Market Integrity and Transparency Part 2 – The How and the What

In this second of two posts, we explore the difficulties presented by complying with market integrity and transparency regulations. Thankfully, there are many innovative technology solutions on the market to address these challenges and we have created a market map of this category to help buyers understand which products might fit their particular use case.

It is clear that the regulatory requirements covering investor protection, market abuse and market integrity are not only deep, in terms of how far they penetrate into business and trading processes but also broad with respect to the areas of a trading firm or exchange that they cover. Anyone who was involved in the implementation of MiFID 2 in early 2018 will attest to the effort that went into achieving compliance with this complex piece of legislation. Indeed, the cost of MiFID 2 implementation was expected to be over $1bn for the top 40 global investment banks and the final cost is likely to have been greater.

Emma Parry, an expert in Conduct Risk, explains why requirements such as Best Execution place such a burden on financial firms:

“Implementing an effective control framework for best execution presents numerous challenges – from establishing the foundation elements (eg. Correct client classification data, consistent reason codes) through to determining the extent to which the review of findings can be incorporated into existing processes (eg. off market rate checking) or requires additional governance.”

She goes on to explain the challenge this presents when trying to manage Best Execution manually:

“When there are potentially millions of transactions per in-scope asset class per annum, clearly spreadsheets are not the answer.  Reporting and diagnostic tools that enable teams to drill into specific trades, a series of transactions or to analyse potential patterns at a client level are key”.

Similarly, the recent regulatory crackdown on transaction reporting for Mifid 1 reporting, let alone MifiD 2,  has demonstrated the need for effective systems and controls that can ensure the accuracy and completeness of transaction reporting. In March 2019, both Goldman Sachs and UBS were fined £34.3m and £27.6 respectively by the FCA for incorrect and misreported transactions, dating back to 2007.

Stephen Hanks, head of markets policy at the FCA is reported to have said that

“there are still issues we see in reports and we are particularly disappointed to still be seeing errors in reports which would have been errors under Mifid, never mind Mifid II. So it’s important for firms to be monitoring the nature of their reports, checking them and send us any errors and omissions – with particular focus on getting the fundamental economics of transactions correctly reported to us.”

The key issue here is one of data – volume, complexity and management. Understanding which data is located where, ensuring correct counterparty and instrument identifiers are attached to each transaction and perhaps most crucially, having consistent and systematic reconciliations of transaction reporting data in place.

Data is also at the heart of compliance with the need for surveillance and monitoring to detect market manipulation and abuse. As Emma Parry explains,

“Firms continue to expand the range of communication channels they use.  These advancements undoubtedly improve internal collaboration and overall client experience but pose an increasingly complex surveillance challenge.  RegTech solutions that support firms in collating disparate structured and unstructured data, as well as enabling the retrieval and reconstruction of complete communication chains is critical to the war against market abuse.”

It is clear that compliance with market integrity and transparency rules requires firms to pay significant attention to vast quantities of data, as well as ensuring that data is accurate and complete for reporting purposes and for monitoring and embedding investor protection in all stages of the client and trade lifecycle. Given the high trading volumes and diverse array of data sources, this is a problem that is beyond human scale and needs a technological solution.

We have identified over 70 RegTech products which provide solutions to many of the problems faced by financial firms in complying with regulations such as MAR, MiFID 2, EMIR and SFTR. Many of these products aim to solve more than one problem, so rather than mapping them neatly into discrete sub-categories, we have tried to indicate which use cases are most applicable to the relevant product.

Clearly, the majority of solutions are focused on monitoring and surveillance, using either trade or e-communications data or a combination of both to help firms detect patterns that could indicate misconduct. Whilst the requirement to record all types of communication seems sensible, as Emma Parry suggests, recording this data alone is not enough to make use of it:

“Even with recorded lines and chat room surveillance, how do you detect a trader’s prompt to go to an unmonitored channel?  Advances in Natural Language Processing are providing enhanced capabilities to detect and capture potential market abuse at the very earliest opportunity.’”

Many of the monitoring and surveillance tools in the market map make use of advanced AI and machine learning techniques to identify patterns and generate alerts when anomalous behaviour appears. This can significantly reduce the number of ‘false positive’ alerts that are generated by more traditional trader surveillance tool, allowing greater effort to be spent on investigating trades that are genuinely suspect.

Products that combine trade and ecomms data with additional data sources such as market data, and even data from a customer relationship management systems have additional power and can meet a larger number of use cases. For example, the existence of a single source of high quality and high accuracy trade data can facilitate transaction reporting, especially if this data is automatically reconciled to its origin. Meeting the Best Execution obligations also becomes easier, and some of the market leading products will even automatically monitor execution quality on an ongoing basis. These products will also significantly cut the time and cost associated with trade investigations and more sophisticated firms are also beginning to use these solutions to surface additional insights from data that go beyond compliance and improve the bottom line.

Market integrity and transparency regulations do not only impact the large buy-side and sell-side firms, however. Smaller asset managers and indeed any firm that offers financial advice must also comply with conduct of business regulations which can arguably be proportionately more costly for these smaller firms. We are seeing the emergence of a number of products that assist these firms with customer profiling and suitability assessments as well as building in conduct risk management across the customer lifecycle.

We consider the Market Integrity & Transparency category to be one of the most dynamic in the RegTech market and we also believe levels of adoption in large firms will begin to increase as regulators focus their enforcement activity more in this area and as AI techniques become ever more sophisticated.

If you are a RegTech firm with a Market Integrity & Transparency product but are not yet featured on our market map, you can apply to be in our RegTech Directory here and we will include you in our next market assessment. Browse the full list or read our categorization criteria.