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Trade Surveillance Increasingly A Front Office "Business" Responsibility

In the wake of Knight Capital, there's a trend in the front office taking on more surveillance responsibility.

In case you managed to miss it, the most recent case for electronic trading controls came in the form of erroneous orders sent into the stock-options market by Goldman Sachs in mid-August. The glitch could cost Goldman more than $100 million and within a week the company placed four IT staffers on administrative leave.

The chances are high that the removal of these IT professionals -- for whatever role they played -- did not completely remove the problem. People make mistakes, it’s unavoidable, and to an extent, the unintentional mistakes should be forgivable. It is the ability to quickly identify mistakes through surveillance and rectify issues through risk management that should be under the spotlight.

Power of Surveillance

Surveillance is of paramount importance in trading controls. It's what alerts risk management when something is out of whack.

The function can be broken down into two main categories:

1) Regulatory Surveillance: This type of monitoring alerts compliance to breaches in the rules that limit trade, such as insider trading, and largely gets people caught for breaking the law.

2) Business Surveillance: In this case, monitoring alerts a firm to breaks in a pattern, such as excessive cancels or excessive orders, and it plays a key role in identifying glitches. For example, a firm may have an average trading volume of 50 million, but one day it suddenly hits 500 million. It's not illegal to trade that much, but it does have the potential to break the business, if the trades take on excessive risks.

In the case of Nasdaq, the firm knew right away something was wrong and shut down their market. Goldman, it appears, also knew right away and stopped to work out the damage. It could have been much worse. Just compare it to Knight Capital in the summer of 2012, a true case of what happens when something goes wrong and is not noticed in time. By the time the dust settled, Knight was ruined.

Shift in Responsibilities & Budget

This effect was not lost on regulators and Knight’s peers, and it sparked a trend of front office executives taking a strong interest in surveillance technology.

To date, most firms allocate the surveillance responsibilities to back-office compliance departments and conduct them as an after-the-fact, t+1, “lets check nothing stupid has been done” review. This is clearly a bit worrying in the wake of recent events, especially when modern trading systems can send out thousands of orders per second. In other words, the automated systems can do a tremendous amount of damage in a limited amount of time. As a result, financial services are looking to make changes.

“We have a significant number of clients globally looking at and improving their trading surveillance,” says John Edge, managing director of Capital Markets and Business Development at NICE Actimize, a financial crime, fraud and compliance solutions provider. “We’re seeing front office taking more ownership, and leveraging the embedded expertise in trading technology from the front office.

For instance, before an afternoon call with Wall Street & Technology, Edge says he had already spoken on the topic to clients in Australia, Singapore, Hong Kong, London, New York, "and plenty more to keep us busy.”

[For more insights from John Edge read: CFTC First To Use Dodd-Frank To Charge HFT Firm]

"The compliance community has been, unfairly to my mind, on the low side of ability to develop tech," says Edge, who estimates the compliance department has been allocated about 5%-10% of budgets for the last decade, with the rest going to their front-office. Almost like a case of the haves and the have-nots, Edge explains that if you work in the front office and are handed lots of money for technology innovation, you get a good idea of what is and isn’t available. “If you’re in compliance you’re probably less familiar with what’s possible. We often sit with them and they don’t realize real-time surveillance is an option."

Now, front-office executives -- armed with robust budgets -- want to accurate surveillance themselves to know what’s going on in real time. “I think there is a culture shift in capital markets where businesses are taking ownership to make sure the most appropriate solution is in place,” says Edge. “The message is out there and it’s not going away. They need to be good at regulatory compliance and surveillance and C-level are being allocated this responsibility. That’s the way to go, it makes sense.”

Ahead of the Pack

Edge says any business that does algorithmic trading has a vested interest in enhancing surveillance and bringing the function out of core compliance and into alignment with the trading floor. “The move is definitely happening. Four or 5 brand name brokerages are doing this at the moment,” says Edge.

Proving the point, “We had a meeting this morning with a COO of a trading floor, who said, ‘it is now my responsibility to ensure we have regulatory surveillance in real-time…’” Historically, that was a core compliance responsibility, but the C-level executives now want surveillance directly owned by the front floor. “It’s all about the trading floor having the data.” Becca Lipman is Senior Editor for Wall Street & Technology. She writes in-depth news articles with a focus on big data and compliance in the capital markets. She regularly meets with information technology leaders and innovators and writes about cloud computing, datacenters, ... View Full Bio

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