Jon Knight, Head of Surveillance, Liquidnet Europe, talks to Best Execution about the importance of market surveillance in terms of creating and maintaining an efficient and orderly market.
What are your views on the regulatory changes striving to curb market abuse practices?
Preventing market abuse is in the best interest of the whole financial market and its participants. Today regulators and investors are unwilling to tolerate market abuse of any kind. At Liquidnet, as a global trading network, we operate a robust surveillance system, Liquidity Watch, in order to protect our members – and it is a responsibility we take extremely seriously.
That said, there will always be people looking for ways to manipulate the market and this is why regulatory efforts to curb market abuse practices, in consulation with market participants, are important. The message must be that if you commit market abuse be prepared to face the consequences, because you will get caught.
What are the current issues and trends that you are seeing?
As trading in the financial markets becomes faster and arguably more complex, so does the task of market surveillance. For example, fragmentation of the European equity market means that market participants can trade the same stock on multiple venues. As a consequence, we monitor very closely for potential manipulation of bid/offer spreads and trade prices on the different venues along with other market distorting behaviours. This means that we survey activity on our own and other trading venues globally.
Surveillance methods, at the very least, need to keep up with developments in trading technology and so at Liquidnet, we make ongoing investments in our monitoring tools with the aim of staying one step ahead.
What are the prime concerns for buyside institutions?
Buyside firms, like all investment firms, have a regulatory obligation to achieve best execution, which is often misconcieved as an obligation to get the lowest cost of execution. In truth, for the buyside, best execution relates to an obligation to minimise market impact and information leakage, as well as cost.
Liquidnet’s buyside members trade through our network because they know that doing so provides them with best execution and reduces the potential for information leakage and market impact. Every day, our members trust us with their most valuable information: their trading intentions. Because of this trust, we have a responsibility to do everything we can to protect their orders and information, and Liquidnet’s Market Surveillance team are key to making sure that we fulfil this responsibility.
How does market surveillance work in Liquidnet globally in terms of protecting the interests of your members?
Liquidnet has MTF (Multi-lateral Trading Facility) status and as such, we have the same requirements as regulated markets. We operate a global surveillance team, which reflects the fact that our members are dispersed world-wide and trade markets around the globe. Today we connect over 700 of the world’s leading asset managers to large-scale trading opportunities – block trading – in 41 markets across five continents, including 29 markets in Europe, and offer a different type of trading proposition1.
We have strict membership requirements that are intended to safeguard the integrity of our network. Essentially, these requirements provide members with the assurance that when they trade with us, they are accessing a natural pool of liquidity and connecting with other like-minded long-term investors.
Under FSA rules we are required to monitor our market for breaches of our rules, disorderly trading conditions and most importantly market abuse. This requirement is in addition to the standard market abuse monitoring requirements that all investment firms have. Essentially we monitor all trading activity on our markets in real time and on a T+1 basis in an attempt to detect a variety of manipulative and information-based behaviours that are, or indicate, market abuse or conduct issues.
Within our Liquidity Watch surveillance system we use a feature called Auto Policing, which analyses our members’ behaviour in real time and helps to ensure their information is protected at all times – particularly frustrating behaviour can result in a member being temporarily suspended from being able to trade a stock automatically by the system. Indeed, if one member does not follow the appropriate protocols, we have an obligation to our other members to prohibite them from interacting within the network.
Is harmonization across different jurisdictions an issue for your organisation and how is it addressed?
Harmonisation of market surveillance practice is a natural progression. We have a single surveillance system here at Liquidnet that applies best practice in whichever jurisdiction it is required, globally. This means that we provide the same high level of surveillance across all of the markets and juristiction we operate.
Who, other than the regulators, are pressing for change?
When it comes to market abuse, it is clear that everyone is pushing for a continued commitment to develop more enhanced methods and processes for market surveillance. It is an area of the financial markets where everyone is trying to work together. Regulators look to market participants and trading venues to help them understand the issues and develop appropriate responses, and the markets need regulators to make sure that standards and rules are applied across markets, and enforced where necessary.
A firm’s surveillance function exists to prevent and identify market abuse, and to be successful, surveillance teams across the industry have to work together to achieve this goal. In my view, a collaborative and holistic approach to market surveillance is needed, and I am positive about the progress that has been made as a result of ongoing dialogue between regulators, participants and trading platforms like Liquidnet.1. The average trade execution on Liquidnet today is c.€800,000 (c.US$1m) versus other MTFs/non-displayed venues at between €5,000-€25,000 and €3,000-€5,000 on European lit markets.