New initiatives in compliance technology
Thu, 17 Mar 2016 10:57:05 GMT
In this article, Mike O’Hara, publisher of The Trading Mesh, asks a panel of experts – Telstra’s Matthew Lempriere, enepath’s Huw Williams, Steve Garrood of Insightful Technology, Andrew Bowley of Nomura, Sam Tyfield of Vedder Price and Citihub’s Bob Mudhar – to assess the new initiatives being adopted in the area of compliance technology, and investigates how firms can best pull together all the necessary data they need for trade reconstruction under the new regulatory regimes.
If you had to list all the inputs into your decision to make an important purchase, where would you start? How many inputs were there, and which communication channels did you use? You might have talked to a sales rep in a shop, browsed several websites, talked to your family or friends – in person, via a smartphone or even Skype – or read an article in magazine. And once you made your decision, did you pay over the internet or over the counter, with cash or credit, and what documents did you need to complete and keep, for tax, insurance or other record-keeping purposes?
The number and variety of potential inputs and communication channels involved in agreeing and executing a transaction between financial markets counterparties is not dissimilar to those required for a big-ticket consumer purchase. A trade idea might start with an email or a conference call, then develop over a series of phone calls or texts – some at the desk, others not – while the precise execution timing may be determined by a combination of news flow and market conditions, distilled by the trader from multiple sources streamed into the trading room.
Just like in the consumer world, many aspects of the trading decision are assisted by recent technology innovations and increasing levels of automation. But the focus of these electronic communication tools is speed, scale and user convenience, not providing a comprehensive cradle-to-grave record of the transaction. This is, however, what regulators are now demanding from banks.
A key response by regulators to the global financial crisis has been increased customer protection, with a strong emphasis on visibility and scrutiny. Trade reporting requirements are increasing across all major asset classes, as is process transparency, in order to demonstrate best execution and to reduce both systemic risk and market abuse.
“MiFID II increases the need for large broker-dealers to capture every quote we issue to a customer as well as all the quote requests and orders we receive from clients, across all asset classes,” says Andrew Bowley, Head of Regulatory Response and Market Structure Strategy at Nomura. “As a consequence, firms are facing a pretty material front-office workflow change. Whether the medium is voice, chat or electronic trading, sell-side firms need to be able to pull all that data together.”
“Firms are facing a pretty material front-office workflow change. Whether the medium is voice, chat or electronic trading, sell-side firms need to be able to pull all that data together”
Andrew Bowley, Head of Regulatory Response and Market Structure Strategy at Nomura
At the same time, the series of scandals that have emerged since the crisis – from rate-rigging to insider-dealing to mis-selling – has alerted compliance teams to the very real possibility of demands for audit trails spanning multiple desks, offices and systems.
The evolving regulatory landscape is making different demands across jurisdictions, but the overall direction of travel is clear. Banks and other large financial institutions are having to put in place the processes and technology to provide regulators with an accurate, comprehensive record of every transaction they undertake, in a manner that is both timely and easily digested.
“The Market Abuse Directive that comes into force in July requires implementation of automated surveillance capabilities by banks,” explains Sam Tyfield, Partner at law firm Vedder Price. “But the delay to MiFID II leaves some of the precise requirements on data capture and reporting blank for the time being. Few firms will be able to satisfy the new requirements fully from day one, but they need to reassess their current approach to monitoring communications relating to trading and conduct a cost/benefit assessment of their options for upgrading existing capabilities.”
“Few firms will be able to satisfy the new requirements fully from day one, but they need to reassess their current approach to monitoring communications relating to trading and conduct a cost/benefit assessment of their options for upgrading existing capabilities”
Sam Tyfield, Partner at law firm Vedder Price
To meet the growing requirement for trade reconstruction, firms are looking to replace existing ad hoc practices – which are costly, labour-intensive and prone to error – with scalable, highly-automated solutions that not only capture a wide variety of inputs across communications and other IT platforms, but also allow indexing, storage and retrieval of the required information in accordance with regulatory mandates.
Due to the far-reaching nature of the transaction value chain, not to mention the diversity of trades processed by global banks, implementing trade reconstruction solutions on an enterprise-wide basis is a major operational undertaking. While the primary driver might be regulatory, the up-front investment required to achieve compliance can also yield long-term benefits, by helping to identify at an early stage behaviour patterns that might otherwise lead to conduct risk.
“Increasing levels of automation in the trade monitoring process reduces the scope for conflict between compliance and trading staff and improves the productivity of both, by automating compliance checks and alerts that ensure policies are being adhered to, while supporting flexibility of communication on the trading desk floor,” says Steve Garrood, Group Sales Director at Insightful Technology.
“Increasing levels of automation in the trade monitoring process reduces the scope for conflict between compliance and trading staff and improves the productivity of both”
Steve Garrood, Group Sales Director at Insightful Technology.
