FIRM Project – Management of Market Price Risks: Regulation and Coordination of Volatility Interruptions in Europe
Between October 2015 and March 2018 the Chair of e-Finance works on a research project to systematically analyzing volatility interruptions on European stock markets. The goal of the research project, which is financially supported by the Frankfurt Institute for Risk Management and Regulation, is to examine empirically and experimentally whether volatility interruptions - so called circuit breakers - are adequate mechanisms to reduce extreme price jumps and market price risks on European financial markets.
Due to the increase of extreme price movement over the past years and the high relevance of high frequency trading, market safeguards such as volatility interruptions seem to be necessary to ensure the integrity of securities markets. The research project therefore aims to analyze the effects of different volatility interruption designs on market quality parameters such as volatility, liquidity, or price determination. In addition, the project will deliver knowledge on whether a coordination of volatility interruption is necessary in the course of an increasing fragmentation of the European securities trading landscape.
The results of the empirical analysis highlight that market safeguards in the form of volatility interruption are able to reduce volatility. But this reduction of volatility comes at the cost of reduced liquidity. The configuration of the underlying parameters such as the duration of the volatility interruption or the width of the triggering price thresholds are of superior importance and should be evaluated in detail when calibrating safeguards. Further, the research project provides empirical evidence against the hypothesis that an active volatility interruption on the main market leads to a volume shift and volatility spillover to alternative trading venues.
In summary, the results support regulators and market operators regarding the implementation and recalibration of market safeguards and contribute to the protection of investors and intermediaries against extreme price jumps and market price risks.
The Impact of the MiFIR Trading Obligation for Shares on Market Liquidity
In July 2017, the chair of e-Finance started - in cooperation with Deutsche Börse AG - a research project to analyze potential effects of the new requirements of MiFID II and MiFIR, which have to be applied by investment firms, market operators, data reporting service providers, and specific third-country firms from January 3rd, 2018 onwards.
MiFID II / MiFIR will fundamentally change the trading and market landscape in Europe. The new regulation aims to assure a safer, sounder, more transparent, and more responsible financial system. Besides, new rules for OTC (Over the Counter) trading, commodity derivative markets, as well as Algorithmic and High Frequency Trading will apply. A key concept of MiFID II / MiFIR is the organization of trading on regulated venues: Non-equity instruments shall be traded on a new category of trading venues called Organized Trading Facilities (OTF). In addition, a new trading obligation for shares has been introduced which intends to restrict OTC trading. Therefore, the new framework will significantly influence European equities trading and will likely result in a redistribution of market shares between trading venues.
By investigating related literature, developing different simulation scenarios, as well as consulting industry and academic experts, the research project examines three research topics associated with the new regulatory requirements. First, drivers and goals of MiFID II / MiFIR are analyzed against the background of the changes in European share trading. Second, the potential impact of the trading obligation imposed by MiFIR on market share distribution and liquidity is assessed. Finally, the impact on the European market structure as well as the relative importance of different types of trading venues is analyzed.
The results of the research project provide a toolbox for market participants to assess changes in market shares of venues and liquidity based on their own expectations as well as a benchmark for studies analyzing the actual impact of the trading obligation after the regulatory requirements come into effect.
EU Project FIRST – Large Scale Information Extraction and Integration Infrastructure for Supporting Financial Decision Making
The research project FIRST, started in October 2010 and co-funded by the European Union, aims to extract relevant financial information from the vast amounts of unstructured data present in the World Wide Web – in real-time. Its goal is to use methods of artificial intelligence to support financial decision making. FIRST will, in a nutshell, harness the knowledge of the internet to support financial decision makers. Next to classical financial data, messages published within news articles and weblogs are of high relevance within this context. Based on these data sources, FIRST will support decisions in the domains of market surveillance, reputational risk management and retail brokerage.
The FIRST project started in 2010 and is conducted over the course of three years. Co-funded by the European Union’s “Information and Communication Technologies” Theme of the Seventh Framework Programme, the project has an overall budget of 4,574 million Euros. The FIRST consortium consists of partners from Germany, Italy, Slovenia, and Spain. As one out of nine European partners, Goethe University, represented by the Chair of e-Finance, plays a vital role within the project.
