The UK’s Financial Conduct Authority (FCA) has revealed that market surveillance abuse models within many firms need shoring up, particularly with the increasing use of innovative technologies within surveillance such as artificial intelligence (AI).
The regulator conducted a peer review looking at the frequency and methods used by nine investment banks to test the efficacy of their client order front running models. In light of the review, the FCA said firms should take greater action to avoid surveillance failures, ensuring all relevant trade and order data is captured, and that governance arrangements around model testing are “formalised and robust”.
“Over the past few years, we have become aware of problems with surveillance alerts not working as intended and assumed by the firm,” the regulator noted, whether due to faulty implementation, ‘bugs’, or inaccurate data.
Under the Market Abuse Regulation (UK MAR), firms must identify and report instances of potential market abuse and a firm must have effective arrangements, systems and procedures in place to detect and report suspicious activity.
Most firms reviewed had formal procedures describing the frequency of testing, which elements of the model were subject to review, and the form of the review. The rest had no formal process whatsoever, the regulator said.
The FCA review found most firms undertook an annual test of some type. The different types of testing were: parameter calibration; model logic; model code; and data (comprehensiveness and accuracy). Around half the firms focused their reviews mainly on parameter calibration.
However, the regulator suggested not all firms have allocated enough “focus and resources” to governance arrangements and such arrangements can often be complex and take “significant” time. “Firms should consider whether intricacy and volume in governance necessarily delivers timely, efficient and effective outcomes.”
“Firms need a vigilant approach to proactively guard against surveillance failures and mitigate relevant risks. This is particularly relevant in light of likely future innovation within surveillance functions. Developments such as the use of artificial intelligence will need to be accompanied by governance that keeps pace and remains effective,” the regulator added.
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