ESMA sets ambitious goals for market surveillance

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4 November 2015

On 28th September, the European Securities and Markets Authority (ESMA) published its long-awaited draft Technical Guidelines for the Market Abuse Regulation (MAR), setting out how MAR will apply in practice to market participants, market infrastructures, and national supervisors.  The new regulation and guidelines will have a substantial impact on market participants’ operations, aiming to increase capital markets’ transparency, safety and resilience as well as improving investor protection.

A number of firms will for the first time need to prove they have automated surveillance capabilities in place, including investment firms engaging in OTC derivative trading and algorithmic trading. Other market operators and investment firms will most likely have to re-architect their internal systems in order to comply with the detailed information capturing requirements and Suspicious Transaction and Order Reporting (STOR) requirements.  ESMA has deemed that, for the large majority of cases, an automated surveillance system is the only method capable of analysing every transaction and order, individually and comparatively, and which has the capability to produce alerts for further analysis in a structured workflow.

Reading, replaying, analysing, alerting…..

With a specific focus on the detection of market abuse, ESMA mandates that a surveillance system should cover the full range of a firm’s trading activities.  Firms will need to consider whether an automated system for market surveillance is necessary, and if so, its level of automation.  ESMA laid out a set of criteria which firms are advised to take into account when considering levels of market surveillance, including:

  • the number of transactions and orders that need to be monitored;
  • the type of financial instruments traded;
  • the frequency and volume of order and transactions; and,
  • the size, complexity and/or nature of their business.

No matter which surveillance system is decided upon, firms will have to be prepared to justify to regulators how generated alerts are managed by their surveillance system and why such a level of automation is appropriate for their business.

The ESMA guidelines also prescribe that surveillance systems should include “software capable of deferred automated reading, replaying and analysis of order book data on an ex post basis.”  This is deemed of particular relevance if the activity and dynamics of a trading session need to be analysed,  for example by using a slow motion replaying tool.

…as well as increasing storage capabilities

In the standards a great emphasis is put on the need to also report suspicious orders that have not been executed.  Furthermore, the analysis performed on suspicious orders and transactions which did not result in a submission of a STOR form also needs to be retained and kept accessible by a firm.  Firms will, therefore, need to adopt competent systems and procedures to document, recall and review analysis on both the above-mentioned scenarios, as well as retain the associated records for five years including the full audit trail of every order, executed or not.

Stefan Hendrickx, Founder and Executive Director of Ancoa, commented: “ESMA’s MAR technical guidelines provide clarity in areas that previous documents left open for interpretation.  ESMA clearly opts for more strict requirements, and a need for automated surveillance systems will apply to the large majority of firms.”

“ESMA’s Chair, Steven Maijoor, did say that the magnitude of the impact on market participants and regulators alike should not be underestimated.  This is demonstrated by the fact that for the first time, OTC derivative traders and high-frequency traders have to prove to regulators they have surveillance capabilities in place.  We believe the deployment of a real-time monitoring and surveillance system can help enable these firms to identify and manage potential risks of market abuse.  What is key for these firms to achieve the ambitious goals ESMA sets is a capability to process and analyse multi-asset, multi-market, structured and unstructured data on a single platform.”

Next on the MAR regulatory agenda is an endorsement of the Technical Standards from the European Commission by the end of December 2015.  This is followed by an objection period open to the European Parliament and the Council.  MAR is expected to enter into force by July 2016.