Market Watch 67: FCA issues algorithm-based enforcements

The FCA’s algorithm-based surveillance

Market Watch 67: FCA issues algorithm-based enforcements

The UK’s Financial Conduct Authority (FCA) has published its latest Market Watch. In a divergence from previous editions, Market Watch 67 sets out how the Regulator is using internal algorithmic surveillance to identify non-compliance – and gives clear examples of how it has used it in practice.

The FCA’s algorithm-based surveillance

As expected, the FCA notes in Market Watch 67 that it uses suspicious transaction and order reports (STORs), alongside other traditional indications of suspected market abuse, as catered for by article 16 of the Market Abuse Regulation (MAR).  

However, what is less expected is that the FCA has also revealed that it is using internal surveillance algorithms to undertake its own market activity surveillance.

In a clear case for automating compliance processes, the FCA says that it receives around 150m order book messages in a single day, which it then ‘blends’ into a single holistic view of market activity. This single inventory allows a ‘helicopter’ view, which – using a ‘suite of proprietary algorithms’ – is able to detect manipulative trading strategies across the board, from spoofing to wash trades.

Enforcement examples: the battle of the algorithms within

In a shift in approach from the FCA, Market Watch 67 diverges from previous Market Watch editions and not only sets out the Regulator’s expectations and methods – but showcases recent examples whereby they’ve put these methods into action.

Interestingly, the FCA sets out how it has used its internal surveillance algorithms to identify inconsistencies within different algorithms within an algorithmic trading firm (that’s a lot of algorithms). The FCA’s own algos were able to flag concerns about this firm’s algorithms, which had the potential to enable to the firm to have undue market influence. They were subsequently adjusted without the need for further enforcement activity.

Moreover, the FCA has used this internal algorithmic surveillance model to identify instances of potential spoofing by a trader at a firm. Again, the issue was rectified without the need for further enforcement.

This new ‘show-and-tell’ or rather ‘tell-and show’ approach showcased in Market Watch 67 hints towards real change from within the FCA, no longer just indicating what they may do, but rather showing what action they are taking – and will no doubt continue to take.

CUBE comment: how long until algorithms become religion?

In January 2020, the FCA launched its Data Strategy on the premise that “As a regulator, we need to both respond to how firms are using new technology, data and analysis and to look at how we can apply these to improve our own efficiency and effectiveness”.

While this current process is currently limited to equity markets, it is a bold step from the FCA and one that demonstrates their commitment to their Strategy. At the beginning of 2021, it appointed Jessica Rusu as its first Chief Data, Information, and Intelligence Officer. Where once the industry might have questioned the FCA’s mettle in committing to innovation and emerging technology, recent moves confirm its conviction.

What does this mean for the firms it regulates? As is often the case, once an organisation starts automating processes, or using artificial intelligence (AI) or data analytics to streamline its processes, it doesn’t take long for it to be implemented across the organisation, from surveillance to compliance and more. It is also likely that we will see a shift in attitude from the Regulator with regard to automation. After all, if it’s successfully using artificial intelligence and sophisticated algorithms to collect, analyse and manage market data – it won’t be long until they expect regulated entities to do the same.

Whether intentional or not – once the FCA sees a traditionally manual, often laborious task being improved and simplified by technology, it will surely be less forgiving of firms that continue to use traditional or ineffective compliance methods. As we’ve found at CUBE, it doesn’t take long for data and automation to become religion.

Data analytics – the future of finance

In the FCA’s 2020/21 Business Plan, Chair Charles Randell said “We must learn the lessons from the current emergency, our own experiments with data and the forthcoming reviews of past regulation, then embed them deeply into the way the FCA operates. And we must actively meet the challenges from market developments, EU withdrawal, new technology and consumers’ changing needs.”

Market Watch 67 is undoubtedly a sign that the FCA’s Data Strategy is being gradually cemented within its own enforcement activity.

Our recent report, Data: Poison or Cure? explored how data analytics is transforming operations within financial services – from digital onboarding to horizon scanning to predictive analysis. It shows how traditional data is being harnessed, alongside non-traditional data sources (alternative data) to provide new, accurate insights across the length and breadth of finance.

Fittingly, Market Watch 67 proves that data analytics isn’t limited to regulated entities – but expands to the regulators too. It’s the future of finance – across the board.

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