Global Trade Surveillance Requirements Across MiFID II, MAR and Benchmark Regulation

Blog entry

By: Jordan Dilworth, research analyst, JWG

Since the financial collapse in 2008, regulators have been concerned about the vulnerability of firms engaged in trading activities and have reacted by emphasising preventive measures. Out of this drive emerged trade surveillance, which aims to prevent market abuse and market manipulation.

In June 2016, the Market Abuse Regulation (MAR) was enforced. This regulation repealed and replaced the Market Abuse Directive. The key changes were to increase regulatory scope by covering European regulated markets, multilateral trading facilities and organised trading facilities, updating the definition of inside information, defining market abuse as suspicious orders and transactions, and introducing more prescriptive monitoring obligations.

Whilst MAR and Markets in Financial Instruments Directive II (MiFID II) were initially to be enforced around the same time, the deadline for MiFID II was pushed back a year. The result? While firms have prepared for MAR, risk operating models must be recalibrated to ensure compliance with both MAR and MiFID II. In addition, contributors of input data must comply with the Benchmark Regulation by monitoring and identifying suspicious data. This article outlines three main points that are based around the first and second lines of defence, real-time monitoring and benchmarks.

Building the first line of defence

Traditionally, firms operate in a ‘three lines’ risk model. The first line of defence is line management, second is an independent compliance risk management team, and third is an internal audit. While this model works in theory, it can be difficult to define clearly which functions are the responsibility of each line of defence.

Concerns around the first two lines of defence include: who and what functions should sit in the first and second lines of defence? For instance, who is responsible for real-time monitoring and is the line between these lines too blurred, making it difficult to breakdown the distinction between the two. How can this problem be overcome? Greater collaboration between firms and regulators is required to understand regulators’ expectations.

How to monitor in real time

Market structures of liquid securities are converging across asset classes. Liquidity is increasingly spread across different trading venues and MAR highlights the need to be looking across products, such as when a connection exists between the derivative of a security and the security itself. In these market structures, MAR requirements to perform surveillance of activity demand micro-second records to replay market conditions and successfully identify any potential market manipulation.

‘Real-time’ monitoring and its position is difficult to define. Regardless of responsibility within an organisation, ensuring that monitoring takes place in real time is increasingly being demanded by regulators and it is clearly a prominent issue for compliance with both MAR and MiFID II.

Surveying benchmarks

The Benchmark Regulation (BMR) has been enforced for critical benchmarks and most of the provisions of the regulation will apply from January 1, 2018. There are significant challenges with regards to implementation, particularly in relation to EU firms referencing non-EU benchmarks.

Although most of the surveillance obligations in BMR are the responsibility of administrators of benchmarks, firms that contribute input data to benchmarks fall under the scope of surveillance requirements. If a firm contributes input data, then the firm will have to comply with the administrator’s code of conduct. Part of this compliance will include conducting surveillance for suspicious input data to be reported to a firm’s compliance team. As this issue is not being widely considered, it is important that this requirement is not forgotten in the rush to comply with the regulatory tsunami coming in 2018.

What is the future of trade surveillance?

2018 will bring a range of challenges and opportunities within the transparency space. With MiFID II being enforced, firms will have to be in continuous dialogue with each other, regulators and vendors to comply with trade surveillance obligations.

In addition, firms will have to rely on regulatory technology to ensure compliance. By using innovative technological solutions to automate the capture and analysis of multiple sources of data, such as decision making, behavioural bias and conduct management, suspicious orders will be more effectively flagged and analysed to comply with obligations.