Global economic slowdown, monetary policies and political unrest have introduced significant uncertainty to the equity market. The risk of holding a U.S. equity position overnight, measured by the difference between previous day’s closing price and market opening price, has increased by more than seven times in the last four years from 2.3bp in 2012 to 17.5bp in 2016 H1. The overnight gap risk is trending towards the 2008 financial crisis level at 28.1bp. The higher degree of interconnectivity and information flow among global equity markets contributes to the increase in the overnight gap risk. In particular, information revealed in the Asia equity markets appears to have a significant impact on the U.S. market open. For example, the intraday return of Nikkei-225 index (day open to day close) exhibits a high correlation to the overnight return of S&P 500 index (previous close to day open) at 43% in 2016 H1. The current inter-market correlation is the highest since the 2008 financial crisis, and has doubled in the last two years. For a strategic trader, the gap risk in the U.S. equity market represents opportunity to profit from the information revealed in Asia. The signal from Asia appears to be even stronger if the intraday move is larger. If Nikkei-225 index changes by more than 1% from open to close, its correlation to the S&P 500 index increases to 56%, compared to only a 25% increase if its intraday change is smaller than 1%. On the other hand, the ability to unload the risk during Asia hours becomes critical for a risk-averse trader. When important corporate or government events are going to happen, risk-averse traders could protect themselves from the price swing by off-loading their positions early. When the two types of traders meet, a potential matching of orders happens. There are two advantages for this type of matching. First, the matching would likely happen during Asia hours when information is revealed. This provides risk-averse traders the ability to hedge before U.S. market open, at the same time, and allows strategic traders to anticipate the gap direction. Second, the matching price is likely to be the previous day closing price. While the closing price is commonly used as the valuation benchmark, this would provide the maximum hedge for risk-averse traders as well as the maximum gap exposure for strategic traders. The matching results from Bloomberg Tradebook’s IWUD<GO> matching platform confirm this phenomenon. As an independent equity crossing platform, IWUD<GO> allows traders to show their interest of matching U.S. equity during Asia hours. Quantity and price are negotiable between buyers and sellers. From the U.S. equity matches in 2016 H1, 96% of them were completed at the previous closing price. On average, IWUD<GO> matches offset 90bp of gap risk, measured by the matching price vs. the next day opening price, which represents 15 times the average bid-ask spread of the underlying stocks at 6bp. This illustrates the value of an off-hours off-exchange crossing network.

MiFID II requires trading venues to store personally identifiable information (each potentially 50 characters long) relating to the traders, investment managers and clients of the orders they receive. While it might be very convenient for surveillance to have order book data married up with personal data, this requirement is not only an additional burden to system load but also raises data privacy concerns. To mitigate these issues the industry is currently working towards an approach that allows trading platforms to rely on short codes submitted during trading, then receiving the mappings to the sensitive data via a separate link at the end of the day. Certainly the short code approach looks like the best way forward given the circumstances, but it forces market members to manage another long list of codes for each trading venue. Wouldn’t it be great if all the venues were to agree to use the same short code standard? Better still, and safer, if trading venues were only obliged to store the short codes while ESMA managed the mappings between those codes and client information. Wishful thinking, perhaps, given all the other mandatory MiFID II work going on and the short implementation timeline.

During recent months, I’ve enjoyed a real ding-dong of conversations between Europeans, Asians, Americans and Brits about FinTech and, to be more specific, RegTech. RegTech is a couple of years in catch-up with FinTech, and is all about how to use technologies to make regulations more efficient and effective. The claim is that the UK leads the field in this space, but why would that be? My claim is that it is because the UK Government and the London Mayor’s Office has made a real agenda and focus of making FinTech London and, more widely, Britain their leading platform. Bearing in mind that financial services delivers a double digit GDP and multi-billion dollar tax contribution to the UK economy, and you can see in part why this is important. But has this made any real difference when over half of the FinTech investments are in Silicon Valley, USA and Continental Europe is dragging its heels by comparison. I guess the real difference is three discussions that took place in recent times: one with the White House, one with a Member of the European Parliament (MEP) and one with the Financial Conduct Authority (FCA). The White House discussion was about decentralized, rules-based regulation and how that is preferable to centralized, principles-based regulation. Each state can pretty much do its own thing, unless it’s embedded in a lengthy law like Dodd-Frank. Dodd-Frank started out as an 850 page document but, after five years of discussion and fine tuning, is now almost 14,000 pages and 15 million words. Even with all that, there’s 40 percent still to implement and the legislation is creeping at the seams of insanity when it comes to interpretation and implementation. It is claimed that this is why the USA has not seen a single new bank start-up in the past ten years, except for a few community banks and the new Goldman Sachs digital retail bank. Compare that to the UK, where almost 40 new banks are going through the regulatory sign-off process with Atom Bank being the first out of the gate. The FCA launched a new Project Innovate earlier this year with its first deliverable being a Regulatory Sandbox, announced in April. The Sandbox allows start-ups to test their ideas with the regulators before release on the general public, and engages FinTech start-ups so that they can get a basic license to offer under restrictions within just two months of application. That process is being copied in Singapore, Hong Kong, Dubai and other nations.  In fact, there’s a competition growing between all these centres. By way of example, the Monetary Authority of Singapore (MAS) is trying to lead Asia as the Fintech focus centre, and have allocated USD$45 million per annum through to 2021 to attract start-ups to their City.  I would say country, but Singapore in this context is like London, Hong Kong and New York, a bit City hub offering a global financial centre focus. So we have all these centres competing to be Fintech hubs with regulatory support, but the USA and Europe are more retrospect. Europe, like the USA, prefers rules-based regulations in general, and would limit start-ups from getting licences too fast. Having said that, Europe is also somewhat innovate with the open sourcing of bank data under Payment Services Directive 2, PSD2 for short, that forces banks to make their data accessible toTrusted Third Parties via open Application Program Interfaces (APIs). Americans don’t like APIs or, to be more precise, American banks don’t like APIs or data access and are fighting against such openness through Washington lobby groups. But the real test of Europe is whether it is stronger together or not. This is the test of the the Brexit, where we could see fragmented Fintech as a result. If the UK loses passporting to the Single Market for financial firms, where do London’s 1.5 million Fintech and financial employees go?  Back office to Dublin, trading to Frankfurt and Paris, and innovation to Finland, Norway and Madrid. This is the danger of the Brexit challenge. My MEP friend was saying that the fact a UK MP can stand up as part of Europe, and fight against the American interpretation of the Basel rules, is testament to the backing that the Union gives us and her. Together we are stronger was her message. It is an interesting message as, in evidence of our divisions, the UK’s rules and innovation structures designed to fast-track firms and create more competition, differ widely from those in Germany. As my German regulatory friend commented: you are more flexible in London. My FCA friend replied that we are more pragmatic. Whatever your views, it is clear that regulation is as much a part of the financial market operations and attractiveness as liquidity and, in order to attract liquidity, regulators are trying hard to create an open, simple and accessible environment for both incumbents and start-ups to operate. London and the UK is clearing in the front of field in that debate. Will the rest of Europe and America catch-up or will we see the errors of our pragmatic ways?