Granularity in Market Abuse Risk Assessment

Introduction

I recently spoke with a multinational bank's Chief Compliance Officer (CCO). His organization is involved in a wide range of financial instruments across various jurisdictions and has improved its monitoring of market abuse risks by adopting a detailed approach to the annual Market Abuse Risk Assessment (MARA) process. In the past, they operated an enterprise-level MARA, but over the years, they increasingly focused on a more detailed assessment of business units.

Their current process is structured around specific regions, desks, and products. According to the CCO, compliance has improved its ability to assess inherent risks and evaluate the effectiveness of controls designed to mitigate those risks better than ever before. They also enhanced their surveillance capabilities by implementing an advanced dealing inventory that captured data sources for trading and communication surveillance. I covered the topic of constructing an advanced dealing inventory in another article. As a result of this streamlined operation, the organization now feels they have better compliance across various jurisdictions.

As a result of these efforts, the bank enhanced its risk detection capabilities and strengthened its relationship with regulators by demonstrating a proactive approach to compliance. I am sharing my thoughts on the significance of conducting a detailed Market Abuse Risk Assessment (MARA) while also considering its constraints.

The Imperative of Granularity in Risk Assessment

Understanding Granularity

Granularity refers to the level of detail and specificity in analysing business activity. In market abuse risk assessments, a granular approach involves dissecting risks at the level of individual products, trading desks, and even trading strategies rather than relying on broad, enterprise-level assessments.

Regulatory Mandates and Expectations

Global regulatory bodies, including the European Securities and Markets Authority (ESMA) under the Market Abuse Regulation (MAR) and the U.S. Securities and Exchange Commission (SEC) under Section 10 of the Securities Exchange Act of 1934, emphasise the importance for firms to establish effective systems and controls to identify and prevent market abuse. These regulations require firms to:

• Conduct Comprehensive Risk Assessments: Understanding and documenting risks specific to their operations.

• Implement Appropriate Controls: Tailoring surveillance and compliance measures to identify risks.

• Ensure Ongoing Monitoring and Reporting: Maintain vigilance over market activities and promptly report suspicious behaviours.

  
  

Benefits of a Granular Approach

Tailored Risk Identification

By thoroughly examining risks, firms can identify unique vulnerabilities associated with specific products or trading strategies. For instance, complex derivatives may pose different market abuse risks compared to equities. Additionally, the likelihood of spoofing can vary by region, influenced by geopolitical events. This variation is evident in recent trends, such as the increased trade volumes observed in the Japanese Bond Market. Furthermore, risks can differ from desk to desk, depending on each desk's trading mandates and whether they deal with market-moving volumes or less liquid assets.

Effective Control Implementation

Targeted surveillance enables the design of monitoring systems that concentrate on high-risk areas. By focusing resources in these critical zones, organisations can ensure compliance and allocate resources where they are most needed, ultimately optimising operational costs.

Regulatory Compliance and Reputation Management

A detailed approach to demonstrating due diligence shows regulators that the firm is both proactive and diligent, which can potentially reduce penalties in the event of any breaches. This commitment to thoroughness also enhances the firm's reputation among clients and stakeholders, showcasing a strong dedication to market integrity.

Proactive Risk Mitigation

Early detection plays a crucial role in ensuring safety, as detailed analysis enables the early identification of unusual patterns or behaviours, allowing for prompt intervention. This allows surveillance teams to adapt more easily to changes, as they will have better visibility on where risks have shifted year-on-year by comparing the differences between their annual MARAs and business units.

Challenges in Achieving Granularity

Data Management Complexity

Managing large amounts of data across various products, markets, and jurisdictions presents inherent complexities. Ensuring data accuracy, completeness, and consistency is crucial to overcoming these challenges, yet it remains a difficult task.

Resource Intensiveness

An organisation requires skilled personnel with expertise in data analysis, regulatory compliance, and financial products to effectively manage operations. Additionally, investing in advanced IT systems that can handle complex analytics is essential, ensuring that the technological infrastructure supports the organisation's objectives.

Incompatibility with Legacy MARA Processes

Many firms today struggle with legacy spreadsheet-based MARA processes, which make it complicated, if not impossible, to conduct a granular MARA and capture vital information. As a result, compliance teams are increasingly in need of improving their operational efficiency and keeping track of the evolving complexities of the global trading landscape.

Regulatory Reporting Requirements

Meeting diverse reporting standards can create a significant compliance burden, as it often strains resources. This challenge becomes even more pronounced when organisations must simultaneously manage requirements from multiple regulators. Regulators are only interested in reviewing risks and controls applicable to their specific jurisdictions. Therefore, they may view an enterprise-level MARA as insufficient.

Striking the Right Balance: Solutions and Best Practices

Leveraging Technology and RegTech Solutions

Organisations should leverage advanced analytics, such as machine learning and AI, to enhance efficiency in processing and analysing large datasets. Additionally, implementing integrated compliance platforms that consolidate data from various sources can significantly improve visibility and control over the data.

Adopting a Risk-Based Approach

To ensure effective use of resources, it is essential to concentrate on high-risk areas. Adjusting the depth of analysis according to the level of risk is also important; this allows for a tailored approach that minimises unnecessary complexity in low-risk areas. By prioritising in this way, we can allocate resources more efficiently and focus our efforts where they are most needed.

Cross-Functional Collaboration

To enhance risk understanding and management, collaboration among compliance, IT, legal, and business units is essential. By fostering interdepartmental synergy, these teams can work together more effectively. Additionally, a culture of compliance can be cultivated through regular training and open communication, ensuring that all employees know their roles and responsibilities in maintaining compliance.

Continuous Improvement and Adaptation

It is essential to schedule assessments regularly to update risk profiles and controls and to implement systems to capture lessons learned and best practices. Both of these directly impact the overall effectiveness of these processes.

Engaging with Regulators and Industry Peers

Maintaining open communication with regulators is crucial for staying informed about expectations and regulatory changes. Additionally, actively participating in industry forums allows for the exchange of insights and strategies, fostering collaboration and a better understanding of the landscape.

Conclusion

Embracing granularity in market abuse risk assessments is gradually shifting from being a "good to have" to a "must-have" approach. While the challenges are significant, they can be overcome with strategic investments in technology, a risk-based approach, and a strong compliance culture. By striking the right balance between detail and manageability, financial institutions can enhance their compliance programs, protect their reputations, and contribute to the integrity and resilience of financial markets.