MiFID- status quo after the implementation in Germany
After the Chair of e-Finance / e-Finance Lab have conducted three empirical surveys with regard to the preparatory status of the German and European financial industry for MiFID within the past two years, our current study in 2008 for the first time documents the status quo after MiFID has entered into force in late 2007.
This survey is motivated by the results of the previous studies. On the one hand the various “best execution policies” are analyzed as a whole and compared with each other. On the other hand this study checks how far the institutions' earlier assessment of the competitive potential of the topic “order execution” is also actually reflected in the best execution policies which were evaluated. A separate analysis of the execution venue that according to the investment firms provide the best possible result for their clients on a consistent basis completes this empirical study.
Final results are available since the third quarter 2008.
The development of new trading concepts and the resulting changes of relationships between intermediaries are key characteristics of the working environment of insitutional investors. Beside the traditional relationships to brokers the buyside has the possibility of using a set of new possibilities for execution. These include besides alternative trading venues like Crossing Networks completely new electronical execution concepts like Smart Order Routing, Direct Market Access as well as Algorithmic Trading.
The term Order-Channel Management (OCM) is the label for a concept in which an efficient order execution should be provided within an environment of fragmented liquidity, where the orderflow is to be segmented and channeled according to the individual order characteristics. This involves besides strategic questions like e.g. the set-up of the required infrastructure, many operative questions according to the individual order-forwarding and the execution strategy, too.
After the development of the OCM-concept as such and the investigation of the status quo in the industry in spring 2007 an empirical validation will be carried out by the Chair of e-Finance in cooperation with cluster 5 of e-Finance lab through an europe-wide survey. Furthermore an adaptive system for the efficient order segmentation should be developed and verified using simulations.
Performance Management in Trading and Post-Trading Industries
In the last years, the objective of European policy has been to integrate the financial markets in analogy to other network industries (e.g. utilities or telecom). Being confronted with the opportunities and risks of cross-border competition, the management of trading, clearing, and settlement infrastructures need to adapt their strategy accordingly.
In previous research, we identified the Balanced Scorecard (BSC) as a suitable tool for performance measurement in the clearing industry and developed a framework for the modification of the generic BSC to the specifics of this network industry. The aim the project is to transfer this framework to other network industries such as exchanges and CSDs. The results will be challenged and validated by means of a multiple case study.
The economic value of smart order routing in European equity trading
The new regulatory environment triggered by MiFID has resulted in a transformed competitive landscape and increased fragmentation among execution venues in Europe. One key component of MiFID is best execution, i.e. investment firms are obliged to achieve the best result for customer orders on a consistent basis.
Specifically for retail transactions, the total consideration, i.e. price and explicit transaction costs, shall apply as a benchmark for the best result. In contrary to RegNMS, MiFID does not require to achieve the best result based on a real-time comparison of available prices. Therefore, after the introduction of MiFID the question on the extent of suboptimal order executions after transaction costs arises. Applying order book data for EURO STOXX 50 securities of ten European execution venues, our research analyses suboptimal order executions including transaction costs.
Future of the European Post-Trading System
The Chair of e-Finance and Cluster 5 of the E-Finance Lab are currently conducting a Delphi study on the Future of the European Post-Trading System. Post-trading in Europe has changed significantly in the last years and is currently facing enormous challenges, e.g. due to the financial crisis, stricter regulation of financial markets, globalization, and the advancing automation of securities processing. By means of a Delphi study among a multitude of experts from different areas of trading, post-trading and academia, the aim is to develop a joint and coherent view of how the European post-trading system will look like in the future.
In the light of globalization and the financial crisis, the intention of the researchers is to detect measures for improvement of the post-trading system and to identify the most important issues in risk management and information technologies within this industry.
Pricing model for the Dubai International Financial Exchange
The Dubai International Financial Exchange (DFIX) and the University of Frankfurt have jointly developed a pricing model that is based on academic expertise as well as practical approaches like for example a best practice and competition analysis.
At first the stock markets of the region have systematically been analysed upon their functionalities, fee structures and fee levels. In a further step the results of this analysis have been extended to a best practice analysis in which the fee models of the leading stock markets in the world surveyed according to their incentives regarding prices and the provision of liquidity.
