The Weak Link in Surveillance: Validating Models for Effective Detection
Recently 2024, the FCA issued Market Watch 79 – Market Abuse Surveillance And Data Governance, Surveillance Failures And Model Testing Peer Review.
This FCA Market Watch is a wake-up call for firms! It exposes real-world issues with surveillance systems through three cautionary tales. The bottom line? Firms must build and regularly validate their surveillance models to ensure they function in the correct manner to surface the desired risk. After all, we’ve all wondered during surveillance: “Are we truly capturing everything we need?” This Market Watch shows why that question matters more than ever. For instance, the FCA found:
- Data issues: Firms may not be capturing all relevant trade and order data, or the data may be inaccurate or incomplete.
- Alert logic flaws: Alert scenarios and thresholds may not be designed or implemented correctly, leading to missed suspicious activity.
- Testing shortcomings: Firms may not be testing their surveillance models frequently or thoroughly enough to identify and remediate problems consistent with a robust model governance framework.
The FCA also detailed a peer review they conducted on how investment banks test their client order front-running models. They found that while most firms have some form of testing in place, there is room for improvement in areas like:
- Frequency of testing: Some firms only test annually, while a risk-based approach with more frequent testing for higher-risk scenarios might be more effective.
- Scope of testing: Testing should encompass not just parameter calibration but also model logic, coding, and data integrity.
- Governance: Firms should have clear and formal governance procedures around model testing.
The FCA concludes by recommending steps firms can take to improve their market abuse surveillance, including:
- Implementing strong data governance practices to ensure all relevant data is captured accurately.
- Enhancing model testing procedures with a focus on comprehensiveness and frequency.
- Streamlining governance processes to avoid unnecessary delays in implementing or modifying surveillance models.
- Proactively considering the risks associated with future innovations in surveillance technology.
The FCA Market Watch is crucial because it highlights compliance issues and regulatory guardrails, serving as a key resource for firms to understand and bolster their surveillance protocols. By highlighting areas of vulnerability and sharing best practices, FCA Market Watch helps firms to improve their compliance roadmap to meet and exceed regulatory standards effectively.
At StarCompliance we work with clients to configure solutions, monitor performance and assist clients with model validation testing. Examples of testing may include but are not limited to:
- Employee population correctly identified;
- Trade files correctly identified and incorporated;
- Employee brokerage accounts correctly received and coded;
- Employee holding periods working as planned;
- Watch / Restricted List Surveillance working as planned;
- Date configurations working as planned;
- De-minimis surveillance thresholds working as planned; and
- Personal Trading Activity is correctly evaluated against a defined set of Policy Driven Workflows including against Firm Trade Data.
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