Understanding Trade Surveillance Systems and Procedures

We’re all aware of the prosecutions that regulators take against participants for trading in breach of market abuse regulations – these actions have high visibility and are well understood as a key part of the regulator’s role and power. 

What is not quite as visible is their focus on the internal systems and procedures that firms have in place to detect and report on market abuse. Put simply, market participants are the gatekeepers of connections into global markets. And many jurisdictions have regulations in place that require firms to be active partners in the effort to prevent market abuse and to identify it when it happens. 

In recent years, regulators have been out on the road reviewing the surveillance setups of market participants – and where gaps are found, they are imposing significant fines.

• In August 2022, the U.K. regulator (FCA) imposed a fine on a large investment bank for a breach of Article 16(2) of the Market Abuse Regulation (MAR), which states that a regulated entity must: Establish and maintain effective arrangements, systems, and procedures to detect and report potential market abuse.
• In early 2022, a leading online brokerage firm was fined by FINRA for “failing to maintain adequate surveillance systems.” FINRA noted that a surveillance system was in place – however, the firm’s processes were inadequate and incapable of flagging suspicious activity. The message from this action is that having a surveillance system in place is not sufficient on its own – a firm must have effective processes to support that system.

We are seeing this form of regulatory oversight in many jurisdictions, including:

So, what are the regulators’ expectations around surveillance systems and processes? 

Let’s start with the recent fine imposed by the FCA. In that case, the major issue was that the firm had not carried out an adequate risk gap analysis (of MAR). And therefore, had not been timely in putting in place an appropriate detection system for MAR and were unable to prioritize the most serious market abuse risks affecting their business. 

This same issue was also called out in the recent FCA ‘Market Watch 69,’ which was critical of many firms who, in their view, had not aligned their trade surveillance setup with an understanding of key risk analysis questions, including:

• What products do we trade?
• Where do we trade – what regulatory jurisdiction?
• How do we trade – how do we connect to venues?
• Who do we trade on behalf of – what is the profile of our customers?
• And, given the responses to the above, what are the most likely types of market abuse?

The regulator’s view is that if a firm does not have a considered and formalized understanding of the answers to these questions, it will not be able to set up an effective trade surveillance system to meet the risks that apply to its business.

What other systems and processes should be considered as part of an effective surveillance program? If we look across regulators such as AISIC and MAS, important considerations for your surveillance setup include:

Senior Management Oversight

• Senior management should have visibility of the trade surveillance framework and receive periodic reports on key surveillance metrics.
• Senior management should initiate periodic reviews of the surveillance program, including a review of alternative vendors and technologies.

Sound Detection Mechanisms and Assessment

• Surveillance process should be automated, and not manual checks of reports
• The following policies should be in place:
  • Alert review criteria – including risk grading of alert types
  • Alert assessment and escalation policies – including guidelines and criteria for closure and escalation of alerts
  • Timelines for actioning and closure of alerts

Sufficient Surveillance Resources

• Sufficient staffing to monitor the level of trading, products and risk types identified by the firm’s risk analysis
• Experienced staff with clear reporting lines that do not involve a conflict of interest
• Staff should have the required skills and undergo continuous learning
• Sufficient IT resources & budget to ensure that surveillance tech is effective and updated

Proper Record-Keeping and Quality Assurance

• Maintenance of surveillance records/documents for audit and inspection purposes
• Quality review of alert assessment, closure and escalation decisions – may include periodic sampling checks of alerts and exceptions
• Process to monitor the status of any outstanding items and follow-up actions required

Prompt and Confidential Reporting of Potential Market Abuse

• Well-defined internal processes that identify what and when suspicious trading activities need to be escalated and appropriate course of actions, including:
  • Verbal reminder or warning 
  • Account suspension
  • Report to regulator (as STR) in jurisdictions where applicable
• Well-defined internal processes to respond promptly to regulator queries for information

Nasdaq Trade Surveillance Advisory Services are available to assist and advise firms’ surveillance programs to ensure effective coverage of their market abuse risk. If you would like assistance or more information on what Nasdaq Trade Surveillance Advisory Services offer, please get in touch at NTSAdvisoryServices@nasdaq.com.