PwC’s 2016 Market Abuse Surveillance Survey suggests that surveillance has yet to deliver as a fully effective tool for preventing market abuse in financial markets due in part to a lack of clarity about optimal organisation of responsibilities and activities. But, PwC observes, the stakes are too high for the firms not to make further investments. The EU Market Abuse Regulation (MAR) requires firms to use automated surveillance systems unless their business model justifies a manual approach.
Involving technology, compliance/regulation/legal and front office staff from the start are some of the most central elements of a successful surveillance implementation programme, along with setting up a joint project group to work on the implementation, especially in larger organisations where there may be more distance between these parts of the business.
Making sure data is in order before signing on with a vendor is also key. Regulations such as MAR and MiFID II require firms to monitor all trading activities, so to minimise the risk of delaying implementation and missing regulatory deadlines, firms should identify all data sources to be used in the surveillance solution before approaching vendors.
Scalable and adaptable
Firms should also value flexibility and implement a technological solution that is scalable and adaptable in line with new or changing regulation and market characteristics. And any surveillance system must have the capability to digest multiple baskets of information – such as trades, positions, pricing and corporate action data – and after normalising that information uncover anomalous activity.
Another vital aspect of implementing a trade surveillance system is ensuring that staff are capable of analysing and interpreting alerts. There are numerous off-the-shelf systems available, but they will only be effective if the firm has individuals with the time and expertise to understand their output. A key MAR requirement is that firms submit suspicious transaction and order reports to the FCA without delay, so it is essential they address this question of expertise during the implementation phase.
“Firms should deploy technology solutions that are open, flexible and adaptable,” says Lars-Ivar Sellberg, executive chairman at Swedish soft-ware company Scila. “They should also avoid relying on too many proprietary formats in case they need to deploy a new system. The ability to pre-load historical data (up to seven years old) is key since regulators can investigate cases that are up to 10 years old, which we have seen with LIBOR and FX manipulation schemes.”
According to Johannes Frey-Skött, assistant vice president apps engineering at Itiviti, a London-based company that delivers trading infrastructure solutions, detection and scoring are vital. “Detection because the system needs to allow for configurability – no two businesses are alike – and scoring because without any type of classification on the severity of a breach alert, users will be unable to prioritise.”
Firms must pay attention to guidance provided by the trading venues in which they participate to ensure their surveillance systems keep pace with regulatory and market changes.
Fit for purpose
Trade surveillance systems need to be evaluated on a regular basis to ensure that they are appropriate for the markets and asset classes in which they operate. For instance, if a business were to begin transacting in a new type of derivative instrument it would be prudent to evaluate the type of manipulative activity that could occur in that instrument and adjust the settings of its trade surveillance system accordingly.
It should work closely with vendors, industry associations and regulators to establish best practice. The surveillance programme should be seen as a long-term engagement, not a quick fix. It is the vendor’s responsibility to closely monitor technological developments such as the rise of artificial intelligence, blockchain and big data/cloud computing, since these areas can have a significant impact on market surveillance.
Companies should take a risk-based approach and continuously evaluate surveillance risks related to their specific business areas. Characteristics in financial markets and consequently the risks associated with certain areas can change rapidly.
“Firms can incorporate regular checks of relevant changes directly into their compliance monitoring programmes, which can be performed internally or with an external adviser,” says Miles Kellerman, an associate at Bovill. “This is essential as it will help ensure that firms are up to date on anti-market abuse rules.”
According to Michael Lehman, a partner at ACA Surveillance Technology, the system should be able to adjust to the changing regulatory landscape. “A good example would be the MAR regulation. Any system should be able to include orders that may have been cancelled and not just those that were executed.”
Firms should choose a surveillance solution that is easy to operate and minimises the workload for internal IT staff. Surveillance/compliance officers must have the appropriate level of expertise, skills and training to understand the products, types of potential abuses and red flags
The programme should have a focus on the ability to reduce false positives, for example by using backtesting/benchmarking and artificial intelligence (such as machine learning) techniques. Any modern surveillance system should have extensive capabilities to minimise false positives – a key concern and time-stealer with legacy surveillance solutions.
The surveillance programme will gather and normalise an extensive set of data that can be used for business development purposes.
“Firms should view surveillance as a business critical area and employ skilled people,” says Sellberg. “They should work with vendors who provide support and personalised user training. Market surveillance is a sophisticated area and may involve complex investigations into serious matters which can result in fines of millions of dollars, even for smaller trading firms.”
A business tool
By properly mapping the client’s data and truly understanding how they transact, a surveillance vendor can produce quality items of interest, says Lehman. “Old methodology was to generate large exception-based findings – proper surveillance is to de-noise that by adding multiple steps to the algorithm before reporting.”
Frey-Skött advocates a managed solution to further reduce the time spent on hardware monitoring and upgrades. “Due to the many other obligations on companies around record keeping, reporting and analysis as part of MiFID II, it is prudent to combine solutions that include modules for market surveillance while also providing algo monitoring, market maker compliance, best execution, TCA, and so on. If this solution can be system agnostic, the investments companies need to make for compliance can be heavily reduced.”
How has the introduction of Market Abuse Regulation (MAR) across the EU since July 2016 affected you? Email your views to firstname.lastname@example.org