During this analysis a lot of potential fee structure designs have been highlighted and evaluated. Finally a fee model had been developed by both parties including incentive mechanisms for the provision of liquidity. The model has been implemented from the start in september 2005 on.
Concept of the trader examination of the Dubai International Financial Exchange
The Dubai International Financial Exchange (DFIX), the Deutsche Börse Group and the University Frankfurt jointly develped the concept of an examination for traders as well as a corresponding practice course for the DFIX Academy, practice department of the stock exchange.
Companies aiming at trading on the DFIX have to ensure that their trading managers pass that examination.
The DFIX Academy chose the Deutsche Börse, one the the worlds leading financial markets, and the University of Frankfurt as partners for joint development because both show a remarkable track record of comparable projects and expertise in training and examinations for financial markets.
The Deutsche Börse and the Chair of e-Finance of the Johann Wolfgang Goethe-University provided the complete service according to that examination including concept, practice for the one-day preparation course, working materials for the traders as well as the examinations themselves in Dubai and London to the DFIX.
MiFID - status quo of the implementation within the german financial industry
In spring 2006, so approximately 18 months before the applicability of the EU-directive "Markets in Financial Instruments Directive" (MiFID) in november 2007, the Chair of e-Finance in cooperation with Cluster 5 of the e-finance lab carried out a study to monitor the status of preparations within the german financial industry.
Via a survey adressing nearly 200 german stock trading companies status of project planning and appraisals of the german financial intermediaries according to the MiFID had been evaluated to be able to present statements according to the estimated costs, utility effects as well as potenital competition relying on representative opinions. The survey reached rate of return of 28,5% .
The evaluation of the returned questionaires disclosed a broad diversity according to the status of the preparations within the german financial industry. At the beginning of 2006 only 14% of the institutions called themselves very well informed about the new regulation, whereas 42% stated that so far they didn't skip the status of collection of information. Alltogether the firms stated that they see low potential for competition within their services and that they recognize the MiFID more as a regulatory duty than as a chance for growing competition.
The estimations of the questioned companies concerning the total value of investments needed to implement the MiFID were concentrated within the ranges of 500000 to 1 Mn. Euro and less than 500000 Euro, obviously beneath the costs estimated by the public. Finally a big share of the surveyed investment firms were optimistic that the implementation of the entire range of requirements posed by the MiFID would be realised within the 18 months left. A glance at the budgets dispatched by the financial firms show that in 2006 32% of the participants of the questionaire already had developed a schedule concerning the adaption of the MiFID, whereas the allocation of the answers show that 2007 was in the main focus of the firms to implement the MiFID.
Impact of Information Technology on Settlement Services for Equities
In spring 2006, the Chair of e-Finance at the University of Frankfurt conducted a market study on the topic “Impact of Information Technology on Settlement Services for Equities”. The aim of the study was to systematically collect data on central parameters of relevant organizations worldwide in settlement and custody. Present academic literature on settlement services mainly focuses on efficiency and on costs aspects of settlement services in specific regions. The impact of information technology, e.g. communication standards and IT setup, on settlement processes has not been subject of academic research so far. The market study is focusing on Central Securities Depositories (CSDs) and International Securities Depositories (ICSDs), services offered by them, and especially on technologies in use by these institutions. The market study consisted of two phases. During the first phase data was collected based on publicly available information. In the second phase, data was collected by a survey.
The study was send to all participants in spring 2007.
MiFID- status quo in Germany in the year of its implementation
In December 2006, the Chair of e-Finance started a follow-up study regarding the implementation status of the EU directive Markets in Financial Instruments Directive (MiFID) within the German financial industry.
The study was conducted in cooperation with Cluster 5 of the E-Finance Lab. After the highly positive response to our first study, a wide-spread desire for an update of the study was recognized in order to reflect the on-going changes in the legislative procedure. The aim of the newly launched study was to document the status of the MiFID implementation in the year of the directive's national enacting on the basis of the more precisely defined MiFID-requirements (i.e. by the Commission's implementing regulation and directive as well as by the German federal government's draft transposition law). By comparing this year's results with the results of the earlier study, we documented the most recent developments within the German financial industry incited by MiFID and the possibly altered attitudes towards the contents and effects of MiFID on the competitive landscape.