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.

1. GLOBAL SERVICES
Business & technology consulting and managed services
Trade Surveillance as a Service
by Phil Henderson
manager, consulting, SunGard Global Services
Cost-effective transaction monitoring
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. However, as a by-product of this “brave new world”, individuals and
organizations have taken advantage of these new arbitrage opportunities to profit through market
manipulation. Current events are rife with examples of individuals and organizations who took advantage
of 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 crude
markets to address the rising cost of gasoline. This plan has a price tag of $52 million and will attempt to
provide 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 become
more aggressive in mitigating activity that can undermine confidence in the markets, placing additional
responsibility on today’s compliance teams as evidenced by the continuum below in Figure 1.
As a result, new expectations for proactive trade
surveillance are gaining increased attention, Best practice
especially as companies seek to eliminate breaches Meeting new standards – pattern
shifts / summary analysis
of internal controls and policies as well as provide
evidence to regulators of lawful trading activities.
Most compliance departments believe that looking Out of character or anomalous
at intraday or end of day activities is adequate trade activity
enough in trying to identify suspicious trade
behavior. However, dramatic trading activities, such Statutory
as in the case of the investment bank discussed obligations
Must have
above, were the result of activities happening over
Regulatory expectations
a period of time. Similar to a frog in a pot of water;
as the heat grows, when one realizes finally what is
Figure 1 - Changing
happening, it is too late.
regulatory requirements

2. Trader Week
Best practice approach: Compliance departments have to $90,000
Net spend
$80,000
look at trading activity over time as well as current intraday Trader A
$70,000
and end of day strategies. $60,000
Suppose a compliance department had the ability to observe net $0
Net spend
Trader B
spend 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 even
monthly basis. This allows the compliance professional to identify
$40,000
Net spend
$20,000
baseline trading behaviors for a particular trader or portfolio. Recent Trader C
$0
trade 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
Wk35
simple statistical reference bands, to identify interesting shifts and
Figure 2 - Trader net spend analysis
fluctuations from normal behavior.
Let’s look at the following example opposite:
The three graphs in Figure 2 outline the spend analysis for three
different 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 package
Trader B has an interesting spike that took place in the early part of
week 2 and week 3. Trader C displays an increased ramp in spending
Expense
beginning in week 25 and week 26 and breaks out of normal bounds Hybrid / Custom
in 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 service
historic profile. Self-adjusting boundaries are necessary in order to
Status quo
avoid manually adjusting for each trader or for other key $
characteristics such as trading location or counterparty. Analysis such Surveillance: Capability / Flexibility
as the above can uncover gradual behavior (technically under the
Figure 3 - Surveillance solution options
radar of daily and intraday analysis), as well as can point to larger
macro behaviors in a trading organization. A mature monitoring and
surveillance solution must be able to take both types of scenarios
into account.
While these next generation monitoring and surveillance solutions are
SURVEILLANCE STUDIES
important, implementing them in an innovative and cost-effective way
has 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 analysis
range of asset classes in the space, or customized systems that can
PATTERN SHIFT Trade frequency analysis
take significant time and cost to design, implement and maintain.
Volumetric behaviour analysis
What is required is a robust set of trade surveillance studies, applied
to an extract of trade transactions (historical and current) specific to a Intra-day volumetric spikes
trading organization, including physical and financial commodities, Percent of market volume analysis
equities and fixed-income asset classes.
Cumulative net spend review
As indicated in the continuum in Figure 3, a Trade Audit/Surveillance PRICE EVENT Buy / Sell open / close analysis
Service model provides both detailed and summary level reports that
Percent off firm review
identify hot spots and specific events that require additional review.
This approach provides evidence of electronic trade surveillance Price outlier by asset
which is strongly recommended by regulatory agencies. OPERATIONAL EVENT Front running
Understanding where potential trouble spots exist is essential for Broker review
effective trade monitoring and surveillance. Knowing high risk
Counterparty review
traders, assets and time frames that may coincide with external
events, provide a wide range of coverage for the compliance team. Deal change review
Detailed reports can then provide specific characteristics of trade EXTERNAL EVENT External market review
behavior for respective events.
Figure 4 - Surveillance studies
Trade Audit/Surveillance Service solutions leverage the fact that most
trade behaviors of interest leave a distinctive footprint or signature
within the trade transactions. These include single transactions of
interest as well as events that are aggregate in nature involving
multiple trades. Major categories focus on price, volume, pattern shifts
and non-economic activity, as well as address internal controls. The
table 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 service
provider 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 a
historical view of trading which introduces very interesting initial insights and
3) begin an understanding of the nature of the standard studies mentioned in
Figure 4 or develop additional studies as the organization identifies them.
Surveillance service models provide the following value to energy and commodity
trading 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 trading
Finding the right resources and budget to support proactive trade surveillance can and risk management. Phil
be challenging. The Trade Audit/Surveillance Service solution approach allows an has participated in all facets
organization to immediately improve posture with regulators through greater of the software development
transparency while mitigating the risk associated with undesirable trade practices lifecycle from requirements
from both a short-term and long-term perspective. The services approach can development to solution
quickly and efficiently provide organizations with prioritized insight and visibility support for both Fortune 500
into areas that necessitate compliance review. and start-up companies.

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