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MiFID II White Paper

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MiFID II is new European legislation that will require strict timing accuracy and clock synchronization for financial institutions. It mandates microsecond level synchronization between trading venues and participants. Reliance on GPS for timing poses issues like signal interference and traceability challenges. To ensure compliance, a dedicated fiber optic link delivering a certified time signal directly from a UTC lab is recommended. This provides a more reliable and tamper proof solution than GPS. Financial institutions have less than two years to implement changes to comply with MiFID II's timing requirements.

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Page 1 MiFID II Whitepaper: Does the finance industry have time for MiFID II? MiFID II Whitepaper: Does the finance industry have time for MiFID II? Dr. Steven Turner Chief Technology Officer Intergence January 29, 2014 A panic is anticipated from the finance industry in the coming months. Many organisations have mostly ignored the upcoming MiFID (Markets in Financial Instruments Directive) II legislation or have decided to delay acting until a competitor moves. Once the directives come into force, many businesses will be scrambling to work out 1) What do they need to do? 2) How much time they have to act before fines are levied? MiFID II is a significant piece of legislation from the European Commission. The ramifications will impact everyone from small investors, through to the very largest tier 1 exchanges. The purpose of the legislation is to level the trading playing field by improving the fairness for both wholesale and retail transactions to promote efficient and safe operation of financial markets through suitable internal controls, compliance and governance. The full ramifications of the legislation are outside of the scope of this white paper and more suited to financial publications. The purpose of this white paper is to focus on one specific area of the legislation which will have significant impact to algorithmic and high frequency algorithmic trading organisations. Timing accuracy and clock synchronisation has always been critical within the algorithmic trading markets for regulatory compliance and security of trades. Accurate time-sequencing of events is essential to rebuild trades for traceability purposes. To ensure that all trades are legal, data packets are time stamped as they move through different networks. However, different organisations implement time in different ways, which can make the accurate tracking of trades impossible. For example, in some cases, data can appear to travel backwards in time when sent from one location to another - as the second time stamping clock is slightly ahead of the first one. Hence data feeds and trading orders used by algorithmic trading must adhere to strict timing accuracies to ensure fairness in the market. Inaccuracies or delays of even a few microseconds can result in failed / invalid trading orders and unfair advantages for organisations with an earlier timestamp of a particular market. Data released to a small number of participants even several microseconds early will give them a significant
Page 2 MiFID II Whitepaper: Does the finance industry have time for MiFID II? advantage and the potential to make many millions of dollars before the data is officially released at the agreed time. This release of data, whether unintentionally or indeed purposely, places the blame squarely at the door of the trading house in violation of the timing requirement, leaving them exposed to massive regulatory fines. Time synchronisation is critical in ensuring the trading houses release data at exactly the same time, down to the microsecond. Should one trading house release data even a few microseconds early, this can put the participants of other organisations at a significant disadvantage and also breaching market regulations. With todays high frequency algorithmic trading, the moment data is released it is acted upon with many thousands of trades occurring almost immediately. Clock drift can occur for a variety of reasons, the most common issue relates to hardware errors on timing devices and interference with the incoming grandmaster clock signal. Traditionally, this microsecond-level timing signal for financial institutions is achieved through GPS-based signalling via an antenna on their main building with a clear view of the sky. The Grandmaster clock signal is then fed into a hardware-based time server to enable accurate time stamping of packets with high accuracy based on a master clock signal. These hardware devices synchronise locally with one another to distribute the grandmaster clock signal to slave devices accurately whilst overcoming clock drift and network latency effects. Traceability for GPS signals is a significant challenge, there is a need for continuous measurement of the received GPS signal and comparison with a known, derivation of UTC . This needs to occur for each GPS satellite providing a time source as they are not geostationary, instead they fly over the measurement station almost every 12 hours with several hours of measurement data available for capture per fly over. GPS Receiver quality is also critical to ensure stability of time data as it could be affected by environmental factors. From an interference perspective, it is relatively