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There goes the neighbourhood

Published in Automated Trader Magazine Issue 18 Q3 2010

It’s open season on hedge-fund managers and high-frequency traders in Europe and the USA. Legislators on both sides of the pond are voting on new rules to redefine the traditional relationship between risk and reward – expect a legalese version of: don’t take the risks because we’re going to deny you the rewards. Much of this is necessary work – after all, we don’t want those naughty defaulting mid-western mortgage holders bringing down the financial system again, do we? But some of it looks more like political grandstanding than enlightened policy-making, and some of it seems downright unhelpful. Automated Trader’s Editor, William Essex, considers the possible unintended consequences of the current transatlantic regulation-fest, and wonders whether we might all be better turning up for work – somewhere else.

We'll get to the latest US developments in a couple of pages' time. Before that, here are the first two paragraphs, complete and unabridged, of a recent formal public statement from the UK-based Alternative Investment Management Association (AIMA). The context is obvious.

"AIMA, as the global hedge fund association, fully supports the regulatory goals of the EU's Alternative Investment Fund Managers [AIFM] Directive. It is desirable both to increase transparency and to improve systemic risk assessment in the interests of financial stability.

"However, we are concerned that many of the proposals in the texts of the Directive discussed by the European Parliament's Economic and Monetary Affairs Committee (ECON) and European finance ministers at the ECOFIN meeting are impractical and unworkable."

Bam! AIMA has gained a reputation, over the years, for being broadly in favour of just about everything from motherhood right through hedge-fund regulation and all the way to apple pie. The Association typically puts out a supportive little press release, sometimes only a sentence long, whenever an influential public figure so much as mentions alternative investment or hedge funds.

We used to think this was mildly amusing. We don't any more. We think it's a deliberate and very clever strategy to keeping powder dry until it's really needed. In raising an issue of public concern like this one, AIMA doesn't complain and can't be dismissed as one of the 'usual suspects'; this criticism comes from, well, a friendly voice. Even the team of redundant ex-Kremlin watchers we keep in the back office noticed that word "unworkable". Even they think something's up.

You can find the whole of the announcement at, so we'll try very hard to limit ourselves to just one or two sentences from the rest of it. Try this for size.

"In particular, it seems that the process of negotiation in ECON was so highly politicised that it took little note of the legal and practical feasibility of the compromise amendments put forward. For example, Article 35a now prohibits investors from investing in third country funds unless the jurisdiction of the fund meets a list of various conditions which have very little to do with prudential regulation. It is questionable whether, today, every EU Member State would meet those conditions."


"We are also concerned that the Directive singles out our industry for special treatment and imposes controls and burdens that it does not place on other financial market participants."


Andrew Baker

Andrew Baker

"Many requirements proposed to be put on the alternative asset managers in the ECON text are disproportionate to the point of being punitive. Often, they are considerably more onerous than obligations imposed on the rest of the financial services industry."

If you have any vuvuzelas left over from the World Cup, prepare to play them now.

"All we are seeking is equal and fair treatment."

Cue vuvuzelas!


And by the way, this is not just some ill-judged release put out by some disgruntled ex-hack of a press attache returning to the office after an even-worse-than-usually disastrous excursion to the dentist. This is a formal statement made by Andrew Baker, who is the CEO of AIMA.

It covers a lot of ground, you might say.

Trisagreements and triscussion points

Moving swiftly on, here's Baker on what might happen if the AIFM Directive ever got passed into law. Baker says: "We have already heard how the Directive would hit small firms across Europe and make it more difficult for new businesses to be created, and how development banks investing in emerging markets would be affected. Real estate and infrastructure investment in Europe would also be impacted because funds in this sector would also be covered by the Directive. We're talking about schools, hospitals, shopping centres, things that affect ordinary EU citizens."

It would be kind of bad, right?

So, given that everything quoted so far was said in May, here's what actually happened next. It would be funny if it wasn't tragic.

Baker spoke (that last paragraph) on 14th May. On 17th and 18th May, in separate votes, the European Parliament and the Council of Ministers voted in favour of adopting the AIFM Directive. But, because they couldn't agree on the wording for a final version of the thing, they each voted to adopt their own variant on the AIFM Directive. That means there are two versions now chugging their way through the legislative process. That's two mutually contradictory directives. If you're complying with [one version of] the directive, you're likely to be in breach of [the other version of] the directive. Have you ever wondered what Catches One to Twenty-one were all about? Try Europe.

