This weekend, the leaders of the world’s 20 largest economies will meet in Toronto to discuss international financial reforms that will — hopefully — help prevent the type of global recession that occurred after the subprime crisis. Particularly on the heels of the Congressional reforms just enacted in Washington, the G-20 discussions will mostly focus on regulation.
Some feel as though a major overhaul is not altogether necessary, however. Some think that technology and greater access to better information can provide all the risk management the financial sector needs. Kevin Heffron, deputy managing director of Trayport, Ltd. in London is among them. His company provides electronic trading systems to brokers who trade equities, currencies and commodities, and he recently sat down to share his perspective.
Jared: This weekend in Toronto, G20 leaders will discuss a whole host of financial sector regulation proposals. Generally, their goal will to be develop some standards and rules that will lessen risks – the risk of over-leveraging, the risk of contagion, the risk complicated trading. What measures do you think are most necessary, specifically in the trading and exchanges world?
Heffron: A proposal to move all trades to exchanges is among the reforms being considered in Toronto. We believe that this is an overreaction to the events and excesses of the recent past and will not necessarily lead to reducing risk. Eliminating OTC trading is not the solution, doing so consolidates trading into less flexible silos and results in less democratic markets. We believe that regulated, well-organized and transparent OTC electronic trading platforms with connections to a variety of centralized clearing counterparties, when appropriate, can be an equally effective tool to reach the G20’s goals to mitigate risk. We only have to think about the recent ‘’Flash Crash’’ to know that the exchange only model has serious flaws.
The key to mitigating risk in the OTC sector, is to broaden access to information and transparency. This approach can achieve the same regulatory goals now being sought by the G20 and the U.S, Congress without requiring the markets to restructure themselves in ways that might have unintended consequences — including potential losses of liquidity leading to higher and more volatile pricing.
Jared: So the best way to lower these risks is not through regulation, but through better information? Through better technology and more real-time, widely available information about trades?
Heffron: We support regulatory efforts, however we believe all the regulation in the world won’t reduce risk unless the information is available and accurate. It comes down to the reliability of the information — no amount of regulation can overcome the lack of accurate data or intentional manipulation. Access to technology simply focuses more eyes on any nascent problems in the financial markets.
We are developing technical solutions that increase opportunities for market users and their regulators to assess risk. Post-trade, we are providing straight-through processing to a variety of clearing houses, price reconciliation and confirmation services so you know the trade has been cleared without risk. Together with calling for a repository of pricing information, we are turning to technology to achieve the goals of the G20 Summit.
Jared: Is it a matter of the public sector being under-educated to provide proper regulation?
Heffron: While most of the non-investment community — including US Congressional leaders – believes the world would be better off if all assets were to trade on exchanges, it is important to point out some key facts. For instance, there is a large electronic OTC commodities market operating in Europe that sees some of the world’s largest deals go through hybrid trading screens with counterparties being put together by interdealer brokers. This network provides risk management, straight-through processing, clearing capabilities, counterparty credit management, real-time reporting and transparency. If one were to look at this operation and its components, it would look very much like an exchange. In short we are bringing the same level of trading technology and risk reduction to the OTC community.
Jared: Can this concept of “more information, less risk” work in other areas as well? Both in and outside the financial sector?
Heffron: Here is an example. Large international energy companies, whose primary business is to produce and distribute electricity, trade electric power all the time. They are constantly going to the open market to manage their risks. In order to optimize this external market activity, they need to have a full and timely understanding of the risk profiles of the various operating units of their own enterprises. This requires a top-quality internal risk management system allowing them to optimize internally before executing external market transactions. Simply put, lowering the cost and increasing access to real-time data reduces risk across every industrial sector and at every level.