straightforward to jam a GPS signal. A quick Internet search offers many affordable options for the purchase of GPS jamming devices, often sold for the purpose of allowing sales & delivery drivers to avoid tracking by their companies during personal stops. However, they may also be used for less salubrious intents including crime and sabotage. Indeed, it is even possible to spoof GPS signals and submit an alternative clock signal if desired. With respect to financial institutions who are reliant on GPS providing accurate timing, if the signal is interfered with or blocked it can be immensely damaging for the business. Other factors which can also interfere with the GPS signal include urban canyon effects and space weather. Hence there is a need to not only provide an accurate signal, but also resilient signal which is immune to the issues facing GPS-based timing. Traceability in Time and Frequency Metrology (Cal Lab Int. Jour. of Metrology, September-October 1999, pp. 33-40) Available from http://tf.nist.gov/general/pdf/1305.pdf
Page 3 MiFID II Whitepaper: Does the finance industry have time for MiFID II? MiFID II Timing requirements MiFID II specifies the critical need for adequate standards for the synchronisation of clocks used by trading venues and their members where algorithmic and high frequency trading takes place. The legislation notes: Clock synchronisation has a direct impact in many areas. It is essential for conducting cross- venue monitoring and detecting instances of market abuse; it will contribute to ensuring that post-trade transparency data can readily be part of a reliable consolidated tape; lastly clock synchronisation will be beneficial for the assessment of best execution since it will allow to better compare effective transactions to market conditions prevailing at the time of their execution. ESMA Consultation Paper Annex B Regulatory technical standards on MiFID II/MiFIR RTS 36, Page 503 The key take home from this legislation is that participants have to synchronise at the same level of accuracy as the trading venue. Trading venues which have operating systems where the gateway-to-gateway latency is less than one millisecond, are obliged to synchronise their clocks according to the level of accuracy at which the venues measure their latency. Gateway-to-gateway latency is defined as the time it take for a message to leave the edge router of data source and arrive at the edge router of the data destination. Given electronic trading venues tend to work at the several microsecond level, they will have to show 1 microsecond traceability. They also must time stamp transactions to that same level of granularity. The level of allowable divergence from Coordinated Universal Time (UTC) and granularity is dictated by the gateway-to-gateway latency time of the trading venue as shown in the following table.
Page 4 MiFID II Whitepaper: Does the finance industry have time for MiFID II? GATEWAY-TO-GATEWAY LATENCY TIME OF THE TRADING VENUE TIME DIVERGENCE ALLOWED FROM UTC AND LEVEL OF GRANULARITY REQUIRED FOR TIMESTAMPS 1 1 millisecond or greater, (equivalent to 1.0x10-3 seconds or higher) 1 millisecond divergence from UTC and all timestamps for reportable events shall be to the nearest millisecond 2 1 microsecond to 999 microseconds (equivalent to 1.0x10-6 second to 9.99x10-4 second) 1 microsecond divergence from UTC and all timestamps for reportable events shall be to the nearest microsecond 3 999 nanoseconds or less (equivalent to 9.99x10-7 seconds or less) 1 nanosecond divergence from UTC and all timestamps for reportable events shall be to the nearest nanosecond Hence the lower the latency, the greater the accuracy required for the trading venue and its members. The need for accurate sequential time stamping between venues is essential to verify packet ordering and timing. Time between financial institutions can vary very slightly (microseconds) between different trading venues depending on the quality of clock source used. These minor variations can lead to major disadvantages and loss of revenue as gaps in time sources are exploited by the high frequency traders. For a time keeping service to deliver against the above regulations it must meet two requirements. Firstly, an ability to show traceability to a UTC time source and secondly, the ability to avoid clock drift and maintain a regular tick. Whilst GPS can provide an accurate time signal in conjunction with specialist time synchronisation hardware, traceability and interference issues can be challenging. This means GPS may not be the best timing solution to meet the tight requirements of MiFID II. To overcome the limitations of the GPS clock signal, there is a need to provide a more resilient clock signal to the customer. It is possible to provide a precise, certified time signal direct to the user, giving an absolute time in any location. The precise time source can be delivered over a resilient, dedicated fibre optic link from a UTC lab, for distribution to the end customer, ensuring maximum resilience and security. The clock signal itself is certified at the user location, as opposed to the clock source to guarantee the signal remains accurate and traceable. Once delivered to the customer premises, precision timing hardware, distributes the signal from the grandmaster clock to slave devices whilst ensuring accuracy. This is exactly the same as if the signal were to be delivered via GPS, however it comes with greater confidence in the reliability and resiliency of the signal. Certification of the accuracy ensures regulatory compliance for traceability. By using a clock signal delivered via a resilient fibre optic link from a UTC lab, users can be assured that the time they implement is not only certified accurate but tamper proof and directly traceable to UTC. This ensures regulatory compliance and accuracy of time
