Trade Surveillance in 2023: Ensuring Market Integrity and Compliance 

The pillars of market abuse, greed and fear, haven’t changed in the hundreds of years in which financial trading has been monitored. But the ways in which these behavioral risks manifest have.

Decentralized work spaces have created surveillance blind spots, while the ease at which deals can be done via electronic communication has created further avenues for misconduct to materialize. Taken together there are more opportunities for bad actors to strike, and a wider field of complex financial products and geolocations across which to hide. Given the exponential growth of data generated as a result of changing workforce trends, already stretched compliance and trading surveillance teams must remain vigilant as the control environment relentlessly expands.

“Firms must recognize their oversight and control weaknesses for remote working and explore new ways to mitigate risk,” said Gregory Rossi, associate partner at consultancy Promontory. “At the extreme end of the spectrum, this may provide opportunities for rogue traders who can exploit the lower level of oversight.”

The gaps in surveillance are a major focus for regulators, Rossi said. Enforcement officials are increasing the level of scrutiny on surveillance teams to ensure the function is capable of dealing with the modern threat landscape. Requirements around record keeping, communications monitoring, and the prevention of use of material non-public information have dramatically tightened in recent years.

A recent sweep of Wall Street banks resulted in fines of $200m each where the use of WhatsApp and other chat apps by traders went unmonitored, even when no evidence of misconduct was found. The admittance that certain individuals were not subject to sufficient market abuse monitoring was enough to trigger a significant escalation of monetary sanctions for such lapses.

Financial services providers and regulators clashed repeatedly over obligations to preserve emails as business records in the early 2000s, but where 20 years ago, five banks paid a combined $8.25m for poor email retention, today’s numbers are no longer immaterial. In light of these considerable compliance and reputational risks, businesses require a more intelligent approach to market surveillance, treating comprehensive coverage of devices, apps, voice and email communications as a necessity, rather than a luxury.

Market abuse monitoring trends and enforcement

Market abuse is a catch-all term for various illicit behaviors that erode the fairness and transparency of the financial system, with the most common forms being insider trading, market manipulation and circulating false or misleading information. Over the last 18 months regulators have noted a rise in marking the close and spoofing/layering cases, and new forms of wrongdoing such as rug pulls, short squeezes and printing, have appeared, often linked to crypto trading.

Many prominent, sometimes overlapping, regulations have been implemented internationally over the last decade to help protect the financial system from these misdeeds, and have subsequently required surveillance teams to broaden their radar.

The European Union’s Markets in Financial Instruments Directive II (MiFID II) and Abuse Regulation (MAR), and the United States Dodd-Frank Act are the most prominent, each mandating businesses to implement robust surveillance systems, report suspicious activities, and maintain compliance with tough guidelines.

Non-compliance is inciting severe monetary penalties and reputational damage, with no let up from regulators “who are far less tolerant towards incidents of financial crime than they were a decade ago”, said Elia Alonso, principal and conduct risk practice leader at Deloitte.

Examinations go beyond the range of coverage into assessing the completeness of data captured by the surveillance system, which means shoring up gaps that can appear when traders hold conversations across various phones and other devices. Regulatory expectations are of a commitment to maintaining market integrity while remaining flexible to evolving abusive scenarios, proactively addressing problems and upholding the core values that underpin financial markets.

Many large businesses have carried out root-and-branch reviews of their existing systems and controls to stay on top of the new conduct risks emerging, and a sea change in what constitutes good surveillance is occurring.

The global threat picture

Marking the close and spoofing/layering are the top market abuse behaviors logged by US regulators over the last two years, with dissemination of false and misleading market information and insider dealing close behind, official figures show.

The diligence of the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) have resulted in commodities asset classes enduring the heaviest enforcement activity, over the last three years.

Where enforcement officials all over the globe are aligned is their focus on the use of personal devices by monitored individuals. What began with a sweep of unapproved or unmonitored communication channels inside US lenders soon spread to Europe and beyond. Noncompliance with recordkeeping requirements resulted in more than $2bn in fines being handed out to all the major names, with the minimum fine per firm coming in at $200m regardless of whether any illicit activity was found.

