Regulatory Alchemy: Transmuting Compliance Tax into Business Value

This article was written by David Murray, Chief Business Development Officer at Corvil.

Necessary evil

The ever-expanding Regulation Regulation Like any other industry with a high net worth, the financial services industry is tightly regulated to help curb illicit behavior and manipulation. Each asset class has its own set of protocols put in place to combat their respective forms of abuse.In the foreign exchange space, regulation is assumed by authorities in multiple jurisdictions, though ultimately lacking a binding international order. Who are the Industry’s Leading Regulators?Regulators such as the UK’s Financial Conduct Authority ( Like any other industry with a high net worth, the financial services industry is tightly regulated to help curb illicit behavior and manipulation. Each asset class has its own set of protocols put in place to combat their respective forms of abuse.In the foreign exchange space, regulation is assumed by authorities in multiple jurisdictions, though ultimately lacking a binding international order. Who are the Industry’s Leading Regulators?Regulators such as the UK’s Financial Conduct Authority ( Read this Term of the financial markets is becoming a lead weight for many shops, increasing operating expenses while dragging down profit margins.

Some consider it a necessary evil for safe, efficient markets and for maintaining investor confidence. Others see it as misguided, if well-intentioned, political meddling into what should largely be a laissez-faire system. All recognize it as a tax: it must be satisfied to avoid consequences, but it definitely isn’t promoting innovation or adding new, unique value to customers.

The costs of compliance, or regulatory tax, can be so prohibitive as to drive smaller shops to shut their doors or pivot, and larger shops to shutter whole sections of their business. Even those who are able to get themselves up to code rarely gain anything more than administrative processes, swelling compliance departments, and teeming collections of inert data - the financial equivalent of lead slag.

And as with lead byproducts, regulation is the gift that keeps on giving. Organizations today prepare contingencies for their regulatory tail-risk, that is, the likely cost of some financial penalty. They realize it is a question of when (and not if) a misstep will result in a penalty. Such a mistake might not necessarily be in maintaining compliance, but in being able to demonstrate it, and may surface long after a transaction is executed or reported.

So as with most taxes, organizations look to do the bare minimum to meet their obligations.

Silver lining

But is there a silver lining? If approached in the right way, the funding to meet transaction reporting requirements may be used to implement a rich, precise, searchable database of order transactions. This database may contain the insight trifecta of business data, customer experience information, and underlying infrastructure performance, which can be used to refine trade strategies, optimize applications and infrastructure, offer greater service level insight into service providers, reduce risk, and even drive new services.

With the impending arrival of MiFID II in Europe and CAT in the United States, there is no time for businesses to sit idly by. Even with the European Commission's postponement in implementing MiFID II’s stringent regulations and with modest targets of 50ms clock synchronization for CAT NMS, the preparatory challenges ahead have not been made any easier. It does, however, give business leaders more time to think about how they will make the most of the rapidly changing frontier ahead. More importantly, it offers a prime opportunity to perform some regulatory alchemy: that is, to Leverage Leverage In financial trading, leverage is a loan supplied by a broker, which facilitates a trader in being able to control a relatively large amount of money with a significantly lesser initial investment. Leverage therefore allows traders to make a much greater return on investment compared to trading without any leverage. Traders seek to make a profit from movements in financial markets, such as stocks and currencies.Trading without any leverage would greatly diminish the potential rewards, so traders In financial trading, leverage is a loan supplied by a broker, which facilitates a trader in being able to control a relatively large amount of money with a significantly lesser initial investment. Leverage therefore allows traders to make a much greater return on investment compared to trading without any leverage. Traders seek to make a profit from movements in financial markets, such as stocks and currencies.Trading without any leverage would greatly diminish the potential rewards, so traders Read this Term their compliance funding to return value to their business.

For the businesses affected by MiFID II and likely future regulations, laying the proper groundwork for compliance requires an examination and understanding of the problems and ambiguity with current methods of timestamping and clock synchronization. While the obligation of new regulations is for clock synchronization within a defined variance and timestamping to a defined level of precision, the opportunity lies in recording, indexing and storing the full order and transaction record, including how it was transmitted and executed.

The passive, most cost-effective way to gather this information is through communication-based collection of what data is sent and received through applications, in what durations and the ultimate result of that transaction, with inclusion of data and events from other sources such as application logging. A key component of capturing this value lies in gaining insight into when and how each order originated and was transmitted, and accurate clock synchronization and timestamping are key requirements to do so.

Many institutions rely on application timestamps to measure and record electronic trading events within their transaction lifecycle. Unfortunately, assuring integrity of those timestamps may require adding special hardware to potentially hundreds of machines to enable high fidelity UTC clock synchronization and, potentially, changes to numerous databases and applications to support. Further, it may not reveal the precise timing of data that was ultimately transmitted or how long it took to traverse the accessible applications and infrastructure.

Business intelligence gold

By instead incorporating wire-based data with critical application-based timestamps, organizations can create a granular, high-fidelity, searchable transaction database, which not only provides the most granular data for surveillance and reporting possible, it also allows businesses to forensically reconstruct events after-the-fact. With such a database of precision transaction records — nanosecond timestamped details of every order and its performance across the transaction lifecycle — savvy businesses have an opportunity to transmute the leaden regulatory tax into business intelligence gold.

How do they do this? By utilizing this wire-based data collection to tap a clever, new source for insight across their operations. Financial institutions should embrace the real value in the visibility they can gain from a more granular view into what’s happening across their trade plants: by desk or client, by trader, by trade type, by asset class, by symbol, by venue, by application performance, by plant latency, etc. and how results differed when correlating these vectors.

The value of this data about the transaction and about its performance, aggregate and accessible by each transaction, may rival that of an individual transaction itself. It is the key to evolving trade strategies, delivering new services and better service levels to internal and external customers, and to governing and improving the digital business engine. It also provides the opportunity to answer questions, arguably in near real-time such as:

• At which venues are we seeing the best hit rates for which symbols?
• Which brokers are providing the best fill rates at the best pricing and how much does their response time fluctuate?
• How are client or desk volumes trending for a given venue?
• What is the performance trend for a given client or set of clients with a specific symbol or venue?
• Which orders or quotes are outstanding?
• What order activity was there for a given symbol during a given time / day?

What is more, when it comes to MiFIR compliance, a software-plus-wire system is the least expensive way to glean a complete record of activity so that a causal, sequential relationship between events can be determined. This record can serve as a valuable business tool that extends way beyond regulatory purposes.

Put simply, there’s gold in them thar wires, if you know where to look and how to leverage it!

While it is unavoidable that we need to cough up the tax or investment to meet regulatory compliance, the good news is that firms can reap the lasting benefits of this investment in more precise, aggregated clock synchronized wire data collection and analysis. More importantly, this investment can yield a delightful byproduct in a searchable database of time-stamped records of order lifecycles, execution results, and client and venue behaviors that can offer the smart business alchemists an unprecedented look into the dark corners of their digital business.

The alchemists never quite figured out how to make gold from lead. But in preparing for compliance for new US and European regulations, even with its significant challenges, we have a chance to transmute this leaden burden into golden business insight. And unlike the alchemists who funded such initiatives, we have to incur the cost regardless!