1) What is market abuse?
The Market Abuse Regulation (‘MAR’) came into force on 3 July 2016 with the purpose of combating market abuse in financial markets and increasing market integrity, investor protection and promoting fair competition. The scope of MAR is wide-ranging, including buy-side, sell-side, issuers, trading venues and other market participants who trade any financial instruments on a regulated market. Examples of market abuse are ‘insider dealing’ and ‘market manipulation’, with various more granular market abuse behaviours falling under these broad categories.
Market manipulation arises when a person places an order or trade or any other activity (e.g disseminating information) that can affect the supply, demand or price of one or several financial instruments.
Insider dealing arises when a person possesses inside information, that is typically price sensitive, and uses this information in order to acquire or dispose of financial instruments to which that information relates.
2) Why is it important to detect?
Surveillance plays a key role for financial institutions in the detection of market abuse risks.
Firms have heavily invested in their surveillance functions with a great number of those deploying automated trade and communications surveillance.
Trade surveillance is the process of monitoring firms’ market activities for potential forms of market abuse, including spoofing (placing buy or sell orders with no intention of executing) and front running (entering into a transaction ahead of a client order that may impact the price of the security). This is based on the analysis of a range of data points including pre-trade, trade and market data to generate alerts based on pre-defined thresholds. Firms generally use a combination of third-party vendor solutions and / or in-house solutions for their trade surveillance. The type of data required for trade surveillance will include trade data (e.g. price, quantity and timestamps), pre-trade data (e.g. information about orders and quotes including where these have not been executed) and market data (e.g. current market price of the financial instrument).
Communications surveillance is the process of monitoring firms’ audio and electronic communications for potential forms of market misconduct. Some firms are moving towards more sophisticated forms of detection across communications, for example, deploying natural language processing (‘NLP’) models to target the context and behaviour of communications in order to identify communications of high risk.
3) What are the key issues and challenges that the industry is facing?
With technological advances and regulatory expectations developing, financial institutions are facing new challenges to better target market manipulation with the use of surveillance tools.
Completeness and availability of data - Recent regulatory findings regarding record keeping requirements have put greater emphasis on ensuring controls are in place to assess the completeness and availability of data which is a key input in surveillance systems. An example of a key data point is Request for Quotes (‘RFQ’). The capture and subsequent surveillance of RFQ data (including RFQ’s that have been traded away) has remained an area of challenge across the industry for many years. This is particularly the case given the various forms of RFQ receipt, as well as the use of third-party systems where the RFQ data may reside outside of a bank’s own infrastructure.
Quality of data – Surveillance functions are continuing to expand the data inputs being used in trade and communications surveillance systems in order to reduce the number of false positives. Examples of additional datasets include employee records, news feeds, internet history and social media. The expansion of additional datasets creates challenges to firms to understand how these datasets can be used to detect market abuse.
Cross product / market manipulation- A key challenge to firms which regulators are becoming increasingly focussed on includes cross-product / market manipulation. Cross product manipulation is when a person places an order or trade in one financial instrument with the intention of manipulating the price of a second financial instrument. Cross market manipulation occurs where a person places an order or trade in one market to affect the price of the same instrument in another market. Detecting cross product and cross market manipulation is challenging for firms due to the large volume of data required, across different products and markets. An additional challenge is identifying and risk assessing which pairs of products are most exposed to the risk of cross product manipulation.
Sustainability of surveillance framework – To date, financial firms have gone through the process of implementing tactical surveillance controls to detect market abuse. Firms are now thinking more strategically about their surveillance target operating model, and how they can drive more effective outcomes by integrating different data points together.
4) How can we help
Through our extensive experience of wholesale conduct issues, we have developed tools, methodologies and reference standards. These capabilities can be deployed on MAR projects and reflect our view of good market practice and understanding of regulatory standards. Examples of this include:
MAR risk assessment – Assessment of firms’ risk assessment methodology to determine whether they meet regulatory expectations and how they compare against peers, including recommendations on next steps. Following on from the assessment, KPMG can assist the firm in prioritisation and optimisation of the surveillance framework in order to be better equipped for emerging risks and regulatory expectations.
MAR health checks – Performing market abuse health checks for firms across the key Surveillance policies and procedures as well as the overarching governance framework. This is typically a review of existing practice, with key observations and recommendations for uplift.
Design of surveillance operating model – Support with the implementation of the firms target operating model including the support of establishing minimum controls standards to be followed.
Surveillance effectiveness reviews – Assessment of design and operating effectiveness of key surveillance controls. This extends to cover Skilled Person reviews and other reports for regulators.
STOR visits preparation – Support firms in preparing for a STOR visit by the FCA, by reviewing the firms Market Abuse surveillance procedures, including its controls for detecting and reporting suspicious transactions and orders. Workshops / mock interviews covering knowledge of the STOR process and understanding of the surveillance framework, to prepare for the FCA visit.
Surveillance data quality review – Supporting Surveillance functions with their data management framework. This covers the assessment over data quality, including the completeness, accuracy and timelines of data being used as part of surveillance activities.
Communications Surveillance – KPMG’s Magna solution provides a tool for the proactive detection of market abuse and broader misconduct activity, allowing firms to monitor risk exposure in real time, flag instances of abnormal or risky behaviour, and investigate and resolve cases before the risk escalates.
Surveillance model validation – Evaluating the effectiveness of firm’s surveillance models to determine if they are designed effectively to target the market abuse risk, involving a review of data inputs, alert logic and thresholds to trigger alerts.
MAR Insights Service – The regulatory horizon is constantly evolving and Regulators expect firms to identify and assess the rules and guidelines that affect their business. Nevertheless, the sheer volume of announcements make it hard to continuously assess the relevance and impact to the firm. KPMG have built a Regulatory Horizon (MAR Cases (kpmgrc.com)) tool which also identifies and summarises key market abuse developments including news, updates and regulatory cases. This service can be used by firms to undertake more dynamic risk assessments as well as to train and upskill Surveillance review staff.