Our recent survey report with LeapXpert found that the top concern for financial institutions (64%) is their level of preparedness for regulatory audits, and potential fines, and it’s easy to see why. Failing to adequately capture business communications on personal devices has become a costly problem for Wall Street banks; approximately $2.7bn in penalties was handed out between 2020 and 2022 under the banner of market abuse.

Over the same period, regulators enforced more than $217mn in penalties related to other supervision and eComms surveillance failures; most of which relates to the use of unapproved channels of communication and record keeping requirements.

The evolution of market abuse monitoring

Where once teams of human reviewers conducted blind, random sample tests of recorded voice calls and “lucky dip” emails, the increasing digitization of trading has changed surveillance. Sophisticated misconduct and market abuse monitoring operations today are underpinned by machine learning tools capable of processing and finding patterns inside enormous datasets. Rules-based lexicon systems of previous surveillance systems have been rendered obsolete by next-generation solutions like Shield, which has the dynamism and robustness to move with today’s turbulent trading landscapes.

Algorithms and other predictive AI techniques are used to identify anomalies and suspicious behaviors that indicate misconduct may be occurring. Pattern recognition and entity resolution tools can be used to detect deviations from acceptable behaviors, flag suspicious actions, and provide risk scores. This allows for faster interventions and improves the standard of investigations conducted.

Natural language processing tools can be applied to historical alerts, categorizing the information to create a more accurate profile of what a high-quality alert resembles. Even identification of as-yet-unknown threats can be flagged through tools applied to parameter setting and adjustment, using adaptable and outlier-based logic.

Moving surveillance operators to the cloud allows solutions to be deployed across an unparalleled suite of eComms and aComms channels, whilst reducing the number of false positive alerts generated for investigators to examine.

Often used in tandem with trading surveillance systems, intelligent monitoring systems give a truly holistic picture of an individual’s actions and behavior and go far beyond the outdated ‘tick-box’ approach of older solutions. The system shifts from investigating individual alerts to a broader, more holistic view of a trader’s conduct, whilst continuously learning and adapting to emerging market abuse patterns.

Where once human reviewers would perform random tests on recorded voice calls and emails in an attempt to detect misconduct, the digitization of trading has pushed surveillance operations to become more sophisticated. Advanced systems are capable of continually learning and improving, and can proactively target a much greater range of dangers from negligent insiders and malicious actor to compromised individuals who may have been influenced by external forces.

The Commodity Futures Trading Commission

The Commodity Futures Trading Commission (CFTC) requires that financial firms maintain, preserve, and produce records (on demand) in addition to supervising “all matters” related to their business as registrants of the CFTC. This includes overseeing all communication including restricting digital communication to only approved devices. In September 2022, the CFTC laid out hefty fines totaling more than $700 million hitting Barclays, JPMorgan Chase, Morgan Stanley, Citi, UBS, Goldman Sachs, and Credit Suisse with $75 million each in fines for failing to stop their employees from using unapproved eComms apps. Bank of America had the unlucky distinction of receiving the heaviest fine: $100 million.

Intelligent technology and modern trade surveillance

Integration of every eComms and aComms touchpoint, and the ability to use data from across the enterprise to deliver effective case management, can only come via machine learning tools.

Breaking free of the limitations imposed by legacy systems, cloud-based surveillance solutions can ingest data from various electronic and alternative communication channels, scale whenever necessary, and minimize the generation of false positive alerts for investigators to sift through.

Intelligent systems shift the focus from investigating individual alerts to adopting a broader and more holistic view of a trader’s conduct. Moreover, they continuously learn and adapt to emerging market abuse patterns, ensuring proactive detection and prevention.

Conclusion

Market abuse monitoring is an essential facet of compliance strategy that helps businesses guard against insider threats and misconduct offenses and ensure there is nowhere for those ageless signifiers, greed and fear, to hide. Machine learning and AI have revolutionized the way trader surveillance is performed, offering blanket coverage across communications channels and international business locations, supported by scalable and efficient cloud infrastructure solutions.

Intelligent, robust surveillance platforms present a holistic view of market activities, enabling teams to identify intricate patterns and interconnected behaviors that might otherwise go unnoticed. This all-encompassing approach ensures early detection of potential market abuse, mitigating the risk of escalation in an era where enforcers need little encouragement to dish out hefty sanctions.