Zentraleüberwachung e.doc

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Central monitoring of trading on an international scale would be desirable. But is it even possible? The monitoring of the different markets is a fragmented as the markets themselves. Is central monitoring only a myth? Two experts have examined this question: Michael Zollweg and Carl-Frederik Scharffenorth from the Trading Surveillance Office of the Frankfurt Stock Exchange and Eurex Germany.

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Zentraleüberwachung e.doc

  1. 1. The myth of ‘central monitoring’ in fragmented marketsIt appeared to be a spectacular case of international insider trading. A Europe-an financial services company is aware of a bulk-sized buy order of a client ina stock and hence acquires a proprietary position. The buy order is bought in Deutsche Börse AGcountry A, the buy order on behalf of the proprietary account is executed in Media Relationscountry B. The Proprietary Trading Desk sells the previously bought positionas soon as the price increased. Mergenthalerallee 61 65760 EschbornThis cross-border case was raised at a meeting of international supervisory Postanschriftauthorities and was presented by an external system provider of a so-called 60485 Frankfurt am Maincross-market-compliant market surveillance software. An automated analysis Telefonof data derived from individual European trading platforms that is operated by +49-(0) 69-2 11-17854the system of the respective software- engineer had uncovered this case. Fax +49-(0) 69-2 11-11501However, the devil is in the detail. The re-investigation of the case by a super-visory body including an inquiry of the financial services company revealed, Internetthat the surveillance system could not reflect the correct trading process. The deutsche-boerse.comentered data as to the alleged prior proprietary transaction while being aware E-Mailof the client order turned out to be incorrect. In fact, the case was subject to social-media@ deutsche-boerse.comtwo independently executed client orders.What happened? The automated identification of the electronic order as client-or proprietary order was incorrect. Moreover, the timely sequence of the orderentries did not match the entry time in both trading systems.The data feed in use admittedly referred to original data of the trading systemsonly in part. Nevertheless, the case shows the difficulties that were to be ex-pected if a central market surveillance system had to be fed with trading dataof all trading systems in order to enable an overall view of trading.A few supervisory authorities and European bodies advance the following the-sis:  An overall view would be lacking without a centralized surveillance of all trading data and a market-fragmented abuse remained uncovered.  Central trading data availability could enable the detection of new trading conduct that points to cross-border market abuse (different ju- risdiction/markets).  A central database and analysis would be required in order to cope with the increasing challenges the watch dogs are faced with, e.g. by the increase in automated trading systems.
  2. 2. One single entity with complete oversight: This seems to be a valid argumentfor an attempted solution and sounds promising at first. Deutsche Börse AGHowever, besides fair comments, there are also considerable economic andlegal uncertainties (area of competence, data protection, different jurisdictions Media Relationswithin the EU, costs) and this raises the question whether the theoretic ad- Mergenthalerallee 61vantages of a centralized market surveillance justify the uncertainties of the 65760 Eschborntechnical implementation and the expected consequences to the trading plat- Postanschriftforms involved. 60485 Frankfurt am MainIdeal market surveillance primarily requires data that is already in use for to-day’s investigations (transactions, orders and quotes, data identifying the en- Telefon +49-(0) 69-2 11-17854tering trading participant/trader including individual identification numbers aswell as respective timestamp granularity as to the time of entry, deletion or Fax +49-(0) 69-2 11-11501change of events in the trading system). Yet a few more aspects are requiredin order to ensure midterm market surveillance, i.e. the encrypted information Internetfor each order/quote concerning the originating party placing the order (human deutsche-boerse.combeing) or ‘originator’ (machine). E-Mail social-media@However, where are the limits of this ‘big picture’ solution? All markets em- deutsche-boerse.combracing all OTC-transactions? If fragmentation really jeopardized market sur-veillance, would you allow the heretical thought that the provision of one Eu-ropean order book is the better solution?The technical implementation of a central market surveillance system wouldall the more be reduced to the lowest common denominator as far as the con-sistency, granularity and design of the data is concerned. The trading systemcomprising the weakest basic supervisory parameters would thus steer cen-tralized market surveillance. Central supervisory requirements for data qualityin trading systems would be an option with the consequence that the opera-tors would be dependent on the technical and timely requirements for themonitoring in the case of updates of their systems. A central market surveil-lance system had to be adapted to the new requirements in the event of themodification of each trading system. Otherwise, a central surveillance systemcould not be ensured. The introduction of a new release of a trading systemmust be postponed - a nightmare scenario for all operators of exchanges andtrading platforms.Additionally a centralized solution would incur high expenses. Independent ofthe huge memory capacity, complex adapters are required in order to read alldata and to reproduce the individual market models. In this process, thefragmentation of the ‘actors’ (lacking distinctive identification of entities underadministrative and private law) is not resolved.
  3. 3. Prior to toy with the universe of all trading data the outcome of this processshould be initially scrutinized very precisely as to which result is actually en-visaged.‘Single oversight’ – the question is: ‘About what?’ Gaining insight depends on Deutsche Börse AGan adequate set of questions and not the central availability of data. Media RelationsLet’s examine the thesis which criteria ‘modern’ fast trading is subject to in Mergenthalerallee 61order to be centrally supervised in an adequate manner. 65760 EschbornThe speed of trading is ‘merely’ a technical challenge for the present systems Postanschrift 60485 Frankfurt am Mainas far as monitoring is concerned. All incidents of the trading systems are alsorequired to be displayed and reconstructed in surveillance systems. Telefon +49-(0) 69-2 11-17854Automated trading has undoubtedly changed the market. The daily volatility Faxmay increase on the market and the response time to price-relevant incidents +49-(0) 69-2 11-11501may decline respectively. In case volatility is to be confined for regulative rea- Internetsons, market models may be analysed and amended by European-wide provi- deutsche-boerse.comsions (e.g. micro-auction trading). Certainly this has nothing to do with trad-ing surveillance, but with market structure. E-Mail social-media@ deutsche-boerse.comThe basic principle of trading surveillance is the coherence of cause and effectas far as trading is concerned. In this context, the trading activities are to becollected in a manner that the specified components (actors) are preferablyavailable in close intervals for the individual markets in a standardized form.These issues are to be dealt with prior to an approach to European-wide cen-tral surveillance:  Development of standardized specifications (functionally/technically) that enable typified surveillance inquiries/replies (remote, but auto- mated cross-market surveillance).  Mandatory electronic identification of the originating party of the order (human being, computer, strategy) per order/quote without disclosing individual-related data. This should apply for entities under adminis- trative and private law (introduction of LEI).  As far as automated trading strategies are concerned, algorithms, their history and effect on the market are to be identifiable also in retro- spect.  Analysis methods that should uncover abusive trading scenarios are subject to regulatory standardization/harmonization.
  4. 4. It’s about time that market surveillance embraces the interdependence of in-ternational markets and products. However, to assume that new insight maybe gained on account of fragmented data (and markets) in ‘lumping everythingtogether’ is incorrect and economically unjustifiable. An ‘one-pot dish’ may bewaived insofar as the surveillance systems are connected in the same way as Deutsche Börse AGthe market places that are subject to monitoring. Media Relations©2012 Michael Zollweg, Carl-Frederik Scharffenorth Mergenthalerallee 61 65760 Eschborn Postanschrift 60485 Frankfurt am Main Telefon +49-(0) 69-2 11-17854 Fax +49-(0) 69-2 11-11501 Internet deutsche-boerse.com E-Mail social-media@ deutsche-boerse.com

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