Discouraging market misconduct
October 2014 | SPOTLIGHT | BANKING & FINANCE
Financier Worldwide Magazine
The regulatory landscape has changed significantly over the past few years. The impact of the financial crisis has led to an increase in focus on market integrity from regulators, and as such an expectation on greater focus from firms on compliance in this area. In order to navigate the increasingly complex regulations, both regulators and firms have had to re-evaluate their priorities and change tack accordingly. This article examines where regulators have been focusing their efforts and how this has impacted the way in which firms now operate.
Developing tools for market surveillance
There has been a noticeable change in the UK regulators’ approach to market supervision since 2008. The first focus for the FCA has been investment in technology. In particular, the FCA has spent considerable resources on market surveillance. It has developed its own in-house surveillance and monitoring system called Zen, and has supplemented this with software from the third-party vendor market, SMARTS technology developed by Nasdaq OMX for real-time monitoring.
Using the third-party vendor market for real-time surveillance while retaining in-house teams for developing core platforms has proved a valuable model. The combination of real-time monitoring and easy access to all transaction data on T +1 basis (including client references) is a powerful one, which we expect to have a major impact on regulatory activity.
Firms have also had to invest in technology in order to achieve compliance. However, the cost can be high as firms must not only buy the systems but also configure them to work effectively. Although this is often a significant investment, firms need to understand that there is an expectation on them to monitor this area and it can save them considerable costs down the line. Using an excel spreadsheet to monitor trading activity, for firms engaging in more than five transactions per day, is a thing of the past and can open the firm up to significant risk should they be subject to regulatory scrutiny. It is a false economy to choose not to invest in a monitoring system for market abuse, since firms must be able to prove to the regulator that they are compliant in this area. There are also many lower cost providers now on the market and the associated cost need not be prohibitive.
Recruiting specialised staff
This investment in technology by the regulator was accompanied by a shift in recruitment practices, which was signalled by the appointment of a number of individuals who joined the FCA after having gained market surveillance experience from the London Stock Exchange, along with a number of ex-traders.
In this way, the FCA has demonstrated that it is committed to ensuring that the skills it has in-house match those in the industry. However, it remains to be seen whether this approach has resulted in an increased focus in this area, and whether the FCA is more likely to challenge firms’ market abuse risk assessment and monitoring efforts. The answer is probably yes. In its 2014-15 business plan, the regulator also stated its intention to focus on managing conflicts of interest, the control of sensitive information and market conduct controls. For firms, managing these areas within the compliance and risk framework is therefore becoming more of a focus than in the past, and clearly a regulatory expectation.
In response, a wider range of firms have mirrored this trend and have sought to recruit their own experts. These in-house risk management roles, such as the newly created Libor responsibility role, have stemmed from the increased regulatory requirements on firms. While having controlled function roles like these are a step in the right direction, it is still surprising to see a lack of knowledge by people holding these key roles, considering how much responsibility they carry.
The challenge is that there is so much demand on resources combined with pressure on costs. The larger institutions naturally focus on where their main regulatory risk is – for example, sanctions – and market abuse monitoring may be lower down on the list of priorities. Is this a risk they can afford to take?
Dictating good outcomes
The FCA’s focus on recruitment and technology has compelled firms to adopt a similar approach in order to achieve compliance. However, it is the culture of the industry that has brought us to where we are today.
As we well know, however, culture cannot be transformed overnight. The changes required to achieve this goal can be difficult to pinpoint, fix and maintain. Sustainable change in this area therefore needs to come from the top-down and be shared across the entire organisation, the sector, the markets and then embedded into future planning and decision making at every level.
For this reason, regulators are now looking closely at how the culture of a firm is contributing to providing good outcomes. It is therefore likely that firms’ HR policies, recruitment guidelines, appraisal processes and bonus payments will reflect the regulator’s current interest in these areas, as well as other types of conduct risk. We have already seen this start to take form with the Bank of England recently announcing that bankers could have their bonuses clawed back for up for seven years after their awards. This focus on culture and conduct is global and for once all the large players seem to agree as we hear this message from the US, Hong Kong and UK regulators alike.
The lessons from enforcement actions as guides to the future
Enforcement action going forward is likely to continue to focus on those individuals who have caused the wrongdoing. Firms are likely to be subject to regulatory commissioned reports on their approach to market conduct controls, which means that having the right technology and skilled workforce in place will be vital.
Firms will also be expected to police themselves and be able to demonstrate that they are maintaining a strong corporate culture and robust systems to discourage and detect misconduct, so this is ultimately where their focus should remain. What is clear is that this is an area of regulation where prevention is cheaper than cure and the regulator is likely to take a harsher view than before of wrongdoers, including where there is a lack of controls. The new regulatory framework for individuals in the UK underpins this message.
Monique Melis is Global Head of Regulatory Consulting at Kinetic Partners. She can be contacted on +44 (0)20 7862 0837 or by email: firstname.lastname@example.org.
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