The growing number of regulations designed prevent market abuse will require brokers to overhaul their monitoring and surveillance systems, with an estimated €113 million being spent this year.
The findings are part of new research from consultancy TABB Group, ‘European market surveillance 2012: Under starters’ orders’, which predicts spending for surveillance systems covering equities and derivatives trading will increase 8% this year, and further to €126 million by 2014.
“Regulations from Brussels may be the trigger, but market surveillance is now morphing into optimal operation control. Despite current budget constraints, firms are beginning to invest in the necessary tools, but those who don’t may well be saddled with fines and a damaged reputation,” said Rebecca Healy, senior analyst at TABB.
Guidelines from the European Securities and Markets Authority (ESMA), which came into force at the beginning of this month, require brokers and trading venue operators to have measures in place to maintain fair and order markets. For brokers, this includes a governance process for developing or buying algorithms, rolling out the live use of the algorithm in a cautious fashion and ensuring staff have the necessary expertise to run and monitor the behaviour of algorithms. There are also guidelines related to pre-trade risk controls for direct market access. In addition, proposals in MiFID II and the Market Abuse Directive aim to restrict high-frequency trading (HFT) activity by placing limits on the way they interact with the market. TABB estimates that HFT currently represents around 40% of equity order flow in Europe.
According to Healey, legacy surveillance systems are in danger of being overwhelmed by the sheer volume and complexity of algorithmic trading data. She added that the rules also require systems that are flexible and adaptable so that algo strategies can continue to work effectively.
“ESMA guidelines call for monitoring cross-border trading in real time, not post trade,” said Healey. “Unfortunately, necessary controls and procedures may prove inadequate ahead of further regulation coming down the pipe. As such, investment firms need to appear beyond reproach, uphold market integrity and avoid fines. This is why reputational risk has quickly become the mantra of compliance officers and risk managers alike.”