An Exchange as 2012 Begins

Author Name: 
Peter Clifford

Occupation : Market operator

The financial services sector was tested last year: by clients looking for secure investments and efficient, effective trading solutions, by regulators scrutinizing “speculation,” short selling, and systemic risks, and by the general public protesting bailouts or financial conditions. 

In 2011, they came to exchanges with their questions – sometimes literally.

Beyond their well-known brands, and beyond being symbols for business and wealth creation, why would an exchange be the focus of this attention? Was this a misguided or outdated concept about markets?

In recent years, what was once a relatively homogenous group of market operators is now a diverse group of companies. The differences continue to expand between exchanges in key areas of business and strategy. In a global market vying for investment, the competitive landscape differs from one jurisdiction to another.

For some, competing in fragmented markets means operating your own dark pools, ECNs, ATSs and other execution venues; for many, the responsibility for overseeing the quality of their markets, the integrity of trading and the vetting of listed companies was impacted from years of deregulation; and for most, the investments in technology are vital to attract liquidity to transparent markets.

Core values and new challenges

What was recognized by the traders, regulators, policy-makers and ordinary citizens is that while a range of alternatives exist for many of the things exchanges do, how these markets are operated remains extremely important. Certain values, including transparency and fairness, are very valuable indeed. 

Early in 2011 the WFE initiated a self-assessment by all its members on the subject of business standards.  This reinforced some longstanding criteria, for example requiring cash market members to have a fund-raising capacity for listing companies. It also introduced new rules that make it mandatory for market regulators to be members of the International Organization of Security Commissioners (IOSCO).  Under these criteria, the 54 WFE members actually operate over 100 distinct equity, options and futures exchanges in 60 countries.

Simultaneously, a strategic survey identified top global priorities.  These topics were grouped into five broad categories:

  • The first concerns the core values of exchanges, and their role in society.  This includes a focus on the real economy (raising capital for SMEs), rebuilding trust in the financial markets, and supporting developing markets standards and infrastructure.
  • Market quality constitutes a second group, with concerns of issuers and investors expressed over market fragmentation, and new trading technology at the fore.
  • With the reforms of the over-the-counter (OTC) markets in derivatives still far from being enacted, exchanges are helping to smooth the evolution of the global risk transfer market towards a more transparent and better regulated tool for financial innovation.
  • Post-trade issues are a perennial concern, but 2012 brings a unique set of challenges to the market as Basel III increases pressure for better use of collateral. 
  • And last but not least for the WFE is the question of global coordination of all these rule changes.  The coordination between nations and regions is a key element to success in defining regimes that will decide such questions as where a credit default swap is cleared.

Fighting for Greater Transparency

Last year, WFE exchanges consistently called for greater transparency for financial markets, and meaningful implementation to reform of the OTC markets.

In February 2011, WFE Chairman Ronald Arculli responded to the IOSCO consultation on issues raised by dark liquidity.  IOSCO asked whether “Dark pools….should provide market participants with sufficient information so that they are able to understand the manner in which their orders are handled and executed.”

The importance of this point was highlighted months later when one US dark pool settled with the SEC over allegations that it had misled it clients, and that a very high percentage of trades were in fact conducted with the broking arm of a related company rather than being matched with other buy-side institutions.

The WFE’s Chairman noted: “The economic purpose of dark orders on exchanges or in dark pools was to facilitate orders of such a size that the market might respond adversely to the client.  But the practice has diverged from that purpose, and today in most cases it is an unknown mix of small retail orders that are being run through dark pools, together with very large institutional orders sliced by algorithms into small “child” orders. This second category is the larger portion of the business. Not exposing those orders to the lit market means that they might not benefit from potential price improvement, and leads to an impoverishment of public, lit price discovery. “

Also in February 2011, the European Commission launched a sweeping evaluation of the MiFID Directive.  In a letter addressed to Mr. Michel Barnier, European Commissioner for Internal Market and Services, the WFE exchanges came together to comment on a variety of market issues including market data, capital raising for small and medium sized enterprises (SMEs), OTC products and commodity futures “speculation.”

Reforming the over-the-counter markets

Poor quality of information and faulty risk management of OTC derivatives contracts have been recognized as a significant cause of the financial crises the world has been experiencing since 2007.

The September 2011 IOSCO consultation on “Requirements for OTC derivatives data reporting and aggregation” was a deep dive into the question concerning what information needs to reported, to whom, and for what reason?  

WFE supported the CPSS-IOSCO Task Force recommendation that at a minimum transaction level data be collected, including the transaction economics, counterparty information, underlying information, operational data and event data.  Clearly, mastery of the overall capital markets environment – its regulated and unregulated parts - must be regained, and these data points are essential for completing the picture. 

But the WFE members also found it necessary to develop more information on how the management of these extensive, complex data sets will be set up once the mandate for market participants to report to trade repositories has been established.

In June of 2011, the WFE leaders from the futures and options exchanges, aka IOMA – the International Options Markets Association - addressed a letter to Mr. Timothy F. Geithner, US Secretary of the Treasury, voicing concerns about exemptions of foreign exchange swaps and forwards proposed to the Commodity Exchange Act.

The regulated futures and options exchanges pointed out that while current market practice adequately deals with certain risks in the two-day foreign currency spot markets, it does not in any way address other important risks that are inherent in the foreign currency derivatives markets.


In August 2011, an IOSCO questionnaire on the “Regulatory Issues Raised by the Impact of Technological Changes on Market Integrity and Efficiency” examined the impact of high frequency trading (“HFT”).

While some policy-makers are skeptical as to the benefits of HFT, the WFE exchanges pointed out that this moniker includes many different types of trading strategies and businesses.  The rise of HFT corresponds to the higher levels of fragmentation of market liquidity that are directly linked to choices made in the past by policy-makers and regulators in several markets.

The public response from WFE was another opportunity for this industry association to refute common perceptions that HFT caused the “Flash Crash” in the US, or that HFT had led to higher levels of settlement failure. 

A subsequent issue of the WFE Focus magazine (September 2011 issue - ) included more information on the subject, and late in the year the WFE Statistics Advisory Group agreed to set up a task force to look at new metrics that might be adopted to look into the questions of market quality. 

Advancing the cause

WFE benefits from being able to attract input from market experts from around the world contributing viewpoints on hot topics in our monthly magazine, Focus, in meetings and within the WFE  LinkedIn discussion group on-line ( ).  The support of the Board of Directors ensures that greater visibility on these issues will continue through 2012. 

What does it mean to be an exchange in 2012?  That will defined in part on the values that exchanges defend together with their clients, regulators and public. As providers of a critical economic good, they must continually prove their commitment to improving the markets and the value of the public’s investment in the future.