Iosco Urges Action on Market Surveillance

Terry Flanagan

The umbrella body for national securities regulators has issued a consultation report on the technological and regulatory improvements that are needed to enhance market surveillance.

The report, by the International Organization of Securities Commissions (Iosco), enumerates the goals of market surveillance as identifying rule breaches, erroneous activity—for example, order entry arising from a malfunctioning algorithm or fat-finger error—and other forms of activity that may be deemed inappropriate, such as submitting excessive orders and cancellations.

Coming a few weeks after the Knight Capital trading glitch, the report seeks to crystallize the role of regulators, including self-regulatory organizations, in policing the markets in an era when markets are increasingly becoming automated, and therefore more dependent on technology.

In the case of Knight, “this may have been prevented entirely had the firm been utilizing adequate controls such as real-time surveillance and risk monitoring”, said John Bates, chief technology officer at software provider Progress Software. “Algos can move so quickly that by the time a human has noticed an error, it’s likely the damage has already been done.”

The Iosco report noted that trading of securities has become more dispersed among exchanges and various other trading venues, and that markets have become more competitive, with trading venues aggressively competing for order flow by offering innovative order types, new data products and through fees and rebates.

Responsibilities for conducting market surveillance vary significantly across jurisdictions, the report said.

In some jurisdictions, each individual trading venue is required to undertake real-time surveillance of its own market. In others, one central entity, often a self-regulatory organization, undertakes real-time market surveillance on a consolidated basis.

In most jurisdictions, statutory regulators do not conduct real-time market surveillance, and instead rely upon trading venues and self-regulatory organizations to identify issues.

“Everybody should be monitoring for suspicious activity,” said Richard Chmiel, senior vice-president of sales and marketing at OneMarketData, a New York-based financial analytics provider. “Exchanges need to monitor incoming orders and look for patterns of irregularity.”

The Iosco report identified one of the primary challenges stemming from technological developments as the need to collect data, and to develop a process to effectively use such information for surveillance purposes.

Miami International Securities Exchange (MIAX), a start-up U.S. options exchange, has implemented OneMarketData’s OneTick Database and Complex Event Processing (CEP) as its tick data management system to implement and store all of its market data.

MIAX will use OneTick for pre-and post-trade analysis and data storage as well as usage reporting, execution quality, customer support, compliance and real-time surveillance.

“MIAX is an example of a firm using technology to conduct surveillance and monitor trading activity on their market relative to other venues,” Chmiel said.

OneTick Database and CEP enables users to write a single set of code for historical analysis and real-time signal generation, run queries that span historical and real-time data and apply analytics to these data processes, Chmiel said.

With regard to algorithmic and high-frequency trading, the Iosco report noted that some jurisdictions have introduced or proposed requiring that more information be provided to regulators on algorithms and their strategies, and place more responsibility on those using algorithms to trade.

In the U.S., for example, the Financial Industry Regulatory Authority, or Finra, is in the process of developing a suite of cross-market surveillance patterns that will run against a combined data set from all markets operated by NYSE and Nasdaq.

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