Spelling it out
Market abuse is a growing concern for financial institutions (FIs). A number of high-profile events (the LIBOR and Foreign Exchange [FX] trading scandals, for example, as well as those connected with the manipulation of ISDAFIX earlier this year) have resulted in hefty fines for FIs – more than $19 billion for LIBOR and FX alone1 – pushing trader surveillance up the agenda.
Trader surveillance is complex, however, and objective truth is hard to come by. The role of traders is to make money for their firms, and in practice the line between good behavior and abuse can sometimes be blurred. The process presents several challenges, such as extracting clear signals from the ‘noise’ of the markets, and providing evidence of intent and market abuse without lengthy recourse to diverse sources of information. To make matters worse, among these sources is communications data, which is traditionally not well-integrated with trade monitoring systems.
To fully address the challenges they face around trader surveillance, FIs must leverage four success factors, which we have labeled ‘the ABCD of successful surveillance’:
More advanced and effective analytics – including integrated monitoring of communications and trading activity – to deliver better quality alerts across data types, asset classes and trades.
More effective and flexible workflow engines, and robotic process automation (RPA), to draw more information from a wider array of trading venues and asset classes. This can reduce the workload involved in investigating alerts, and help FIs develop systems with improved drill-down capabilities, as well as the ability to analyze metadata.
Trader surveillance systems that work within a robust governance framework and the three lines of defense. These can reinforce a culture of compliance by delivering quantifiable information about front-office traders’ behavior within a conduct risk framework.
Integration, validation, cleansing and standardization, to ensure that the data FIs feed into their systems is accurate, and can be audited and validated across a variety of sources.
Change in the air
The need for effective trader surveillance systems is becoming more pressing. So far, the default position for FIs has been to use systems designed primarily to meet the requirements of regulators. While regulations allow for a certain degree of flexibility when addressing trader surveillance, FIs are wary of distinguishing themselves too much from their peers – there is safety in being part of a group of institutions that all manage risk in the same way. As a result, there has been only modest technical advancement in this space.
Yet this picture is changing rapidly. Increasingly, rather than matching their trader surveillance capabilities to those of the bodies that regulate them, or even their peers, FIs are looking to establish their own leading practices. But why? And why now?
The key drivers of change are:
- Regulators’ desire for more ‘semantic’ information around trades2. This has been driven largely by the Market Abuse Regulation (MAR). But it is emerging as good market practice, driving a more holistic approach to surveillance that encompasses electronic communications (e-comms) and trade monitoring.
- At the same time, regulators and market drivers are pushing many FIs to expand the remit of their surveillance to cover a broader range of asset classes, such as fixed-income, commodities, and other Over-the-Counter (OTC) products. Meanwhile, new trading venues such as Organized Trading Facilities (OTFs) must be catered for. Across these new assets and venues, systems originally designed for more traditional, ‘regulated’ asset classes (such as equities) are struggling under the weight of an increasing number of trades, idiosyncratic reporting requirements, and the sheer volume, variety and velocity of the data involved.
- Trader surveillance systems are also generating thousands of alerts per day, more than FIs’ compliance teams can feasibly monitor. This is pushing up costs, as FIs expand their compliance departments with additional Full-Time Employees (FTEs) to keep pace. Not surprisingly, FIs want to increase the quality of their alerts, and speed up how they process them.
In a recent Chartis survey3, 71% of respondents claimed to be in the process of upgrading their trader surveillance systems. Crucially, financial resources do not seem to be a big concern in these projects: only 5% of respondents named budget availability as their biggest challenge. Global expenditure on trader surveillance is also increasing: analysis by Chartis points to a rise in spend of 5% this year, taking it to $758 million by the end of 2017.
Clearly then, FIs understand the need to improve their trader surveillance, and have allocated resources to meet it. Effective surveillance can be a vital tool in an FI’s fight against market abuse, and help to reduce workloads and boost efficiency. But in the drive to establish best-in-class trader surveillance, FIs are repurposing their existing systems, which are struggling under the strain. Nevertheless, by following the steps outlined here, FIs can achieve broader, more accurate surveillance, using the best, most relevant data, and framed within the right organizational culture.
- The Market Abuse Regulation (MAR) and the Regulation on wholesale Energy Market Integrity and Transparency (REMIT), for example, require alerts of market abuse to identify ‘intent’.
- For more details, and a breakdown of respondents, see Appendix A.