Trump administration signals new direction for institutional investors

The coming year will see regulatory issues once again dominate discussions in institutional trading, although the focus will be less on compliance and more on what regulations ultimately will look like.

Among the themes:

• The direction on trading the Securities and Exchange Commission will take with new leadership;
• Changes in the Dodd-Frank Wall Street Reform and Consumer Protection Act that could mean a return in fixed-income trading to traditional market making; and
• The possibility of less equivalence in U.S. and foreign regulations, such as the European Commission's Markets in Financial Instruments Directive II, slated to take effect in 2018.

“What these changes will mean for broader market structure oversight are still to be seen,” said Ryan Larson, head of U.S. equity trading at RBC Global Asset Management (U.S.) Inc., Chicago. The impending departure of SEC Chairwoman Mary Jo White and the agency's Director of Trading and Markets Stephen Luparello “will most definitely be a game-changer in 2017,” he said.

One focus of the SEC in 2017 will be what it does with recommendations made by its Equity Market Structure Advisory Committee, a panel of representatives from brokerages, exchanges and money managers that was set to complete its work in February but has been extended to work until August of next year, Mr. Larson said.

“The ability for market participants to play an active role in the dialogue about market structure and, alongside regulators, to come up with meaningful market-driven solutions to the challenges that still exist and what market structure will look like in the future, will be paramount and shouldn't be lost on any new chair, commission or even presidential administration,” he said.

One recommendation expected to come from the advisory committee will be action on exchange access, or maker-taker, fees in which brokers receive a rebate for trading on certain exchanges, said Joseph Saluzzi, partner, co-founder and co-head of equity trading, Themis Trading LLC, Chatham Township, N.J. “The maker-taker pilot will be done,” Mr. Saluzzi said. “That's something that has energy from all sectors of the market ... I expect there to be a proposal for a pilot from the SEC within six months.”

Another SEC initiative, its tick-size pilot program for small-cap stocks that began its two-year test in October, should show benefits in the coming year, Messrs. Larson and Saluzzi said.

“While still in its infancy, very early results suggest that spreads have definitely widened; we've observed a significant increase in quoted size at the (national best bid and offer), yet we have also observed no notable change in overall trading volumes for the pilot,” Mr. Larson said. “Still, this pilot is very important, especially if it does indeed improve liquidity and not volume in smaller-cap stock, but more so in the concept that regulators and participants are no longer willing to accept a one-size-fits-all approach to market structure.”

Added Mr. Saluzzi, “So far all the early signs are good. Anecdotally, there has been an increase in the number of small-cap quotes, and spreads have not reasonably widened. We're seeing good stuff. We're just waiting for the SEC to disclose regular reports.”

The uncertainty of future SEC leadership is paralleled in the coming year by the question of what Dodd-Frank will look like, as well as the future of the Volcker rule, which among other things requires banks holding inventory in fixed income to back that with additional capital, causing many market-makers to reduce their inventory. In 2017, fixed-income trading issues will be “tied more to the regulatory environment,” said Adam Sussman, senior adviser, head of market structure and liquidity partnerships, Liquidnet Inc., a New York-based electronic trading venue provider. 

“People have been talking about the need for more liquidity venues for a long time,” Mr. Sussman said. “In a deregulatory environment, what does that mean? Do banks go back to holding more inventory? Does the march to electronic trading continue?”

RBC's Mr. Larson said there's a potential positive in the removal of some Dodd-Frank regulations on the equity side. “While still yet to be seen, easing regulation with respect to Dodd-Frank/Volcker could ultimately to better facilitation of capital, thus enhancing liquidity available in the market, which could have even further implications in the form of lower trading costs,” he said.

The issue of trading costs will be more prevalent in 2017, said Matthew Stroud, head of delegated portfolio management, Americas, Willis Towers Watson PLC, New York. Asset owner clients, Mr. Stroud said, “are asking how to keep costs down. That includes trading; that's a big piece of it. They want more efficiency, more buying power. There's a lot of pressure on fiduciaries to get results, and finding economies of scale is a big part of that. That's both through (transaction cost analysis) and making sure that there's good value for everything in their portfolio. You'll see more work with managers and other third-party fiduciaries on that.”

David Griffin, product manager, transaction cost analysis, at State Street Corp. division Elkins McSherry LLC, Boston, said his firm and other transaction cost analysis providers “all need to step up our analytics and particularly get more granular in fixed-income TCA” to comply with MiFID II disclosure regulations that take effect in 2018.

“A lot of people don't use fixed-income TCA,” Mr. Griffin said. “In a lot of ways, it's very challenging to compare execution in fixed income because it's tough to get an accurate benchmark. But MiFID does require that trade-cost assessment in fixed income in a broad sense. That could be a game-changer for some clients.”

The issue of regulatory equivalency between the U.S. and European requirements should be watched closely, particularly if U.S. regulations are changed, said Justin Llewellyn-Jones, chief operating officer, global head of derivatives, at trading software developer Fidessa Group PLC, New York.

“Where the U.S. decides to go on a different regulatory schematic, you have a good chance of a lack of equivalence” on cross-border regulation, Mr. Llewellyn-Jones said. “It's the same with Brexit in the U.K. That lack of equivalence results in friction. And there are opportunities and costs to friction. So a lot of the concern is what different regulatory bodies will do differently from the others.”

One constant among all in 2017 will be the emphasis on cybersecurity, with responsibility extending to money managers from regulators' current focus on the sell side. 

“A lot of that surrounds where the buy side fits in a regulatory framework. Institutional investors aren't really captured as much as the sell side is in regulations,” Mr. Llewellyn-Jones said. “But I suspect you'll see the start of a little bit of a creep, mainly in the cybersecurity space,” including Regulation Automated Trading, the Commodity Futures and Trading Commission's rules on disclosure of algorithmic code.”

Cybersecurity poses the same threat on the buy side as it does on the sell side, so I think the regulators ... will want to apply some of these rules to the buy side."