Page 5 MiFID II Whitepaper: Does the finance industry have time for MiFID II? stamping. Organisations using this service will have greater confidence in the accuracy of their time stamping and clock synchronisation, mitigating concerns over potential regulatory fines and loss of reputation. Whilst GPS could provide accurate timing, there are still concerns over the transmission medium of GPS-based clock signal due to potential interference, by using a dedicated, resilient fibre connection direct to the clock source, these concerns can be mitigated, enabling both compliance with the new MiFID II legislation and protecting the brand image of the trading house. Given the depth and breadth of the MiFID II legislation it is highly likely that the majority of financial institutions are presently non-compliant. The Financial Conduct Authority (FCA) anticipates the new legislation to take effect from 3 January 2017. This gives organisations less than 2 years to become compliant at the time of writing. The implications of non-compliance are not yet fully understood but could result in license revocation in extreme cases, shutting down an organisation. It is therefore essential that organisations work on addressing these regulations immediately. The timing accuracy requirement discussed in this paper is one aspect which could be rapidly addressed through the use of a UTC traceable and certified time source from a UTC lab via fibre optic link. This could certainly ease the IT headache commonly associated with maintaining an accurate, synchronised clock signal via GPS-based methods. 2 http://www.fca.org.uk/firms/markets/international-markets/mifid-ii
Page 6 MiFID II Whitepaper: Does the finance industry have time for MiFID II? About Intergence Intergence is an independent IT Consultancy and Professional Services firm, headquartered in Cambridge, UK, with a regional office in the Middle East (Dubai, UAE). Privately Owned, Intergence was founded in 2003 to address the growing requirements of clients demanding high-level impartial expertise in networks and IT. Our close relationship within the Cambridge academic community enables us to innovate in partnership, rapidly incorporating the latest technology advances into our solutions. Intergence are experts in IT Optimisation, specialising in areas such as application, infrastructure and data centre optimisation. We provide consulting services to align your IT function to your business strategy. We provide Managed Sourcing services to help you resource highly skilled expertise and Managed Services, delivering challenging IT projects on time and to budget. Utilising a unique combination of world class expertise, industry-leading methodology and unique tools, Intergence has a clear and common purpose - to allow our clients to extract more value from their existing assets, whilst delivering a first-class service. For more information, please visit: www.intergence.com

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MiFID II White Paper

  • 1. Page 1 MiFID II Whitepaper: Does the finance industry have time for MiFID II? MiFID II Whitepaper: Does the finance industry have time for MiFID II? Dr. Steven Turner Chief Technology Officer Intergence January 29, 2014 A panic is anticipated from the finance industry in the coming months. Many organisations have mostly ignored the upcoming MiFID (Markets in Financial Instruments Directive) II legislation or have decided to delay acting until a competitor moves. Once the directives come into force, many businesses will be scrambling to work out 1) What do they need to do? 2) How much time they have to act before fines are levied? MiFID II is a significant piece of legislation from the European Commission. The ramifications will impact everyone from small investors, through to the very largest tier 1 exchanges. The purpose of the legislation is to level the trading playing field by improving the fairness for both wholesale and retail transactions to promote efficient and safe operation of financial markets through suitable internal controls, compliance and governance. The full ramifications of the legislation are outside of the scope of this white paper and more suited to financial publications. The purpose of this white paper is to focus on one specific area of the legislation which will have significant impact to algorithmic and high frequency algorithmic trading organisations. Timing accuracy and clock synchronisation has always been critical within the algorithmic trading markets for regulatory compliance and security of trades. Accurate time-sequencing of events is essential to rebuild trades for traceability purposes. To ensure that all trades are legal, data packets are time stamped as they move through different networks. However, different organisations implement time in different ways, which can make the accurate tracking of trades impossible. For example, in some cases, data can appear to travel backwards in time when sent from one location to another - as the second time stamping clock is slightly ahead of the first one. Hence data feeds and trading orders used by algorithmic trading must adhere to strict timing accuracies to ensure fairness in the market. Inaccuracies or delays of even a few microseconds can result in failed / invalid trading orders and unfair advantages for organisations with an earlier timestamp of a particular market. Data released to a small number of participants even several microseconds early will give them a significant
