The need to be alert.

Lorne Chambers, Global Head of Sales and Account Management, SMARTS Integrity, NASDAQ OMX, talks to Roger Aitken about the market surveillance issues that face brokers, exchanges and regulators.

The market surveillance tools that your organisation provides were originally developed by SMARTS Group, an Australian company acquired by NASDAQ OMX in 2010. Did the financial crisis mark a turning point in the need for your solutions?

In a way the financial crisis did mark a turning point since we’d plateau’d a little bit as investment dollars really dried up. We were adding customers at a pretty high rate up until 2007, initially driven by markets becoming increasingly electronic, then, more recently by surges in the volume of trading messages leading to system replacements such as at the London Stock Exchange in 2006. Additionally, as emerging markets started to mature, they wanted to demonstrate that they had international best practice on surveillance.

From 2008 to 2011 growth was flat. We brought in some big names such as BATS, BM&FBovespa and ICE (IntercontinentalExchange Inc.) but at a slower rate than prior years for the exchange and regulator product (SMARTS Integrity), however it was a different story for the broker side, and the financial crisis was in many ways a turning point for our SMARTS Broker product. This is what we provide to trading participants, primarily the sellside but also the buyside. The crisis put a great deal of focus on regulatory requirements for trading participants, which explained the uptick seen in brokers coming to us looking for compliance solutions and concerned about reputational risk.

What are the key regulatory drivers behind the requirement for increased market surveillance in Europe and North America? And, are the different regions in step with each other?

In terms of regulations in Europe, the Markets in Financial Instruments Directive (MiFID) and the Market Abuse Directive (MAD) came first. However, MiFID and MAD did not spell out exactly what was expected and were fundamentally principles-based. This contrasts with the European Securities Market Association’s (ESMA) ‘Guidelines for systems and controls in an automated trading environment for trading platforms, investment firms and competent authorities’ (21st December 2011). ESMA’s publication provided more detailed guidance than was contained in MiFID and MAD.

However, it should be noted that our products – for exchanges, regulators and brokers – were already complaint well before those guidelines came out because we had led the way in developing these solutions. And, we certainly saw heightened interest from brokers asking for solutions once it was clearly spelled out what they were meant to be doing under MiFID and MAD.

In the US, it has been more rules-based. FINRA rule 5270 (1st June 2013), for example, spells out in greater detail what you can and cannot do. Despite this distinction all of the alerts and reports that might be run on our solutions in Europe would still run in the US marketplace.

What are the main challenges that the regulatory authorities face in policing market abuse?

The first is getting adequate budget to get appropriate systems and staffing in place, but assuming you pass that hurdle, its finding the non-trading-data data points that help solidify your case. We call this going beyond the alert, identifying the smoking gun that helps to answer the question of intention, or whether there was a link between an insider and the trader. We have partnered with Catelus and SMARSH to help customers identify electronic communication networks of relevance, and identify the communications of interest, and link that back to a case in the trading data. We think that this will help cut down investigation times for market abuse cases by relieving the need to review thousands or millions of emails/communications.

Market abuse has also been the news. What are the specific issues that your solutions address and across which asset classes?

We help customers identify potential cases of all the forms of market abuse, across asset classes – including equities, derivatives, fixed income, commodity and energy trading. To that end we run over sixty different concepts covering all the different forms of market abuse and market manipulation including insider dealing, front running, spoofing and all items mentioned in the ESMA guidelines. The reports and alerts our systems generate seek to pick anything that is not within the spirit of the rules.

You already provides solutions to 50 trading venues and regulators, and over 80 brokers across 60 countries. Who else needs to consider implementing market surveillance measures and why? And, why haven’t they done so already?

We are looking at the energy regulators, energy markets, trading participants, the European regulators and the Swap Execution Facilities (SEFs) in the US. Everyone would like to have a better system but it comes down to budgets and an inertia to change.

We are seeing a lot of activity in the energy markets. Just having ACER (the Agency for the Co-operation of Energy Regulators) undertaking cross-market surveillance does not alleviate all the market participants and all the local regulators of their monitoring responsibilities. A number of regulators are coming to us and we are also seeing an uptick among the trading participants on the energy markets.

Given some of the wording contained in the drafts of MiFID II, there is the potential that European regulators will need to consolidate order book data from fragmented markets and either handle the surveillance of order book data or outsource it to a third party. What we do in Canada with The Investment Industry Regulatory Organisation of Canada (IIROC) – a national self-regulatory organisation (SRO) monitoring trading rules across Canadian trading venues – is provide a solution that takes thirteen separate order books and merges them into a single view. We feel this is a robust model of how to consolidate multiple order books for surveillance that we can explain to regulators in other jurisdictions.

What are your future plans?

Certainly we want to expand into other asset classes. In the US, the Consolidated Audit Trail (CAT) rule presents opportunities. Essentially the CAT project is trying to take every trade in the US – accurately time stamped and client account identified – and put it into one massive repository with 20-40 billion records a day that will need processing. Nasdaq OMX can utilise that data with its own technology

Having secured the first SMARTS Broker client in China we are trying to expand there as well. It means on-boarding more local brokers to use the product and securing our first SMARTS Integrity win in China.

©BestExecution 2014

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