Live from the Finance Magnates Virtual Summit: MAR & market surveillance for CFDs

Contracts for Difference, better known by their acronymic abbreviation CFDs, have been very much the subject of a metaphorical tug of war between long established and well respected electronic trading companies in their main markets of England and Australia, and the respective regulatory authorities FCA and ASIC, which have been launching a deluge of curtailments over the past few years.

FinanceFeeds has made its position very clear on these matters with a series of in-depth reports on British and Australian attempts to restrict the method by which CFDs are sold, with industry opinion varying from a conspiracy by exchanges to lobby regulators to put OTC products onto exchanges because they do not have the technology or wherewithal, nor the attractive trading methodology of OTC firms, so the only way of gaining their retail audience back is to bully the OTC industry, to an opinion that regulators do not fully understand the modus operandi of many brokers or requirements of their clients, hence these efforts simply push brokers offshore where they will carry on as normal but without regulations.

Today, at the Finance Magnates Virtual Summit 2020, senior FX industry regulation and regulatory technology specialists looked at this in detail.

Debating this matter on today’s panel were the erudite Ron Finberg of Cappitech, Mark Kelly, Founder and CEO of Regulatory Advice LTD, Shay Heffets, Co-founder of DASSOM DIGITAL, and Shiran Weitzman, CEO of Shield.

Mr Weitzman began, his involvement in communication for market surveillance being key to this discussion “e-com is not e-commerce, it is electronic communication. This is something that has evolved over the years. The terminal and chat communication facilities within the terminals such as Bloomberg and Thomson Reuters, and now with the digital communication revolution that happened ten years ago has led to every area that allows humans to communicate. Today, it is around any voice or text channel, so we are specifically talking about the financial chat rooms such as offered by Bloomberg.”

“There are so many these days, Slack, Trello, Whatsapp, for example, which many financial services firms use. As far as financial market abuse is concerned, almost all financial markets companies use these messaging services, so the wider scope of monitoring these relate to how to facilitate communication freely, but to minimize market abuse” he said.

Mr Heffets continued the discussion with regard to digital messaging “The collection of data is not really the real challenge. There is no one solution that will cover all communication channels. If for example two individuals want to keep their communication private, they will find a way to do that.”

“The solution starts with culture of organizations. The understanding by employees that surveillance is important and that good conduct is required. There is no way that anyone will be able to cover all aspects of communication. The combination of voice and text across most known systems today has created another problem, that being the tremendous amount of data that now exists on multiple channels” said Mr Heffets.

“You would be surprised what regulators are looking for when they are auditing systems. They look for phrases, such as front running, or other such key words” said Mr Weitzman.

“We need to understand the context, as in what happened before and after a specific conversation, what their role is, and of course if someone takes it offline and talks in an encrypted channel such as WhatsApp, nobody is recording WhatsApp conversations” said Mr Weitzman.

“The idea is to link the trade or transaction itself, and the intent that is available in the electronic communication. A lot of things may not be captured in the e-com, instead capturing it in the trade” he said.

“This was evident when the big banks were rigging the FX benchmarks rates, via messenger services. These were criminal cases, however in many cases there are instances in which those having these conversations aren’t really criminals, but they are trying to cut corners. Therefore the tools we are using are evolving” said Mr Weitzman.

Mr Finberg then moved onto areas which count as market abuse and which do not and asked Mr Heffets to elaborate on this.

“Really you are looking for the four areas of market abuse, which MAR covers. When it comes to insider trading, you would seek to understand if there has been information which was due to go into the public domain, upon which someone has taken action prior to it going public. Market manipulation is the secondary area, where the actions of a trader do not make sense. This prompts regulators to look at what motivated a trader to make an action that does not make sense. There is often a lot of implicit information that shows that market abuse was intended” said Mr Heffets.

“You should be looking at behavior, crossing a series of data points that demonstrate certain behavior. Rather like building a puzzle, it then begins to give you the data to make the decision to pursue a client for market abuse. However, as a broker, your job is to inform the regulator and then carry on with your job” said Mr Heffets.

Mr Finberg said “That is a good point, in that a company’s responsibility is to report it, rather than to try to stop insider trading or market abuse. Dealing with it is the job of the regulatory authorities or the judicial system.”

“I can see two issues that have been referenced here, one is that you aren’t going to be able to catch everything. Firms simply need to demonstrate to the regulator that they have done everything that is reasonably possible. This helps to scoop up some of the things that wouldn’t have normally been caught. The responsibility of dealing with it is down to the regulator” said Mr Kelly.

“You need to know what ‘bad’ looks like in order to add filters and expert rules to the data collected. The scenarios may be a big spike or a big dump in market price, then needing to look into the possible reasons behind it. You would need very intelligent filters to capture the data and analyze it well. If you get a surveillance package out of the box, you’ll find they are very tailored toward exchange trading, and therefore they have very good reports about spoofing or layering, all of the things that are pertinent to an open order book, however the CFD market doesn’t have this, therefore if you are doing a risk assesement on how your CFD firm is most at risk, this would require a different method” said Mr Kelly.

