Firms are being warned that their legacy surveillance systems will not be able to cope with the avalanche of new regulations set to descend on Europe.

Increased market fragmentation, the sheer volumes of data and ever-more complex trading strategies are making it harder for firms, as well as regulators, to monitor market manipulation. In response, the European Securities and Markets Authority (Esma), the pan-European financial services regulator, is looking to impose strict new market abuse rules.

“Legacy systems find it difficult to keep up with the ever evolving legislation,” Martin Porter, business development director at B-Next in London, a specialist provider of trading compliance and trading software, told Markets Media.

With big fines and a damaged reputation on the cards for any firm who falls foul of the new regulations, such as the revised Markets in Financial Instruments Directive (MiFID II) and the upcoming Market Abuse Directive, Porter believes that it makes perfect sense to increase compliance spending.

“At the moment, there is a preventative reason why you need to put in this type of infrastructure and systems,” said Porter.

“Some firms are doing surveillance and monitoring already but I think firms will gain a competitive advantage if they do adopt these guidelines before they become mandatory as it will show they are conducting their business in a fairer manner.”

A new survey released by New York-based markets consultancy Tabb Group reveals that spending for market surveillance programs covering equities and derivatives trading alone across Europe will grow by at least 8% in 2012, increasing from €105 million in 2011 to €126 million by 2014.

Legacy systems run the risk of being overwhelmed by the sheer volume and complexity of algorithms and data volumes, with high-frequency trading now accounting for an estimated 40% of equity order flow in Europe.

“The growth of correlated trading makes one-dimensional surveillance redundant,” said Rebecca Healey, a Tabb senior analyst in London. “Esma guidelines call for monitoring cross-border trading in real time, not post trade. Unfortunately, necessary controls and procedures may prove inadequate ahead of further regulation coming down the pipe.

“As such, investment firms need to appear beyond reproach, uphold market integrity and avoid fines. This is why reputational risk has quickly become the mantra of compliance officers and risk managers alike.”

Porter at B-Next believes that in the current economic climate, some firms may be loath to commit money to something they think is not essential.

“It is a substantial investment in compliance expertise and trading surveillance systems but it is nowhere near what firms invest in their trading platforms,” said Porter. “It’s a small percentage of what they already spend on trading technology to ensure that they are conducting business properly. Therefore, it is a good spend. Whether they all agree with it in times of a flat market is debatable, though.”

But investing in these new surveillance systems may actually prove to be beneficial in more ways than one in the long run.

“Regulations from Brussels may be the trigger, but market surveillance is now morphing into optimal operation control,” said Tabb’s Healey.

Porter at B-Next added: “You can utilize this information and these results from the new systems to assist you in your future trading services, trading patterns and profitability.”