As you might not be surprised to discover, there is an established europrocedure, with its own eurobureaucratic infrastructure, for resolving eurodilemmas of this nature. The next stage (and this was all written down somewhere by sober-faced Europeans who believed in what they were doing) is to take the two versions of the one directive through a "trialogue" process (from dialogue to trialogue, geddit?) involving the people who voted for one version, the Parliament, plus the people who voted for the other version, the Council, in discussion with the European Commission, who notionally don't know anything about it - yet. The task of the triologists is to arrive at a "final, definitive text" (don't let your colleagues hear you giggle as you read this) that is "acceptable to all parties" to the discussion - sorry, triscussion.

And the punchline of the whole story (this is being written in the first week of July) is that the AIFM Directive is scheduled to be adopted formally into the EU legal system in mid-July; that's just around about the time you read this magazine. If you happen to be reading this in Brussels or another eurocapital, those parades outside your office window are celebrating the triscussion participants' unanimous vote in favour of the final, single, indivisible, definitive AIFM Directive. Switch on the news channels. It's there at the top of the hour.

Those naked shorts

Those naked shorts

No space, sadly, to acknowledge that even a final, definitive text of a Directive doesn't get to be EU law until it has been debated and voted into national law by the parliaments of each of the EU's twenty-seven member states. Yes, that's twenty-seven separate parliamentary debates before this - shall we call it federal? - law can be admitted into the legal systems of the twenty-seven member states of the, ah, union. (There's a precedent here somewhere … can't quite think what it is.)

But we can't leave this subject without a quick mention of German Chancellor Angela Merkel and her late-May ban on naked short selling of euro-government bonds, leading shares, et cetera, in Germany. "The euro is in danger!" said Merkel, raising high the Stars and, er, Blue Background. Mike Hamm, managing director of Fernbach, sets the scene. Hamm says: "Germany's move against short sellers caught the financial markets somewhat by surprise. In light of the recent indecisiveness of the German authorities how to deal with the euro crisis and the debt problems in Greece, few were expecting the German government and the regulator BAFIN to set overnight new regulations without the usual lengthy internal and external deliberations."

Note in passing the - perhaps unintentional - implication that while you can factor in "the usual lengthy … deliberations", it is more problematic to factor in the likelihood of a politician taking swift action. Merkel's move was popular. Hamm says: "There is certainly political pressure on the Chancellor to demonstrate leadership in tackling the financial crisis. In Germany there is a growing perception within the public but also within the main political parties that financial speculators have brought havoc to the EU." In case you're wondering (and to adapt the name of a popular toy store), financial speculators are us. Hamm adds: "Many equate all alternative investment constituents such as short sellers, high frequency traders, hedge funds or venture capital firms as the main culprits. The discussion of the current economic situation is very emotional and often lacks a rational, differentiated assessment of the factual causes and consequences."

Mmm. The next move was a call from Merkel and French President Nicolas Sarkozy (who didn't ban anything) for EU-wide action on "certain financial techniques and the use of certain derivative products, as, for example, short selling and credit default swaps".

That'll help.

We'll slide politely past the memory that the immediate consequence of Merkel's original ban was a Europe-wide market crash. We won't get into the terminology of the debate over whether a ban on short sales, naked or otherwise, is a bad or a disastrous or a pointless thing - terms such as "politically motivated" won't appear in the article, and unlike some people, we won't use the word "dithering" to describe the twenty-seven EU governments' reaction to the Merkel/Sarkozy call to action (sic). That's all been said and done. With a respectful nod to George Soros and his colleagues across the FX industry, we will first concede that, yes, this does seem really to be an attempt to ban market volatility, and secondly, that yes, this does look awfully like a German/French government initiative to take on the FX markets.

But we've been there before too, so forget unintended consequences (thanks for the volatility, ma'am), and let's talk about what's really going on here.

Capital requirements, anyone?

Nobody panic! We knew this was coming. The latest package of amendments to the EU's Capital Requirements Directive (CRD) include a stipulation that bonuses to hedge-fund managers across the EU should be regulated - which means, limited to a fixed proportion of base salary and not actually paid until several years after they have been awarded. Nothing actually happens until 2011 at the earliest, and, this being the EU, there's a lot more voting and debate to come before the new improved bonus-lite CRD gets implemented across the twenty-seven EU member states.

