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Monitoring and surveillance play a crucial role in maintaining integrity and preventing manipulative activities in financial markets. As trading operations become more sophisticated and regulatory pressures mount, the need for effective surveillance technology and processes increases. When considering surveillance of related instruments – which can be defined as financial instruments that are interconnected or correlated due to shared underlying factors — we see some common challenges that regulators keep close watch over.
One evolution in the surveillance space is the increasing complexity of trading operations. With the proliferation of trading venues and the intricacies within businesses, surveillance processes have become more complicated. This complexity arises from the diverse array of trading instruments, as well as the interconnectivity between markets and the global nature of financial activities. And the steady drumbeat of regulatory pressure compounds this complexity, as financial institutions must stay abreast of new rules, adapt their surveillance systems, and ensure compliance with evolving standards.
A significant challenge for surveillance teams is the overwhelming volume of data. The financial world generates an immense amount of data daily, even hourly, across diverse instruments, markets, and trading activities. Sifting through this data to identify potentially manipulative behavior or irregularities requires sophisticated tools and algorithms, and the task of collating, analyzing, and extracting meaningful insights from this enormous data pool is an imposing challenge.
Recently, the financial industry has seen an increase in prosecutions related to manipulative activities. Regulatory bodies such as the U.S. Commodities Futures Trading Commission (CFTC) have been actively pursuing cases of manipulation across various instrument types. These prosecutions often reveal behaviors that have persisted for years, highlighting the importance of vigilance and continuous monitoring.
Manipulation can manifest in different forms. Singular manipulation involves manipulating a single instrument’s price to one’s advantage. Related instrument manipulation presents a more intricate scenario, where one instrument is manipulated with the intent to profit from another. One such example can be seen in a fine brought by the CFTC against an entity involving the trading of soybean orders where the entity was placing “spoof orders in one futures contract with the goal of inducing a fill on Trader A’s orders placed on the opposite side of the market in a different futures contract—a different soybean product (cross-product spoofing) or a different expiration month (cross-calendar spoofing).” The end result of related instrument manipulation can be a complex web of interrelated actions.
The primary challenge for surveillance experts with regard to related instruments is twofold: understanding the relationship between different instruments, and having insight into the global nature of trading activities.
- Instrument Relationships: Consider the example of oil futures trading. The web of related instruments extends beyond the primary market to encompass various derivative contracts and options. Mapping these relationships becomes like a puzzle, with thousands of products and contracts to account for. Unraveling these connections is a fundamental step in detecting potential manipulation.
- Global Trading Landscape: The geographical dispersion of trading activities adds a layer of complexity. Traders might exploit price differentials between markets located in different regions, making it challenging to track manipulative behavior across borders.
Surveillance of related instruments involves cross-referencing data from geographically dispersed markets and uncovering hidden relationships between entities and trading desks. The goal is to not only identify potential manipulative activities, but also to visualize these relationships in order to make investigations more efficient and insightful.
As trading operations become increasingly involved and regulations more stringent, the challenges of monitoring across related instruments and detecting manipulation becomes harder to ignore. Sophisticated surveillance technology and processes play a pivotal role in meeting this challenge, and by extension, helping to ensure the integrity of financial markets.
To learn more about the type of trading patterns and signals a surveillance program should flag when monitoring across related instruments, visit us here.
Ian Hawkins is VP and Head of Product at Nasdaq Trade Surveillance.
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