Determining Required Market Surveillance Levels

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By Stefan Hendrickx, Founder and Executive Director at Ancoa
Whilst the financial services industry might be breathing a collective sigh of release at the delay of MiFID II, it would be prudent to remember that not all related regulations have been delayed.  The Market Abuse Regulation (MAR), aimed to increase the transparency, safety and resilience of European financial markets, is due to be implemented in less than 4 months on 3rd July 2016.
OTC derivative and high-frequency traders will (for the first time) need to prove they have surveillance capabilities in place, whilst market operators and investment firms will most likely have to reprogramme their internal systems in order to comply with suspicious transaction reporting requirements.  Smaller prop-shops and hedge funds might be surprised to find out that they too might fall under the forthcoming MAR.
How do you determine the required surveillance level?
With specific regards to detection of market abuse, ESMA mandates that a surveillance system should cover the full range of a firm’s trading activities.  Firms will be required to consider whether an automated system for market surveillance is necessary and, if so, its level of automation.  ESMA laid out a set of criteria which firms are advised to take into account when considering levels of market surveillance, including:

  1. the number of transactions and orders that need to be monitored;
  2. the type of financial instruments traded;
  3. the frequency and volume of order and transactions; and,
  4. the size, complexity and/or nature of their business.

Firms should take note that ESMA has deemed, for the large majority of cases, an automated surveillance system to be the only method capable of analysing every transaction and order, individually and comparatively, and which has the ability to produce alerts for further analysis.
Regardless of what type of surveillance system is eventually decided upon, firms will have to be prepared to justify to regulators how generated alerts are managed by their chosen system and why such a level of automation is appropriate for their business.
What’s new: reporting both manipulation and intent
A change from the existing STR (Suspicious Transaction Reports) regime, the new STOR requirement mandates that suspicious ‘orders’ are to be reported to regulators, as well as the ‘transactions’ that are required today – even if the orders do not proceed to execution.  Furthermore, regulators will shortly be reviewing the cancellation or modification of orders, meaning analysis of suspicious orders and transactions which did not result in a submission of a STOR form would also need to be retained and accessed by a firm.
Time is ticking
The forthcoming additional market abuse requirements, including the reporting of suspicious orders and the preservation of suspicious order and transactions analysis, mean that brokers, OTC derivative traders, high-frequency traders, prop shops and hedge funds alike will all have to perform a review of their surveillance systems in time for the imminent implementation of MAR.  They will also have to justify to the regulator the decision behind selected systems.  Automated surveillance systems have been recommended by regulators as being the only capable method, for the large majority of firms, of appropriately analysing every order and transaction.  The Market Abuse Regulation may not have hit as many headlines as MiFID II, but unlike MiFID II it is fast-approaching with no expected delays.  The time to act is now.
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