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Regulations, High Frequency Trading and Cloud Services

By Kulvinder Gill | Friday, November 4th, 2011

As part of our Exploring Cloud Services for Hedge Funds seminar recap, we have explored IT outsourcing and outsourcing middle and back office operations. In today’s final segment, we will look at compliance and regulatory requirements.

What are the main technology trends within buy-side?

There are many drivers affecting investment decisions today on technology, but the two main drivers are:

  • Regulatory change exemplified by the Dodd-Frank Act, money market fund rules, cost basis accounting, and the European Alternative Investment Fund Managers Directive (AIFM)

  • Buy-side firms in general are being affected by the rapid changes in the trade execution business where latency reduction, connectivity to new/more execution venues, and high frequency trading are increasingly popular topics.

The combination of these two drivers has placed a lot of emphasis on transparency and disclosure and resulted in more internal and external scrutiny. Effective risk control today requires firms to invest in data management in the broader context -- this includes data and systems integration, data quality, data processes and technology to efficiently manage the flow of data across what is a very complex real-time environment. The data management challenge is one of the bigger ones facing firms today and affects everybody from the trading desk and analysts through to the risk manager and compliance officer.

Some examples where regulation affects hedge funds are the AIFM rules and Dodd-Frank Act, which will increase reporting requirements to investors and regulators. Funds will need to create technology applications and processes so they can report investment performance, client assets, financial records, and other pertinent information on a regular basis. One additional area that may require technology upgrades is the management around new asset classes.

High frequency trading (HFT) is another key driver affecting change on the technology front. All the regulatory discussions on short selling, HFT, order management, and sponsored access mean firms need to continuously review trading tools and systems and have a more flexible approach to cope with increased scrutiny and future changes. The increased presence and impact of HFT in the markets and focus on low latency execution forces firms to look at upgrades to trading systems, connectivity applications, and trading hardware. 

This system review is necessary to continue delivering and securing profitable trading strategies and supporting best execution requirements and other external requirements. The volatility, lower ticket sizes and focus on latency generates an incredible amount of data to process at incredible speeds. The focus should be on how to connect to venues and how to manage that connectivity as an ongoing business, not just establishing the connection.

What are the implications for risk management and compliance of real-time, low latency markets (e.g. firms engaging in HFT)?

Hedge Fund Outsourcing Guide

Many firms' current infrastructures are not set up to handle unified performance levels across all the asset classes they trade or the areas and venues where they are active. Firms in this space often run multiple independent trading applications to manage the specific requirements of a market or the performance requirements of a specific strategy. What once served a wide area of the market from a trading perspective in the back-office, for example, cannot handle shorter-term and higher frequency trading strategies. Developing latency-sensitive trading strategies often requires new stand-alone infrastructures including back-office processes.

The main challenge for risk management and compliance management is bringing together an ongoing and holistic view of the firms' trading activities as it happens in real time. Decisions need to be made on what type of compliance and surveillance tools will be used within the firm to manage this to the satisfaction of regulators and investors, especially when running on different platforms and in different geographies.

Just as investments have been made to develop ultra low latency and low latency trading infrastructure (often including colocation, proximity hosting, multi-core processing, high performance data feeds, complex event processing (CEP) technology, etc.), investments need to be similarly made today to develop a low latency risk and compliance infrastructure to minimise enterprise-level complexity and risks.

How can the cloud or hosted services play a role in risk management, compliance, and managing market fragmentation?

Considering the regulatory changes affecting IT departments, trading across multiple venues exposes firms to a combination of national and international regulations. This needs to be managed in real time (trade, risk and compliance) with an infrastructure that can cope and grow with the business. Scalability, time to market, changes enforced on trading and risk infrastructure need to be managed in a cost effective way.

The global trading environment is much more open and accessible today. Hedge funds need to be able to reach new geographies and markets more rapidly than ever before, which creates challenges on how to deploy an infrastructure to tap into the opportunities that arise across the globe. Speed, costs, and flexibility are key words.  In many cases, it is faster and easier to work with a partner that has existing local resources or can leverage a global network of data and hosting hubs as well as expertise to manage a trading environment. 

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