Glossary

Trade Surveillance

Economies around the world depend on thriving stock markets, however the unfortunate reality is that there are those who attempt to manipulate the markets illegally. For this reason, each country has its own regulations in place that are designed to prevent illegal trading and market abuse and protect investors. Trade surveillance is the practice of monitoring financial transactions to ensure that no nefarious activity is taking place. 

How Does Trade Surveillance Work?

Financial firms that are involved in trading are required to have a trade surveillance system in place. These systems automate the process of monitoring, capturing, and reporting potential illegal activities according to the specific laws and regulations of each country. As regulators become more stringent, it is becoming ever more important for companies to have appropriate systems in place.

While there are a number of different trade surveillance systems available on the market, they all generally operate in the same way:

 

  • Data Collection – all client and trade data is automatically uploaded to the trade surveillance system.
  • Data Enrichment and Analysis – market and other reference data is also uploaded to the system so that the firm’s data can be compared to market data and anomalies can be flagged.
  • Data Testing – certain tests are applied to the firm’s trade data and managers are alerted to suspicious activity. 
  • Investigation – once trades have been flagged as potentially harmful, it is up to the compliance team to conduct a thorough investigation. False positives can be disregarded and truly suspicious trades are reported to regulators. 

What Activities Does Trade Surveillance Monitor?

The following are some of the most common types of illegal trading and market abuse that trade surveillance systems are designed to pick up:

 

  • Insider trading – when individuals with access to confidential company information use that knowledge to buy or sell stocks.
  • Spoofing – when a trader places an order to buy or sell a stock but then cancels the order before execution. This creates a false sense of demand. 
  • Wash Trading – when the same stock is bought and sold simultaneously, creating the impression of market activity that is not actually happening. 
  • Quote Stuffing – when high-frequency traders generate hundreds of orders at once and then cancel them before execution. Similar to spoofing, but on a larger scale. 
  • Cross-Venue Manipulation – when a trader buys or sells on one particular trading venue or exchange in order to influence the price on another venue. 
  • Churning – when a broker conducts a large number of trades in a client’s account just to generate commissions. 

What are the Major Trade Surveillance Regulations?

Each country has its own trade surveillance regulations. Some of the major regulations include:

  • MIFID II – The EU Markets in Financial Instruments Directive II was passed in 2018 and introduced new requirements for financial firms to conduct trade surveillance across Europe. To comply with MIFID II, firms are required to capture and archive business-related communications and provide access to the records if necessary for an investigation. 
  • UK MAR – The UK Market Abuse Regulation was passed in 2021 in order to regulate UK firms post-Brexit when the EU regulations stopped applying to them.
  • Dodd-Frank – The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010 in the United States as a response to the 2007-8 financial crisis and includes a wide scope of trade surveillance regulations with strict enforcement. 

How Can Firms Ensure Compliance?

It is crucial for financial companies around the world to have a robust trade surveillance system in place that can accurately monitor trade activity and ensure that they are in full compliance with all relevant regulations. In most cases, financial companies are also required to monitor communications between employees and clients in addition to the actual trade activity. LeapXpert’s business communication platform easily integrates with many third-party trade surveillance systems and enables companies to capture and archive all communications as required by law.