A challenging environment
Both technological and regulatory trends are breaking down traditional silos within banks, with the result that workflows across asset classes are increasingly homogenous and automated. Many hitherto over-the-counter instruments are migrating to electronic trading and central clearing – notably interest rate swaps and other liquid, standardised derivatives – while cost pressures are encouraging firms to adopt multi-asset platforms in the front, middle and back office. But many differences remain, whilst the flexibility and diversity of today’s communication channels – personal or institutional – suggest that inputs to trading decisions will continue to be transmitted via multiple systems for the foreseeable future. Anecdotally, some global banks permit use of many as 30 instant messaging (IM) platforms alone.
“Historically, vertical silos within banks have developed their own distinct solutions,” says Bob Mudhar, Partner, Citihub Consulting. “But a number of forces, including regulation, are encouraging them to focus on the similarities between asset classes rather than the differences. From a compliance perspective, the burden is significantly reduced if you can use solutions across businesses. At present, firms are at many different points across the spectrum, with some still operating on a very siloed basis, while others, through luck, planning or happenstance, are already well down the path of using common elements – such as a universal trade warehouse – throughout the firm.”
“A number of forces, including regulation, are encouraging banks to focus on the similarities between asset classes rather than the differences. From a compliance perspective, the burden is significantly reduced if you can use solutions across businesses”
Bob Mudhar, Partner, Citihub Consulting
Faced with reconstructing trades from snatches of conversations and instructions conducted by a combination of emails, chatrooms, smartphones, turrets, order management systems and the rest, banks have been literally throwing bodies at the problem. Most trading room communications are already captured in some form or another. But the information is rarely archived or indexed in a way that makes it accessible on demand. So when a request comes in from a regulator, the response is to draft in staff – often from third-party consultants or law firms – with barely adequate levels of training or guidance, to plough through hours of recordings and files in the hope of coming across the transaction under investigation.
Voice recordings present a particular problem. At present, banks may use phonetic searches to trawl through voice files in search of a particular term or phrase. This is typically done overnight due to the amount of data involved, even if searching just yesterday’s data. Running a search across the last three month’s data for example, could be more problematic, not only because of the processing required, but also because the data might no longer be easily accessible. Moreover, voice files are hard to cross-reference with electronic data from other sources, which is necessary to provide the full context for any trading conversation.
Components of compliance
Clearly, current practice is not sustainable in a regulatory environment that is imposing tighter requirements, including shorter time constraints, nor a commercial environment that is imposing tighter budgets. The challenge for banks therefore is to graft a flexible compliance monitoring framework onto existing workflows and data capture capabilities that deploys best practice methodologies and emerging technologies to increase process automation and standardisation in the capture, storage and accessibility of trade-related information. Such a framework not only has to work with the existing reality of trading decisions taking place across multiple systems and devices, but must also take account of local regulations relating to data privacy and sovereignty.
“In terms of data capture, it is important to be able to collect and store data from multiple sources in a common format, regardless of the multiple silos and systems that reside in every large bank. In parallel, the data must be indexed using the appropriate meta-data so that all the information relevant to a particular trade can be retrieved simultaneously,” says Matthew Lempriere, Global Head of Financial Services, Telstra.
“It is important to be able to collect and store data from multiple sources in a common format, regardless of the multiple silos and systems that reside in every large bank. In parallel, the data must be indexed using the appropriate meta-data”
Matthew Lempriere, Global Head of Financial Services, Telstra
A critical element of data capture to support trade reconstruction is the ability to handle the proliferation of communication channels. While some firms have banned use of personal mobiles on the trading floor, others have taken a more inclusive approach to the fast-changing communications arena by sanctioning and monitoring use of a wide range of social media channels, from multiple IM platforms to Skype for Business to Twitter. Trade monitoring and reconstruction solutions must be able to pull in data from all of these sources into a common format for indexing and cross-referencing with other more traditional trading room inputs, such as market data feeds and newswires.
A further challenge across traditional trading room telephony via turrets, traders’ mobiles and video-conference calls with clients is the ability to capture all sides of the conversation clearly and distinctly. This is not always possible either in the heat of debate or when a comment is muffled by an outburst of laughter, for example. But with many telephony services shifting to IP, it is increasingly possible to record each participant on a separate, hi-definition channel, which allows for easier isolation and accurate transcription for inclusion of that data into an indexable communication platform.
“When archiving or indexing voice communication, it’s important to include the appropriate meta-data, such as a particular trade ID, but also the identity of participants to the discussion,” says Huw Williams, Chief Scientific Officer at enepath. “With a conference call about a particular transaction, for example, multiple parties could join or leave the call at any time, so you need to associate all the necessary meta-data with the file to archive, retrieve and make sense of the call.”
In meeting the needs of financial markets regulators, it is important also to respect laws and conventions relating to data privacy and integrity. As such, there is an emerging trend toward compliance tools that provide regulators with a ‘window’ onto the data that they require, rather than packaging it in some way. This ‘portal approach’ not only ensures data integrity, but also shows the regulator the relevant data in situ, i.e. in an unaltered state from when it was first recorded.
