The decade that we’ll call “The Tens” has come and gone, making it a natural time to pause and reflect on developments in the realm of market regulation and what those developments might mean as we step into the Twenties. This exercise is particularly relevant because it has been exactly ten years since the passage of Dodd-Frank in the United States, marking the beginning of a new era of regulation for financial markets. In this blog post, we take a look at four key insights from the decade past and then look at four trends that will likely shape the future of regulation.
Four Key Insights for Market Regulation
If the first decade of this century was all about explosive growth in electronic trading, then the period from 2010-2019 can justifiably be characterized as the decade when the pendulum swung back toward greater regulation. This began with the passage of Dodd-Frank in 2010 and continued with MiFID II, the FX Code of Conduct and more. While electronic trading continued to grow, expanding in areas such as FX and fixed income, the more significant trend was one where rules and regulations caught up with the changes on the trading side.
Looking back, we see four key takeaways from The Tens:
- The more things change, the more they stay the same: In some sense, manipulative behavior never changes. Problems such as spoofing, wash sales and insider trading have existed as long as markets have been around, and that isn’t going to change. To address this situation, it is essential that a compliance and surveillance program be comprehensive, intuitive and active, as covered in our blog, Don’t Get Hit With An FTS (Failure to Supervise).
- There are some new things under the sun: The basic forms of market manipulation may stay the same, but the level of sophistication in schemes is on the rise. In one instance this past year, a group of 18 traders were found by the SEC to have conspired in a coordinated campaign in U.S. equity markets and were fined $31 million. As new technologies emerge and global markets become ever more integrated, opportunities for manipulation increase. The only way to counter this trend is to fight fire with fire and continually upgrade and enhance the tools used to counter malicious activity. A good example is the hybrid procedural / machine learning tools that we recently introduced in Validus.
- When it comes to market regulation, it’s a one way street: The truth is, markets never become less regulated. While reforms come along from time-to-time, the basic arc of regulation – regardless of jurisdiction – is that more and more is added all of the time. While it can be argued whether or not this is always a good thing, it’s wise to recognize that new regulations will likely lead to further expansion of the regulatory mandate and anticipate how and why your regulatory regime and processes will need to evolve.
- In the long run, we’re all better off: It’s a common reaction to complain about regulation, and it’s not entirely without merit. At times, new rules bear little relation to the economic realities of active markets and can even be counterproductive in terms of market liquidity and stability. By and large, however, regulations make the world better because they ensure fair and equitable treatment for all participants; the resulting increase in confidence and certainty allows for markets to grow and expand.
Where We’re Headed for Trade Surveillance and Compliance
Looking forward, there are several particularly prominent trends that will likely continue into the near future. Specifically,
- Coordination and cooperation increase: As the interconnectedness of markets and the sophistication of trading tools and strategies increase, the need for enhanced cooperation between regulators is all the more important. In the U.S., the CFTC, SEC and DoJ have increased their efforts as highlighted in the annual enforcement report from the CFTC, in which the agency revealed that they filed more actions in parallel with criminal authorities in fiscal year 2019 than in any prior year. Exceptions exist, particularly when it comes to EU and CFTC coordination for futures markets with likely strains arising from Brexit in 2020. However, the longer term trend points to greater cooperation.
- The net widens: Just as “playas gonna play”**, “regulators gonna regulate” which means that they are naturally inclined to take an ever more expansive view on the type of activity and actions that are subject to their oversight. For example, according to law firm White & Case, the CFTC reauthorization bill under consideration broadens “the CFTC’s existing authority to prohibit fraud and manipulation…from specific intent to recklessness in certain instances, and expand(s) the prohibition on false reporting to include ‘any false statement of material fact’ to the CFTC in any context”.
- MiFID II starts to bite: It has been two full years since MiFID II went into effect, and now is the time when we can expect the regulation to start to “bite”. It takes some time for participants to implement required changes and regulators to revise definitions and then it comes time for regulatory actions to start coming down the pike. We highlighted one area of concern in our blog on RTS 6, which governs the use and management of trading algorithms, and other aspects of MiFID II will see action as well. Be prepared!
- The picture becomes clearer in crypto: Cryptocurrencies were founded on the belief that they didn’t, or wouldn’t, need to be regulated, but the marketplace has other ideas about that. In addition to noted cases of loss and fraud such as Quadriga CX, practical matters relating to custody, taxation and more must be resolved in order to spur greater institutional participation in the asset class. In the long run, increased crypto regulation will lead to greater adoption, and the tide will continue to flow in that direction, a topic that we covered in our white paper: A Way Forward for Crypto Market Compliance.
The future looks bright
All in all, the decade just past was one of the most active decades for market regulation since the 1930s as new rules and new approaches were deployed in the face of profound changes in market structure and trading technology. It’s easy to lose sight of the fact that the global economy was in dire straits ten years ago; the strength and resilience of our current markets is a testament to the best efforts of regulators to get things right. While the markets face a host of difficulties, from xenophobic, beggar-thy-neighbor economic policies to radical technology disruptors like cryptoassets, the arc of progress is a strong one. We hope to see more good times ahead.
What changes might come in the year ahead? Read our “10 Radical Predictions for 2020” on our LinkedIn page.
Eventus Systems, Inc. offers a multi-award winning global trade surveillance and market risk platform Available as a cloud-based or real-time enterprise on-premise solution, the Validus platform provides sophisticated market surveillance and financial risk capabilities, enabling clients to solve some of the most pressing regulatory challenges. For more information, contact us at firstname.lastname@example.org