But the thing is consistent with the rest of the regulatory jigsaw now being glued firmly into place on top of Europe's trading infrastructure. There's a reasonable chance that they're actually goint to do it.In the 'Most Relaxed Response' category, the award goes to this [nameless by agreement] hedge-fund manager. "What do I think of it? It's unworkable. Why do I think that? Because I like the idea of living in Zurich."

Would the last star-performing hedge-fund manager to leave the West End of London kindly switch off the British economy? Thank you.

Unenlightened self-interest?

It isn't logic. It isn't common sense. It isn't - for us - just a matter of shaking them warmly by the throat and getting them to see sense. It's the politicisation of regulation and the picking of soundbite-sized targets. The hedge-fund manager who began an interview for this feature with the words, "They're all idiots!" and ended it with, "So like I said, they're all complete idiots!" was speaking off the record, strictly on background, so we can't attach a name to the quote. But actually - they're not.

If you're going for the votes of an electorate in which the over-emotional non-financiers outnumber the financiers by a factor of lots and lots, and if you're speaking in the aftermath of - yes, the crash, but more importantly, the bail-out of the banks (which, as you know only too well, played badly in political terms), AND if your concept of a long-term view matches the time between now and the next election, you're acting entirely sensibly if you choose to (excuse the technical language here) bash an easy target.

Without meaning this as a criticism, it might be reasonable to suggest that the finance industry - and in particular, those of us who know how to fine-tune an algorithm - have reached a point at which we are - no, really - too clever for our own good. Organisations such as AIMA may be putting our case, but these are populist times. Political short-termists motivated by rational self-interest don't have the time to consider sophisticated long-term arguments about the benefits of a healthy finance industry, after all.

Consider some of the media/political rhetoric highlighted by David Dungay in his piece 'Flash ban wallop!' in the Q4 2009 issue (see Consider some more recent political output. Arlene McCarthy, the MEP responsible for steering the Capital Requirements Directive (yes, another directive; see the box 'Capital requirements, anyone?') through the European Parliament, said of her charge: "This EU-wide law will . . . end incentives for excessive risk-taking."

How? It limits hedge-fund managers' bonuses. Stop taking those risks because they're not going to let you take the reward. The European Union's Internal Market Commissioner, Michel Barnier, backed up McCarthy with the observation that: "This is a step in the right direction." Ending incentives, he means. And here are two more facts to rub together: first, the UK hosts some 80% of Europe's hedge-fund industry; secondly, when George Osborne, UK Chancellor of the Exchequer, failed in an attempt to block the hedge-fund bonus ban, his comment was that he found "not many allies" in those discussions.

It probably would be rocket science if we started from here and extrapolated all the way to the conclusion that eurodiscussions are never weighted towards the member states with the most "skin in the game". But it's also obviously true. Crudely, the member states whose economies would be least affected by thumping our kind of finance - they're the ones who think knocking down an industry that isn't even on their turf is going to fix their problems. With their electorates, maybe. In the short term.

Civilisation as we knew it

It's at this point in the writing of a long feature that started out reviewing reaction to proposed and actual new regulation, but somewhere along the way turned into a jeremiad with an underlying theme in the neighbourhood of "They're coming to get you!", that the urge to call up Richard Balarkas and find out what he thinks becomes irresistible.

For Balarkas, CEO of Instinet, what we're seeing here could be a historic reversal. Balarkas says: "Equity markets have been through an enormous process of democratisation since the mid-eighties. By that, I mean the removal of inefficient structures, monopolies, privileged positions. The markets we have today are so different; they're typified by buyer power." Yes, you have to go through the whole compliance thing, but there's no sense of having to join any kind of privileged club. Balarkas continues: "Top of the evolutionary tree are very smart people using their own money, who can trade very cheaply - high-frequency traders exercising enormous buyer power."

It's a bit like flying, in a way, and international flying in particular. Whereas once the phrase 'jet set' actually meant something, today - it doesn't. Top of the evolutionary tree are people who can buy first/business-class air travel without thinking about it, but we can all fly. Balarkas says: "What I'm scared about is that we're seeing that stall. It would appear that there are plenty of regulators, and possibly more politicians, who seem inclined to tar every aspect of the financial industry with responsibility for the financial crisis that was essentially triggered by sub-prime debt in the US and the inappropriate selling of complex derivative instruments."

