Complaints about regulation, particularly in the fixed income divisions of global investment banks, are in plentiful supply, but there are precious few ideas of what to do about it.
Some banks have taken an axe to the organisational chart in the hope of bringing costs down; others are hoping that, as their competitors leave the market, the business will become profitable again, or that there will be a last ditch regulatory reprieve for their trading desks on the back of concerns about growth.
It’s going to be a rocky ride, and one which will blur the boundaries of what we think trading involves.
Take prices. Banks can show prices for securities on exchanges, electronic execution platforms, or just in response to a request for a quote. But under the MiFID II rules, this becomes a regulated activity for any financial product. When certain conditions apply, every client must receive the same prices and, in some cases, so must competitors.
This is an inherent part of any market structure rule — market-makers get a defined set of rights and responsibilities, and if they get too many rights and too few responsibilities, other market participants complain.
But bringing it entirely inside the regulatory perimeter will encourage more and more price formation to happen in the shadows.
Public markets will have wide bid-offers and small sizes, while market players will have tentative conversations about where, hypothetically, bids might come to meet indications of interest. These will not stray into actual trading until the last possible moment, but the net effect will surely be the same — large, top tier clients will continue to have the best opportunities to trade at prices where they want to trade. The art of talking about price for as long as possible without ever making a firm (regulatory) price will be elevated to a fine art.
Even when a trade is agreed, banks will have incentives to push back the actual moment when, for regulatory purposes, the trade occurs.
If trades can be confirmed between banks in real time, which is the basic promise of blockchain technology, the space between that confirmation and trade repositories or traditional settlement systems opens up opportunities. If the blockchain that banks use contains a promise to execute trades all at once at the end of the day, and net them out before “settling” for cash or securities, banks could slash collateral and capital consumption by simply refining what "trade" actually means.
Finally, the entities doing business aren’t going to necessarily be the markets divisions of banks.
Already, the lines are getting blurry — banks are starting agency brokerages, brokers are starting to call investor clients, banks and brokers alike are trying to redefine themselves as tech firms. Hedge funds, like Citadel, are using existing tech platforms and establishing brokerages, while tech firms like Bloomberg are establishing execution venues.
The turmoil has been going for a while, but it is only going to accelerate, as the major investment banks take their tough decisions. Settlement, clearing, back office and anti-money laundering operations are all crucial — but none of them need to be carried on inside a company with a banking licence.
Just as ICAP decided it could carve its profitable electronic execution businesses out of brokerage regulation by splitting them from other businesses, banks and other voice brokers will make the same call, cutting costs along the way.
If any of these predictions come true, they amount, essentially, to regulatory arbitrage — a dirty word these days. But that doesn’t make them wrong or risky. Regulators set the rule, firms figure out how to play the game. Welcome to the future, just like the past.