XLoD London 2023: Experts discuss continued expansion of regulation

Panel of experts examined changing market conditions and regulatory challenges.

This valuable session with regulators, at the must-attend event for surveillance experts on the sell side and buy side, was billed as crystal ball gazing but offered much more than fantasy from the influential speakers on the panel. 

On the panel were Jamie Bell, Head of Secondary Market Oversight, UK FCA; Cliffe Allen, MD, OTC Derivatives, NFA; and Jerome Reboul, MD, Policy & International Affairs, AMF.

They were asked to identify emerging risk and Bell got the ball rolling. He pointed out the step change in the markets in terms of high volatility that present significant challenges for regulators and anyone performing oversight. He added that the feedback loop in place between the market and social media is now more profound than ever and is driven by emerging AI. This means regulators need to act faster.

AI driving growth

AI has also driven growth and impact in correlated markets which creates potential concentration risk that must now be monitored (for example the Archegos case and the nickel crisis). He indicated a change in approach to fixed income and commodities regulation and supervision at the FCA and said that is a message that needs attention at any firm active in that space.

This was backed up by separate news of an upcoming FICC Director appointment at the FCA to drive this. In short, the FCA will be doing more surveillance of these asset classes, which strongly suggests firms should be too.

The FCA is keen to adopt common data standards so that it can share important data more openly and effectively. Firms can expect it to be more intrusive in terms of the data requests it makes, and this will allow it to join the dots to help identify emerging risk.

Allen stated that emerging risk requires an all-hands-on deck-approach. The NFA convenes a hot topics committee comprised of key examination program executives that focuses on exam process and impact on members. 

The areas of focus for securities market regulators are innovation (especially AI); cyber and operational resilience; and retail customers.

One area of focus, unsurprisingly, is AI and how it is applied by member firms, along with activity that is a result of it. This is very much on the NFA exam agenda. In addition, there is an exam deep-dive on the supervision of sales and trading staff with regards to their use of unapproved technology and channels/platforms. The exam program will be beefed up to analyze how firms supervise and monitor the possibility for this. Anyone that is in contact with US people must be using approved channels. 

Reboul was speaking as a securities market regulator and said that data-driven supervision is very much on the rise. The AMF is using AI tools of its own and these are showing huge promise for how they supervise. The macroeconomic environment is troublesome. He guardedly said that there are no great financial instability concerns – which caused a sharp intake of breath from the audience! The areas of focus are innovation (especially AI); cyber and operational resilience; and retail customers.

The ball went back to Bell, who said that in such a complex environment with so many rules, the regulator does try to talk to the industry but it cannot have definitive answers for everything that is asked of it. The FCA has invested considerably in its newsletter MarketWatch as well as its own forums and external ones.

Flexibility required

He gave those present a piece of cautionary advice and said “be careful what you wish for!” The regulator needs the industry to make some decisions for itself, create its own solutions, and develop peer-based acceptable market practice. He used the approach to voice surveillance as a good example, and said that firms need to approach this by accounting for the risk in their business and monitoring it proportionately.

Some flexibility, as opposed to prescription, helps to reduce the cost of compliance and improve operational efficiency, he said, but there is an obvious tension there. The regulator appreciates best efforts to comply as well as the considerable complexity involved with compliance globally. 

The moderator asked the panel to talk about lessons from the regional bank failures in the US this year. Allen kicked off and alerted all to the fact that NFA does not regulate banks. Despite that, he advised that in terms of risk management, the devil is always in the detail. He stressed the need for the three Ms: measure risk; monitor risk; manage risk.

The regulator needs the industry to make some decisions for itself, create its own solutions, and develop peer-based acceptable market practice.

In some cases there is concern that smaller member firms at NFA do not analyze concentration risk as closely as they should. Silicon Valley Bank was the sole bank that some relied on and this was a blind spot.

Reboul used the same bank disclaimer. He added that regional banks in the US were not required to analyze and report their liquidity positions based on the tier they occupied. This is a regulatory gap that does not exist in EU regulation. He outlined three lessons that exist related to liquidity tension:

  • arbitrage is occurring at unprecedented speeds now;
  • Credit Suisse was a very ‘Swiss’ issue but the potential for a repeat needs to be isolated in other jurisdictions;
  • there is a need for swift and accurate communication with the market in a time of crisis when managing risk.

An audience survey asked should regulators focus more greater clarity in helping firms handling existing risk (44% thought so) or the ability to respond more quickly to tackle emerging risk (56% said yes).

Reboul’s view was that clarity is of more value to incumbents, which creates a bias that benefits existing players rather than new entrants and challengers.

Defining materiality

Allen continued on this theme and repeated sentiments expressed earlier in the session on demands for more prescription. He said that when pushed to define materiality, many members often recoil when they hear what they do not want to hear! He used the example of off-channel communications and focused video and the related chats. Do firms need to capture and monitor both, just one, or none?

He left the crowd hanging and advised that firms demonstrate that they approach risk monitoring appropriately. He added that when the NFA perceives that the industry is really craving clarity, it uses member workshops to consult and establish current best practice.

Bell was equally honest. He said blurred lines foster innovation but also allow the regulator to cover itself, but accepted the latter justification is not ideal and that the regulator should be pressured here. The decision, he said, would then be made as to whether it was in the firms’ interest to be given prescription.

The final themes the panel addressed were ESG and crypto. Bell started by saying that ESG is so important for the planet but has been politicized so much and this will only be accentuated in elections next year. Crypto needs to demonstrate its own value, but Bell stated he has less enthusiasm personally for crypto than he does for AI. Crypto needs global cooperation as the demand and use of decentralized assets progresses.

Crypto needs to demonstrate its own value.

Reboul said that ESG already has a bench of regulation in the EU and the first duty now is to assist its implementation. International cooperation is key to ensure that more fragmentation does not result but the framework must be interoperable despite the different political views globally.

Crypto needs as much clarity as possible from a regulatory perspective. The retail and institutional markets are very different – the retail market needs to be regulated properly and the institutional needs to be encouraged to innovate. 

Please note that this article is not a comprehensive reproduction of all that was said in this session and is an interpretation of comments made by the regulatory journalist – it has not been officially approved by the speakers or conference organizers.