  • 2. Page 2 MiFID II Whitepaper: Does the finance industry have time for MiFID II? advantage and the potential to make many millions of dollars before the data is officially released at the agreed time. This release of data, whether unintentionally or indeed purposely, places the blame squarely at the door of the trading house in violation of the timing requirement, leaving them exposed to massive regulatory fines. Time synchronisation is critical in ensuring the trading houses release data at exactly the same time, down to the microsecond. Should one trading house release data even a few microseconds early, this can put the participants of other organisations at a significant disadvantage and also breaching market regulations. With todays high frequency algorithmic trading, the moment data is released it is acted upon with many thousands of trades occurring almost immediately. Clock drift can occur for a variety of reasons, the most common issue relates to hardware errors on timing devices and interference with the incoming grandmaster clock signal. Traditionally, this microsecond-level timing signal for financial institutions is achieved through GPS-based signalling via an antenna on their main building with a clear view of the sky. The Grandmaster clock signal is then fed into a hardware-based time server to enable accurate time stamping of packets with high accuracy based on a master clock signal. These hardware devices synchronise locally with one another to distribute the grandmaster clock signal to slave devices accurately whilst overcoming clock drift and network latency effects. Traceability for GPS signals is a significant challenge, there is a need for continuous measurement of the received GPS signal and comparison with a known, derivation of UTC . This needs to occur for each GPS satellite providing a time source as they are not geostationary, instead they fly over the measurement station almost every 12 hours with several hours of measurement data available for capture per fly over. GPS Receiver quality is also critical to ensure stability of time data as it could be affected by environmental factors. From an interference perspective, it is relatively straightforward to jam a GPS signal. A quick Internet search offers many affordable options for the purchase of GPS jamming devices, often sold for the purpose of allowing sales & delivery drivers to avoid tracking by their companies during personal stops. However, they may also be used for less salubrious intents including crime and sabotage. Indeed, it is even possible to spoof GPS signals and submit an alternative clock signal if desired. With respect to financial institutions who are reliant on GPS providing accurate timing, if the signal is interfered with or blocked it can be immensely damaging for the business. Other factors which can also interfere with the GPS signal include urban canyon effects and space weather. Hence there is a need to not only provide an accurate signal, but also resilient signal which is immune to the issues facing GPS-based timing. Traceability in Time and Frequency Metrology (Cal Lab Int. Jour. of Metrology, September-October 1999, pp. 33-40) Available from http://tf.nist.gov/general/pdf/1305.pdf
  • 3. Page 3 MiFID II Whitepaper: Does the finance industry have time for MiFID II? MiFID II Timing requirements MiFID II specifies the critical need for adequate standards for the synchronisation of clocks used by trading venues and their members where algorithmic and high frequency trading takes place. The legislation notes: Clock synchronisation has a direct impact in many areas. It is essential for conducting cross- venue monitoring and detecting instances of market abuse; it will contribute to ensuring that post-trade transparency data can readily be part of a reliable consolidated tape; lastly clock synchronisation will be beneficial for the assessment of best execution since it will allow to better compare effective transactions to market conditions prevailing at the time of their execution. ESMA Consultation Paper Annex B Regulatory technical standards on MiFID II/MiFIR RTS 36, Page 503 The key take home from this legislation is that participants have to synchronise at the same level of accuracy as the trading venue. Trading venues which have operating systems where the gateway-to-gateway latency is less than one millisecond, are obliged to synchronise their clocks according to the level of accuracy at which the venues measure their latency. Gateway-to-gateway latency is defined as the time it take for a message to leave the edge router of data source and arrive at the edge router of the data destination. Given electronic trading venues tend to work at the several microsecond level, they will have to show 1 microsecond traceability. They also must time stamp transactions to that same level of granularity. The level of allowable divergence from Coordinated Universal Time (UTC) and granularity is dictated by the gateway-to-gateway latency time of the trading venue as shown in the following table.
