James Rundle: How the West Was Won

Sometimes, effecting change requires a nudge in the right direction. Equally, it can take years of scandals, millions of dollars in fines, and a few arrests before those in power decide it’s time for change. That was the tone of the Chancellor of the Exchequer George Osborne’s speech to the City at Mansion House this month, in which he outlined the mechanisms of how the foreign-exchange (FX) markets would eventually be regulated. Osborne has certainly taken his time to initiate a year-long, market-wide review.

Inertia
The UK government has been mired by its own indecision and inertia, although some say the glacial pace of change is as much a pan-European phenomenon as it is a domestic one. After all, financial regulation is set at a European level and devolved when appropriate to the nation-states. How any regulatory restrictions will be implemented without resulting in regulatory arbitrage or without international cooperation is unclear, and how it will affect London’s position as the prime European financial center remains to be seen.

Indeed, while a firmer hand should clearly have been taken long ago in terms of some of the practices in the FX market, much of the job of regulators is slowly being accomplished already. The backlash and broad fines around rate-rigging have alarmed many banks about what might transpire as a result of the investigations into the 4 p.m. fix. Whether it’s banging the close, or an innocent example of proficient risk management, the electronification of the markets lends itself well to the desperately needed surveillance and compliance functions. Last month, I covered a few of the emerging technologies in FX, which have arisen as a result of electronic influence, but the same is true of other asset classes, too.

The obvious example of this is in the over-the-counter (OTC) derivatives markets, where a move to introduce execution platforms for standardized contracts has had an indelible impact. Regardless of whether or not everyone ends up using Bloomberg because it’s on their screen, or Icap because of existing relationships, or other swap execution facilities (SEFs) if some of them ever end up launching, they are achieving their objectives of injecting transparency into the heretofore opaque swaps market.

Electronic trading is both born from and gives birth to data, specifically trade data, which can be used effectively and quickly for oversight purposes. Voice-based trading doesn’t generate the same level of data, even if fancy new semantic technologies are making huge advances in speech analysis.

None of this works without formalized rules. It sometimes seems as if regulators are dragging their heels in rulemaking, given the long wait between Group-of-20 mandates over derivatives trading, and what we’ve ended up with in the US, not to mention the EU’s slow-and-steady approach. But in some ways, electronic markets encourage a level of self-regulation, given the information on display and the tools that can be built from that.

Disruptive Elements
Electronic trading also introduces disruptive elements, such as high-speed, high-frequency activity. But it also introduces prescient elements of market structure, too. Just look at some of the electronic trading of rates and bonds that was going on even before the US Commodity Futures Trading Commission (CFTC) finalized its rules on SEFs, or the exchanges now emerging that seek to limit so-called “predatory” elements of high-frequency trading.

Far from being a “Wild West” future of techno-economic dystopias, technology actually has the potential to introduce an element of steadiness to markets—that is, if it’s properly marshalled and overseen. Indeed, it’s one of the best weapons in the regulatory toolkit, and a look at how language about technology has changed from regulators over the past year at least is indicative that they recognize that. It might not do their job for them, but it’s certainly making it easier.