Revisiting Best Practices for Trade and Market Abuse Surveillance (Downloadable Checklist)
Regulators around the globe are open for business despite the challenges of the COVID-19 era. Recent enforcement actions, exam deficiencies, and announcements suggest that firms’ surveillance obligations have only increased due to the extended work from home environment.
Regulators view the increased potential for insider dealing and market abuse from recent market volatility and the work from home environment as true risks. They are looking for firms to adjust their surveillance programs accordingly to capture these risks.
In this blog post we examine recent regulatory events around trade surveillance and market abuse and provide best practices that can be applied to your firm’s surveillance program. These observations and best practices are to be considered within the context of these recent regulatory events and should not be considered an exhaustive or comprehensive solution.
We have also updated our Trade Surveillance Program Gap Analysis Checklist to incorporate these and additional best practices.
Adjust surveillance programs and systems alongside evolving risks
Although the Financial Conduct Authority (FCA) introduced the Market Abuse Regulation (MAR) in July 2016, the adoption and change needed is not yet there for many firms.
Julia Hoggett, the FCA’s Director of Market Oversight, recently gave a speech called “Market abuse in a time of coronavirus.” In the speech, she discusses the need for surveillance processes to evolve as risks evolve: “Whilst the fundamentals of the market abuse offences are constant, the ways in which the risk may manifest are not. The manner of surveilling for them must, therefore, also change.” It’s clear from this speech that the FCA is advocating for holistic change.
From re-reading this speech as well as Hoggett’s past speeches on market abuse from 2017 and 2019, it’s possible to glean a roadmap for developing and implementing a properly risk-based surveillance program. In her 2019 speech, Hoggett said, “There is still more for the industry to do to improve its capacity to surveil for market manipulation.” This feels particularly prescient given the recent enforcement actions from the CFTC and SEC related to spoofing. Could there be more to come in the UK?
- Adopt a mindset of compliance/surveillance across your firm
- Review your firm’s surveillance program and make any necessary adjustments to capture COVID-19-related risks
- Calibrate your surveillance systems to identify anomalous behavior across changing market conditions and multiple asset classes
Monitor for spoofing and other manipulative trading
Recent penalties brought by the CFTC and SEC are a reminder of the importance of monitoring for manipulative trading, including spoofing. In a press release regarding a recent spoofing case, the SEC said, “Generally, in the course of principal trading, Traders placed numerous non-bona fide orders on one side of the market for a particular Treasury instrument – i.e., orders they never intended to execute – in order to create a false impression of buy or sell interest in that instrument that would raise or depress prices and allow the Traders to obtain opposite-side executions on bona fide orders at more favorable prices than would have otherwise been possible. After securing beneficially priced executions, the Traders would typically cancel the non-bona fide orders.”
Best Practice: The CFTC and the SEC both look at the activity of the participant’s orders, prices, and timestamps for potential manipulative activity. Review your surveillance systems to ensure they align with the current observed definition of spoofing.
ACA’s Market Abuse Surveillance Solution can detect spoofing. Below is a visualization of how the system's algorithms detect spoofing and recreate the potentially spoofed trade for further investigation.
Detecting potentially anomalous trading activity
The FCA has begun to closely examine firms’ trading patterns and event behavior to determine whether the firm has acted in an anomalous fashion. On October 9, the FCA announced a new metric for evaluating market cleanliness, the Potentially Anomalous Trading Ratio (PATR), which looks at potentially anomalous trading that occurs ahead of a price-sensitive news announcement. As part of this announcement, the FCA highlights the importance of calibrating systems to reduce statistical “noise” and identify items that are truly out of the norm.
The FCA’s evolving approach to market surveillance aligns more closely with the U.S. Securities and Exchange Commission’s (SEC) Division of Enforcement’s technology and ARTEMIS tool. That tool – for which the technical specifications are not published – appears to monitor participants’ activity around company announcements and scan for suspicious trading patterns and win/loss ratios at individual firms as well as firms that may be acting in concert.
ACA’s Market Abuse Surveillance Solution will soon include a win/loss ratio algorithm that builds upon methodologies like those used by the FCA and SEC to detect potentially anomalous trading activity.
- Remain diligent about employing a risk-based approach to trade surveillance
- Design your surveillance program to respond to evolving risks and scale alongside dynamic market conditions that may lead to firm trading behavior that falls outside of the historical norm
- When developing your firm’s surveillance process, understand the meaning and goal of the approach.
- Ensure your surveillance program centers on the nature of your firm’s trading setup in addition to potential risks driven by employee activity. Not every algorithmic test will align with your firm’s trading style or asset classes. The approach should stem from a thorough understanding of full trade recreation, beginning with how a trade may be incepted through to execution and allocation. A trade does not begin with the order, but for fundamental managers, it begins with the research process and data capture. For quant strategies it may begin with the model and computer programmer.
Event tracking and employee personal trading
A few years ago, it was a best practice to record and review (or potentially chaperone) meetings with Expert Networks due to the potential transfer of material non-public information (MNPI). Firms adopted controls around this, which included involving Compliance in the firm’s disclosure and approval process. In the age of COVID-19, this event list has expanded to include paid or non-paid consultants or issuers where MNPI could be present.
Employees’ personal trading is also part of this list. The FCA noted in Market Watch 63 that firms need to be aware of the risks personal account dealing (PAD) pose and have appropriate monitoring in place. ACA has observed that SEC seems to be requesting firms’ employee trading activity in the same format as a fund’s portfolio to monitor for certain transactions. The SEC’s ability to see activity down to the account level allows them to trace activity back to the employee or their employer.
There are multiple risks around meetings/events relative to personal trading, including the information gained during these meetings. Another risk is around expenses and fiduciary responsibility to the investors in your fund. If the fund either pays for the meeting directly or it occurs because of commission generation then it should be the investors that benefit from that research and not the employee. If a trade is determined not to be appropriate for the fund and the employee wants to make a personal investment, this needs to be disclosed and documented.
Best Practice: Confirm the MNPI controls applied to your firm’s trades are also applied to employee trades, as well as the tracking and testing of events or meetings.
Please note these tests are not limited in scope to equities. All asset classes should be considered in a full scope surveillance process and lately we have seen a lack of controls in fixed income specifically highlighted.
How We Help
ACA’s trade surveillance and market abuse solutions are designed to help your firm manage its firm-wide and employee trading risk in a way that meets regulatory expectations and industry best practices. Our offerings include consulting, managed services, and technology to provide your firm with a holistic solution for developing and executing a comprehensive and truly risk-based surveillance program.
For questions or to discuss how ACA can help your firm strengthen its surveillance program, increase efficiencies through technology, and ensure your regulatory obligations are met, reach out to your ACA consultant, or contact us here.