Half of buy-side traders fear that the cost of risk trades will rise as a result of plans by the European Commission to shorten trade reporting delays, according to the results of June's reader poll on theTRADEnews.com.
“The response reflects the amount of risk business done by various buy-side firms,” said Kristian West, head of European trading at buy-side firm J.P. Morgan Asset Management.
“We see it as a real value-add and thus utilise it more than many – as a result we would weight the response differently.”
Many buy-side firms are concerned that brokers who take on risk trades will have less time to unwind positions – and must therefore raise costs to cover increased risks – under proposed new rules to be introduced as part of MiFID II, which may reduce the acceptable reporting period for large trades from three days down to the opening of business on the next working day.
“The guys who do risk trades are nervous about the changes; they worry that regulators will replace one set of arbitrary time limits with another,” said Guy Sears, director of wholesale at UK buy-side industry body the Investment Management Association.
Risk trades are conspicuous in the lit markets – typically large orders for illiquid stocks, trading away from the market price – and so once reported, are easily identified. Currently the three-day window on reporting allows the broker time to unwind or rebuild the position as needed. Next-day reporting would increase the risk of market impact and consequently hike the premium charged to the buy-side.
If costs are increased then risk trading could become too expensive and this could affect the stocks of smaller firms more badly than others.
“Small- to medium-sized enterprises (SMEs) have a much more restricted shareholder base,” said Sears. “[The proposed delay] just gears up the fact that the smaller a firm is, the harder it is to find liquidity in its stock and the harder it will be to get away with trading a large chunk without market impact.”
While 49% of survey respondents expressed fears over costs, a significant minority (31%) asserted that the main effect of the shorter reporting delays would be to increase transparency in the market. A smaller number (20%) identified the exploitation of trade information by high-frequency trading (HFT) firms as a risk.
“The increased cost of risk trades and greater exploitation of order flow by high-frequency traders are both unambiguously negative,” said Stephen McGoldrick, director of market structure at broker Deutsche Bank. “Some of the 69% of people that voted for these options will probably acknowledge that shorter delays will lead to greater transparency, but at a worse price.”
A delegation of buy-side traders, including J.P. Morgan's West, approached the EC in March to put the case against shorter trade reporting times to European rule makers. However in April, Laurent Degabriel, policy officer for securities markets at the EC, reaffirmed the commitment to transparency above all else.
If the delays are included in the final proposals from the EC, expected in October 2011 at the earliest, there is still room for flexibility that would allow for improved transparency without being overly punitive on asset managers.
“The EC is likely to be most sensitive about SMEs; you may find that stocks that are widely traded on lots of markets will get shorter delays, while SME stocks keep reporting delays where they are,” he suggested.
McGoldrick agreed that the EC should take a closer look at market circumstances rather than applying a broad brush approach to reporting delays.
“Currently, you qualify for a trade delay because of the size of an order, but this applies irrespective of whether a trade is done on the quietest trading day in August or just after a significant market announcement,” he said. “In both instances, liquidity will be significantly different and we think regulators should look at adopting an improved delay regime that looks at prevailing market conditions, instead of just reducing the delays.”