Detecting market abuse

The new regulations that were implemented both in the EU (MAR, MIFID II and MIFIR) and in US (Dodd-Frank Act) in the aftermath of the 2008/2009 crisis brought in tighter trade surveillance requirements. In this post, we addressed such requirements related specifically to market abuse detection and prevention.

Regulation in the EU

The EU MAR (Article 16) states that trading venue operators, brokers and buy-side firms (ESMA’s MAR 26/Oct/2016 Q&A) shall establish and maintain effective arrangements, systems and procedures - that are appropriate and proportionate to the scale, size and nature of their business activity (ESMA’s MAR 26/Oct/2016 Q&A) - aimed at dealing with market abuse and attempted market abuse situations, in such way that:

• Trading venue operators are required to prevent, detect and report (to the respective financial markets authority) such situations;
• Brokers and buy-side are required to detect and report (to the respective financial markets authority) such situations.

Specifically regarding market manipulation, the EU MIFID II (RTS 6, Article 13) states that investment firms shall establish and maintain an automated surveillance system which effectively monitors orders and transactions, generates alerts and reports and, where appropriate, employs visualisation tools.

General functionalities of a trade surveillance system in what regards market abuse

The various existing trade surveillance systems vary in their structures and functionalities. However, broadly speaking, a sound and thorough trade surveillance system should include the following functionalities: 

• Alerts, which should be subject to: 
• Frequent testing (checking for false positives and for false negatives);
• Updates (changing old alerts and creating new alerts), in response to the tests made and to new market abuse trends;
• Case analysis, which should include the following features:
• Data analysis (including trading statistics); 
• Corporate events and news feed analysis; 
• Market (trades and order book, at the intra-day level) replay/reconstruction;
• Communications (voice, chats, social media) analysis; 
• Workflow management, which should allow for the different people in the organization that are involved in the case analysis, from start to end, to:
• Archive; 
• Escalate; 
• Audit;
• Report.

Scope of a trade surveillance system in what regards market abuse

A sound and thorough trade surveillance system should be able to deal with:

• Cross-product/cross-asset manipulation; 
• Cross-market/cross-venue manipulation.

Intent

One thing is detecting potential market abuse situations, other thing is to prove them. For such, in the cases of market manipulation, it should be necessary not only to show that the trading actions were in line with the definition of a certain type of market manipulation, but also to prove that there was an intention to manipulate the market.

There a couple of things that an analyst should look for when checking out for signs of intent. Indeed, the analyst should see whether the market participant:

• Profited, or could have profited, with such trading actions;
• Incurred frequently in these type of trading actions.