Originally published in Traders Magazine
Market manipulation and trade surveillance continue to make headlines. Trade surveillance remains dynamic and right now, the field is going through a period of new technological advancements, while regulators have higher expectations for compliance coverage than ever before.
According to Tony Sio, Head of Regulatory Strategy and Innovation at Nasdaq, there have been a robust number of enforcements in early 2024, and a few noteworthy trends are expected.
There have been several significant social media-related market manipulation cases as well as guidance, with some notable cases in progress from the Securities and Exchange Board of India (SEBI), the Securities and Futures Commission (SFC) in Hong Kong, and the US Securities and Exchange Commission (SEC), he said.
This year, Sio said, regulators have also put out multiple guidances around financial influencers and schemes such as pig-butchering scams, which use fake online personas to trick individuals into fraudulent investments.
In the US, the recent win by the SEC Shadow Trading cases has put a focus on insider trading through economically related securities, Sio commented.
Regulatory scrutiny surrounding various forms of market abuse is intensifying, with no signs of slowing down, Shayne Ganeson, Global Head of Relationship Management at TradingHub, said: “If anything, we can expect it to increase.”
“US regulators are getting wise to the new forms of market abuse that have emerged with the increasing sophistication of our markets,” he said.
“As advanced detection technology is more widely implemented, enforcement against cross-venue, cross asset abuse will increase dramatically,” he added.
Meanwhile, according to Joe Schifano, Global Head of Regulatory Affairs, Eventus, in recent years, the focus of market manipulation enforcement in the U.S. has shifted.
While direct cases of manipulation remain, regulatory bodies are increasingly scrutinizing firms’ surveillance processes and capabilities, he noted.
The question is no longer just whether manipulative activities occur, but whether firms have systems in place to detect and prevent such activities effectively, he said.
According to Schifano, this shift has led to increased enforcement actions targeting firms’ internal processes, particularly when these processes involve outdated third-party surveillance software.
“Legacy systems are frequently cited as weak points in firms’ compliance frameworks, underscoring the need for modern, comprehensive surveillance mechanisms,” he said.
He added that in some cases (see here and here), the regulatory spotlight falls not just on the manipulative actions themselves, but on the robustness of the firm’s surveillance infrastructure. “Questions arise about whether firms have the right data, if their systems are properly calibrated, and whether they have operational procedures in place to identify and rectify gaps,” he said.
“The reliance on legacy systems that cannot adequately address these concerns can expose firms to significant regulatory risks, making it imperative for them to reassess and, where necessary, overhaul their surveillance frameworks,” he stressed.
Legacy Systems
Schifano believes that trade surveillance is at a critical inflection point.
“Legacy providers, once the bedrock of compliance efforts, are increasingly falling short in their ability to adapt to today’s dynamic trading environments,” he said.
These older systems lack the flexibility required to tailor surveillance methodologies to the unique risk profiles of different firms, Schifano said.
“As a result, compliance teams are often forced to develop cumbersome workarounds, layering internal methodologies on top of existing systems that are no longer fit for purpose,” he commented.
However, Schifano said change is on the horizon, adding that more firms are beginning to recognize the limitations of their legacy systems and are embarking on the challenging but necessary journey of modernization.
“This shift is essential for firms to stay ahead of evolving regulatory expectations and to ensure that their surveillance mechanisms are both effective and efficient. The transition to newer systems is a critical step in maintaining compliance and protecting against regulatory scrutiny,” he pointed out.
Ganeson agreed, saying that it is wise for firms to assess their trade surveillance models and protocols now and ensure they are robust and up to date.
“In some cases, this may mean looking for best-of-breed trade surveillance software. By proactively addressing these issues, firms can help prevent costly fines and safeguard their reputation,” he said.
There is plenty of room for growth when it comes to trade surveillance within financial institutions, Ganeson said, adding that many banks’ approaches to trade surveillance are decades out of date, designed in a time when you had to keep an eye on one financial instrument or venue at a time.
To properly monitor trading activity, banks need a wide and accurate picture of what is occurring across multiple venues and asset classes, he said.
“At the same time, they need to narrow floods of time-wasting false alerts down to true attempts to game the market,” Ganeson said.
He argued that data governance plays an enormous role in the trade surveillance. “The data used for surveillance needs to be accurate, timely and compliant in order to properly support monitor trading activities and detect and flag artificial market movements accurately. Without proper data governance, trade surveillance is undermined,” he said.
Nasdaq’s Sio said: ”We’d also be remiss not to mention the continual guidance on AI’s use in financial markets, highlighting the need to address governance, robustness, transparency, explainability, and non-discrimination risks.”
As technology evolves, these guidelines will become more intricate, he said.