  • 4. Page 4 MiFID II Whitepaper: Does the finance industry have time for MiFID II? GATEWAY-TO-GATEWAY LATENCY TIME OF THE TRADING VENUE TIME DIVERGENCE ALLOWED FROM UTC AND LEVEL OF GRANULARITY REQUIRED FOR TIMESTAMPS 1 1 millisecond or greater, (equivalent to 1.0x10-3 seconds or higher) 1 millisecond divergence from UTC and all timestamps for reportable events shall be to the nearest millisecond 2 1 microsecond to 999 microseconds (equivalent to 1.0x10-6 second to 9.99x10-4 second) 1 microsecond divergence from UTC and all timestamps for reportable events shall be to the nearest microsecond 3 999 nanoseconds or less (equivalent to 9.99x10-7 seconds or less) 1 nanosecond divergence from UTC and all timestamps for reportable events shall be to the nearest nanosecond Hence the lower the latency, the greater the accuracy required for the trading venue and its members. The need for accurate sequential time stamping between venues is essential to verify packet ordering and timing. Time between financial institutions can vary very slightly (microseconds) between different trading venues depending on the quality of clock source used. These minor variations can lead to major disadvantages and loss of revenue as gaps in time sources are exploited by the high frequency traders. For a time keeping service to deliver against the above regulations it must meet two requirements. Firstly, an ability to show traceability to a UTC time source and secondly, the ability to avoid clock drift and maintain a regular tick. Whilst GPS can provide an accurate time signal in conjunction with specialist time synchronisation hardware, traceability and interference issues can be challenging. This means GPS may not be the best timing solution to meet the tight requirements of MiFID II. To overcome the limitations of the GPS clock signal, there is a need to provide a more resilient clock signal to the customer. It is possible to provide a precise, certified time signal direct to the user, giving an absolute time in any location. The precise time source can be delivered over a resilient, dedicated fibre optic link from a UTC lab, for distribution to the end customer, ensuring maximum resilience and security. The clock signal itself is certified at the user location, as opposed to the clock source to guarantee the signal remains accurate and traceable. Once delivered to the customer premises, precision timing hardware, distributes the signal from the grandmaster clock to slave devices whilst ensuring accuracy. This is exactly the same as if the signal were to be delivered via GPS, however it comes with greater confidence in the reliability and resiliency of the signal. Certification of the accuracy ensures regulatory compliance for traceability. By using a clock signal delivered via a resilient fibre optic link from a UTC lab, users can be assured that the time they implement is not only certified accurate but tamper proof and directly traceable to UTC. This ensures regulatory compliance and accuracy of time
  • 5. Page 5 MiFID II Whitepaper: Does the finance industry have time for MiFID II? stamping. Organisations using this service will have greater confidence in the accuracy of their time stamping and clock synchronisation, mitigating concerns over potential regulatory fines and loss of reputation. Whilst GPS could provide accurate timing, there are still concerns over the transmission medium of GPS-based clock signal due to potential interference, by using a dedicated, resilient fibre connection direct to the clock source, these concerns can be mitigated, enabling both compliance with the new MiFID II legislation and protecting the brand image of the trading house. Given the depth and breadth of the MiFID II legislation it is highly likely that the majority of financial institutions are presently non-compliant. The Financial Conduct Authority (FCA) anticipates the new legislation to take effect from 3 January 2017. This gives organisations less than 2 years to become compliant at the time of writing. The implications of non-compliance are not yet fully understood but could result in license revocation in extreme cases, shutting down an organisation. It is therefore essential that organisations work on addressing these regulations immediately. The timing accuracy requirement discussed in this paper is one aspect which could be rapidly addressed through the use of a UTC traceable and certified time source from a UTC lab via fibre optic link. This could certainly ease the IT headache commonly associated with maintaining an accurate, synchronised clock signal via GPS-based methods. 2 http://www.fca.org.uk/firms/markets/international-markets/mifid-ii
  • 6. Page 6 MiFID II Whitepaper: Does the finance industry have time for MiFID II? About Intergence Intergence is an independent IT Consultancy and Professional Services firm, headquartered in Cambridge, UK, with a regional office in the Middle East (Dubai, UAE). Privately Owned, Intergence was founded in 2003 to address the growing requirements of clients demanding high-level impartial expertise in networks and IT. Our close relationship within the Cambridge academic community enables us to innovate in partnership, rapidly incorporating the latest technology advances into our solutions. Intergence are experts in IT Optimisation, specialising in areas such as application, infrastructure and data centre optimisation. We provide consulting services to align your IT function to your business strategy. We provide Managed Sourcing services to help you resource highly skilled expertise and Managed Services, delivering challenging IT projects on time and to budget. Utilising a unique combination of world class expertise, industry-leading methodology and unique tools, Intergence has a clear and common purpose - to allow our clients to extract more value from their existing assets, whilst delivering a first-class service. For more information, please visit: www.intergence.com