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Trade Surveillance Services

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The world of trading, and in particular, energy and commodities trading has undergone a dramatic transformation over the last few years. Most notable is the shift to over-the counter trading, …

The world of trading, and in particular, energy and commodities trading has undergone a dramatic transformation over the last few years. Most notable is the shift to over-the counter trading, introducing quick, efficient and low-cost trading.

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  • 1. GLOBAL SERVICES Business & technology consulting and managed servicesTrade Surveillance as a Serviceby Phil Hendersonmanager, consulting, SunGard Global ServicesCost-effective transaction monitoringThe world of trading, and in particular, energy and commodities trading has undergone a dramatictransformation over the last few years. Most notable is the shift to over-the counter trading, introducingquick, efficient and low-cost trading. However, as a by-product of this “brave new world”, individuals andorganizations have taken advantage of these new arbitrage opportunities to profit through marketmanipulation. Current events are rife with examples of individuals and organizations who took advantageof these opportunities. A couple of examples include: 2011, a large investment bank lost $2 billion through the activities of one trader In who managed exchange traded funds and Delta One derivatives. Delta One derivatives closely track the underlying securities and give the holder an easy way to gain exposure to several asset classes such as equity swaps, forwards, futures and exchange traded funds. This bank lost almost 11% of its market value the next day. 2010, the trading arm of a large multinational agricultural products company was In fined $12 million by the CFTC for causing a non-bona fide price to be reported. The company wanted to be the first to buy a crude future at $100 per barrel although there were offers to sell at a much less price. In addition, it engaged in buying activity that increased the price to reach that desired $100 price. 2010, a large integrated financial institution was fined $10 million by the CFTC In for concealing a significant block trade violating a CFTC mandate that block trades must be reported five minutes after executing.In recent news, Fox News reported that President Barack Obama has proposed a plan to regulate crudemarkets to address the rising cost of gasoline. This plan has a price tag of $52 million and will attempt toprovide more visibility into trading activities and will require additional measures to ensure compliance.These and other examples are causing regulatory agencies such as the CFTC and the SEC to becomemore aggressive in mitigating activity that can undermine confidence in the markets, placing additionalresponsibility on today’s compliance teams as evidenced by the continuum below in Figure 1.As a result, new expectations for proactive tradesurveillance are gaining increased attention, Best practiceespecially as companies seek to eliminate breaches Meeting new standards – pattern shifts / summary analysisof internal controls and policies as well as provideevidence to regulators of lawful trading activities.Most compliance departments believe that looking Out of character or anomalousat intraday or end of day activities is adequate trade activityenough in trying to identify suspicious tradebehavior. However, dramatic trading activities, such Statutoryas in the case of the investment bank discussed obligations Must haveabove, were the result of activities happening over Regulatory expectationsa period of time. Similar to a frog in a pot of water;as the heat grows, when one realizes finally what is Figure 1 - Changinghappening, it is too late. regulatory requirements
