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Effective Surveillance Can Only be Achieved with Communications Coupled with Market Data Analysis

By Ofir Shabtai, CTO and Co-Founder of Shield FC.

Whilst enterprise software applications have proven effective at flagging up possible noncompliance events, once an exchange is flagged, it is largely down to the compliance team to follow through with the necessary investigation directly.

With the considerable challenges of monitoring modern data-driven financial markets, it’s essential that compliance managers consider not just the transactions-related communications, but also any contemporary trade and market data that accompanies a suspicious event.

Time and again, it has been proven that this high level of vigilance and scrutiny is essential in uncovering potential fraud and the deliberate manipulation of markets.

Seeing the whole picture

By their very nature, traders are sophisticated and resourceful individuals. Unfortunately, this means rogue traders are often able to find creative ways of bypassing the standard checks within the financial system. Throughout the years unscrupulous individuals or teams have conspired to trade securities and commodities to methodically and selectively manipulate market prices.

On top of that, new advances in technology have made the manipulation of markets harder to detect and easier to achieve. As a result, financial compliance teams must conduct increasingly complex and potentially time-consuming data-driven investigations.

Imagine an example where a small group of traders are colluding to raise the price of a large tech company’s stock. They may use automated trading software to ramp up the trading volume, artificially inflating demand, or they may launch a publicity campaign (perhaps over social media) to surreptitiously circulate rumours designed to drive up the price of the company’s stock (such as a major technology breakthrough). Equally these traders could be aiming to drive the stock price down through collusive trading or stock bashing schemes.

There are many ways to manipulate financial markets by using sophisticated technology, which means compliance investigations must be armed with all the relevant facts and data to be truly effective. This includes the collection and analysis of all relevant transaction and market data, on a historical and intraday basis.

Empowering enforcement with improved compliance data

To detect potential breaches/problems, most regulated financial firms utilise sophisticated compliance monitoring systems which flag suspicious events and potential violations of any applicable regulations.

This usually entails the monitoring software presenting the compliance team with a red flag so they can carry out an investigation on all communications by traders in connection with the suspicious transaction. At this stage most systems then require the compliance team to move to another platform to investigate details of all the other orders that were processed contemporaneously with that trade.

On the face of it this may seem like a simple process, but large compliance departments receive thousands of potential noncompliance alerts every day which makes doing this manually impractical. To streamline the data analysis whilst supporting a rigorous compliance investigation, companies need to utilise an Enterprise software solution that displays all trade-related electronic communications on a timeline and connects all relevant trade and order data together.

This is the only way compliance officers can get the whole picture, both regarding the traders’ intentions and the larger financial context of a potential regulatory violation.

Crucial trade data for effective investigations

Unfortunately, market manipulation can be very hard to detect, particularly when (in some circumstances) it is only evidenced by the careful scrutiny of trade-related data.

For example, when most traders are considering a purchase or sale of stock, they will look at the bid/ask spread. In an efficiently managed market this spread will be minimal (the gap between the buy and sell price will be very small). Therefore, detecting subtle differences in the bid/ask spread may be the best way to uncover market manipulation that would have been virtually undetectable through other methods.

To illustrate this, consider the importance of limit orders which are collected in a typical order book. Market orders are placed and executed near-instantaneously at the current prices, whereas a limit order is placed when a trader wants to buy or sell at a different price. Except in certain futures markets, this order book works as a first-in, first-out ledger. Orders are recorded with the limit price that is set by the trader and the quantity becomes part of the aggregated quantity, which shows a total of all the limit orders at this price. Therefore, a precise and accurate review of the order book will highlight if traders have attempted to manipulate markets using spoofing or layering techniques.

Automated detection

To address these increasingly complex threats, compliance technology has grown to be incredibly sophisticated. Once machine learning software has collected enough data, artificial intelligence solutions are then able to detect and alert compliance teams to the most subtle and well-hidden of market manipulations.

Advanced AI solutions with natural language processing capabilities can even predict a trader’s intention to commit market manipulation, adding yet another layer of security to an increasingly sophisticated technology-driven compliance environment.

Automated detection has the potential to save compliance teams from taking on the mundane and highly costly task of analysing huge amounts of potential data subjects, and then having to intelligently and rationally select which ones need to be investigated for compliance.

By being armed with all the relevant data and being sure they are looking in the right place, compliance teams can get on with the job of tackling market abuse without having to second-guess themselves at every stage.

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