In an exclusive Risk.net panel session, convened in collaboration with Droit, experts discussed the evolving challenges and opportunities resulting from tighter regulations, and tips for building a future-proof real-time trade control framework
Trade controls are an area of major concern for regulators worldwide. Scrutiny over trading controls at financial institutions has mushroomed, and the trend is only set to continue.
The US Federal Reserve has been working closely with the Options Clearing Corporation and the UK Prudential Regulation Authority (PRA) to monitor controls for the past few years. The PRA is now particularly focused on preventive and detective controls, evidenced through high-profile regulatory statements such as PRA SS5/21, first issued in July 2021.
Blythe Barber, Droit
“Previously, firms would be fined based on the failings of an audit result. Today firms must have the ability to prove and demonstrate on an ongoing basis that they have sufficient preventive controls in place as part of the audit process,” said Blythe Barber, head of business development – Americas, at Droit, speaking on the panel.
Regulators are becoming more sophisticated, he added. “They understand the data, they’ve hired data scientists, have deep industry experience, they are running industry sandbox exercises, and now have a handle on investigating the data.”
Taking real-time decisions is essential, and financial institutions must be able to act with confidence, even when trading is high volume, low latency, cross-asset or cross-product.
On the Risk.net panel, experts discussed the importance of real-time controls for making fast, unequivocal ‘ready-to-trade’ decisions, and how policy automation and full auditability can bring greater transparency to decision-making, with increased operational efficiency and a repeatable, defendable process.
Here are the key themes that emerged from the discussion:
Fortify the regulatory compliance framework
Financial institutions worldwide face immediate and long-term challenges as they evolve the best solutions for trading controls to meet expected regulatory standards.
Regulatory mandates can be swift and issued at short notice. The US Commodity Futures Trading Commission’s rewrite of swaps reporting rules was one such upcoming regulatory change to global trade reporting regimes noted by the panel. The deadline for financial institutions to comply was extended from May 25 to December 5 this year.
There are similar challenges surrounding regulations on trader mandates and expectations on ‘hard blocks’ versus ‘soft blocks’. The PRA‘s SS5/21 sets out that controls should include both, but the interpretation of what constitutes a soft block varies among firms. In addition, there may not be clarity around how a firm controls this environment and proves to a regulator what they may be solving for.
“When you don’t have the infrastructure to support a quick change, it becomes a giant project. How do you get around to driving a huge project every time there’s a new regulation?” a panelist asked.
Another regulatory compliance challenge facing financial institutions – especially those with a global footprint and cross-border trading operations – is the lack of standardization across regions. This means controls should be dynamic, not just built for the regulations that are in place today, but capable of adapting to new requirements.
“It is essential to be able to pivot to new regulation,” said Barber, “and banks should assume every regulation will eventually become global when building control frameworks.”
For instance, regulatory legal frameworks, such as the European Union’s Markets in Financial Instruments Directive (Mifid) have an impact on a firm’s global operations, and therefore firms should not solve for Mifid for their EU operations only.
Manage pre- and post-trade as a single flow
Setting up a single technology team within the firm to handle client and regulatory technology, and managing pre-trade and post-trade as a single flow, is a valuable best practice, according to the panel.
“I’m really focused on pre-trade all the way through [post-trade] as a flow without having disparate technology teams driving this,” a panellist said.
Building clean client and security reference data is vital not only for internal compliance but also when utilizing vendor technology platforms. No data should be thrown away, and it is essential to have a real-time trade capture engine that is agile and enables firms to stay a step ahead of regulatory mandates.
It is also important to move reporting eligibility earlier in the technology stack, as this eases post-trade operations and separate eligibility rules written on the source systems.
“There are a multitude of data sources, various products and system complexities, with decisions being made at various points of the trade lifecycle. The higher up the stack you can do your eligibility in a standardized manner front-to-back, the more the downstream operationalization reduces,” said Barber.
Data depository best practices
The technological demands for storage, audit and creating central data depositories cannot be underestimated. Panellists advised bringing data together and institutionalizing it before distributing it on a proper application programming interface.
Having a central data depository, standardizing taxonomies and maintaining a clean repository is essential for client analytics, risk analysis and regulatory reporting.
Increasingly, a key component of efficiently managing trading controls is achieving the right balance of preventive and detective controls.
Automating preventive and detective controls, through next-generation technology platforms that can store all information and data in one place and maintain an audit record, can aid compliance and save time.
Together, these are compelling reasons for financial institutions to focus more on the use of technology through the trade lifecycle and promote corrective action and remediation.
Open-source approach
There is no doubt that financial and time-related costs make it impossible for financial institutions to launch new technology every year to solve for each new regulation.
Panellists believe the build-buy and open-source approach can help firms to meet regulatory and compliance demands faster. They posed some critical questions to consider when making these decisions: What do you need to deliver and who does it best? What capabilities can I buy that are best in class? And how can this be integrated with open source?
“There is an increasing desire across the industry towards making [platforms] modular, providing optionality to implement best-in-breed vendors and getting control around the estate is the way forward,” said Barber.
An important aspect of the build-buy open-source approach is breaking silos and encouraging collaboration among departments by combining functions such as regulatory transformation, compliance, operations and technology teams to work together.
“My approach is how are we doing this for compliance and how can we leverage that compliance engine to solve not just for the regulation, trade supervision piece and e-communication piece, but also for clients,” a panellist said.
Innovative technology-led platforms can drive intelligent decision-making in an ever-complex, rule-driven landscape and provide solutions for pre-trade and post-trade controls, evaluating the permissibility of transactions, compliant regulatory reporting and beyond.
In summary
As firms build and strengthen future-proof real-time trade control frameworks, it is essential to operate with a global mindset and assume regulations will impact everyone.
Enhancing preventive and detective controls across the full trade lifecycle is also becoming crucial. Employing mission-critical breakthrough technology is then vital to get ahead and arm for global regulatory compliance and next-level trade controls.
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