RegTech in FX: Closing the gaps between regulatory intention and interpretation

The month of September will mark the 9 year anniversary since the 2009 G20 Pittsburgh meeting which established the framework for new derivatives regulation, leading to a fountain of new rules being established across different regulatory jurisdictions for financial institutions to follow.

First Published: e-Forex Magazine 76 / Reg Tech / July 2017

The FX market has been among those asset classes burdened with a mountain of regulatory change, in areas such as central clearing, order execution, price transparency, trade reporting and business conduct rules. Some parts of the FX market, such as spot FX, have been exempt from many of these new regulations, but the recently released Global Code of Conduct on May 25th has also established a set of principle-based guidelines to help reshape the way the markets and the people within them operate.

While trade execution requirements, central clearing and regulatory trade reporting, amongst other rules, have been established in the US already through the Dodd-Frank Act, in Europe, the revised Markets in Financial Instruments Directive and its accompanying regulation (Mifid II and Mifir), is only set to come into force in January, 2018, and will cover many of the same rules that have been introduced in the US and in other regulatory jurisdictions around the world. 

The new rules and principles mean that FX traders and salespeople have a mountain of compliance that they have needed, and still need, to work through as rules continue to come into force, in order to make sure they do not fall foul of compliance standards. Even though that seems like a very complex task, regulatory technology (RegTech) vendors have been responding with new innovations to help solve these various problems.

REPORTING

In Europe, Mifid II is set to impose pre- and post-trade transparency requirements on non-equity markets, including FX, once those rules come into force in January, 2018. These rules require disclosures of trade details from registered trading venues, either a multilateral trading facility (MTF) or an organized trading facility (OTF), to relevant regulatory bodies to help identify relevant positions in the market.  

Like most regulations, that requires a significant technological lift. NEX Group, which was spun out of the former interdealer broker ICAP, provides its NEX Regulatory Reporting service to help clients facilitate more efficient information management and trade reporting of FX derivatives contracts. 

“NEX Reg Reporting bring efficiencies to trade reporting by utilising technology to perform a series enrichments, transformations, determination checks and validations, in preparation for delivery to the regulatory end points subject to agreement from the client,” says Chris Thompson, product director at NEX Regulatory Reporting. 

“Known as our Regulatory Reporting Hub, all data is stored in Amazon Web Services’ highly fault tolerant, scalable and secure storage vaults, and retrieved using tools like MapReduce and Athena. This allows regulatory flow, exception management, management information and reporting to be supported and monitored via a centralised web-based user interface,” he continues. 

Chris Thompson

Chris Thompson

“NEX Reg Reporting bring efficiencies to trade reporting by utilising technology to perform a series enrichments, transformations, determination checks and validations, in preparation for delivery to the regulatory end points subject to agreement from the client,”

The scope of reporting is of particular interest to FX participants as there are specific nuances that apply to certain contracts but not others. For example, an OTC derivative, such as a contract for difference (CFD), based on a non-venue traded product may not be transaction reportable nor trade publishable, while a similar OTC derivative, but based on an EU venue-traded FX future or option, would be transaction reportable but not trade publishable.

A venue-listed contract would be transaction reportable if the venue was in the EU, and trade publishable if the trade was executed off-exchange. An OTC derivative like an FX forward might be deemed equivalent to an FX Forward trading on-exchange and therefore trigger transaction reporting and trade publication.

“Where RegTech can help in the above is in automatically analysing the features of your traded product, its underlying components and any venue-traded equivalents in order to determine whether and how to report on a trade by trade basis,” says Mark Kelly, head of professional services at NEX Regulatory Reporting. 

TRANSPARENCY

While NEX Group’s solution may focus on the post-trade food chain, other RegTech vendors are looking to make sure that by the time the trade lifecycle gets to that stage there is a transparent process in place which allows corrections on trades and near to record keeping. That is made tougher by roughly 50% of FX derivatives transactions being conducted via voice. 

According to report published by the Bank for International Settlements, FX spot trades are done electronically 70% of the time, while more complex derivative transactions like swaps, forwards and options are done electronically 40%, and 55% of the time respectively. 

To help keep a high level of transparency during the trading process, firms like GreenKey Technologies have launched a voice-to-text translation service, with the idea being to make sense of the sometimes complex language that is being exchanged between counterparties on an FX trade. “GreenKey today is not only offering a voice turret, but also a voice-to-data translation ability that serves the front, middle and back office. We can now provide the tools needed to enable real-time transcription and intraday playback of particular transactions,” says Nader Shwayhat, chief executive at GreenKey. 

