Across Time and Space: MiFID, MAR, Dodd-Frank, and Universal Time
By George Bollenbacher, Capital Markets Advisors
Originally published on the TabbFORUM
In today’s markets, both the buyer and seller – the liquidity maker and the taker – increasingly turn executions over to technology. As a result, market regulators are suddenly concerned about the accuracy and synchronization of the markets’ clocks. But answering the question, ‘What time, exactly, is it?’ can be a fraught and expensive proposition.
One of the market teapots that is having its own fair share of thunder and lightning is the rather arcane area of time in the markets – in particular, the deceptively complex question of: “What time is it, really?” As we shall see, answering that can be a fraught and expensive proposition.
Understanding the Basics
The importance of time and time synchronization is based almost entirely on the automated nature of markets and especially of market participants. In the olden days, when humans routed orders to exchanges or OTC market-makers, trading was slower, volumes were lower, and precise timing wasn’t very important. With people making decisions all along the order path, at people-speed, it didn’t matter so much exactly when every step of the process happened.
Today, many of the trades executed in the myriad markets for every type of instrument are done completely by algorithms. Both the buyer and seller, both the liquidity maker and the taker, increasingly turn the executions over to technology, so the norm is now to have bots trading with bots. And the trend will only become more pronounced.
What Time Means
Thus the new markets are all about time. In addition, the timekeepers all operate behind the scenes, but we now need to have answers to such questions as:
- When, exactly, did the order go in?
- When, exactly, was the bid or offer made?
- When, exactly, did the execution occur?
In particular, time affects the quality of execution – as in:
- What was the market when your order went in?
- How long did it take your order to get in?
- When did your order trade?
- What happened in the market between when your order went in and the execution?
And time is critical in detecting market abuse. For example:
- Spoofing – How long were orders available for execution?
- Painting the Close – How much before the close was a trade done?
- Wash Trading – How long between offsetting trades?
- Painting the Tape – How long between trades between market-makers?
So it shouldn’t surprise us that the world’s market regulators are suddenly concerned about the accuracy and synchronization of the clocks that answer all of these questions.
What the Regulators Say
The first place to look is in Europe, where we must leaf through MiFIR, MiFID II, MAR, and MAD. In all of those pages, we find one reference to clocks – Article 50 of MiFID II, which requires that “ESMA shall develop draft regulatory technical standards to specify the level of accuracy” of business clocks. On July 6, ESMA published the required Delegated Regulation and its Annex. The reg requires clocks to sync with Coordinated Universal Time (UTC), while its Annex sets out the level of accuracy.
Before we look at the requirements, though, we have to ask the inevitable questions of applicability: To whom or to what instruments does this apply? The answer is that it applies to “Operators of trading venues and their members or participants.”
We already know what venues mean in MiFID-speak: RMs, MTFs, OTFs, and SIs; and we can surmise what is meant by members. But who are participants? Here, the Delegated Regulation specifies: “Persons having access to regulated markets or MTFs” but not “users who only access the trading venues via direct electronic access,” and apparently not those who access OTFs or SIs. That looked helpful until the part about electronic access, and then it seemed to fall apart. So is an asset manager who executes a trade on a venue through a broker a market participant? What about a customer that has direct market access? I don’t know, but I’m sure ESMA will clear it all up for us before January 2018.
Enough stalling, though – it’s time to find out what the regulations require, and it’s all in one small table:
First, ESMA specifies both the granularity of system clocks and the divergence from UTC. If the trading system has a gateway-to-gateway latency of greater than 1 millisecond, the system clock must be within 1 millisecond of UTC time, and must keep time to within 1 millisecond or better. For systems with a latency of 1 millisecond or less, the clock must be within 100 microseconds of UTC, kept to 1 microsecond. One other note, voice trading systems that do not allow algorithms have a 1 second requirement.
And what is latency? “Gateway to gateway latency shall be the time measured from the moment a message is received by an outer gateway of the trading venue’s system, sent through the order submission protocol, processed by the matching engine, and then sent back until an acknowledgement is sent from the gateway.” So latency appears to encompass execution, not just receipt and acknowledgement.
In the U.S.
To begin with, Dodd-Frank itself says nothing about clock synchronization. In addition, the CFTC has no rules about it either, although it was discussed at CFTC meetings in 2012, 2013, 2014 and 2015.On the other hand, FINRA, acting on behalf of the SEC, issued Regulatory Notice 16-23 last July, which does address timing and synchronization. It is effective in February 2017 for systems that capture time in milliseconds or finer; in Feb 2018 for systems that don’t. Firms will have six months from the effective date to comply, and all the requirements are contained in FINRA Rule 4590.
So let’s look at FINRA Rule 4590.
- Question #1: Whom does it apply to? “Each member” of FINRA.
- Question #2: What clocks have to be synchronized? “Business clocks, including computer system clocks and mechanical time stamping devices, that are used for purposes of recording the date and time of any [reportable] event.”
- Question #3: What time must they be synchronized to? “The National Institute of Standards’ (NIST) atomic clock,” which timing experts tell me is equivalent to UTC.
- Question #4: What is the synchronization requirement? “Business clocks … must be synchronized … within a one second tolerance of the National Institute of Standards’ (NIST) atomic clock, except that computer system clocks that are used to record events in NMS securities, including standardized options, and OTC Equity Securities … must be synchronized within a 50-millisecond tolerance of the NIST clock.”
In addition, the SEC adopted Rule 613 in 2012, requiring the creation of a plan for the Consolidated Audit Trail (CAT). In November, the plan was approved, saying in Section 6.8:
“Each Participant shall: (i) other than such Business Clocks used solely for Manual Order Events, synchronize its Business Clocks at a minimum to within 100 microseconds of the time maintained by the National Institute of Standards and Technology, consistent with industry standards; (ii) other than such Business Clocks used solely for Manual Order Events or the time of allocation on Allocation Reports, through its Compliance Rule, require its Industry Members to: (A) synchronize their respective Business Clocks at a minimum to within fifty (50) milliseconds of the time maintained by the National Institute of Standards and Technology, and maintain such a synchronization.”
Time Across Space
So, as with every other market rule we are dealing with, we have to compare how each jurisdiction approaches what is a global issue. Let’s start with applicability. In the E.U. the rules apply to venues, and their members and participants, although it’s not clear to me, at least, what constitutes a participant for this purpose. Also, there is no indication that the E.U. rules apply only to trades done on E.U. venues. The U.S. rule only applies to FINRA members. So a FINRA member that is also a member of an E.U. venue appears to be subject to both rules.
In the E.U. the divergence and granularity standards are driven by the processing speed of the venue’s systems, which may be another argument for Brad Kastuyama’s slower-is-better market. In the U.S. the divergence is driven by the instrument – faster for NMS and slower for the rest. And just for a little more confusion, the E.U. rules cover both divergence and granularity, the FINRA rules only cover divergence, CAT covers both and the CFTC has nothing. And there are different tolerances. Fortunately, it does look like UTC and NIST time are essentially the same.
Before we completely throw our hands up, though, let’s think practically for a minute. To begin with, there is a point of granularity below which we cannot go. For instance, it actually takes some time to perform market actions, and it actually takes some time to measure and record time. So, even though the time experts can speak in picoseconds, you don’t have to. Finally, what we’re really after here is fairness in the markets – so that everyone has a fair chance to get an execution, and we can reliably detect market abuse. How granular do we have to get to ensure those? Give me a minute and I’ll get back to you on that.
Originally published on the TabbFORUM
This column does not necessarily reflect the views or opinions of FinReg Alert or Tradeweb Markets LLC.