“Rather than storing all data in perpetuity, many firms are setting their policies in strict accordance to regulation, for example fully deleting data immediately upon expiry of regulatory mandates”
Huw Williams, Chief Scientific Officer at enepath
Insightful’s Garrood suggests firms should aim to provide regulators with only the information they require and the ability to interrogate it quickly and efficiently. “It benefits neither the firm nor the regulator to dump huge amounts of data, which could lead to more questions from the authorities,” he says. Moreover, the easier it is for the regulator to view and interrogate the requested information, the quicker the resolution of the case. “While respecting different data protection policies, regulators and banks are looking to access data from a single viewpoint in single instance from multiple sources around the world. Getting the architecture right is the key ingredient in how data is presented and accessed,” Garrood adds.
enepath’s Williams agrees that firms are looking to be more precise in their compliance with regulatory requirements on archiving. “Rather than storing all data in perpetuity, many firms are setting their policies in strict accordance to regulation, for example fully deleting data immediately upon expiry of regulatory mandates,” he says. “In addition, firms need to retain flexibility to accommodate different technical requirements across jurisdictions. Compression of audio files must be reversible, for example, as some jurisdictions, including the US, do not accept lossy compression of audio files.”
Data related to transactions conducted in a particular jurisdiction may need to be held locally, but accessed remotely by a central compliance function, which may be working primarily in a different language. As such, firms need to abide by data sovereignty requirements whilst also responding quickly and effectively to requests from financial markets regulators. “Cloud-based data hosting solutions can help firms to resolve the challenge of meeting varying data sovereignty requirements in multiple jurisdictions, but cloud strategies must take into consideration the client’s individual circumstances and requirements, including cyber-security,” says Telstra’s Lempriere.
With a comprehensive monitoring infrastructure in place across voice and electronic communication channels, compliance teams will be able to adopt a more proactive approach to ensuring trading activity is not breaching regulation. As well as conducting searches in response to regulatory requests, compliance officers could set up alerts, triggered by use of certain words or patterns that might imply illegal or inappropriate behaviour. This might involve the compliance officer being informed of any discussion of a particular type of transaction, for example a deal that only the M&A desk should be aware of, to ensure no breach of Chinese walls that could lead to insider dealing.
Ideally, such alerts could lead to an internal investigation, which would resolve a potential problem without the need to inform the authorities. If it did become necessary to bring activity to the attention to the regulator, the fact that the bank had been able to identify the issue itself would typically be taken into consideration should any sanction be imposed.
“As well as enabling them to have close-to-real-time oversight of trading activity, there is an opportunity for banks to help their compliance staff to be more proactive,” says Telstra’s Lempriere. “Rather than conflict resolution, the compliance team will be better placed to nip potential problems in the bud, monitoring business patterns and influencing business behaviour, thus proactively reducing the risk of reputation loss or regulatory sanction.”
In the longer term, Insightful’s Garrood believes the new generation of compliance technology could yield further returns. “There are business development benefits from the efficient and systematic capture of communications with clients which can be fed into customer relationship management systems,” he says.
The future of compliance technology
Facing future regulatory requirements to track, index and store all trade-related communications, no matter how seemingly inconsequential, bankers might well despair at the potential cost and complexity of meeting this challenge in an imperfect and fast-changing world.
But there is room for optimism. Similar to other types of technology currently being deployed in the finance sector, compliance technology has firmly entered a collaborative phase, in which firms with different capabilities and fields of expertise come together to provide a distinct value proposition in a particular industry vertical or geography. Both cloud-based collaboration and open APIs are beginning to take hold, heralding a new era in which it is becoming common practice for new solutions to be comprissed of a range of supporting tools and capabilities, easily accessible by and integrated with existing core banking systems.
According to Telstra’s Lempriere, this open-source-based, collaborative approach is enabling the innovation of fintech firms to enter the realm of the global financial markets, with established service providers partnering with start-ups and early stage technology firms. The result should be scalable, flexible and affordable solutions. “Compliance is an area where market-specific capabilities are often required, such as voice recognition and transcription in different languages, but which benefit from being integrated with other tools that have a more universal usage, from telephony and networking services to trading turrets with high-definition voice capture to voice and data indexing and storage to alerting and searching functionality,” says Lempriere. “Open APIs permit these and other components to be plugged in according to client need.”
This need for plug-and-play flexibility in compliance solutions is driven in part by the global nature of the financial markets and the firms that operate in them, but also the evolving and extra-territorial nature of regulation. Firms need to be aware not only of the evolving concerns and requirements of their local regulator, but those of their trading counterparties and the market infrastructures with which they interact. In this context, compliance is a moving target, a process not an event, requiring compliance capabilities, including trade monitoring and reconstruction, to adapt accordingly.
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Writing and additional research by Chris Hall, Associate Editor, The Realization Group