best practices and compliance across the industry, including the types of tools and technologies needed, for micro-second trading across multiple asset classes” recalls Berman, whose early career included a stint at Larry Hite’s MINT CTA as well as co-managing a hedge fund at ED&F Man. Berman is now a type of compliance consultant, helping clients draw up internal policies, procedures, protocols and internal training programmes for employees. “The legal interpretation of security rules is one thing and the practical interpretation of the rule can sometimes be more difficult” he finds.


But more guidance is becoming available, in the form of the 743-page-long Regulation SCI (Systems Compliance and Integrity) rule which “augments and formalises many procedures for exchanges and large Automated Trading Systems (ATS)” he outlines. SCI came into force on November 3rd, 2015. Berman explains “systems have to be in compliance as of that date and SCI is about making sure registrants take it very seriously, and get senior people at all levels to govern software, integrity and backups”. Systems need to be tested regularly as careless errors in coding could cause problems and “there have been very significant fines related to these types of issues in the past” warns Berman. He recognises that no system can be robust against every possible negative eventuality, but Berman hopes “SCI encourages participants to build the systems as robustly as possible with policies and procedures to mitigate and minimise damage to yourself and markets”.


Angst over Liquidity Market structure is another area of Berman’s focus and in fixed income markets there are many complaints about liquidity – but Berman notes “the jury may still be out on this based on studies by the Fed, including the Fed’s new liquidity blog (Liberty Street Economics)”. Still, he recognises that there is “angst about fixed income markets, including declining dealer inventories, and concerns over the Treasury flash crash in October 2014” and is keeping abreast of a whole host of new initiatives. These include the growth of new venues, such as alternative trading systems, as well as new methods for trading fixed income securities, including those that focus on buy-side to buy-side trading.


Despite the diversity of trading venues, only a small number of bond issues trade every day, and for companies with multiple issues only some of them may trade daily – meaning that some sellers may struggle to find buyers. The liquidity picture in bond markets is complicated by the number of highly customised issues, so some large asset managers are calling for more standardisation with a few, plain vanilla CUSIPS instead of hundreds of them.


For the time being Berman reckons low rates make it easy for companies to raise debt and less likely that companies make changes such as streamlining bond issues.


SEC Proposals for Liquidity Risk Management The SEC is heeding investor concerns however, and its latest proposals for mutual fund liquidity risk management illustrate how the complexity of regulation has grown.


“In contrast to some parts of fixed income markets, Berman judges liquidity in equities is typically higher for many large- cap stocks and often reasonable for smaller stocks.”


“A typical rule was once a few dozen pages long but now they can be 500 pages or more” says Berman.


To cut to the chase, the nub of the proposal is that mutual funds may need to start quantifying position-specific liquidity, in terms of how long it may take for a fund to sell its holding. The associated requirements will create extra work.


“Some funds do all of these things, but the vast majority do not, and others don’t do any” is Berman’s 10,000 feet view. For instance even though many firms are of course monitoring liquidity for internal purposes, reporting the data to the


regulator will require the involvement of general counsel and CCOs.


The associated proposal for ‘swing pricing’ would also be new for US mutual funds. Although this type of variable fund pricing is used other jurisdictions such as Luxembourg, Berman sees “significant ramifications in terms of what threshold triggers the swing pricing, how it is changed, and how the NAV of the fund itself could change due to the cost of trading”.


Rebates Debate In contrast to some parts of fixed income markets, Berman judges liquidity in equities is typically higher for many large-cap stocks and often reasonable for smaller stocks. But for small and micro-cap stocks there are concerns about overall market liquidity as market cap declines concerns about liquidity grow and here proposals such as the two year Tick Pilot programme announced in May 2015 are aiming to test if liquidity improves when spreads are forced to be widened.


Former SEC Commissioner Luis. A. Aguilar has for some time been calling for a review of the exchange rebate model, and in November called for a pilot suspension, for the most liquid stocks. Berman thinks changes to the maker-taker rebate regime “could have big consequences for everyone including retail investors” and this view was shared by nearly all EMSAC participants in the October 27, 2015 meeting.


The notion of nominally fixed commissions, charges and rebates seems strange to Europeans who typically pay in basis points, but fixed rate charges do have a disproportionate impact on lower priced shares (which tend to belong to smaller companies including ‘microcaps’). “For a stock with a penny spread the rebate becomes a chunky amount” says Berman and he notes that some exchanges may offer bigger rebates for larger volumes. Therefore, to reduce or eliminate rebates “may widen the spread for retail investors” Berman worries, but the issue is not that simple – because there may be unintended implications for other parties, including trading venues.


Various rebate models exist. Berman explains how for most models, the party posting a quote that gets hit earns a rebate, and the party that accessed that quote pays a fee. In the inverted model, the party pays if a posted quote is hit, and that party that accessed the quote receives a rebate. There are even more models for off-exchange venues. There is an on-going debate over whether the charges and rebates should be reduced, capped, subject to separate rules - or indeed left alone - and EMSAC’s newly created Regulation NMS sub-committee may report further on this in 2016. THFJ


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