higher risk investments.

Trading desks today face the combined challenge of how to process massive amounts of market data, how to connect and route their orders to the appropriate venues and how to make best use of software, hardware and network connectivity to do it all in a timely manner. The days when a small reduction in latency could result in a big gain in revenues are gone. Nowadays, low latency is a pre-requisite to do business and we have to look beyond pure speed if we aim at achieving a competitive edge.

The first question the trader has to answer under MIFID II is whether a bond id sufficiently liquid that it will have to trade on a venue. ESMA will make that determination issuing specific guidelines. Traders have to check these guidelines to see if they can simply provide an OTC price or if they need to trade it on a venue. Under MIFID II, if the firm's market making activity an a bond is significant and frequent, then the firm must be registered as a SI in order to commit capital to the trade. If the firm instead operates on that bond infrequently and in small sizes, then it can just provide an OTC price.

if the bond does not meet internal criteria for capital committment or the firm does not want to trade it because it does not want to become an SI then the firm act as an agent, working the order on a RM or MTF or find the other side operating as a riskless principal or matched principal. Finally, it can operate as an OTF where customer-only orders interact.

In any case, transparency obligations will be enforced, according to the liquidity bucket of the bond. the trader has to check whether the bond can avail of a transparency waiver. If yes, after a compliance check, the price can be given to the client and Bloomberg's APA will hold the release of the completed trades as per ESMA's guidelines. If not, the price provided to the client has to be made public through an APA (Approved Publication Arrangement) simultaneously. Bloomberg will be an APA.

How are you getting ahead of impacts of recent regulatory proposals? Do you think there is more the buyside can do to increase their partnership in response?

Tighter regulations around the world have profoundly changed the financial markets landscape over the last few years. In many cases they have contributed to bring more clarity, in other cases they have created more ambiguity and uncertainty.

We have been very vocal during the latest approval process for MiFID II by taking an active role during the relevant consultation process as part of buy-side working group.

Our view is that, especially in Europe,  policymakers do not take on board enough feedback from the industry and that might lead to unintended consequences. This happens because often new legislation are initiated as an emotional immediate response to extreme crisis events or fraud cases. The risk in these cases is that the discussion around the table of policymakers might become too politicised and philosophical around topics that are sensitive for the public, such as ”more transparency is always good” and “less transparency is always bad”.

The risk is that the new legislation in the best case does not address the issue that was supposed to address and in the worst case it brings unintended consequence. In both cases it is a missed opportunity.

We envisage a greater role for supervisors, central banks and regulators towards creating a financial market environment where investors are protected by predatory behaviours and fair competition can be established among all market participants.

However, legislators should involve more the industry bodies in the consultation process in order to ensure that all interests are represented.

In Pioneer we have been very vocal during the latest approval process for MiFID II, both as part of buy-side working group and taking an active role during the relevant industry consultation process. With particular reference to transparency, we reiterate our view that we have always supported the idea that an appropriate level of transparency is necessary and beneficial. However, transparency should be a mean to bring certain benefits to the end investors and not an objective itself.

We remain convinced that transparency, especially in fixed income, is strictly correlated with liquidity and does not work for all markets. So we are in favour of the development of more transparent obligations as long as it enhances the price formation process and brings benefit to the end investors. In the more illiquid markets, instead, these challenges are harder to solve just imposing more transparency, because all you need is more liquidity, and in such markets more transparency might lead to the opposite effect.  We feel that the extension of pre-trade transparency without a proper calibration to the less liquid part of the market harm liquidity rather than improving it.

We feel that more efficient post-trade transparency with proper calibration to ensure market makers can absorb the risk and to protect liquidity across less liquid instruments might provide the transparency the market is looking for. )

Role of the OMS and EMS

As I said, given the technological development of the trading landscape over the last few years, OMS are critical to cope with the highly fragmented today’s market structure and to minimize  inefficiencies and risks connected with the trading process, with potential for an enhanced price discovery process and better quality of execution.

EMS (Execution management System) are key to enhance the execution functionalities of the OMS, increasing the percentage of trading volume executed electronically, enhancing traders’ capability to source liquidity from all available sources, from low touch and DMAs to algo trading and dark pools and to make that choice with the speed that today’s trading environment requires. The latter is critical when you have trading volumes in excess of 500 bil Euro yearly across all asset classes with a huge variety of requirements and criteria in terms of how best to achieve best execution. 

What are the biggest constraints or challenges you see in the future trading landscape?

With more than 250 bil $ under management and a global multi-asset trading desk with volume in excess of 1 trillion bil Euro yearly, it is easy to understand that liquidity is our main concern.

We have to deal with a huge variety of orders across a wide range of asset classes, each with a diversified set of requirements and criteria in terms of how best to achieve best execution. 

In order to succeed with such a large trading operation, we have to use a mix of orders, from brokers’ algos to low touch and DMAs, from dark pools to traditional high-touch orders. When liquidity is low and market impact might be significant, our approach is to source liquidity from all available sources.

In defining our execution strategy, liquidity is certainly the key element we consider. Our objective is always to build our positions trying to minimise market impact. Due to our large sizes we want to do that with the appropriate level of confidentiality to protect our investors. Therefore, the route and venues that we select depend really from the type of order that we are trying to execute. If we are working a large position, we feel our investors are better protected when trading away from lit venues, using high-touch orders with our most trusted counterparties, because our trading info are better protected as no one can see what you are trying to do and you can eventually get a decent part of your institutional block trade done. We know that if a large trade is spotted entering the market, our traders are open to abuse by HFT firms. It’s like playing poker where the other players else can see your hand. We have nothing against HFT, we just do not want to interact with them. These firms are making it fundamentally more difficult for institutional long-term investors to interact with the market and find liquidity at fair prices and generates volumes not liquidity.

If we are executing high ADV stocks, then we normally look at low-touch, electronic platform, DMA and algos, because we believe it can give us a better access to a fragmented liquidity and ensure the required level of anonymity.