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Opinion: The FSA, ESMA and the Commission – The Markets’ Strictest Parents?

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By Matthew Coupe, sales director, EMEA, Redkite Financial Markets

When the UK’s streets broke out into mass rioting this summer, the UK government responded with unprecedented force. Officially, the riots were quashed by intelligence-led, nationally mobilised law enforcement, backed by the politicians at the heart of Westminster. Unofficially, of course, the streets were out of control, and detainment measures are said to have been taken that are still being questioned through the courts. It’s gone remarkably quiet again. Orderly behaviour has resumed and we are left with a financial bill and the job of rebuilding the shaken communities, questioning all the while the parental responsibility of this youthful minority.

When you consider the potential damage and indeed chaos that a handful of financial market participants from London’s City streets could potentially cause, it is no surprise that the FSA, the European Securities Markets Association (ESMA) and the European Commission are introducing such an ambitious level of regulation. The global economy cannot clean the markets retrospectively by simply putting the culprits in jail. And the industry as a whole recognises that parental responsibility for its actions will reside within every organization – giving a whole new challenge and perhaps even a significant boost of corporate importance to today’s compliance officers.

The big pieces of legislation are MiFID II – now evolving from a directive into the regulation MiFIR – and the Markets Abuse Directive II, which has been widely covered in the press through various ‘leaked’ documents. Quick on the tail of MiFIR and MAD II, and taking an accelerated path to legislation, comes the succinctly entitled document ‘The systems and controls in a highly automated trading environment for trading platforms, investment firms and competent authorities.’ Originally published as a consultation paper back in July, and aimed at delivering best practice guidelines to the market, ESMA is now looking to enact it as early as the end of the year.

So what are the powers-that-be trying to achieve? How does it affect the role of the Compliance Officer? And how can they do this so quickly?

Essentially, Europe’s regulators want to ensure stability and oversight in today’s rapidly changing electronic markets and they need to be seen to implement agreements made at a G20 level, from where there stems increasing pressure to harmonise regulation globally. To ensure future stability, market participants – and to be specific, the compliance functions within these institutions – need to be able to monitor their firms’ activities in the context of the changing regulatory environment and be able to alert and intervene when appropriate. Indeed, one of the organisation requirements within ESMA’s guidelines, states: “Investment firms should ensure that compliance staff has a feed of the firm’s orders in as close to real time as possible and have systems for monitoring those orders.”

ESMA also calls for the compliance officer to have much greater training on the trading strategies that are deployed with the ability to interact with the traders themselves. It states that investment firms engaging in highly automated trading activities should put the correct procedures in place “to ensure that staff exercising the compliance function has sufficient understanding, skill and authority to challenge staff responsible for trading when the trading activity gives rise to suspicions of market abuse (in particular market manipulation).”

While the timeline for MiFIR is now looking to be 2014, seven years after MiFID first came into effect, it is perhaps surprising to find that ESMA’s guidelines may become legislation so quickly. But ESMA’s role is changing. It is soon to be setting and describing the technical standards that are mentioned in all drafted securities markets regulation and consultation papers. ESMA will define the details of the regulation and propose its recommendations to the European Parliament, which will then enact into law.

The requirement for compliance staff to be fully equipped with the appropriate tools and technology, that can handle the high level of trading volumes across all instruments, strategies and venues, in order to control the information flow from a risk and compliance perspective continues into MiFID and MAD. MiFIR’s 2014 legislative timeframe may seem a way off, but when it does come it will demand much greater scrutiny to be put on execution quality of client orders. Compliance officers will need to monitor and observe all order flow to make sure that the bank is executing its order within acceptable parameters.

Similarly, MAD II proposes a more heavy-hitting approach, as all insider trading and market manipulation practices will be tried within the criminal court. The idea of imposing criminal punishment carries weight with senior stakeholders within Europe’s financial institutions, as sanctions imposed on those guilty of these practices “should be effective, proportionate and dissuasive”. The regulation also calls for greater awareness of monitoring for market abuse in our increasingly fragmented landscape not just across regulated Markets and MTFs but also across OTC transactions and Organized Trading Facilities – the new name for Broker Crossing Networks, which also carries the same regulatory requirements as MTFs.

When looking at the future MiFIR and MiFID II regulation and directive, recent market events suggest that there will be a much greater focus on risk and market transparency. There is a clear call for the whole market to take responsibility and understand its dynamics (who’s doing what and with whom, and with what impact?). There is general consensus too that the compliance officer needs to adopt a more active role in the control of the business, through direct understanding of automated trading strategies and their goals and objectives, to understanding in greater detail the impact of micro market structures. This will therefore naturally lead to more sophisticated technique for Market Abuse detection and more intelligence-led approach to market surveillance, which would be for the good of the industry.

But just as Twitter provided the initial channel to gather dissenting youths together to create this summer’s street carnage, and the Blackberry provided an unmonitored gateway to continue momentum, people will always look for a way to ‘get around’ the law and avoid detection. Our financial markets have clearly demonstrated their collective power of destruction – we must all take responsibility to monitor, observe and keep pace. Regulatory intelligence technologies that can detect erroneous behaviour must continue to evolve with our changing landscape and the starting point of all these legislative changes – to protect the end investor and make sure they are represented appropriately within the market place – must remain front-of-mind. If we are to ensure the future, long-term security of our markets, we should strive to learn more about front office activity and its objectives, and we should continue to analyse the potential impact of those activities on the market as a whole.

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