THE “TRIPLE-A” APPROACH.
Financial firms looking to address the latest European regulatory measures requiring trade surveillance and speedy reporting of suspicious activity would do well to consider a “Triple-A” approach to the task at hand. What does that mean? A focus on Assessment, Agility and Assurance, says Nick Gordon, business development director at Certeco.
In an effort to bolster market integrity, European regulators have introduced new measures to root out unscrupulous trading behaviour. A centrepiece of their campaign is Europe’s Market Abuse Regulation (MAR), which came into effect this year and which is still being fine-tuned. Under MAR, a range of market participants will need to report any suspicious trades, orders or patterns of activity. The hitch is that many of these firms have never before had to deal with this sort of obligation. Identifying suspicious trades, building and installing the necessary technical systems and creating the organisational workflows needed to satisfy regulators throws up a welter of issues. So how can firms make sure they will make the grade?
The problem is far from straightforward. It requires advance planning, a consideration of wider organisational issues such as the relationship between compliance and the front office, and a readiness to engage with a range of firms to engineer and introduce a trade reporting system that will meet demanding requirements. One way to address all of this is what might be called a Triple-A approach. That involves breaking the problems down into three broad categories. The first is Assessment, where firms review their trading activity in order to understand the nature of what they’re dealing with. The second is Agility. This means designing, building and introducing interoperable systems that can be adjusted to meet complex or changing requirements. Finally there is Assurance. This is where the focus is on testing to make sure the solution is fit for purpose.
In theory, firms should have a strong grasp of the business they are in. In practice, it is often not so simple. The speed, complexity and fluidity of modern trading mean that the nature of the business is constantly evolving. Yet any trade surveillance and reporting system needs to be based on the nature of the underlying business. There are no one-size-fits-all models, in part because regulators themselves have not been cut and dried about what needs to be reported.
The lack of rigid rules results in a need to think about a firm’s trading activity in terms of risk. Companies will want to ensure that the priority of any system is calibrated to focus on where the greatest risks lie. For example, one type of firm that now needs to meet MAR requirements is the interdealer broker. IDBs frequently undertake complex transactions, which in turn means risk profiling becomes fundamental.
IDBs and other firms need to think about what the regulator is asking of them and what their own business requirements are. Then they need to bring all of that together. Firms that have greater exposures to cross-market activity will have different needs from those that specialise in one market or asset class. The complexity of monitoring activity at a cross-market level is naturally much higher.
Building trade surveillance and reporting systems involves first and foremost building solutions that will generate alerts for the business. These alerts are the building block of a trade reporting process. But solutions need to be able to work within existing infrastructures and at the same time be flexible enough to change with the times.
Alerts also are only the first step in the process for meeting regulatory requirements. Once alerts have been generated, they need to be investigated for anything that might be considered suspicious. This is where the importance of Agility becomes clear. The business needs a system that can allow the alerting system to be calibrated based on back-testing. For instance, a company may find its alerting system is generating too many false positives, which can become costly.
Firms can build in protocols that allow front- or back-office staff to adjust parameters based on business or compliance requirements. Throughout the entire process, it’s important to separate business requirements from technical requirements. This can be helpful in bringing IT, legal, compliance and front office stakeholders together to achieve a solution.
Finally, having determined requirements and designed a system, there is the question of whether the solution fits the bill. Companies also need to be able to ensure it will work 24/7. Here, it becomes a matter of more than just software and hardware. There are also issues in terms of introducing effective and efficient workflows between the back and front office.
One other major point is worth noting. Automation is vital throughout this process. The sheer amount of trades that are being monitored and the number of alerts generated require a degree of automation if a firm is to avoid devoting too much resource to the regulatory requirement. Creating a bespoke automated system can help firms maintain healthy margins while still satisfying regulations.
Breaking down the problem into the three “A”s described above can help companies get to grips with the new regulation. But there are still business decisions that can have a huge impact on the success or failure of any new surveillance system.
Some firms may want to build their own solutions, from start to finish. These are often going to be larger international firms that already have a good deal of in-house expertise. But for a sizeable number of firms that are suddenly caught in this new regulatory web, this will not be an option. For these firms, a big question then becomes whether to outsource the requirement to a single provider or seek to mix and match problems with specific vendors. The more complex the trading profile, the more likely it will be that multiple solution providers will need to be brought in.
Whatever solution firms opt for, there is one thing worth bearing in mind. Never underestimate the scale and complexity of the challenge. The last thing a trading outfit wants to do in this day and age is to get on the wrong side of a regulator.