Proactive Investors - Markets are in an era of 'constant but predictable volatility' and the City of London is working on ways of managing this, including allowing more access for specialist trading companies, the boss of the Financial Conduct Authority said today.
Reforms including increasing liquidity are key, said FCA chief executive Nikhil Rathi in a speech today, to help the system cope and boost the City's competitive position.
To help with liquidity in London, regulation should be loosened to allow trading firms such as market makers, who Rathi said were "too often" restricted by rules designed for large, global banks.
"The old approach - ‘same business = same risk = same treatment’ – no longer fits today’s financial landscape," he said.
The FCA is looking at adjustments to encourage wholesale trading and improve market liquidity, Rathi said, including reducing barriers to entry for "specialised trading firms that don’t hold retail deposits".
The chief UK financial watchdog hailed the "massive shift" in the US as non-bank traders now capture flows across US equities, where New York has seen a mushrooming in the influence of market makers and secretive trading firms such as Citadel Securities, Jane Street, DRW, Susquehanna International and London-based trio XTX Markets, Maven Securities and Mako Global.
Alongside this, Rathi said a shift "from reactive to proactive regulation" was needed, as well as "a new mindset towards risk".
He said "tailored regulation" for these firms "sparks growth and competitiveness, while protecting market integrity", while also freeing up capital and attracting new entrants to London.
The sharp rise in volatility in the past few years should not be conflated with systemic risk, he said, though he pointed to factors such as increased use of passive investment strategies, algorithmic trading and higher market concentration, where 10 firms represent nearly 50% of the FTSE 100’s value and seven companies generated over half of the S&P 500’s return last year, as fueling sharper price swings.
"Excessive moves, especially intraday, due to runaway volatility that dislocate prices from fundamentals are the central concern," he said.
As well as a deeper understanding of potential new systemic risks, Rathi said regulators and market participants, "must now expect to face this predictable volatility – as a constant".
The market-making and trading firms alluded to in the speech are "smaller" than some of the biggest banks but hardly small.
The likes of Citadel and Jane Street have become some of the most profitable and powerful firms on Wall Street, and are increasingly being seen as moving towards becoming systemically important.
Thanks to the electronification of financial markets and the sort of looser regulations that Rathi mentions, these firms have moved from upstarts just a few years ago to grab market share from Manhattan's more heavily regulated banking heavyweights, using computer algorithms to match buyers and sellers of equities and options at super-fast speeds
Citadel, for example, boasts on its website that it handles $455 billion in trades every day, including close to a quarter of all US stock trading, while Jane Street's gross trading revenues amount to around a seventh of the combined equity, bond, currency and commodity trading revenues of all the dozen major global investment banks last year.