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JWG regulatory trading digest

Published in Automated Trader Magazine Issue 34 Q3 2014

Record fines have been dominating the headlines in the US, as the federal government appears to have finally hit the brakes on Dodd-Frank rulemaking. In July, BNP Paribas reached an $8.97 billion settlement with the US Justice Department (that also took it out of the market for 12 months) for breaching sanctions on Sudan, Iran and Cuba. However this was subsequently dwarfed in August as Bank of America agreed to pay a cross-jurisdictional record fine of $16-17 billion for mortgage related misconduct in the run up to the financial crisis.

To date, the US federal government has published a grand total of 4,229 documents under the Dodd-Frank Act, since it was initially passed in 2009, but it seems as if this frantic rulemaking is finally slowing down. This is not to say that US regulators are resting on their laurels. SEC/CFTC probes into high frequency trading (HFT), which were launched in light of the publication of Michael Lewis' 'Flash Boys', remain ongoing, and New York Attorney General, Eric Schneiderman, has been particularly vocal about going after big firms who favour HFT over other forms of trading.

Meanwhile, things have certainly been heating up in the EU. The regulation that everyone is talking about is MiFID II, which is set to rewrite the rulebook for algorithmic trading - as well as just about every other type of market activity. The major development this quarter has been ESMA's publication of its consultation and discussion papers seeking industry input as they begin focusing on writing the technical standards.

One of the most important things that ESMA set out in this exercise was how they plan to define HFT and what implications this will have. They have set out two approaches; the first an infrastructural definition, based on matching distance, volume capabilities and trading frequency; the second a more flexible approach, taking an ongoing assessment of the nature of the daily lifetime of orders on trading venues. Judging from the responses in the public domain, it is fair to say that market participants are not particularly receptive to either of these.

In addition, ESMA stated that they believe, regardless of the approach they take to defining it, that any market participant caught by the HFT definition should be considered subject to MiFID provisions across all of their activities. We await the authorit's reactions to the rather robust industry responses to its proposals in the next round - which is scheduled for year-end.

Meanwhile BaFin, author of the German HFT Act, who are widely seen as the instigators of MiFID II's HFT rules have been having their say on what is happening at the EU level. In the same way as the HFT Act, "MiFID II now stipulates on an EU-wide basis that high-frequency traders engaging in pure own account trading need authorisation… one regulatory instrument which is contained in MiFID II but not in the High-Frequency Trading Act is the price quote obligation for market-making algo traders." This reflects the fact that, whilst, in some areas, MiFID II is simply implementing what is already happening in Germany across the entire union, in other areas it goes much further.

Even the UK House of Lords is getting in on the trading rule act, launching an inquiry into "the EU Financial Regulatory Framework" and asking the FCA to comment on testimony from Brad Katsayuma, the main protagonist in the 'Flash Boys' book.In the meantime the FCA, themselves have called for evidence from market participants as part of their wholesale sector competition review.

Moving on to Asia, the Japanese Financial Services Agency (JFSA) has published an update to their Financial Instruments and Exchange Act (FIEA). The FIEA is to Japan what MiFID is to Europe, albeit slightly less ambitious in its scope of focusing more specifically on investor protection and the adaptability of Japanese markets. A major part of this initiative is enforcing tighter controls on IT governance for trading firms, and it is expected to catch around 3,800 firms.

Over in Singapore, the Monetary Authority of Singapore (MAS) have made the first move on the Basel Committee on Banking Supervision's (BCBS) guidance on Domestically Systemically Important Banks (D-SIBs), and released their consultation paper on a 'Proposed Framework for Systemically Important Banks in Singapore'. This paper explicitly states their requirements: "MAS expects all D-SIBs to comply with the risk principles and implement effective risk data aggregation and risk report practices within three years of their designation as D-SIBs".

MAS is setting a precedent by considering foreign banks in their assessment of domestic systemic importance. This broadened scope of their assessment has the potential to open a large can of worms for traders in that a bank, which is not considered a D-SIB in its home jurisdiction, may be considered one abroad, forcing it to comply with D-SIB requirements regardless.

The focus down in South Africa has been OTC derivatives, with the South African Financial Stability Board (FSB) publishing a policy document in July, which includes proposals for new rules around authorisation for OTC providers, CSDs and CCPs. This is in the context of the so called 'Twin Peaks Bill', which is set to reorganise the country's regulators. It will create a new Prudential Authority (PA) and the FSB will become the Market Conduct Authority (MCA). The exact implementation date remains unknown, but many have speculated that it will come into effect by the end of 2014.

Finally, the big news in India has been the Securities and Exchange Board of India (SEBI) making a push on position limits for derivatives traders. This has a certain amount of overlap with what the EU is trying to do under MiFID II, in terms of much greater transparency in derivatives markets. We have never seen the regulators so active … but they look set to get busier still.

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