TECH TUESDAY: Checklist: 7 Processes Surveillance Teams Need in Place, According to Regulators

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By Amit

Regulatory prosecution of market abuse is par for the course nowadays. If a market participant has breached specific regulations, it is expected that there will be regulatory repercussions. Interestingly, over the past few years, regulators have shown an increasing focus in not only the adherence to these regulatory protocols, but also the systems and processes that firms have in place to monitor for them. Recent regulations, guidance notes, and fines and prosecutions can attest to this. 

Take, for example, the Financial Conduct Authority in the UK. A market participant was fined over GBP 4.7 million by the FCA in December 2022 for failing to “properly implement the MAR trade surveillance requirements.” Between July 2016 and January 2018, the firm had surveillance processes that “were deficient, and therefore, inadequate in properly addressing the risk of market abuse.” Additionally, its monitoring systems did not have coverage of all asset classes which are subject to MAR.

In the US, a market participant was fined by FINRA in early 2022 for “failing to maintain adequate surveillance systems.” The judgement stated that the firm’s processes “were inadequate and incapable of flagging suspicious activity.”

Outside of these fines, several other regional regulators have laid out explicit guidance of surveillance processes and systems:

  • European Securities and Markets Authority (ESMA): Market Abuse Regulation

According to Article 16(2) of the Market Abuse Regulation (MAR), a regulated entity must “establish and maintain effective arrangements, systems, and procedures to detect and report potential market abuse.”

  • Monetary Authority of Singapore (MAS)

A regulatory review program focused on “the adequacy & robustness of the brokers’ trade surveillance operations,” including: a governance framework, surveillance processes and a resources escalation policy.

  • Australian Securities & Investments Commission (ASIC)

A regulatory review looked at market participant’s arrangements to prevent and detect misconduct, and included consideration of: adequacy of order filters & controls, governance around order & trade surveillance alerts (including their assessment & escalation), compliance with suspicious activity reporting obligations.

In consideration of this regulatory activity and guidance, below are seven important points to consider to ensure your firm’s surveillance program meets the requirements a regulator would check for.

1. Alert Effectiveness

This is critical and all about the need for participants to have processes that ensure: the deployment of a detection program that provides effective market abuse coverage in line with the firm’s risk assessment as well as continued review, calibration, and tuning of those alerts to maintain their effectiveness into the future.

The ongoing effectiveness of a firm’s alerts is under the spotlight from regulators globally. For example, in the recent “Market Watch 69” the FCA commented that it had carried out on-site reviews across a range of small to medium sized firms – and concluded that the setup and calibration of alerts for most of these firms was poor.

2. Data Inputs Quality Control

Firms need to ensure that they have transparency and end-to-end assurance for all data inputs into their surveillance systems. Surveillance service providers should be able to assist in this process

At a minimum, quarterly and half-year reviews are recommended and may include: reconciling message volumes against internal sources to ensure all trading activity is captured, monitoring field values against tolerance thresholds to ensure quality is maintained, and generating a “red flag” for further investigation if there are any breaches of the thresholds.

3. Sound Detection Mechanisms and Assessment

Robust alerts and the ability to rate the impact of the alert are important features that a regulator would most likely review.

Key considerations include the automation of surveillance processes as well as an alert review policy that provides guidance on the criteria used to grade the risk of alert types, criteria for closure and escalation of alerts, a clear process and mechanism for alert escalation, timelines for actioning and closure of alerts and a process to monitor status of outstanding items.

4. Availability of Surveillance Resources

Sufficient staffing to monitor the level of trading and risk types identified by the risk assessment is also necessary and should consist of experienced staff with clear reporting lines that do not involve conflict of interest, staff with the required skills, a process for continuous learning and training, and sufficient IT resources and budget to ensure that surveillance tech is effective and regularly reviewed.

5. Senior Management Oversight

The importance of oversight cannot be understated. Senior management has a significant role to play to ensure that there is accurate visibility into the ongoing trade surveillance program, including receiving and reviewing periodic reports on surveillance metrics and initiating periodic reviews of the program, including review of alternative vendors and technology.

6. Proper Record-Keeping

Transparency and accountability are key and best maintained through diligent record keeping.

This includes maintenance of surveillance records and documents for audit and inspection, quality reviews of alert assessments, closure and escalation decisions, and periodic sampling checks of records.

7. Prompt and Confidential Reporting of Potential Market Abuse

If market abuse is detected, prompt and confidential reporting are crucial to mitigating risk and ensuring compliance.

This includes prescribed escalation actions, such as, a verbal reminder or warning, account suspension, a report to a regulator (as STOR) where applicable, as well as processes for prompt handling of regulator queries for information.

When approached with these key considerations in mind, running an effective surveillance program – one that meets regulatory scrutiny and that provides effective coverage of market abuse risk – is perfectly within reach.

To learn more, visit us at Nasdaq Trade Surveillance

Originally published on Traders Magazine.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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