Buy-Side Trade Surveillance: Drivers, Challenges and Implications

michael-o-brien-17By Michael O’Brien, Vice President, Head of Product Management, Global Risk & Surveillance, Nasdaq

Regulatory developments are continuing to play a major role in the buy-side’s adoption of trade surveillance technology, according to a recent survey.

There is no doubt that there has been a shift within buy-side firms globally over recent years – buy-side institutions are increasingly relying on direct execution for trades and less on their sell-side counterparts. In fact, in Nasdaq’s 2016 Global Compliance Survey, 52% of buy-side firms cited that they are relying less on sell-side institutions for trade execution.

However, with increased direct execution, and thus increased trading volumes, from buy-side firms comes additional focus from global regulators and new requirements from regulations, such as MiFID II and MAR. While traditionally, buy-side firms have relied on their sell-side counterparts to ensure regulatory compliance, they are now faced with the need to demonstrate that their own systematic surveillance processes and controls are in place.

In a recent buy-side analysis, Nasdaq and Aite Group set out to determine the current state of trade surveillance adoption on the buy-side – further investigating its specific drivers, challenges and implications.

Based on study participants’ responses, it was evident that regulatory drivers have and will continue to play a significant role in the adoption of trade surveillance technology on the buy-side. For global buy-side firms, there is a need to focus on both global regulations as well as local regulations in regions where they invest.

Further affirming this, in Nasdaq’s 2016 Global Compliance Survey 64% of buy-side firms noted that they were concerned with global regulation and how it would impact their firms. MiFID II and MAR were the two most notable regulations of concern.

Managing reputational risk
Increased regulatory focus on the buy-side is forcing these firms to take a closer look at how they are currently managing their monitoring processes and whether these processes need to be adapted to effectively manage reputational risk and avoid costly fines. Almost all participants in the study stressed that they believed that upholding and protecting the reputation of their respective firms is the most important compliance function. This was also reiterated in Nasdaq’s Global Compliance Survey, with 64% of respondents noting that this was the most important role of the compliance team.

As a result of regulatory pressure and the importance of effectively managing reputational risk, buy-side firms are showing more concern over specific types of manipulation – most significantly, insider trading. With several public cases and fines in recent years, buy-side firms are well-aware of the potential reputational risk that insider trading poses, even when inadvertently. Study participants overwhelmingly noted insider trading as their foremost compliance concern.

While insider trading is the main concern for buy-side compliance teams, buy-side firms face a number of other potential market abuse scenarios and sophisticated manipulation techniques that can pose significant reputational and financial risk to their firms, such as front-running from sell side counterparts, speed manipulation, layering and spoofing.

Obstacles to implementation
While there are clearly compelling drivers for trade surveillance implementation on the buy-side, numerous firms remain in the beginning phases of adoption. While there are several reasons for this, some of the key findings uncovered in the study implied that a major challenge in implementing trade surveillance measures on the buy-side is the inability to effectively consolidate disparate data sources, including trading activity, and electronic and audio communications, among others.

Furthermore, some buy-side firms do not currently have the appropriate technology framework to support trade surveillance requirements.

Despite the challenges, global and regional regulations continue to place additional pressure on buy-side firms to implement systematic trade surveillance and monitoring processes – further driving the shift from a traditionally reactive compliance culture, to a more proactive and even soon-to-be predictive compliance culture. Buy-side firms must adapt in order to remain compliant and protect their organisations from potential reputational risk.

For additional information, contact MarketTech@nasdaq.com for the full report.

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