Capturing the rogue traders
05 Mar 2012
Investment banks having started monitoring social media sites in an attempt to sniff out potential rogue traders. Sites such as Facebook, Twitter and LinkedIn are increasingly being used as part of compliance tools to detect and prevent insider trading.
Nicolas Mallison, a director in Ernst and Young's fraud investigation and dispute practice, said: "When we conduct investigations of some fraud or insider investigation, often the key piece of evidence condemning a person is a message in an email, text, instant message or internet post. Our challenge is to figure out how to use those forms of communication in a proactive way, to prevent rogue trades from happening."
Ernst and Young, in conjunction with US security agency the Federal Bureau of Investigation and technology vendors, has developed a range of "know-your-trader" tools that help banks and other financial institutions to analyse the stresses their employees are under and form part of the broader fraud detection process. The firm has created a library of over 3,000 key words and phrases, including simple terms such as "destroy" or "I'm not comfortable", to detect stress levels.
Mallison said: "Traders are obviously always under a lot of pressure, so what we're looking for is changes or spikes in behaviour."
The evolution of anti-fraud tools comes amid growing pressure by regulators on insider trading, and a crackdown on market abuse is a consistent thread running through a raft of regulation currently being drafted in Brussels. Legislation includes the Markets in Financial Instruments Directive, the Market Abuse Directive and Regulation on Energy Market Integrity and Transparency, all of which seek to address market manipulation in one way or another.
Meanwhile, regulators such as the Financial Services Authority have dished out a record number of fines in recent years (see chart), with misdemeanours around market abuse and insider trading among the crackdown.
Tony Turner, a principal at the US-based IT firm Financial Tracking Technologies, said: "Regulators are being much more public and aggressive in combating insider trading. That is the main reason why financial institutions are looking to improve their anti-fraud software. The second reason is client demand - they want to know that appropriate risk and compliance controls are in place."
The issue hit the headlines again last month, when Threadneedle Asset Management said it had suffered a rogue trading incident last year. What was different in this case was that the asset manager's systems, based on predictive analytics, had managed to detect an impending rogue trade and averted disaster.
Surveillance systems have traditionally been based on the use of predictive or behavioural analysis software that uses historical data as the basis for future expected activity. If trading is in any way different from the norm, then alerts are sent to compliance officers.
While the use of a broader range of data, such as Twitter feeds, is designed to complement and enhance these systems, they are unlikely to solve the inherent problem many financial institutions have in operating siloed risk oversight, say analysts.
Breaking down silos
Frédéric Boulier, director of compliance for Emea at financial IT firm Nice Actimize, said: "Financial institutions are finding it hard to escape from their siloed approach to risk management. Paradoxically, regulation has by nature magnified this by encouraging the use of Chinese walls between different conflicted business areas, for example. A firm might have a trader in New York and one in London who individually take positions in a security which fall below a particular limit, but, when combined, exceed it."
The challenge, then, for banks, consultancies and analysts is to create solutions that sit on top of a bank's myriad compliance and risk systems and piece them together to create a holistic view. That process is becoming more important as trading continues to take place faster, and across different asset classes.
Richard Bentley, industry vice-president within risk monitoring IT firm Progress Software's banking and capital markets division, said: "Over the last three years, there has been a sea change in surveillance, monitoring and risk systems. We need to be able to look across a sequence of events that take place across different silos and correlate these over time."
However, these new types of surveillance systems will only be as good as those who operate them. Some experts have suggested that a trader's strong track record could contribute to lax oversight. A strict compliance culture is also required.
Mallison said: "Technology is only one piece of the puzzle. It is a misguided belief that firms can outsource their compliance to a black box. They need people with appropriate training and a strategy on risk that is communicated throughout the organisation."