Changing dynamics of market surveillance

Regulators are running full-tilt to protect the markets from intentionally abusive as well as unintentionally disruptive behaviour, Miranda Mizan, principal of the TABB Group said during a StreamBase webinar on new requirements for market surveillance.

The flash crash of May 6, 2010, which saw the Dow Jones Industrial Average drop almost 600 points in about five minutes, showed regulators just how inadequate their surveillance capabilities are for dealing with current market realities.

“The way markets are surveilled needs to be as dynamic as the markets themselves. The continued growth of electronic trading, plus the rise in high-frequency trading and algorithms raises the need for protection against disruptive order flow reaching the market, whether this is from the inappropriate choice of an algorithm or an algorithm that’s gone haywire,” Mizan said.

Market participants have a strong interest in effective surveillance, Mizan notes. Brokers want to know their algorithms are functioning properly, and “[n]obody wants to be the one to inadvertently kick that first domino that causes havoc. […] In short, they’re saying, ‘Watch my back, stop me from doing anything disruptive, and help me trade better.’ ”

Regulatory measures making their way through the legislatures of Europe and the U.S., touching everything from the way derivatives are traded to pre-trade risk controls for brokers, have three main objectives, Mizan explains.

The first is detection, where the aim is real-time monitoring to discern anomalies and identify abuse as they occur, and following up with alerts. Mizan emphasizes that the real-time capability should be seen as complimenting rather than replacing traditional historical analysis.

“Offline, it’s just as important to be able to see traditional patterns of abuse and find new threats that may cross markets or media, and that are not visible in real time,” she said.

The second component is prevention, which Mizan stesses is particularly important. “New risk controls and greater scrutiny of client and proprietary flows should protect against disruptive order flow ever reaching the markets in the first place,” she explains.

The third element is deterrence. Awareness of real-time and offline monitoring, as well as regulatory cooperation across markets and borders will—in tandem with an array of other prevention and detection tools—up the ante on abuse, Mizan says.

The real challenge of effective surveillance, Mizan adds, is wading through a seemingly endless fog of data to discern the anomalies and patterns that require attention.

“We have live data, static data, and now social media. The point here is to be able to collate the information wherever it comes from. This means aggregating [data] from various sources, integrating it, normalizing and consolidating it, and then overlaying a sophisticated analysis that can filter out the noise so that reports and alerts can be generated, prioritized and dealt with. […] Most importantly, this whole environment must be able to bend and flex with the changing needs of business, the marketplace, and regulation.”