white paper on trader surveillance

1. Trader Surveillance – thoughts for the future and
some historical perspective – fintech*attitude for
open surveillability.
It is interesting to me that, when we read both EY's¹ and the BoE FEMR
report², it is almost like a Tale of Two Cities. Surveillance is all about
preventing crime, or identifying criminal activity – right?
The first, an auditor's perspective, talks of financial crime: including
trader surveillance, anti-fraud and AML. It continues to list capabilities
such as forensic data analysis, monitoring & supervision, eDiscovery, IT
forensics, information governance and legal IT. It is largely a reactive or
defensive approach assuming pending litigation and that the firm is, and
its traders are, under investigation. This is certainly one reality, but I
suggest it is certainly not the #1 reality.
The second takes an organisational strategy approach, which therefore
creates an opportunity for competitive advantage Why? Because it
means any trading operation has a clear opportunity to be best-of-breed
(e.g. utilities) or simply best-of-show (e.g. CTRM) at pre- and post-trade
transparency.
Trader surveillance is, in fact, as old as trading itself. Having started
trading in 1987, I was actively involved in audit processes by end 1988.
This was of course both internal and external processes. Since I was
involved in assessing portfolios outside my trading area it was not
difficult to divine someone else was checking my 'book' too. Silently. For
all the right reasons, not perjoratively.
And so the Fair and Effective Markets Review dives into FICC Market
Standards Board a need for industry to lead a stronger collective
process and called for: senior leadership of FICC market participants to
create a new FICC Market Standards Board (with participation from a broad
cross-section of global and domestic firms and end-users at the most senior
levels, and involving regular dialogue with authorities), and draws especial
attention to Accountability Regimes (e.g. SM&CR).
As a builder of an embedded OTC derivative business at a large physical
trader, one had to ensure the confidence of senior management (SM) –
meaning the executive suite – who after all, had the ability to help grow
the business or slow it down if they were not comfortable the team was
highly effective and responsible, enabling SM to discharge their
responsibilities efficiently and effectively. By taking an important role to
allow SM to query activity for potential flags (risks) and therefore provide
solutions to emerging vulnerabilities – driven out of our STP CTRM
system, which we designed and built – we also gave ourselves the
chance to be a major contributor to the “flag & solution process”. In
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2. time, we earned the respect we deserved for being both pro-active and
highly communicative.
The key enabler was fintech – but our attitude towards being openly
surveillable was the critical success factor – our #1 reality. Even in 2000
it was all about fintech. Fintech that codified our ethics, written in
individual RRRO's (roles, responsibilities, rights and obligations),
published and agreed at the team level. These became actionable,
reviewable and rewardable – and, perhaps most importantly – reportable.
To our senior management, clients and the regulator. We enabled senior
management reporting to our shareholders and clients, as well as our
bankers. We consolidated regulatory reporting, check-and-balance.
We were given exceptional opportunities to represent the company
publicly in industry forums (e.g. World Bank) and present next-
generation ideas for regulatory developments to the regulator (CFTC). It
became part of our differentiation strategy and value driver for the
business.
Team buy-in was driven by: growing the business depends on
observable good behaviour, which will be rewarded. In simple English,
“one should visit the principal often, and never be sent for”.
The fintech obviously carried out $P&L performance, and attribution. We
generated reports for volumes transacted, curve shift and all the $Greeks
(i.e. moneyness, not just numbers). We generated Flash $P&L by trader
daily “on-the-close”, but we were able to do it instantaneously, on-
demand. We tracked $P&L for (1) existing open, (2) today's portfolio
management and client transactions, and (3) prospective client
transactions. We posted client views of their portfolio on a secure
website. We could see they had received and downloaded them – per our
D&D (disclosure & disclaimer) agreements, their execution by the client
was part of our AOS, KYC and ISDA margining agreements. Each weeks
activity had to be signed off by client senior management, daily by the
clients back office – not the “trader”. Internally, each and every trader
had to input transactions as completed, none could go home until flash
$P&L was completed and it carried a 30 minute deadline to market close.
All pretty much standard today – some were innovative in 2000.
Philosophically then, we can extract some core principles:
• we know we will be surveilled – so let's make it easy
• conduct rigorous scenario analysis – of self and others
• conduct rigorous scenario analysis of clients for sales team
• impose team-designed checks and balances e.g. breakevens
• be anticipatory and predictive – prospective transaction analysis
• predict capacity problems and resolutions (e.g. restructuring)
• devise “quick-view metrics” - for example the cumulative backward
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3. roll³ – enabling oversight and facilitating questioning by senior
management.
• Compound sign off - “boss” received top sheet signed by
deskhead, attached below individual trader signoff and ops
manager check also signed. Boss initialled and returned a copy to
us.
Innovative controls:
• Variance analysis of Flash $P&L to Actual – volumes and money.
• Variance analysis of “New today” to yesterdays “Prospective”
transactions
• Trader, and desk, risk limits were more detailed, rigorous and
proscriptive than those required by the overall business.
• All re-structurings to be priced in separate geographies
• Trackability of $P&L attribution meant could monitor and report
small transacted volumes with exceptionally large margins, large
transactions with zero or negative margins, etc.
• Once a trader booked a deal to STP, control was lost electronically.
It had to be released back to “trader status” for any modification,
creating a recorded loop of mistakes, errors etc, trader input errors
were zeroed by an equal offset and then re-entered, an auditable
trail.
IN SHORT – desk reporting-tools + trader-designed controls both
supplemented any other surveillance being carried out.
We assigned a part of compensation pool to be peer-reviewed and GRC-
reviewed, taking from under-performers and rewarding innovators and
consistent quality providers.
Personally, I expected that trader surveillance must acknowledge and
reward good behaviour as enthusiastically as it deducts for poor
conduct.
Winning friends and influencing people:
Senior management's job was supported from the desk and GRC, we
were a team player. Our communicative competence was high and
immediate. We were easy to check – both in terms of own and client
activity.
GRC's job was supported from the desk. We provided checks and
balances on everything up to and including available credit capacity or
margin amounts owed/due.
Surveillance is all about preventing crime, or identifying criminal
activity? – wrong. It is all about building excellence for a scalable and
tractable business model.
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4. Great surveillance sets a higher bar for competitors and gains client
loyalty.
To build a surveillance-enabled business is the goal. That requires
confidence building within GRC, with senior management and on the
trading floor.
¹
http://www.ey.com/Publication/vwLUAssets/ey-trader-surveillance-
report/$FILE/EY%20Trader%20Surveillance%20report.pdf
²
https://www.bankofengland.co.uk/-/media/boe/files/report/2018/fair-and-
effective-markets-review-progress-report.pdf?
la=en&hash=E3F55D5C0600F927F1E767EAA818C4E571E72FD9
³
Always operating in t+1 derivative world, capable of t+x, we summed
positions backwards as NPV cashflows and graphed them to show (1)
duration, (2) difference from a week ago, and (3) a day ago. A picture tells
more than 1,000 words.
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