By: Joseph Schifano, Global Head of Regulatory Affairs, Eventus Systems
Trade surveillance: it’s a fundamental need for a well-functioning marketplace. With so much value changing hands, the ability to assess risk, create comprehensive reports and spot problematic behavior is crucial to imparting peace of mind to clients and staying out of regulatory crosshairs. This is true in any market, from the established worlds of equities and fixed income to the rapidly developing digital assets space.
In the U.S., a wave of enforcement actions has emphasized the need for robust trade surveillance capabilities. Recent years have seen record-shattering fines for spoofing and similarly manipulative activity, with penalties as high as tens or even hundreds of millions of dollars. Among market participants, there is a consensus this remains a top priority for regulators and that another wave could come crashing down at any time. Meanwhile in the UK and Europe, market participants are eyeing the developments across the pond and expect their regulators to follow suit.
In this environment, firms are more reliant on their trade surveillance systems than ever before. Yet the approach taken by the legacy providers in this space – reducing false positives by narrowing the types of data they capture – is simply not enough to ensure security and compliance. Their clients often end up missing risk factors or instances of potential manipulation, and when a regulator calls in search of an explanation, they risk being left without an answer.
The solution is simple: capture more data, not less. By casting a wide net at the outset, Eventus Systems’ clients can feel confident that our Validus platform is flagging dynamics or behaviors that warrant a closer look. This is the scope, scale and accuracy the industry needs – and one that legacy surveillance systems that require endless recalibration to reduce false positives just can’t provide.
The Narrowing of Trade Surveillance
This obsession with reducing false positives stems from a common problem: information overload. For as long as technology has supported trade surveillance, compliance teams have complained that they receive a high volume of alerts that qualify as potential instances of market manipulation as defined by the system’s parameters but are ultimately deemed non-problematic, i.e., false positives. As a simple example, think of an institution with two siloed trading desks. If one desk sends a buy order around the same time that the other desk is selling the same security, the trade surveillance system may flag the trade as wash trade, even if one such transaction is not problematic.
There are countless instances in which a specific trade like this one could trigger an alert for market manipulation. Other times, these systems may flag risk factors that the firm has accounted for and is comfortable with. To combat this, trade surveillance providers have defined known risk factors within increasingly narrow parameters. The theory is that being as targeted as possible will reduce false positives and leave only the most essential alerts.
It sounds like a great model – it just doesn’t work. It is impossible to conceive of all the different ways in which market participants may be exposed to risk or bad actors, so narrowing the risk factors and over-calibrating thresholds is an inherent vulnerability. Doing so means that instances of manipulation that don’t fit the mold will likely go unnoticed. Surveillance analysts must continuously try to determine the right parameter thresholds, which are increasingly based on reducing false positives instead of finding problematic behavior. These firms have fewer false positives to sift through, but what good is that if problematic behavior is missed?
These surveillance measures are hyper-specific, focused on finding one particular type of risk factor or market manipulation. But to truly thrive in today’s compliance and risk management landscape, firms must look at the marketplace more broadly. By leveraging modern approaches to identifying the most actionable instances of potential manipulation, market participants can take an all-encompassing view without sacrificing any of the precision and productivity that false positives so often hamper.
The Case for Automation
At Eventus, we provide solutions that enable this all-encompassing view. We accomplish this by casting a wide net and considering a broader pool of candidate alerts, so nothing slips our radar. At the same time, we maximize the efficiency of our clients’ human and technical resources through automation and trend analysis.
Sound counterintuitive? Not if you’re using the right technology. Our Validus platform is a stark illustration of the unlimited potential of automation and machine learning. Where other systems reduce false positives through over-calibration and hyper-sensitivity to parameter thresholds, ours analyzes it all and identifies the most important alerts by asking the kinds of questions a human would ask.
Take the wash trading example from above. With legacy systems, firms must formulate granular and often imperfect standards to define what qualifies as wash trading and what doesn’t. Our solution takes in all transaction data, regardless of predefined parameters, and approaches each instance on a case-by-case basis. Some questions we might ask include: How often is the behavior occurring? What’s the market share? How many of these trading desks are running into each other, and is this something that began recently? Through various types of automation – machine learning, statistical analysis, trend spotting – we can answer these questions accurately and efficiently, helping our clients gain a clear view of all activity occurring on their watch, not just that which meets a narrow description.
In addition to providing more complete and accurate trade surveillance, our system wins on nuance and flexibility. Often, trade surveillance is based on subjective thresholds rather than a clear regulatory standard. Facts and circumstances always vary, so the ability to monitor a wide variety of trends over time is essential. In addition, there are varying opinions among market participants on how to approach trade surveillance. Our method enables clients to set their own reviews and show their work.
This is a crucial capability for market participants, but the power of our Validus platform goes far beyond day-to-day monitoring. Our approach means clients benefit from a broader pool of candidate alerts that are available for trend analysis, and this plays a key role in our overall offering. These candidate alerts are documented with reasons why the candidate is deemed non-problematic. By keeping these candidate alerts in the system, clients can perform supervisory reviews of all alerts captured, helping to ensure that problematic trends are detected early.
By documenting the logic for why a given candidate alert was not flagged as potential manipulation, we create a robust audit trail. When regulators come knocking with questions as to why one of these instances went unaddressed, Validus allows our clients to provide detailed reasoning and demonstrate that they conduct a secondary review of their automated procedures. Clients of legacy providers cannot demonstrate this justification if they never saw the candidate alert in the first place.
If knowledge is power, then why would any firm want to cordon off a few transactions from the rest? By implementing automation after all data are collected, as opposed to before, we provide our clients with the sophistication needed to thrive in today’s regulatory environment.
Conclusion
Innovation is a hallmark of our industry, and compliance should be no exception. From the bad actors who seek to wreak havoc on the markets to the regulators whose goal is to stop them, everyone has leveled up, adopting new technologies and pursuing their goals with a renewed vigor. To meet the moment, trade surveillance solutions must keep pace.
Legacy systems are not equipped for the task. By exclusively focusing on reducing false positives, regardless of the drawbacks, they risk keeping their clients in the dark and imparting a false sense of security. Instead, market participants must think differently and embrace solutions that capture more data and provide greater insight through automation. Cast a wide net and shine a light on your trading.
Joe brings 20 years of experience to Eventus, where he partners with client stakeholders, champions their needs and concerns, communicates regulatory trends, offers insights to maximize effectiveness, and helps compliance and supervisory staff build best-in-class surveillance and monitoring capabilities. He most recently served as Deputy General Counsel and Global CCO at Tower Research Capital.
About Eventus Systems
Eventus Systems is a leading global provider of multi-asset class trade surveillance and market risk solutions. Its powerful, award-winning Validus platform is easy to deploy, customize and operate across equities, options, futures, foreign exchange (FX), fixed income and digital asset markets. Validus is proven in the most complex, high-volume and real-time environments of tier-1 banks, broker-dealers, futures commission merchants (FCMs), proprietary trading groups, market centers, buy-side institutions, energy and commodity trading firms, and regulators. The company’s rapidly growing client base relies on Validus and Eventus’ responsive support and product development teams to overcome its most pressing regulatory challenges. For more, visit www.eventus.com.