By Simon Miller
In the light of vast regulatory changes to the financial marketplaces, clearing houses have found themselves at the forefront of these challenges as regulators look to see how supervision of derivatives markets should be
developed in the context of the financial crisis of three years ago.
Eurex Group, the derivatives arm of Deutsche Boerse, is one of those exchange conglomerates facing up to the changing regulatory world.
Formed in 1998 when DTB and Soffex officially launched a joint trading platform, Eurex became one of the first exchanges providing access to listed derivatives markets by using a fully electronic and integrated trading and clearing platform.
Historically, Eurex Group has relied on integrated trading and post trading services as a main differentiator between itself and its competitors. Member interfaces in the industry were generally based on proprietary development.
However, with industry standards emerging and regulatory changes through European Market Infrastructure (EMIR), Dodd-Frank among others, Eurex Group is reviewing its systems to adapt to the new world.
Manfred Matusza, director and head of Clearing System Design at
Eurex Clearing, notes that member interfacing has come into focus over the past few years.
“Our legacy technology is custom made just for Eurex Clearing. With
standards emerging in the industry we think our initiatives will benefit from adopting these standards,” he says. “We do have a perspective on how to develop member interfaces, but from a mid-term point of view, it is about industry development. Where our members benefit is that they will not have to connect in a unique and proprietary way to us, but they will have synergies in connectivity to multiple industryinfrastructure providers.”
Matusza continues: “We see significant changes coming, for example, in terms of regulatory and market structure changes, and we will have to do a lot to adapt in the next years. This is one of the reasons why we are
changing our member interfaces in a way that the participant impact is minimised when we introduce changes to our clearing systems.”
It is this flexibility that Eurex Clearing hopes will maintain its competitive advantage as market participants look for clearing houses to comply with regulatory requirements.
However, it is no easy task to change a system if it requires all members to adapt their in-house systems at the same time. Regulatory changes do not leave much of a choice but functional extensions may or may not be of interest to clients.
Deutsche Börse senior vice president for Cash/Derivatives IT Hanno Klein explains: “The proprietary technology that we are in the process of phasing out represents a fairly large footprint on the customer side which means we have to roll out software to the customer site for any change of the interface. Until now, the customer has to install new software from us on his hardware even if he has no intention or is not yet ready to use any of the new features.”
The requirement to frequently extend the functionality also means rolling out many changes which challenges the current architecture. This implies that participants and ISVs worldwide have to be ready on a single day to support a new release of the Eurex system. The same players and vendors are faced with many other exchanges requiring changes throughout the year.
“This approach implies a large global project for each rollout and that is why we wanted to move ahead and remove our footprint on the member site,” said Klein.
Without rolling out software to the client, an interface is merely a set of electronic messages being sent back and forth according to so-called Rules of Engagement. As a result, users can use their own operating system or environment. The definition of these messages was previously hidden to the client as he would interact with the software provided by the exchange. This immediately raises the question whether an exchange should come up with its own definition or adhere to an international standard for doing so.
This is where the Financial Information eXchange (FIX) protocol comes into play. This ubiquitous standard for pre-trade, trade and post-trade communication has been developed through the collaboration of banks, broker-dealers, exchanges, industry utilities and associations, institutional investors, and information technology providers from around the world.
Eurex Group says that standards such as FIX offer a universal language to define business processes by means of standardised workflows consisting of messages, fields and valid values. FIX provides a common terminology for the financial industry which greatly reduces the learning curve for customers wanting to connect to and interact with Eurex.
Klein adds: “The fact that FIX allows optional fields on its messages, it is very easy to add things which can be ignored by those of our members that are not impacted by a change and then hop onto it when it is relevant to them. Usage of FIX not only makes it easier for our members to understand our interfaces, it also allows us to be much more agile and to develop additional services or extend existing services where members can decide at their own pace when they are ready to take in these new functionalities and features.”
He continues: “The member has less to worry in terms of how many software releases we launch each year, except for deadlines set by the regulators of when new requirements have to be met. With our new interfaces, it will be much easier to react to the challenges.”
Aside from making system access easier for clients, predicting demand for change is something that is a challenging task for the industry.
“This is something that is very difficult and it is not easy to anticipate future requirements. But our experience here is that the closer the collaboration is
between us and our user base the better we can understand and support the requirements of our participants,” comments Matusza. “Through that open dialogue we are having in various areas, we can grasp what our users need in the near-to-longer term. Thus we then can try to lay the groundwork.”
Klein adds that the changes in the Eurex system infrastructure will help to introduce changes more easily than before.
“With Eurex’s New York based subsidiary ISE the architecture has recently changed to where we now believe we are better prepared in terms of scalability to whatever capacity increases we may see,” he says. “Many exchanges are based on architectures with a small number of tightly coupled systems sharing central resources but ISE’s new equity options trading system uses high performance messaging between a large number of rather independent components having local resources.”
Having begun the switch to a less centralised, less “big box” IT approach
in conjunction with standardised interfaces, there is still an understandable concern over the impact of the regulations yet to come.
EMIR and Dodd-Frank are slowly crawling their way into action – although political wrangling could delay delivery once more – and Europe is in the midst of considering what to do about derivatives with the UK already threatening legal action over proposals that European trading must be done through a Eurozone clearing house.
So how can a clearinghouse predict what is going to impact on services, let alone when?
According to Eurex Clearing the key is to anticipate, prepare and develop the necessary systems to minimise time-to-market for changes as needed.
Matusza comments: “Obviously there is a lot of regulation that could affect clearing services in the future; all of them have different time lines. On the one hand we try to monitor, we have a sophisticated team that monitors and tries to anticipate future requirements, but at the same time we are heavily investing in key system components, for example risk management.”
He concludes: “We have basically developed a real-time risk infrastructure in the last two years calculating risk impact and distributing information about risk exposure changes on a real time basis. We have also already started to introduce a further dimension to our proven clearing services by addressing segregation and portability needs that are of benefit to both clearing members and their clients. Our systems are well prepared for expected regulatory requirements in these areas as and when they emerge."
Casebook: MiFID in action
Since the financial crisis of 2008, regulators and politicians alike have struggled to put in to place new laws to reflect the need to protect the world from another systemic crash.
The principle instrument in Europe concerning electronic trading and clearing is the Markets in Financial Instruments Directive (MiFID) which has been revised to reflect the issues raised, not only by the crisis but also commitments made by the G20 to improve the transparency of such opaque markets such as derivatives.
Firstly the scope of MiFID has been extended to more firms such as data reporting providers, certain commodity firms and third country firms. This will result in increased scrutiny and compliance for firms that are currently not under the umbrella of current regulatory oversight.
Secondly, derivatives which are considered sufficiently liquid and eligible for clearing will need to be traded on eligible platdforms. This provision is being
implemented in order to fulfil the G20 commitment but the criteria will be set out by the European Securities and Markets Authority.
In addition, OTF’s will be introduced as a third category of trading venue to bring into scope additonal trading venues that have been set up since MiFID was originally implemented.
As a result, firms operating OTFs will require separate permission and will be restricted from executing trades against their proprietary book.
Firms which use algorithmic trading and firms which provide clients with direct electronic access to trading venues for execution purposes will also see specific systems and control requirements introduced. These will be aiming to have systems that are suitably resilient and include risk controls such as preventing systems from sending out wrong instructions and to slowdown, if not brake the flow of orders.
Finally, there is also a provision for a market-making obligation for algorithmic trading strategies that, although it could be omitted, marks a future intention by the EU.