The FCA’s Market Watch 69 newsletter presents a wide-ranging discussion about
firms’ arrangements for market abuse surveillance. The discussion is based on the
FCA’s observations of small and medium-sized firms so is likely to be most relevant to the buy-side and smaller sell-side. FCA’s indication of best practice: Whilst the discussion examines the various approaches firms take, the FCA indicates the following best practices:
1. Market abuse risk assessments:
- Market abuse risk assessments should be comprehensive, accurate and up-to-date to help ensure effective surveillance coverage.
- Assessments are most effective when they consider the different types of market abuse and how these apply across different areas of the business and asset classes.
- This should also include consideration of market access as well as trading remits and strategies.
2. Order and trade surveillance:
- Firms should consider the individual characteristics of different asset classes and instruments, before applying this information to calibrate alert scenarios.
- Firms should avoid using common thresholds across and within asset classes owing to differing volatilities across instruments.
- Firms should be aware of recent developments in third-party system functionality in areas such as tailored calibration.
- Where firms use vendor-supplied systems, they should ensure they understand how alert scenarios work by regularly engaging with the vendor.
- Regarding insider dealing risk specifically, firms should not set fixed lookback periods for insider trading but instead consider the period of time during which inside information might exist.
- Self-calibrating systems are particularly useful here as they will calculate lookback periods by considering multiple factors like price move, volatility and market trends.
- Firms should monitor all orders and trades, including cancelled and amended orders, as these can be critical indicators of certain forms of market manipulation.
- Firms should not simply close exception alerts where overt evidence cannot be found (such as an obvious link between a customer and the issuer or source of inside information), as its absence is not necessarily conclusive.
3. Policies and procedures
- Policies and procedures should be clear, detailed and up-to-date in order to ensure a consistent approach to reviewing alerts.
- Once created, there should be measures to ensure that employees follow them in practice.
4. Outsourcing
- UK-based firms which outsource aspects of surveillance to an overseas department or separate organisation remain responsible for identifying and reporting potential instances of market abuse to the FCA.
- To this end, the UK-based function should have sufficient expertise and resources to oversee the surveillance being provided.
5. Front office
- Firms with staff performing dual roles in the front office and compliance department should ensure they have adequately assessed and mitigated any potential conflicts of interest. This is likely most relevant for smaller firms with multipurpose teams.
- This entails tailoring their market abuse training to the risks associated with the desk, asset classes traded, customer types and any other relevant factors.
- Clear escalation policies and senior management support can also help front office staff.
6. Countering the risk of market abuse-related Financial Crime (SYSC 6.1.1R)
- Firms should ensure that they have a formalised SYSC 6.1.1R framework in place.
- Market abuse training can benefit from specific examples including whether to execute a trade if the customer discloses, pre-trade, that they are in possession of inside information.
- Unequivocal support of senior management is essential.
TradingHub’s view as a 3rd party trade surveillance SaaS provider:
The FCA stresses the need for firms to consider the individual characteristics of different asset classes and instruments before calibrating alert scenarios. This approach ensures effective monitoring whilst minimising false positives. However,
we would point out that the work required to tailor alert logic to potentially every instrument and scenario may be too onerous for the buy-side and smaller sell-side given their limited resources. In addition, cross-product abuse surveillance introduces further instrument-specific thresholds which complicates matters further.
The FCA then makes mention of progress in third-party systems “in areas such as tailored calibration”. This refers to systems capable of self-calibration at the level of individual instruments. Such approaches eliminate the burdensome need to create and maintain substantial numbers of custom parameters, including those associated with cross-product abuse monitoring.
We strongly encourage firms to explore the possibilities afforded by tailored calibration. However, we agree with the FCA that users of vendor-supplied systems must understand how alert scenarios work in order to identify gaps and weaknesses. This is particularly important for systems offering self-calibration owing to the sophisticated models they employ in their analysis. In addition, such tools very often require more extensive training to achieve the required level of
understanding.
TradingHub’s MAST product is a model-based trade surveillance tool with self-calibration. For our customers, we provide a wide range of resources to help our users reach a strong level of understanding, including:
- A user guide covering MAST’s self-calibration models as well as the alert logic for each metric.
- Asset class methodologies which detail MAST’s individual approach to each asset class, in particular its approach to detecting cross-product abuse in each.
- UAT sites ahead of each release which customers can use to test our alert logic.
- A forthcoming ‘sandbox’ environment where customers will be able to input test data and verify MAST’s output.
Furthermore, we offer training and support both during and after implementation to ensure full understanding of MAST’s approach and corresponding best practice.