“Voice recording as a requirement is now just expanded, but the pre-trade transparency requirements are new with respect to Mifid. There is no specific statement that says it has to be done the way GreenKey is doing it, but it just has to be recorded and available for audit within days. What we’re doing is providing a process that fully integrates with the systems on their desktop.  GreenKey doesn’t disrupt existing workflows; it enhances them,” he continues.

New rules and principles mean that FX traders have a mountain of compliance to work through

 

New rules and principles mean that FX traders have a mountain of compliance to work through

COMPLIANCE

The company has three key products – Voice, Scribe and Sync. The ‘Voice’ product enables “full trading turret parity, recording and mobility,” and can record and play back conversations during the day in case trade details or specific elements of a conversation need to be checked off with compliance teams or counterparties. 

“Think of all the number of times in a single day where conversations are misstated or misquoted, and you get all sorts of trade breaks that happen. If the counterparties are able to work things out on their own, at the point of trade, by just playing back a recording, it means they can stop issues before they become a regulatory or legal challenge. The dispute is managed at a relationship level rather than a legal one,” says Shwayhat. 

The ‘Scribe’ tool, that GreenKey announced on May 9th had its application accepted by the US Patent and Trademark Office, helps flag words that might be in breach of compliance standards.  

“For the front office using our Scribe tool, compliance absolutely factors into that. It can do real time surveillance, real time compliance, key word searches and tags, and it can flag certain words. There are a lot of capabilities that have been the standard within call centers for years, but now we’re looking to apply them to a dealing floor, which on some levels is just a massive call center.”

Catching acts done on the trading floor that may hurt a bank’s business has traditionally been easier said than done, however. With the launch of the Global Code of Conduct, enforcing new ethical standards on staff needs technological support in a modern, fast trading environment. Ideally, today, banks want to stop things getting out of hand before they even happen.  

Droit Financial Technologies LLC, a RegTech vendor specializing in helping traders on the sell side and buy side be regulatory compliant when trading, was set up in 2012. Its team is made up of experienced derivative traders, quants, e-commerce specialists and technologists who have created its flagship product, dubbed Adept, to help traders make the right decisions in a transparent way. 

“We created a product to systematize the process of taking regulatory rules and transforming them into what we call computational law,” explains Brock Arnason, co-founder and head of product at Droit Financial Technologies. “The idea being that you take a source text, implement a process where you can annotate that text and directly link it to decision trees. Every time you come to a decision you store a rich audit record.”

Nader Shwayhat

Nader Shwayhat

“Think of all the number of times in a single day where conversations are misstated or misquoted, and you get all sorts of trade breaks that happen.”

BUSINESS CONDUCT

With the onset of new regulation, oftentimes there are big operational risks around trading even a simple FX contract. Arnason says that Adept is designed to deal with the mountain of different legislative requirements and helps banks stay between the correct boundaries of regulatory scrutiny. 

“Our product offers a robust framework for internal and external business conduct controls. These include validation of client suitability and appropriateness, and a host of internal policy constraints for customer-facing transactions. The complex pre-trade rules imposed by Mifid-Mifir regulations will significantly change the process by which financial instruments are negotiated and traded. The ability to execute efficiently while demonstrating adherence to a strict code of conduct is essential to compliant global derivatives trading.” 

For those not necessarily on the trading floor, there is often a need to review and examine new regulation and track the progress of old regulation that comes out. Subscribing to emails from the various regulatory bodies around the world is not necessarily going to be the most efficient way of collating all that information. 

JWG helps aggregate all this information into one single spot: “A major challenge we hear from our banking clients all the time is simply that the sourcing and centralisation of all the obligations they are required to be compliant with can be a mammoth task for hundreds of websites in scores of jurisdictions,” says Elliot Burgess, head of products and client services for RegDelta. 
 
“RegDelta is a platform where a firm can find all their regulatory obligations in a central golden source database. We have a team of analysts tracking and monitoring new publications from regulators, we store all these documents in a single, unified format on RegDelta, which clients can use to analyse new developments at the paragraph level, track accountability in terms of who owns what, and interpret the impact of change on their operating model. It serves as the single version of their business truth,” says Burgess. 

Brock Arnason

Brock Arnason

“The ability to execute efficiently while demonstrating adherence to a strict code of conduct is essential to compliant global derivatives trading.”

AI, MACHINE LEARNING & CLOUD

The sheer scale and pace of change in the industry needs constant vigilance, but sometimes even sophisticated technology companies cannot keep up. RegTech vendors employ a mix of artificial intelligence, machine learning and cloud computing to help ease the use of their technology and be more efficient when deploying it. 

For JWG, the number of regulatory sources it needs to keep up with is a challenge. Some of the process is manual, but where it can help it, the firm uses website trackers and scrapers to gain the most up-to-date information for its clients. But even once it has that information, it needs a way of sorting it all out – something it uses specific technology for. 

