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Compliance: what the buy-side can learn from the sell-side

Compliance: what the buy-side can learn from the sell-side

By Bruno Piers de Raveschoot
Friday 9th December 2016

The Market Abuse Regulation (MAR), which came into force in July this year and builds on the 2013 Directive, has strengthened the hand of the regulator.

What changes under MAR?

MAR now demands that buy-side firms carry out their own monitoring for market abuse. This was a burden that firms had previously managed to avoid, as their brokers could carry out this monitoring on their behalf. Likewise, the scope for both instruments and venues has also increased. The sheer quantity of data that firms now need to collect, monitor and report on significantly increases regulatory risk.

Not only this, but the buy-side now needs to be able to cope very quickly with the new regulation and its new monitoring and associated data needs. They also need to have systems in place to detect insider dealing and market manipulation on orders and trades before exchanges and, more importantly, before these same detections are picked up by the regulator or their broker.

Indeed, under MAR, brokers who detect manipulation or attempts of manipulation will report them to the regulator, without being able to inform the asset manager of their action.

As such, the buy-side is facing a compliance challenge unlike any it has faced before.

This challenge mirrors the journey that sell-side companies went on more than 10 years ago. By learning from the sell-side’s experience, the buy-side will be better able to stay on the right side of the regulator.

Lessons from the sell-side

The first lesson to take from the experience of the sell-side is that successful compliance requires the effective management of an exponentially greater volume of data to monitor but also data needed for the detection. This data is complex to obtain, especially when it comes to monitoring asset classes that are non listed or illiquid.  Buy-side firms must take a new approach to data monitoring and surveillance, investing in tools and solutions that are capable of working to the new regulatory requirements and the increased scale of responsibilities that this entails for compliance teams.

As part of this process, forward-thinking firms are not only looking at what tools are needed to meet current regulatory requirements, but thinking about how these tools can be future-proofed.

We explored this topic at recent RIMES Regulatory Seminar, held specifically to discuss the impacts of MAR.

At the Seminar we examined the effective use of lexicons as a surveillance e-communications tool used by the sell-side to monitor trades. Lexicons are libraries of the key words and phrases that may indicate suspicious behaviour. The experience of sell-side firms is that lexicons are not always dynamic and agile enough to capture the increasingly subtle and obfuscated language that traders use. The implication for the buy-side is that many sophisticated firms are reviewing lexicons more frequently in order to understand how the lingo and jargon is changing, and ensure their surveillance tools remain efficient and accurate as the months and years pass.

Another lesson compliance teams can take from the sell-side is how to address the challenge to achieving an overarching view of all MAR regulatory obligations in order to act quickly and confidently.

Some buy-side firms are creating central data repositories in-house to collate and analyse necessary data. However, the experience of the sell-side told us that this approach could prove inefficient and costly. Instead, asset managers can adopt market surveillance tools that read any file type without needing to reformat the data.

Many firms are also considering whether keeping compliance in-house is still an option.

By outsourcing these tasks, asset managers avoid much of the cost associated with the otherwise necessary overhaul of their IT. Moreover, with managed service providers, asset managers will be able to benefit from levels of expertise most will not have in their own organisation. However, it must be remembered that ultimate responsibility for compliance rests on the heads of the asset managers – not their managed service providers. It is therefore essential that any such partnerships are only made with signficant due diligence.

Compliance monitoring is now core

MAR represents a seismic shift in regulatory responsibility. These new compliance responsibilities are real, and affect every single member of a buy-side firm. Without the right cultural pressure and prioritisation in place, several months after MAR became law many firms are still struggling to allow time for proper analysis to correctly address the changes required. And, the truth of the matter is, they are now out of time. Key decision makers must see compliance training as essential and ensure that every member of their team understands the requirements and boundaries of the regulation.

As the sell-side did some 10 years ago, buy-side firms need to recognise that compliance monitoring is now a core part of their operational requirements. They must start thinking about how to change their business to reflect this fact. In part, this requires taking a fresh look at transaction and order monitoring systems capable of handling the increasing scope of instruments. This is a huge change and one that buy-side firms must act on immediately.

Bruno Piers de Raveschoot is COO of the regulatory division at RIMES


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