  • 2. Trader WeekBest practice approach: Compliance departments have to $90,000 Net spend $80,000look at trading activity over time as well as current intraday Trader A $70,000and end of day strategies. $60,000Suppose a compliance department had the ability to observe net $0 Net spend Trader Bspend across all assets for each trader or portfolio over the past 6 to ($5,000)12 months. This data could be aggregated on a weekly, daily or evenmonthly basis. This allows the compliance professional to identify $40,000 Net spend $20,000baseline trading behaviors for a particular trader or portfolio. Recent Trader C $0trade data, as it is settled, can be layered into the baseline data. This ($20,000)will allow the compliance professional, along with the use of some Wk1 Wk2 Wk3 Wk4 Wk5 Wk6 Wk7 Wk8 Wk9 Wk10 Wk11 Wk12 Wk13 Wk14 Wk15 Wk16 Wk17 Wk18 Wk19 Wk20 Wk21 Wk22 Wk23 Wk24 Wk25 Wk26 Wk27 Wk28 Wk29 Wk30 Wk31 Wk32 Wk33 Wk34 Wk35simple statistical reference bands, to identify interesting shifts and Figure 2 - Trader net spend analysisfluctuations from normal behavior.Let’s look at the following example opposite:The three graphs in Figure 2 outline the spend analysis for threedifferent traders over a 36 week period. Trader A’s net spend profile $$$fits within normal boundaries which is denoted by the green band. 3rd Party packageTrader B has an interesting spike that took place in the early part ofweek 2 and week 3. Trader C displays an increased ramp in spending Expensebeginning in week 25 and week 26 and breaks out of normal bounds Hybrid / Customin week 33. Although the magnitude of spend is different for the Trade audit /three trades, the normal boundaries self-adjust for each trader’s Serveillance servicehistoric profile. Self-adjusting boundaries are necessary in order to Status quoavoid manually adjusting for each trader or for other key $characteristics such as trading location or counterparty. Analysis such Surveillance: Capability / Flexibilityas the above can uncover gradual behavior (technically under the Figure 3 - Surveillance solution optionsradar of daily and intraday analysis), as well as can point to largermacro behaviors in a trading organization. A mature monitoring andsurveillance solution must be able to take both types of scenariosinto account.While these next generation monitoring and surveillance solutions are SURVEILLANCE STUDIESimportant, implementing them in an innovative and cost-effective wayhas turned out to be difficult for many compliance departments. They NON ECONOMIC ACTIVITY Buy / Sell review (cross/wash)are often limited to software not quite flexible to support the proper Activity ratio analysisrange of asset classes in the space, or customized systems that can PATTERN SHIFT Trade frequency analysistake significant time and cost to design, implement and maintain. Volumetric behaviour analysisWhat is required is a robust set of trade surveillance studies, appliedto an extract of trade transactions (historical and current) specific to a Intra-day volumetric spikestrading organization, including physical and financial commodities, Percent of market volume analysisequities and fixed-income asset classes. Cumulative net spend reviewAs indicated in the continuum in Figure 3, a Trade Audit/Surveillance PRICE EVENT Buy / Sell open / close analysisService model provides both detailed and summary level reports that Percent off firm reviewidentify hot spots and specific events that require additional review.This approach provides evidence of electronic trade surveillance Price outlier by assetwhich is strongly recommended by regulatory agencies. OPERATIONAL EVENT Front runningUnderstanding where potential trouble spots exist is essential for Broker revieweffective trade monitoring and surveillance. Knowing high risk Counterparty reviewtraders, assets and time frames that may coincide with externalevents, provide a wide range of coverage for the compliance team. Deal change reviewDetailed reports can then provide specific characteristics of trade EXTERNAL EVENT External market reviewbehavior for respective events. Figure 4 - Surveillance studiesTrade Audit/Surveillance Service solutions leverage the fact that mosttrade behaviors of interest leave a distinctive footprint or signaturewithin the trade transactions. These include single transactions ofinterest as well as events that are aggregate in nature involvingmultiple trades. Major categories focus on price, volume, pattern shiftsand non-economic activity, as well as address internal controls. Thetable in Figure 4 outlines some of these studies.