Check in three hours early, open your baggage, turn on your laptop, take off your shoes, stand in front of this x-ray machine, can't take those cosmetics in your hand luggage - we can all nip across the Atlantic for shopping, dinner, a show and then overnight in New York or London. The flight/finance analogy works best at the point where you start shouting: "What did we do to deserve this treatment?" Balarkas says: "My overall fear is that the knee-jerk reactions of politicians, and the lack of a coherent and transparent process for evaluating, discussing and debating issues of market structure with regulators, will make the process of democratisation stall, if not actually go into reverse."

To describe market development in terms of democracy is to remember that people are involved - and jobs, employment, careers. If politicians can find political capital in labelling trading a 'bad thing', it's a fair projection that pension funds, institutions, even schools and hospitals might be hit, but there's an even more immediate impact on the people actually generating the wealth. If these highly intelligent, creative, internationally mobile wealth creators can't dream up a way of no longer being there when the axe falls.

But before we look to the future, let's go queue at the metaphorical airport for a few long but mercifully metaphorical hours, and then skip across the water for a quich look at what's happening in the US of A.

Leaving the casino?

If this was Hollywood, we would now pause for plot exposition: the two leading characters would deliver dialogue in which they explain to each other what the situation is, and what they're doing about it. But this is Washington, so we're dealing with a cast of leading characters, from politics and the US media, large enough to fill, well, the Hollywood Bowl. And to judge from recent media coverage, they've all brought their own megaphones to the dia- sorry, tria- sorry, multilogue. The financial regulation bill now moving through the US legislative system is a decisive step towards the imposition of tough controls and curbs on the activities of banks, hedge funds, derivatives traders and others, but it's also a compromise.

The 'American way of regulation' is not exactly bureaucratic in the European sense, but it is comprehensive and all-encompassing in the distinctly US sense that all interested parties - including lobby groups - tend to have an influence on the outcome. Thus, the Volcker Rule, whereby banks have to spin off proprietary trading operations (and desist from 'casino banking') if they want to continue as plain-vanilla deposit-takers, has been adjusted to allow said banks to keep partial ownership of those spun-off subsidiaries. They're still in the game.

Among other highlights: OTC derivatives would be brought onto exchanges except where they were being used to hedge risk by non-financial companies (a return to the early days of the derivatives markets, almost); there'll be a new oversight body to impose higher capital and liquidity requirements on 'systemically significant' enterprises; and there'll be a levy on big financial players to cover the cost of setting up and running that and other new regulatory bodies that the new bill stipulates. There will also be lots of studies into the feasibility of heavier and more pervasive regulation in other areas of finance. Good thing we don't allow terms like 'buck-passing' in this magazine.

Lots of work for lots of regulators; lots of staff to recruit; still lots of negotiating to be done before the whole apparatus beds down into a coherent framework for financial activity. US financial stock prices rose on US markets as the bill's (relatively) final form became clear, and Bob Froehlich, senior managing director at Hartford Financial Services, was quoted as saying: "Two years later, people will look back and say 'My gosh, nothing really changed.'" Only a cynic would celebrate this great triumph by setting out to find loopholes in, for example, the 'divest but continue partially to own' provision applicable to 'casino banking' practitioners, and of course there's a clear distinction between a derivatives trade to hedge financial exposure and a derivatives trade to hedge a price move in a mission-critical commodity. Isn't there?

But these 2,000 pages of closely debated legislative drafting are still vulnerable to negotiation and change. One comment that is seldom made about the US approach to legislative change is that, although it tends to appear on the horizon like a stampede of grandstanding politicians making the most of their opportunities in the TV lights, in fact it typically arrives as a series of incremental steps towards a very small change. Sounds big, delivers small. Sounds iconoclastic, delivers a slight nudge to the status quo. The reason for that is the existence of a lobby group for every side of the argument (except, perhaps, the defaulting midwestern mortgage holders). There is, as you might say, balance.

And that would be fine if balance equated to certainty. We could all get on with the job free of any worry that those feasibility studies will turn against us; free of any worry that if we don't tie ourselves up in lobbying, rival lobby groups might turn against us; free of the worry that our elected leaders will be more concerned with the electorate than the health of the financial sector; free of - you get the idea. The next US presidential election is scheduled for November 2012, just ahead of the end of the world. [We covered those Mayan prophecies about what's coming up in December 2012 in Peek Ahead a while back; see also Wikipedia and Roland Emmerich's film 2012.] These next couple of years won't be a time for decisive table-banging.