“Often, manipulators and insider dealers may execute via a spread bet or a CFD in order to circumvent those exchange orientated systems” he said.

“It is very limited. We have an army of compliance officers, yet a limited set of resources for submitting suspicious trade reports” said Mr Weitzman.

“You are dealing with so much information and processing it, it is possible to miss the point. It is expensive and mainly not effective” said Mr Heffets.

“I think, when one applies common sense, there are ways to use the current systems but I don’t see that as a long term solution. I see AI as the future. In order to understand and eliminate false positives and understand the real positives we have to advance this further” said Mr Heffets.

“Our focus should be on reducing the false positives. The traditional method such as smart lexicons, feedback from the compliance officer, improving the risk based approach for specific types of electronic trade and scenario of event that happened should be combined with increasing the frequency of alerts that can be acted upon” said Mr Weitzman.

“The human intuition is very important” said Mr Heffets. “I see nothing wrong with humans training the computers in future, but we do need the human activity.”

“Once you reduce the amount of false positives, your resources have more time to spend on the cases that are due for investigation. With regard to reasonable suspicion, you need to consider the effect it may have on your client. An innocent individual, being reported to the regulator, may have an effect on the individual’s life. You have to consider that a report to a regulator on a false premise that targets an individual can have an effect that would change their life” said Mr Heffets.

“I terms of the consultation paper that came out, it is difficult enough for countries to move currencies where they want, so it is very difficult to imagine that a firm would be able to manipulate the market by doing so if they figure that an interest rate may be different to how it had been in the past” said Mr Kelly.

Mr Kelly said “MAR includes derivatives FX that is listed on a regulated marketplace, but spot FX is not and it is not being specifically regulated in the future. There have been instances whereby brokers are passing on bad slippage to clients, for example, it is likely that the regulators will say that this is not covered by MAR. I think ESMA has come out in the right place and left FX off the table for the moment.”

Mr Finberg moved onto what the divergence between the FCA in the UK compared to the EU will be post-BREXIT.

“I think Mark knows more than me, but from what I read, the FCA wants to make it simple. They published the changes they are making to the MAR regime, and those changes state that the FCA regulated firms will continue to follow the same guidelines as apply in Europe” said Mr Weitzman.

“It is possible that brokers may need to report to two regulators, one in the UK and one in the European Union, but the parameters and procedures are the same” said Mr Weitzman.

“The new bill that was put before Parliament recently basically lifts and shifts all of the rules on MAR from the EU into the UK. You’ll be expected to send suspicious transaction reports to the FCA, just as is currently the case” said Mr Kelly.

Mr Finberg looked at companies that have one hub that manages clients, across other regions and how this will have to be structured.

“All of the scrutiny and suspicious trade reports will have to be sent to the local regulator, being the one that oversees that particular region, therefore post Brexit, this would have to be done in the UK if the entity is in the UK, and in Europe if the entity is in Europe” said Mr Kelly.

“I think brokers will have to be careful about what data they can share about UK customers to EU regulators and vice versa” said Mr Kelly.

“It may be that the regulators have an interest in stopping financial crime, so therefore they have an interest in remaining aligned. If they begin to operate separately it will scupper this. You cannot undo years of intermingling and therefore it is likely that they will remain working together” said Mr Heffets.

Finally, digital assets, an area famous for pump and dump schemes and financial crime, have not been covered at all by the regulatory reporting rules on market abuse. Mr Kelly said that the onus should be on brokers. For example, during the MtGox and Silk Road crimes, it would have been down to the anti money laundering due diligence than it would be market abuse.

Perhaps, with the constant refinement of the electronic trading industry by its astute and diligent leaders, along with regulatory technology firms which provide solutions which report inconsistencies and help remove felons from the trading world, we are creating a huge bureaucracy for ourselves whilst the fraudulent crypto peddlers, whose thin-air non-existent currency has created tremendous problems over the last ten years, walk free, totally outside any form of monitoring.

Unauthorized channels such as WhatsApp and Telegram, both encrypted, have become an issue with regard to working from home. There is no compliance department overseeing behavior at home. This is a current issue that should bother any financial firm, and to increase the dramatic aspect of it, the director of Market Oversight at the FCA made a speech, and she addressed the dynamics of working from home in that speech. They see it as almost transparent, and they expect firms to implement very tough policies with regard to use of private devices, and market abuse via individuals working form home.

It is very likely that this is in the regulator’s remit and high on their agenda.

Mr Heffets concluded by saying that the FCA considers the CFD brokers not to be contributors to the financial markets sector. Instead they see CFD trading as an area in which most people lose their investment and that market abuse is prevalent.”

Whether it is or not is not really the question here, it is more about how the FCA views it, and that is what counts here. “Don’t expect sympathy, and get your act together” concluded Mr Heffets.