FCA expects robust and increasingly sophisticated market abuse surveillance controls

In Market Watch 79, the UK’s Financial Conduct Authority (FCA) has shared its observations concerning failures of market abuse surveillance at authorised firms, and observations stemming from their peer review of firms’ testing of front-running surveillance.

Failures of market abuse surveillance were frequently caused by the faulty implementation of surveillance systems, poor change management controls that introduced errors, and missing necessary information feeds, such as trade or order data for certain business flows.

The impact of these failures meant that certain business flows were not monitored and that alerts were either partially or wholly ineffective due to inadequate testing. The length of time it took firms to identify and fix these failings ranged between a few weeks or less to two years or more. Coincidentally, a firm in the US was recently fined $350 million as a sub-set of trading and order data had not been feeding into their surveillance platforms, as outlined here.

The FCA observed that one firm had not activated a news feed to facilitate the identification of insider dealing, a failure found only after contact from FCA. Separately, the poor design and setting of a firm’s insider dealing alert parameters, led to potentially suspicious activity going undetected for several years.

In a separate review, the FCA looked at the frequency and methods used by several large investment firms to test the effectiveness of their client order front running models. Some firms had no formal process covering this, whereas some focused their reviews too heavily on parameter calibration. The FCA cites factors to consider, including the type of financial instrument, the market participants involved, trading methods and trading venues accessed.

Finally, the FCA helpfully lists the steps firms should take to help prevent surveillance failures, including:

• Ensuring all relevant trade and order data is accurate and captured
• Having comprehensive governance arrangements as well as documentation covering testing
• Appropriate tailoring of alert models and testing by second line and internal audit
• Having processes to proactively guard against surveillance failures

It’s clear that the FCA is increasingly stressing the importance of having effective market abuse surveillance by conducting deep dive, thematic and peer reviews and identifying weaknesses in the controls at firms.

The UK regulator is pushing the boundaries further than before by highlighting that their expectations, and what they see as best practice, are becoming more advanced and sophisticated.

Given the profound consequences for firms getting this wrong, the FCA is encouraging firms to review the observations in their latest MarketWatch newsletter and consider the adequacy of their arrangements.

At Kaizen, our proprietary surveillance solutions provide trade and communications monitoring on one system to help middle office and compliance teams comply with market abuse regulations and detect spoofing, layering and other forms of market manipulation.

• For a free demo of our surveillance solutions, please contact us.
• Read the MarketWatch newsletter in full on the FCA’s website.