Buyers beware! the challenges of effective trade surveillance

Insight | Post 1 | 14 May 2021

We’ve all seen those movies where a minor character blithely walks into the darkened room in the haunted house, or investigates the unlit cellar where the axe murderer lives. “No, don’t do it!” we all want to scream at the screen.  It’s a natural response for sensible people.

Financial service firms are frequently given, in less dramatic circumstances, similar warnings in language that suggests something equally as scary is about to happen. In these instances the “Regulator” is cast as the bogeyman lurking in the shadows  and sharpening their claws.  The concerned citizens providing these warnings are of course not totally altruistic in their intentions and generally are communicating on behalf of companies that provide RegTech solutions for meeting regulatory requirements in specific areas; market abuse surveillance monitoring to meet market abuse rules being one of those areas. 

The current Covid-19 pandemic has created a perfect storm of gloomy warnings on the back of Regulators commenting, understandably, that the impact of mass working from home is a new phenomenon that regulated entities may need to reflect in amended control procedures.  This is clearly stating the obvious.  Given the reality of electronic trading it is unlikely, however, that the fact that a trader is sitting at home in PJs, rather than at a desk in Tokyo for example, is by itself going to lead to an increase in market abuse, which is what has been suggested.

The scaremongering does, however, raise a genuine concern.  Most firms employ a surveillance system provided by a third-party vendor that they rely on to identify suspicious trading activity as part of their Compliance controls.  Those surveillance systems should be agnostic as to where the trade instruction emanates from geographically; so, whether the instruction comes from an office in the City of London, or from any other financial centre, or from a house in the suburbs, is irrelevant.

The important thing is whether the surveillance system used is actually detecting all relevant suspicious activity.  Firms should be asking themselves the same pertinent questions, regardless of any topical considerations, such as:

  • Does our surveillance system cover all of our trading activities?
  • Does it cover all the asset classes and instruments that we trade?
  • Do the surveillance models used include consideration of derivative instruments as well as the underlying products?
  • Are the thresholds of the surveillance models calibrated correctly? 
  • When did we last review the calibrations? 
  • How do we know that the surveillance models are functioning as they are meant to?
  • Have we tested the system with dummy data to check whether an expected alert is created?
  • Does the system really meet our needs or was it just what was available/cost effective at some past point in time? 
  • How can we check the effectiveness of the system without relying on the system vendor?

These are all questions that a firm might expect to have good answers for during a regulatory inspection when surveillance is likely to be top of the agenda, especially in the current climate.  Not being able to provide a satisfactory response to these sort of questions is something that firms should be genuinely worried about when it comes to thinking about the possibility of regulatory censure. 

So, time for firms to ignore the vendors that continually cry wolf and instead focus on revaluating how to test the quality of existing surveillance controls before deciding whether changes are needed to meet the true dangers that lurk in the regulatory forest.

By Simon Green | Subject Matter Expert | AML Analytics

The Outlook for Enforcement Action Linked to Breaches of Market Abuse Rules

Insight | Post 2 | Coming Soon!