Market operators and financial institutions must maintain market surveillance and innovate their practices to ensure market integrity while creating value and opportunities, he added.
“We are seeing greater expectations on behaviors such as related instruments monitoring, which is manipulation or insider trading that occurs through economically related instruments as opposed to just the instrument directly,” he said.
Technology presents an opportunity to enhance market surveillance, Sio said: “We have long invested in AI for market surveillance, seeing its benefits in our operations and client services.”
AI, however, is not a cure-all, Sio said, adding that it enhances human intelligence but cannot replace it.
Analysts still need their expertise and judgment to interpret AI outputs, verify findings, and stay updated with market and regulatory changes to use AI responsibly, he said.
“Ensuring firms have adequate surveillance coverage will be one of the biggest challenges for surveillance departments in the coming years,” he added.
Emerging Trends
As we approach the end of the year, several key enforcement trends are emerging, Schifano said. Regulatory bodies like the CFTC are placing greater emphasis on the processes firms use to ensure compliance, he said. The principle that fines should exceed the “cost of compliance” is driving more rigorous examinations and a focus on procedural adequacy rather than just the detection of manipulative activities.
This trend is particularly evident in the increased scrutiny of how firms manage their surveillance systems, according to Schifano.
Regulators are not just looking for evidence of manipulation; they are assessing whether firms have robust processes in place to prevent such activities from occurring in the first place, he said.
“This shift toward process-oriented enforcement is likely to continue, with more firms finding themselves under the regulatory microscope for failing to maintain adequate surveillance systems,” he said.
Simultaneously, Schifano said there is growing legislative scrutiny of regulatory bodies themselves, with questions being raised about the effectiveness of current enforcement programs.
“This scrutiny adds another layer of complexity for firms, as they must navigate not only the direct requirements of regulatory bodies but also the broader political and legislative environment,” he said.
The OTC space in particular is one to keep an eye out on, added Ganeson.
“Traditional rules-based surveillance approaches do not have any intrinsic understanding of shared underlying risk exposure of different instruments, so they are unable to detect activity in OTC derivatives, traded along with another instrument to offset risk,” he said.
Manipulation is likely to be occurring in the OTC space, where the price of futures contracts may be squeezed just ahead of agreeing prices for large OTC transactions, Ganeson said.
“Currently there hasn’t been any major prosecutions, however, with advanced technology evolving, detection tools might be able to sniff out abuse that have otherwise gone unnoticed,” he stressed.
Proactive Approach Is Needed
In light of these trends, trading firms must take proactive steps to protect themselves, Schifano argued.
The first step is a thorough reassessment of their trade surveillance methodologies. As discussed in a recent article, firms must be willing to shed outdated technologies and embrace modern, flexible surveillance solutions, he said.
“This transition, while challenging, is essential for maintaining compliance in an increasingly complex regulatory environment,” he noted.
Schifano said that firms should start by identifying areas within their operations that are particularly vulnerable, whether by business line, region or specific trading activities.
“By taking a targeted approach to modernization, firms can gradually build a more robust surveillance framework that meets the demands of today’s regulatory landscape,” he said.
Partnering with technology providers that offer responsive, cutting-edge solutions can also provide the agility needed to adapt to ongoing regulatory changes, he added.
“Ultimately, the key to protecting against regulatory risks lies in a commitment to continuous improvement,” Schifano said.
“Firms that are willing to invest in modernizing their surveillance systems and processes will be better positioned to meet regulatory expectations and avoid costly enforcement actions,” he said.
Meanwhile, according to Sio, in a market environment that is increasingly complex, aside from the technology itself, it’s also about the approach.
“Surveillance is an ongoing process. It evolves with the changing dynamics of the markets, the emergence of new technologies, and the sophistication of market participants,” he stressed.
According to Sio, firms need to continually assess, review and take stake of their surveillance technology to determine how to best innovate to enhance their market surveillance capabilities, to keep pace with the challenges and opportunities of the modern financial ecosystem.
Ganeson agreed, saying: “It’s no longer enough to take an ineffective, tick-box approach to trade surveillance.”
He said that compliance and risk leaders need to reorient their processes and technology to align with how traders trade in today’s markets.
“It’s not enough to monitor one equity or one derivative instrument at a time,” he said.
According to Ganeson, technology must be capable of seeing trades as expressions of risk and appraise the shared underlying risk exposure of different instruments.
“Today’s riskiest forms of market manipulation are happening in places that traditional rules-based approaches are not capable of spotting – but regulators are stepping up the pressure and increasing their action, so the time for banks to rethink their strategies is now,” he said.
“Financial institutions need to lean on modern technology and leverage models that significantly expand the lens they are looking through so they can capture the alerts that demand attention,” he added.