The Coming Storm: Get ready for a regulatory hurricane

Traders Online: Rob Shapiro: " If Reg NMS were a hurricane, it would undoubtedly be a Category 5 monster. Though Hurricane NMS is still well offshore, its powerful winds of change have already begun to howl down the canyons of Wall Street. Traders are tracking this regulatory perfect storm with a wary eye, trying to predict where it will make landfall. There is little doubt that Reg NMS promises to dramatically reshape the terrain of the U.S. equity markets and how traders must approach their jobs.

Rumor has it that the SEC is not even sure what the most sweeping piece of securities regulation since 1975's May Day will bring. Though more than eight months away from implementation, Reg NMS has already triggered a liquidity consolidation turf war.

Indeed, soon after the NYSE/Archipelago and Nasdaq/Inet formed their respective alliances, the nearly dead "regionals" struck back by inking their own series of strategic deals with everyone from Merrill Lynch to hedge fund monolith, Citadel. Who would have ever thought the SEC-through Reg NMS-would have been such a godsend to these once struggling entities?

A Seismic Shift

Similarly, we learned from the Order Handling Rules and shift to decimalization that, in addition to getting what we want, regulators could inadvertently cause a string of secular push-outs, which market players never quite anticipated. The collapse of the OTC principal model, the worst of the NYSE's specialist system and a seismic shift to a slice-em and dice-em approach to order implementation immediately spring to mind.The spectacular rise of ECNs and consequential splintering of liquidity can also be traced back to these rules. In fact, the tidal surge from these prior, less catastrophic, "Category 3" regulatory storms still continue to shape many aspects of today's equity trading dynamic. It is no secret that the majority of buyside and sellside traders still openly question, or have failed to adopt, the latest suite of advanced trading tools technologies such as DMA aggregation systems, algorithms and pre- and post-trade analytics.

And it is upon this unstable foundation that a post-Reg NMS world will be built. This might suggest why so many traders feel out of joint. Our trader's sixth sense has detected the figurative drop in barometric pressure that will precede this monster storm that promises to alter our professional landscape in fundamental and unfathomed ways. Most of us already feel the winds of change beginning to pick up.

Painful Questions

Think for a moment: Does it seem like there are so many trends in motion you can hardly keep track? Are new trading technology vendors popping up like prairie dogs from the desert floor? Is your vision of the future state of trading dominated by questions rather than clarity? Do you secretly fear you might need a dramatic retooling of your skill-set?

If you answered, "Yes, Yes, Yes and Yes," you are not alone. A sense of foreboding and uncertainty has enveloped Wall Street like late summer humidity. And somewhere out there swirls Hurricane NMS, gaining strength, slowly working its way toward us.

Which leads to the question of how to survive in such an environment?

The most logical, tactical approach to dealing with profound uncertainty is to remain flexible and adaptable-in a word: resilient. Therefore, as traders, we must be prepared to do something we have always found difficult: change on the fly.

Traders fight change because we are creatures of habit. A trader's day has an organic quality; a rhyme, reason and rhythm that are integral to our success. Efficiencies and effectiveness in performance are found in how tight and right' our workflow is structured. We come to trust and rely upon our intermediaries, whom we regard as extensions of how we think and act. And there is a tendency to become emotionally attached to outdated technology because, like us, it still works just fine.

A dogmatic approach will not serve to protect us as this powerful storm of change comes ashore. As traders, we will need to challenge ourselves to master each piece of trading technology that dangles off our cramped desktops. It won't pay to defensively dismiss the irreversible, secular shift to algorithms as over-hyped Wall Street sizzle. We'll need to open our minds and embrace inherently threatening rules-based, quantitative tools, and see them for what they truly are: a new approach to sourcing and analyzing liquidity and information that will allow us to better leverage our value proposition within the context of advanced trade implementation strategies.

As the pace of equity trading quickens, as volume and volatility spike, as screens begin to flicker and liquidity continues to fragment, the pendulum will swing away from Old School ways of dealing toward New Age trading techniques and analytics. Floor brokers will morph into DMA aggregators, phone-in instructions will give way to hot-button trading tactics, IOI's will be replaced by more efficient ATS block trading venues. Make no mistake, the winds of change are blowing in this direction and we will need to bring our most adaptive, A-Game to this next level of engagement.

Finally, those who contend that advances in trading technology, tools and techniques will render the discipline of trading easier are dead wrong. If anything, trading will become more complex and the resilient trader's role will never be more critical to the liquidity and information sourcing dynamic. Those firms, on the buyside and sellside, which have gone "long black box" and "short gray matter," will undoubtedly get whipsawed when they come to realize that the marketing hype they based their desk trading strategy upon is fundamentally flawed. A black box will never be optimized without gray matter. Pre-trade and post-trade analytics dissolve into alphanumeric gibberish without high-touch human interpretation and application. DMA software is best left in the box if a trader is too green to understand what truly makes a stock go up and down. In this regard, the more things change, the more they will remain the same.

Trading will always be about the trader, not the tools; the same way golf will always be about the golfer, not the clubs.

Reg NMS will make landfall this summer, fittingly as the U.S. hurricane season commences. Nonetheless, we must begin at once to temper ourselves against the powerful winds of change that will soon rip through our collective trading rooms.

We will need to adapt. We will need to be flexible. And we will need to become resilient. Those who follow this ambitious course of action will emerge as the Best of Breed' traders of tomorrow, well equipped to thrive in an exciting and challenging post-NMS equity trading landscape."

Robert Shapiro is SVP, Advanced Trading Strategies Group at Abel /Noser Corp.

(c) 2005 Traders Magazine and SourceMedia, Inc. All Rights Reserved.

http://www.tradersmagazine.com

http://www.sourcemedia.com