NYSE Technologies and Markit work together to promote European market transparency

NYSE Technologies and Markit have launched a joint initiative to consolidate data and enhance transparency in the European OTC equity markets. From now on, NYSE Technologies will integrate data from Markit BOAT within its own range of market data products.

Mark Schaedel, Senior Vice President, Global Data Products, NYSE Technologies, tells us: "This will give joint users access to trade reports on an average of roughly EUR 30 billion of OTC trades in equities every day which is equivalent to approximately 80% of the daily volumes traded on all European equity markets through April 2010. We are very excited to be working toward a seamless, market-wide OTC data solution with Markit to improve the quality of market data across Europe's cash equity markets."

The initiative is open to other publication venues in Europe in order to give market participants access to the most comprehensive dataset on the European OTC equity markets from a single source. The new service will include deployed data feeds, hosted and managed solutions, web services and historical products. NYSE Technologies will also integrate data from Markit BOAT and other data providers into packaged solutions which provide customers with a single view of activity across all major European cash equity markets.

More at

It's not over until the fat-tailed shaggy dog barks

So the grizzled, maverick veteran says to his rookie partner: "In Europe, the risk is that politically motivated pressure will slow down the industry as a whole, and possibly even reverse the democratisation of markets. Heck, we'll end up with enforced low-frequency trading."

And his rookie partner says: "Yeah, and in the US, the risk is that we'll be living with uncertainty right through the election and beyond. Some kinds of uncertainty are good for business, but you can't plan a strategy for the long term if you can't be sure you won't end up saddled with a whole extra weight of new regulation."

The grizzled maverick veteran mutters something under his breath about hiring a better scriptwriter and/or dialogue coach, and then fires up the battered old cop car they brought to the stake-out. As they clatter off into the sunset and the credits roll, we turn our attention back to AIMA. Here's AIMA's Chairman, Todd Groome, with his views on US financial reform. Groome says, first: "Our industry did not cause the crisis, and was as negatively impacted as any sector. Nevertheless, as a mature industry, representing investment managers and other professionals throughout this global industry, we have acted to support improvements in our regulatory framework and in financial stability."

Not our fault, but we're on board. Groome continues: "The agreement by US legislators on financial reform, the Dodd-Frank Bill, is a very significant step in the evolving and broader international regulatory framework. This is a landmark piece of legislation that, once passed, will represent an important part of the global system of supervision for the financial services industry." And hedge funds are a good thing too. Groome says: "The diversity of our industry's activities serves to reduce pro-cyclicality in financial markets, and thereby supports financial stability. Through a more informed supervisory relationship, we expect supervisors and other public authorities to obtain a better understanding of our industry, as we contribute to their efforts to identify market stresses and vulnerabilities."

Let's cut to the 'But'. Groome says: "This bill would tax larger US hedge fund managers to finance the estimated costs of this legislation, despite the fact that no hedge fund received public funds or caused any financial stress to a banking institution or other counterparty during the crisis. The inclusion of hedge funds in this financial tax suggests that our industry has been singled out for more onerous treatment. If this tax is targeted at perceived wrongdoers or those who caused the crisis, hedge funds had nothing to do with the cause of the crisis, and there has been no finding before, during or since the crisis that hedge funds cause increased risk to financial stability."

It’s not over until the fat-tailed shaggy dog barks

Which is where we began. The 'known unknown' in all this imbroglio is this: the various hedge funds and other financial entities that are being singled out don't have to be based where they are today. There are claims that 'bashing' hedge funds will damage the wider community. That's because the hedge funds might leave. You can find mention of India, Brazil, Switzerland, various parts of Asia in this issue, and although this article isn't just an unusually long-winded way of referring you to Andy Webb's piece on SGX (page 32), the fact is that we do find ourselves frequently talking to non-EU, nonUS exchanges (and other less high-profile bodies) where the key message is how keen they are to attract business.

Wolfgang Fabisch says: "Wrong regulation would cause a tendency to leave a jurisdiction. The distinction is between wrong and right, rather than heavy and light." Good point. How right was the ban on shorts? How wrong is your remuneration package?

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