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FX Crisis Forcing Banking Surveillance Re-Think

Banks are being forced into a major reassessment of how they monitor and survey human communications following the recent regulatory investigations into FX market manipulation.

With already over $3.3 billion in fines levied against a number of major banks for the alleged misconduct of individual traders in the FX market, experts say that banks are looking for new surveillance tools and techniques to help them reduce this exposure.

“Regulators are now highly likely to ramp up their pressure on bank’s management to tightly enforce trading floor compliance/surveillance efforts via ‘FX control rooms’, and beefing up staffing aggressively in this area,” says Howard Tai, senior analyst at Aite Group.

Tai adds that some large global banks are banning traders from participating in chat rooms or from messaging over electronic dealing platforms with traders from other banks, while salespeople are under greater scrutiny with regards to how they exchange market colour or conduct FX trades with their clients.

However, while one market source says that shutting down communications lines was an “understandable” initial reaction from the banks, it should not be a long-term solution to the problem. “There have been some real problems with communication flows since the allegations surfaced, some of the banks are scared to talk to their own customers,” the source says.

In Europe, Rebecca Healey principal at Tabb Group, predicts that the new Market Abuse Regulation (MAR) being introduced in Europe will have a big impact on how banks view and practice surveillance.

“This is a global market and now regulators in Europe are trying to implement surveillance solutions that will function across borders and asset classes. This will be a significant change and could prove challenging for a number of firms in the region,” she says.

Meanwhile, the banks that have reached settlements with US and European regulators over the allegations of FX market manipulation are having to change their surveillance procedures and capabilities as part of these agreements.

“The CFTC and FCA settlements have requirements about what the banks have to build or remedy in terms of their internal compliance systems,” says Matthew Kulkin, senior associate at Squire Patton Boggs.

Both the size of the fines levied against the banks and the new regulatory requirements mean that these firms are increasingly looking to self-police FX trading activity, starting with how traders communicate. “A lot of the banks are building new in-house regulatory teams to capture compliance violations and self-report, rather than wait and have someone investigate them,” says Kulkin.

As FX is a communications intensive business, with email, chat and messaging playing an important role in the FX dealing process, shutting down these channels or merely having more compliance staff tracking this information is unlikely to prevent a repeat of the recent FX crisis, explains Stephen Epstein, VP of product marketing at Digital Reasoning.

“FX traders and salespeople need to electronically communicate. This is how they conduct their business and drive order flow within the FX market. Putting restrictions on how they communicate ultimately hurts their business and the markets,” he says. “At the same time, using compliance analysts to review every electronic message is overly costly and really unsustainable. There is clearly a role for technology in all this, which is forcing these financial institutions to rethink how they use technology and understand the challenges they face with their currently surveillance technologies.”

Aaron Nelson, lead product evangelist at Digital Reasoning, adds, “Part of the problem facing these firms is just the mass of information in the noise of constant chat and email. The current surveillance technology is based on looking for keywords or expressions, but this isn’t always effective because these specific terms can always be avoided and it also provides lots of false positives in terms of red flags.

“What we’ve found is that there’s a big technology gap in terms of being able to analyse electronic communications and accurately revealing all of the potential malicious behaviours,” he continues.

This is one of the reasons, says Nelson, why the banks were unable to catch the conversations taking place in chat rooms and emails, which could have potentially prevented the current FX crisis.

Instead firms need to look for more sophisticated technology templates that can actually understand how the language in chat rooms and emails is being used and in what context. This will allow the banks to more effectively cut through the noise and identify where there are real risks of human malpractice.

For more on why banks’ current technology failed to protect them from this human risk exposure and how firms should position themselves ahead of new regulations join Profit & Loss and Digital Reasoning for a free webinar, The FX Crisis: Dealing with Human Risk and Restoring Trust Within the FX Market, on 27 January, 10am EST/3pm GMT.

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This article first appeared in: Profit & Loss Squawkbox, 22 January 2015