“One major piece of technology we utilise in our RegDelta platform is ‘a semantic ontology manager’. We leverage it to give RegDelta the context for natural language processing and ability to bucket like obligations across hundreds of legislative initiatives down to the paragraph level. This is extremely important for firms that are needing to assess how well they have complied with the entirety of their regulatory rule book, rather than relying on a series of siloed projects that address one regulation at a time,” says Burgess. 

Droit Financial operates a model with similar technology.

Ieuan Williams

Ieuan Williams

“At NEX Reg Reporting we leverage the latest graph database technology to define regulatory reporting specifications in a semantic language capable of representing the complexities of trade reporting.”

“We have a systematic approach to change management for regulatory and market microstructure rules. Droit has automated robots that monitor hundreds of data sources. These include product eligibility at clearing venues, rule books for electronic trading facilities, formal rule publication by various global regulators, etc. Relevant changes are identified, modeled, and distributed to our clients in advisories and structured rule updates,” says Arnason.

The importance of translating all that data and putting it into a readable and workable format is also not lost on the RegTech vendors either. The sheer scale of the data made available has also led to opportunities to use machine learning capabilities within the RegTech solutions. 

“At NEX Reg Reporting we leverage the latest graph database technology to define regulatory reporting specifications in a semantic language capable of representing the complexities of trade reporting. This brings all reporting regimes into a single knowledge space, a golden source of specification, allowing us to extract meaning, observe overlap between regimes and, critically, formally proving a specification for correctness. This rich source of knowledge is exposed to our systems through a REST API, which is used to both generate validation and enrichment code for our software, and generate human readable English specifications in Excel or PDF,” says Ieuan Williams, CTO of NEX Regulatory Reporting.

Voice-to-text translation services can make sense of the sometimes complex language that is being exchanged between counterparties on an FX trade.
Voice-to-text translation services can make sense of the sometimes complex language that is being exchanged between counterparties on an FX trade.

“The sheer volume of data fed into the NEX Reg Reporting Hub provides valuable insights into the behaviour of markets. By leveraging Amazon Web Services we are able to analyse reporting data as it enters the Hub, aggregating this new information with close to half a petabyte of existing data, using tools like Kinesis, MapReduce and Athena. These enable our machine learning algorithms to observe market trends in near real-time,” Williams continues. 

The use of more advanced technology is not necessarily a win-win even for RegTech firms, but could be seen as something useful for improving current practices in the future. 

“Machine learning could be something we utilise in the future, but it’s not something we see as ready for prime time at the moment. I could see a situation where RegDelta could have a layer of artificial intelligence on top that could perhaps mimic human behaviour and interaction with relevant regulatory content, increasing the quality and match rate of relevant information to users. These are all things we’re thinking about as a value add, and we’re talking to a number of RegTech firms that are in that space. Job number one, however remains getting a holistic regulatory change management platform embedded in the toolset we use to manage compliance,” says JWG’s Burgess.

In some ways though, the technology used at vendors is too advanced for some of the banks. GreenKey’s Shwayhat says that instead of waiting for firms to catch up, they try and make it easy as possible to use their relevant solutions. 

“As much as banks say they want to deploy cloud, it’s still not quite there yet across the Street. We bring the cloud to them, so we can deploy GreenKey behind its firewall on site in very light-touch containerised deployments and leverage their own private server. Or if they are already using Google or Amazon, we can deploy within their existing cloud,” he says. 

Elliot Burgess

Elliot Burgess

“A major challenge we hear from our banking clients all the time is simply that the sourcing and centralisation of all the obligations they are required to be compliant with can be a mammoth task for hundreds of websites in scores of jurisdictions,”

FUTURE

Like the regulatory environment surrounding them, these RegTech firms are not able to just stand still, but must continuously evolve to their clients’ needs. In some cases, the new technology being used to meet certain, specific requirements will also present opportunities to provide solutions elsewhere in the bank workflow. 

“In addition to the above, NEX Reg Reporting plan to offer peripheral bespoke solutions to solve additional challenges that have arisen from MiFID II around order record keeping, commodity position reporting and extracting value and analytics from the data presented to us. Transaction reporting is at our core but regulatory technical standards create a wealth of opportunity for innovation in the future,” says NEX’s Thompson.

To make the most of the new technology, advancements in trading electronically in more complex derivatives will also make it easier to adopt new RegTech solutions. Judging by the pace in change today, that might not be a long way round the corner.

“A lot happens via voice, even if the final execution is the click of a button. So from our view, even if someone executes electronically, the person in the conversation is still very critical. Large complex FX derivatives, we believe, will continue to be done in some shape or form with human assistance. We’re trying to make that process more electronic, so as much as there are voice conversations happening, we want them to be done as electronically as possible,” says GreenKey’s Shwayhat.