The relationship of regulation with automation and technology

November 9, 2022

With advances in automated trading in recent years, regulators have had their work cut out to catch up with the markets. The implications of automated trading have been under scrutiny around the globe for more than a decade.   

In Europe, the 2018 second Markets in Financial Instruments Directive (MiFID II) defined algorithmic and high-frequency trading (HFT) and traders faced more stringent requirements. Firms and venues are required to have effective systems and controls in place, with additional rules around HFT. Exchanges have had to implement regimes to identify algorithms involved in submitting orders.  

Organizational requirements around governance and process require a consistent compliance framework that covers all relevant aspects of algo activity. This includes development, pre-, and post-deployment testing, and monitoring and control in the production environment.   

The development, maintenance, and operation of algorithms have become more complicated, and adding all the compliance overhead has split the market. On the one hand, firms for which algo trading is not their main selling point typically look for standardized solutions or use third-party brokers. On the other hand, larger specialists aim to spread the costs across their volume of business. While in the past, it was enough to design a smart trading strategy, now and in the future, firms need a larger-scale approach to introducing algos. Regulatory and operational needs are equally important.  

The continuing need to keep down costs and innovate quickly should never compromise compliance  

In times of crisis, pandemic, and war, industry leaders have historically focused on the continuing need to keep down costs and innovate quickly. The financial industry is always looking for ways to benefit the end client, despite the compliance costs. This could drive an increase in high-touch tech to deliver efficient, quick service. However, trust between partners remains key, and automation efforts must not lose sight of this. By building an automated trading infrastructure that streamlines workflows, traders can focus on high-value tasks. Automation frees up valuable time to manage high-touch orders, decrease manual errors, and allows for an increased flow of orders.  

From a compliance perspective, innovation that is focused on workflow automation needs to work hand-in-hand with the applicable regulation. While automation can simplify business operations, elevated levels of operational and regulatory compliance must be met. This calls for robust governance, a high standard of oversight, and clear visibility of an order’s progress. This oversight, together with inflight interaction and risk checks, gives the trader the control he needs. The importance of data that can be returned from an automation engine should not be underestimated by a user of workflow automation software. The trader needs to be able to monitor what is going on and retain the ability to intervene where necessary. Final control should always remain with the dealer to ensure accountability and decision-maker responsibility.  

Workflow automation tools must always consider relevant regulatory compliance  

Human input however remains critical, and practitioners recognize that not everything is fit for automation. It is important to make objective decisions about which workflows would most benefit. Data can be used in analysis to profile and prioritize where best to make improvements. AI (Artificial Intelligence) and analytics solutions can also help you to make better-informed decisions.  

Before designing the solutions, the best practice for any technological advancement is to understand the business problem and the regulation. Considering compliance as an afterthought or add-on to a solution can result in delays to final sign-off. Viewing the applicable rule book in parallel with functional requirements can avoid many negative consequences. In the future, as automation becomes increasingly mainstream and more sophisticated, embedded compliance considerations will be the default.  

When planning for regulatory compliance, change is a constant  

We are all used to hearing from financial regulation policymakers and market structure experts about upcoming policy changes, the latest proposed rule amendments, and consultations. However, once the legislators agree on the new rules and the text is nearing its definitive version, the application of those changes takes center stage. From a technology provider’s perspective, the conversation shifts from the why and what to the how and when, and implementation plans start to firm up.   

In Europe and the UK, review cycles are built into the fabric of the rule makers’ frameworks. This means that change is a permanent feature. As a result, flexibility is important as the relationship between technology and regulation continues to evolve.  

Regulatory, as much as operational needs, drive a trading platform’s functionality. It is now a given that trading platforms have integrated compliance features. Key features such as system stability and resilience, detailed audit trails, monitoring tools, comprehensive testing, risk controls, and exchange rules are all rooted in the rule books. And integrated compliance is even more critical where automation is employed.  

An automation engine that maintains a comprehensive audit trail to ensure the compliance team is fully aware of events and actions is key. Along with traders who are entirely in control, with built-in kill switch style functionality and parameter modifications, all logged.  

The future belongs to innovation that works together with the applicable regulatory compliance.  

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