The Futures Industry Association (FIA) – the industry body representing organisations active in the trading and clearing of listed derivatives and over-the-counter (OTC) derivatives – says members are looking into how blockchain and distributed ledger technology (DLT) can be used to their advantage.
Greg Wood, senior vice president of global industry operations and technology, says the FIA is researching the impact of fintech developments on an ongoing basis within the derivatives ecosystem, but interest from across the industry is heightening.
“We’ve seen disruption over many years as trading and clearing becomes increasingly electronic and automated in nature,” he says. “Our members are interested in applications that provide solutions to operational and regulatory requirements that integrate with existing workflows, and - where necessary - existing service providers.
But in the highly regulated derivatives space, which has felt the impact of a range of new rules and reporting requirements in recent years, adopting new technologies is less straightforward than in sectors such as retail banking Wood tells bobsguide.
Here, Wood considers the relationship regulators have with blockchain and other fintech developments, and the impact artificial intelligence has had on financial markets.
How much have fintech start-ups disrupted the larger players in derivatives markets?
In contrast to fintech in retail banking or mobile payments, where you have the potential for an "uber moment", the focus in capital markets is mostly about enabling innovation rather than disrupting existing business models. To this point, FIA has highlighted several firms within our Innovator’s Pavilion showcases at our conferences. Most of these startups are seeking to transform processes within the incumbent institutions rather than displace them, and a few of these firms have been able to make headway into the industry by offering solutions that are lower cost than existing providers and/or provide greater efficiencies. However, as with all industries there are many challenges around wholesale adoption – especially within the large bank-based clearing firms that set a high bar for any technology provider to meet before they can be integrated into the bank’s technology stack.
Blockchain in particular has overhauled many markets. Where - across the derivatives ecosystem - would you think it's had its biggest impact? And which corners of the market do you think it will have greatest resonance?
We’re still watching developments in this space. Many have been around the periphery of the industry, for example there have been several proofs of concept for physical delivery of commodities, as well as interesting developments around collateral movement at certain clearing houses. These are areas that have traditionally been very inefficient and ready for disruption. We have yet to see anything that may disrupt the traditional model of central clearing of trades - though there are some proposals for creating an industry wide workflow tool for OTC derivatives that could complement – or indeed challenge - existing workflows provided by third party service providers.
Are there any areas blockchain and other recent tech developments require regulatory attention?
We know that regulators are following all developments across fintech, not just blockchain. The challenge for any regulator is to understand how new technology works within existing rulesets. In general FIA have advocated that it is the application of technology that needs to be compliant with regulation – which should be principles based to allow for evolution of practice - rather than regulation being rewritten around technology. We have seen regulators approach topics such as automated trading in a variety of ways previously and there is a danger that regulation that becomes too prescriptive may inhibit innovation.
Are there any use cases for blockchain that you think regulators should consider for the use of surveillance or reporting requirements?
We’ve seen other technologies such as machine learning making headway in surveillance as pattern detection becomes increasingly difficult in the big data generated through high volume markets.
Does the FIA have any concerns around the security of blockchain, or the associated APIs?
Cybersecurity should be at the heart of any application of technology - be it blockchain, cloud computing, SaaS, neural networks, etc. The financial services ecosystem is only as robust as its weakest link so anything deployed into production should meet the appropriate standards - such as those promoted through the NIST Cybersecurity Framework in the US. As fintech firms become mainstream it is important that they put cybersecurity to the fore of their platform, especially since large financial institutions will not integrate those platforms without it.
Global derivatives trading firms currently face more regulatory pressures with Mifid II, Dodd Frank and its reforms etc applying compliance and reportage pressures. Are systems adequate, or is there a need to utilise more fintech applications to lighten the workload?
New regulations - such as the rules in MiFID II and EMIR on reporting - have certainly put additional pressure on trading and clearing firms, and regtech solutions on reporting, in particular, have picked up some traction especially as firms have common requirements that are better outsourced than developed in-house. Regtech is another example of how technology is not necessarily disruptive but rather complementary to existing process - the goal is not to eliminate the need for compliance, but rather to help banks, brokers and trading firms cope with huge increases in regulatory requirements, and do so in an efficient way.
Artificial intelligence looks to be the next big tech revolution, particularly for algorithmic trading firms. How could that reshape derivatives markets?
We’ve seen continued evolution in algorithmic trading for the last 10 years at least, with pattern detection, complex event processing, etc, becoming increasingly ingrained in how automated trading systems have become more sophisticated. This is not just the domain of a few technologically sophisticated firms; all types of market participants are utilizing automated trading tools that are becoming smarter. These tools can be provided by software vendors, brokers and now through crowd-developed platforms with embedded machine learning and other forms of AI becoming increasingly mainstream. However, it is important to note that regulation in this space ultimately puts the responsibility of how automated trading systems interact with the market squarely on the human overseeing the machine. As automated trading systems continue to evolve, the focus should remain on ensuring that there is clear governance in place regarding the systems’ development, testing, deployment and monitoring - as well as requiring that the appropriate risk controls are in place at the firm employing the system, the firm providing market access and at the market itself to mitigate the impact of any potential issues. It is through this type of framework that innovation can continue without the need for reactive or prescriptive regulation.
If you enjoyed this article and are interested in hearing the perspectives of the financial industry on the applications of blockhain technology, listen to our podcast entitled "How long until blockchain makes a telling contribution to financial services?" as we explore the brave new world of blockchain with an expert panel from IBM, Barclays and exciting startup, Synswap.