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Market Surveillance 2.0: Beyond the Crisis

27 August 2014

School for (Avoiding) Scandal

Compliance officers have the responsibility to ensure their firms do not cross the line into fraudulent or manipulative behavior. And they are now more accountable than ever if this does happen. Here are 5 steps compliance officers should consider when choosing a market surveillance system.

A recent article in the FinOps Report (“Chief Compliance Officers: Five Steps to Hiring the Right Team”) started me thinking. According to the article, compliance officers “may as well act as though you’re responsible for everything, because you’re going to have to live with the results.”  This has never been truer than today. 

As I said in my last commentary, for traders, orange is the new black; with law enforcement agencies such as the US’s FBI and the UK’s Serious Fraud Office watching financial markets, the game just got more dangerous. Compliance officers have the responsibility to ensure their firms do not cross the line into fraudulent or manipulative behavior. And they are now more accountable than ever if this does happen.

Changes to corporate culture, practices and technology are needed or more people will end up in prison. Detecting “unwanted behavior” such as rogue trading, system errors, insider trading, front-running, wash trading or quote stuffing will help compliance officers prevent a raft of trade-related meltdowns, ranging from the failures at UBS to Knight Capital. Monitoring trader behavior can help avoid another LIBOR or FX fixing scandal.

So I propose five steps that compliance officers can take to make choosing their surveillance software easier.

Step 1 – Buy vs. Build

Consider the extent to which you want to buy versus build. You need to decide this first. Do you have the team to build something 100% bespoke? Many firms do not have either the experience or the budget. But equally, a commercial off-the-shelf system can be too restrictive, especially for global multi-jurisdiction operations. Maybe you are looking for a middle path – a hybrid of the two.

Step 2 – Pace of Evolution

Consider how easily you can evolve your technology in the face of the next big scandal. Look at FX – out of nowhere it became the hot topic when regulators began to investigate traders, with around 10 banks suspected of manipulating the 4pm FX benchmark assessment.

FX joins LIBOR, the gold fixing, short selling, front running, rogue algos and dark pools in the School for Scandal. There is always another transgression just around the corner.

Step 3 – Profiling Behavior

Consider how best to use big data analytics on historical data to find patterns and trends that can enhance on-the-fly detection of anomalies. Profiling of ‘normal’ behavior from historical data can give highly granular insights into activity by trader/instrument/client/time of day that can materially improve real-time alerting.

[Related: “Learning From the Past: Predictive Analytics Offer Early Warning System” (free QuantFORUM registration required)]

These insights can elevate alerting from one-size-fits-all parameters, with high volumes of noise, to granular alerting using logic and calibration tailored to specific trader/instrument/client combinations. Better results, less false positives, more productive teams – a win-win.

Step 4 – Interface to GRC

Consider how comprehensive a case management platform you need. Do you want to wire your surveillance activities into the wider governance, risk management and compliance structure, or have it stand alone? To what extent is the wider GRC structure capable of handling on-the-fly output from surveillance?

Step 5 – To Host or not to Host

Consider a hosted versus on-premise system. A hosted system is necessarily cookie-cutter in order for vendors to achieve economies of scale that can be passed on. An on-premise system doesn’t have to be expensive and would be better suited to firms that want ownership of the future direction of their surveillance.

There obviously is far more that could be said here and, in the current regulatory climate, “Five Steps” could easily have been “50 Steps.” But if you start with this road, you might just avoid scandals and keep your company and your boss out of the headlines – not to mention the attention of people in dark suits who are usually found dealing with serious crimes and organized syndicates.

Spotlight-white-trans For more stories in the Market Surveillance 2.0: Beyond the Crisis Spotlight Series click here.

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2 Comments to "School for (Avoiding) Scandal":
  • Comment_230146_210851315613283_100000652474653_678322_2285980_n

    28 August 2014

    sadly is part of the problem being there are still officers in charge in positions that both ignored and profited from these scandals ?

  • Comment_photo_cedelen_150

    28 August 2014

    Good article Theo. It's not just the software that goes into the build/buy decision. It's also about the expertise needed to build a system that provides insights and information. It's one thing to track the activity, it's a whole different process calibrate the tech to uncover what's important.

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