It is clear that the financial services industry now stands at a crossroads. It can choose to display corporate responsibility, fully engage in the legislative process and prudently manage compliance risk. The alternative – stonewalling regulator efforts and ignoring public criticism – will inevitably lead to a decline of not only the industry’s reputation but the industry itself.
Basel III, Dodd-Frank, ESMA Guidelines, REMIT, EMIR, MiFID and MAD reviews, individually and collectively, paint a very stark picture. Regulation is here to stay, and it is becoming more and more difficult to grasp and monitor the combined effect of the different rules.
A number of proposed regulatory rules are looking to limit trading strategies. For example, both the U.S. SEC and the EU Commission are considering rules to stipulate that an order must reside in an order book for a minimum time period before it is cancelled. In MAD and MiFID reviews, introductions of order to trade ratios are being considered. Under the ESMA Guidelines “Systems and controls in an automated trading environment for trading platforms, investment firms and competent authorities,” Direct Market Access providers are now obligated to monitor and understand their customers’ activity on the market venues where access is granted, as well as report any suspicious transactions to the competent authority.
Regulators are increasingly asking for more sophisticated and prescriptive market abuse detection capabilities, such as real-time surveillance. These requirements will most likely not only become tougher and more detailed over time, but regulators will also take a much more specific and active interest in market abuse detection and follow up on any patterns of suspected abuse. This will require firms to quickly collate relevant information in a format that is easily presented and shared between relevant parties.
Raising the Stakes
In addition to developing more stringent rules for market participants, regulators are becoming more vigilant about getting to the bottom of suspected market abuse, whether its source resides within its jurisdiction or is based elsewhere in the world. And they are raising penalties for verboten behavior.
Whether the regulatory action is a fine or a criminal prosecution, those found guilty are subject to not only financial damage but reputational damage as well. Ultimately, they also provide fuel to clamp down and regulate the whole industry.
The Regulators’ Role
Regulators can no longer rely on trading venues to conduct effective market surveillance, as only a portion of the consolidated market is traded on their marketplace. So it is logical that ESMA is pushing its fellow regulators to take a more active role in market surveillance and fostering a collaborative spirit between regulators to share information and cooperate in market abuse cases.
This means that regulators must invest in technology and know-how in order to take an active role in market abuse detection and follow-up. This is a big challenge for any organization, and regulators will increasingly seek information and data from market participants to better understand and be able to make decisions in individual cases.
What is Effective Surveillance?
Clearly there is now a business case for firms, trading venues and regulators to invest in surveillance systems that can look across markets, products and regulatory jurisdictions.
For a bank or broker, such a solution must be able to analyze trading activity and the effectiveness of algorithms, ensure that trading activity falls within regulatory frameworks, and comply with corporate ethics of the company. The system needs to be integrated with other compliance tools – such as pre-trade risk, social media surveillance, staff dealing and customer due diligence – to give a complete picture of regulatory risk and the ability to demonstrate a comprehensive approach.
Regulators, meanwhile, need surveillance systems that can analyze orders and trade data and then share information with their peers and cross-jurisdictional authorities such as ESMA. The data model needs to be flexible enough to allow data feeds from disparate sources.
Ultimately, technology is only the tool, and it needs to fit into the broader picture of processes and workflows.
There is upside in all of this. For the visionary organization, a well-functioning and integrated compliance and surveillance solution is becoming an important opportunity to get ahead of the competition and – perhaps even more importantly in today’s climate – also a way to demonstrate a company’s full commitment to corporate responsibility and engagement in the evolving regulatory landscape.
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