  • 3. Looking at each category in turn: on-Economic Activity. These daily N perational Event. These studies O Baseline studies try to identify potential support the examination of data to (3-12 Months of Trade Transactions) activity that could be the indication ensure certain internal trading ✓ Historic review ✓ Proven studies of day trading or zero-net trading behavior policies are being met. ✓ Immediate insight ✓ Prioritize efforts Periodic Periodic Periodic refresh refresh refresh (e.g. wash trades). Assurances that improper ✓ Mitigate risk one two three communication between desks is Pattern Shift. Taking historical trade Internal review Optional – Periodic refresh not occurring or that certain data of 6-12 months, these studies Refresh one business is not concentrated on Refresh two identify changes in historical Refresh three one broker or counterparty are trading patterns for a portfolio, important for some compliance desk or trader. organizations. rice Event. These studies examine P External Events. These studies look pricing behavior for trades that may Figure 5 - Typical surveillance at price shifts in the market that be executed close to the opening as a service engagement support potential external events. or close of the market or prices that They are helpful for making sense are away from the average prices of the results of the previous entered for similar transactions categories of studies. within that particular organization.Typically, as outlined in Figure 5, an initial review is performed by the serviceprovider which will take historical data and establish a baseline of trading behavior.This will usually 1) help prioritize what trading activities to examine 2) provide ahistorical view of trading which introduces very interesting initial insights and3) begin an understanding of the nature of the standard studies mentioned inFigure 4 or develop additional studies as the organization identifies them.Surveillance service models provide the following value to energy and commoditytrading organizations: aintain a proactive posture with M dentification of prioritized areas I regulators. Trade Audit Surveillance that necessitate additional review. services support the development of Trade Audit Surveillance Services key reports that can be leveraged to quickly identify the targeted areas identify potential areas to self-report that should be investigated by and can be used as collateral with compliance departments. This allows regulators during an audit. for prioritization of resources and the investigating of key transactions that n-depth analysis with no investment I may be of interest to the compliance in systems, tools, training or staff. To professional. capture historical data and provide PHIL HENDERSON the necessary analysis of that data Customized reports. Not all may require the expenditures toward compliance organizations want to see Phil Henderson is a manager a data warehouse or third-party the same thing. Taking the standard with SunGard Global solution. With trade surveillance set of reports and studies as Consulting Services. He is services, compliance organizations are templates, compliance organizations experienced in delivering able to leverage the set of studies can customize the parameters of the business intelligence and against their data to find interesting study for their specific needs. In compliance solutions for events to act on. The only investment addition, additional studies can be energy trading clients as a is to provide a one-time historical set identified that may be of interest to senior business and quality of data and periodic trade data that organization specifically. assurance analyst. Phil is (usually at a monthly level). well-versed in Front-Office and Mid-Office processes related to energy tradingFinding the right resources and budget to support proactive trade surveillance can and risk management. Philbe challenging. The Trade Audit/Surveillance Service solution approach allows an has participated in all facetsorganization to immediately improve posture with regulators through greater of the software developmenttransparency while mitigating the risk associated with undesirable trade practices lifecycle from requirementsfrom both a short-term and long-term perspective. The services approach can development to solutionquickly and efficiently provide organizations with prioritized insight and visibility support for both Fortune 500into areas that necessitate compliance review. and start-up companies.
  • 4. About SunGard Global Consulting ServicesSunGard Global Consulting Services helps financial services and energy companiessolve business problems by managing their complex technology and operationalneeds. Focused on large scale data and process management, custom applicationdevelopment and systems integration; we combine business and technologyconsulting and managed services to deliver innovative custom solutions. We helpour customers capitalize on and manage the consequences of business, technologyand regulatory change.For more information, visit www.sungard.com/globalservices/learnmoreAbout SunGardSunGard is one of the world’s leading software and technology services companies.SunGard has more than 17,000 employees and serves approximately 25,000customers in more than 70 countries. SunGard provides software and processingsolutions for financial services, education and the public sector. SunGard alsoprovides disaster recovery services, managed IT services, information availabilityconsulting services and business continuity management software. With annualrevenue of about $4.5 billion, SunGard is the largest privately held software andservices company and was ranked 434 on the Fortune 500 in 2011. Look for uswherever the mission is critical.For more information, visit www.sungard.com For more information, please visit: www.sungard.com/globalservices/learnmore©2012 SunGard.Trademark Information: SunGard, the SunGard logo and Global Services are trademarks or registered trademarksof SunGard or its subsidiaries in the U.S. and other countries. All other trade names are trademarks or registeredtrademarks of their respective holders.

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