Beware of Relying on ‘Industry Standards’
Surveillance System Calibration – Beware of Relying on ‘Industry Standards’
The FCA has been openly critical of surveillance system calibration and configuration. They disapprove of market participants’ tendency to implement vendor-supplied systems using ‘out of the box’ and ‘industry standard’ settings to calibrate their alert parameters. Don’t fall into this trap!
MAR and REMIT are enforced in a number of ways. The most obvious is direct regulatory oversight of orders and transactions through direct reporting. However, an increasing number of regulators are using their new powers to knock on doors and ask to assess market participants’ MAR and REMIT business processes and systems for ‘fitness for purpose’.
One of the most conscientious regulators in this respect (or aggressive, depending upon your point of view) is the UK’s FCA. They have an ongoing programme to visit firms and trading venues to assess their MAR market abuse surveillance arrangements. From time to time the FCA publishes its findings, and these are quite instructive when it comes to reading the minds of the regulators, especially where their views on the adequacy of surveillance systems are concerned.
Recently, the FCA has been openly critical of some aspects of surveillance system calibration and configuration. They are particularly perturbed by their finding that a number of market participants are using vendor-supplied systems using ‘out of the box’ and ‘industry standard’ settings to calibrate their alert parameters. The FCA has also observed firms using average peer alert volumes as a measure of the appropriateness of their calibration. While the FCA recognise that market participants may see certain benefits in understanding how their approach relates to that of their peers, putting undue weight on these comparisons creates risks to the independent assessment of each market participant’ business.
The FCA expands upon their criticism of ‘out of the box’ functionality to include the tendency for some market participants to make heavy use of random sampling, and over-rely on alert calibration as set up by the system vendor. The FCA has also encountered some instances where market participants do not set their own clear parameters for their surveillance. While the FCA concedes the importance of utilising the experience and judgement of surveillance analysts, it goes on to say that in its experience, these techniques have led to inconsistently applied surveillance rules in a number of instances and potentially suspicious trades have been missed.
A related criticism from the FCA is of the tendency of market participants to regard the ESMA list of examples of fictitious devices, misleading signals, and price-securing as exhaustive. If market participants act on this assumption, they will miss other types of market manipulation that fall within the broader scope of MAR Articles 12, 15, and 16. The FCA’s comments reveal a general theme in MAR and REMIT that it is better to have an over-sensitive surveillance system than one that continually fails to detect real instances of market abuse.
The FCA reminds all market participants that they are individually responsible for making their own judgements about alert calibration, and that they risk failing to comply with MAR if they assume that because a certain calibration is appropriate for their peers, it must be appropriate for them.
At deltaconX, we believe that the same points are true for REMIT, although so far, ACER and the NRAs appear not to have been so forthright in publishing their views on surveillance system adequacy, and the weakness of relying on peer-group-approved ‘industry standards’.
As a market surveillance system vendor, we agree with the main FCA criticisms centred on ‘out of the box’ functionality to support ‘industry standards’. We believe market participants need to base their surveillance system calibration on a fundamental tenet of MAR – that a particular company’s market surveillance business processes and systems must be appropriate and proportionate to the scale, size, and nature of that company’s business. In this respect, each company is unique when it comes to requirements and calibration – there is, and can be, no ‘one-size-fits-all’ approach.
At deltaconX, we regard each client’s MAR and REMIT compliance needs as unique, therefore requiring a unique calibration and configuration of their market surveillance system. ESMA’s and ACER’s list of ‘indicators’ are treated as convenient, high-level administrative buckets for the aggregation of structured and unstructured data to be exposed to a number of client-specific surveillance rules, and not as an end in themselves. Surveillance rules may be blended or nested to address ESMA’s warning that these indicators overlap. This flexibility enables the creation of additional ‘indicators’, be they created by the regulators or by our clients themselves. Alert calibration is always client-specific.
Beware of vendor claims that their market surveillance system supports all the listed ‘indicators’ and ‘industry standards’ out-of-the-box. You may implement yourself out of MAR compliance, a somewhat embarrassing situation to be in if your NCA comes a-knocking at your door!