Trade Surveillance: Watching you watching me

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“Technological innovation is no longer a choice: it is an imperative.” So said Scott O’Malia, Commissioner of the Commodity Futures Trading Commission, about trade surveillance during his keynote address at the recent SAS-sponsored New Risk in Energy 2014 conference in Houston.

He was attempting, as he has before, to spur his agency into spending more of its newly expanded budget on trade surveillance technology. But his talk serves equally as a wake-up call for the industry.

“It almost goes without saying that derivatives markets are becoming increasingly complex in the new post-Dodd-Frank era, as more and more transactions move to exchanges and clearinghouses, and market participants are trying to respond to new regulatory demands,” O’Malia said.

“Only real-time market surveillance will allow the commission to oversee these highly sophisticated and automated markets. For example, order messaging analytics could look for data that may indicate potential market disruptions like the Flash Crash, trader collusion, rogue trading or manipulative algorithms.”

The commissioner’s exhortation that automated surveillance should be the foundation of the CFTC’s oversight and compliance program was only phase one of the agency’s message to the market at the Houston conference, a who’s who of the energy risk business organized by my former publisher at Scudder Publishing Group.

O’Malia’s call to action had opened the first day of the show, and day two began with Matthew Hunter, deputy director of CFTC’s Division of Market Oversight, demonstrating exactly what the agency can already derive from the tidal wave of data it now takes in under Dodd-Frank regulations. It was an impressive display.

Hunter’s animated visualizations of the market’s movements were a pulsating flow of data that he could easily scroll back and forth across time to show price and volume shifts during the trading day, then freeze to point out suspicious activity or show the impact of a known incident.

The demonstration made clear that if you aren’t able to generate the same level of insight into your own trading shop’s activities on a fairly real-time basis, you’ve got a regulatory risk problem on your hands. It’s a risk that will only grow when O’Malia gets his wish and the commission sinks more money into trade surveillance technology.

Together, O’Malia and Hunter spelled out the message that Dodd-Frank has changed the regulatory environment for the energy trading business. Public comments by O’Malia and Hunter only add weight to the hefty fines and trading prohibitions already levied against the market under the new compliance regime. The most repeatedly fined activity of late is uneconomic trading for the benefit of related positions. An example would be purposely taking a loss on physical trades in order to drive price in a direction that nets a greater profit on a financial position correlated or related to the physical hub.

Today there’s a bull’s eye on everyone’s back. If the regulators are watching you, then your people need to know, like it or not, that you are watching them. The implication isn’t that your staff is taking risky positions or trying to move the market. The simple fact is that many trades put on during the normal course of business might look suspicious to a regulator, so you need to find them first, ensure they don’t fall outside acceptable practices, and then either self-report problems or accurately capture the entirety of the trade data to defend the activity in an audit.

That’s the why. The how is an analytical method to handle the massive, rapid flow of data coming off the modern trading desk and capture it in a way that makes self-surveillance fast, easy and accurate. The goal is the ability to visualize the movement of the market as a whole, compare it to the established pattern of your trading business and understand the right questions to ask when questionable activity is revealed. All before the regulators come calling with the same data and the same questions.

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Ian Jones

Senior Strategist, Energy Risk Management

Ian Jones is Senior Strategist for SAS' energy commodity risk management practice. Prior to joining SAS in 2009, he served as editor of the industry trade journal The Risk Desk.

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