The Race to the MAR Deadline Is On: Can Buy-Side Firms Cross the Finish Line on Time?

By Stefan Hendrickx, Ancoa

Originally published on TABB Forum

Not subject to MiFID II delays, the new Market Abuse Regulation aiming to increase the transparency, safety and resilience of European financial markets is due to come into effect on July 3. While compliance preparations by the sell side are well underway, however, many buy-side firms, including proprietary trading firms, asset managers and hedge funds, are unaware of or are procrastinating over the fact that they might fall under MAR’s remit.

Unlike the F1 World Championship, which sees expert teams of technologists and drivers compete for the title in more than 20 Grand Prix races, the Market Abuse Regulation (MAR) race will conclude on July 3, 2016, with regulators across Europe requiring participants to cross the finish line in one fell swoop. While compliance preparations by the sell side are well underway, the buy side is off to a slow start in determining when and how to join the MAR race.

Our recent conversations with buy-side firms, including proprietary trading firms, asset managers and hedge funds, have shown that a substantial number of firms are unaware of or procrastinating over the fact that they might fall under the remit of the forthcoming Market Abuse Regulation (MAR). Not subject to MiFID II delays, the new legislation aiming to increase the transparency, safety and resilience of European financial markets is due to come into effect on July 3.

As evidenced by the FCA’s Market Abuse Thematic Review for Asset Managers last year, the establishment of appropriate systems and procedures by firms in order to detect potential market abuse will likely become high priority for national regulators. It is worth noting that firms based outside of the E.U. will also be affected by MAR if they are trading financial instruments on E.U. markets.

The question is: How should smaller buy-side firms determine if they are going to be MAR-affected or not?

New criteria: surveillance technology and automation are key

Under MAR, firms will be required to consider whether an automated system for market surveillance is necessary and, if so, its level of automation. In its Technical Standards, ESMA laid out a set of criteria that firms are advised to take into account when considering levels of market surveillance, including: the number of executions and orders that need to be monitored; the type of financial instruments traded; the frequency and volume of order and executions; and the size, complexity and/or nature of their business.

Firms should take note that ESMA has deemed, for the large majority of cases, an automated surveillance system to be the only method capable of analyzing every execution and order, individually and comparatively, and which has the ability to produce alerts for further analysis. Regardless of what type of surveillance system is eventually decided upon, firms will have to be prepared to justify to regulators how generated alerts are managed by their chosen system and why such a level of automation is appropriate for their business.  

Intent on change: capturing both intent and market abuse

One major development in the market abuse legislation for all firms is a transformation of the existing STR (Suspicious Transaction Reports) regime into a new Suspicious Transaction and Order Reports (STOR) requirement. STOR mandates that suspicious ‘orders’ are to be reported to regulators (i.e., intent), as well as the “transactions” that are required today – even if the orders do not proceed to execution. Because regulators will be reviewing the cancellation or modification of orders, analysis of suspicious orders and executions which did not result in a submission of a STOR form would also need to be retained and accessed by a firm.

This is expected to affect buy-side firms in the following ways:

• Dependence on third-party market surveillance: Buy-side firms will no longer be able to rely on their broker to perform market surveillance on their behalf. Brokers, on the other hand, will be required to continue market surveillance practices and flag a STOR with the regulator directly, without notifying the buy-side firm. Doing so would be a breach.
• Storage of orders: The biggest challenge for the buy-side may be the actual storing of the analyses of suspicious orders and executions. Currently, many firms only keep an audit trail of executions, whereas orders are not often kept in any sort of systematic structure.
• Capable analysis software: ESMA guidelines 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 considered 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.

Crucial capability

Buy-side firms need to consider their current capabilities in order to meet MAR requirements. Yet concerns remain over cost of implementing appropriate surveillance systems and the amount of resource taken up from sifting through numerous alerts.

Systems with a built-in contextual approach can help reduce the number of false-positive alerts, thereby saving on valuable resource. Surveillance tools can facilitate an immutable audit trail of structured and unstructured data (such as instant messaging and other forms of communication), and certain tools can furthermore normalize and consolidate data from across systems, ensuring improved visibility across the firm, thus enabling better analytics at large.

Other areas that can also help minimize time spent on managing alerts are the inclusion of a back-testing environment for alerts, as well as a flexible approach to handling different segments of the business according to perceived risk and other characteristics. Moreover, some vendors offering market surveillance systems charge a flat fee, as opposed to the approach of charging per asset class, instrument or market, which can add up substantially over time.

The finish line in sight

In just more than three months from now, buy-side firms will need to be in a position to self-assess whether an automated level of market surveillance would be regarded necessary by the regulator. Establishing a data trail of orders as well as executions is an important first step. In this instance, automated surveillance systems can help solve regulatory obligations.

Not only can regulatory compliance be achieved through the use of market surveillance tools, overall business opportunities can be explored because of the increased level of business intelligence. In the race to the MAR finish line on July 3, 2016, there is really no downside for prop-shops, asset managers and hedge funds to having the right market surveillance tools in place. High performance through technology and automation brings competitive advantages and improves business success.