This session at the premium surveillance event for finance featured expert regulator comment from: Cliffe Allen, MD OTC derivatives, National Futures Association; Joep Knook, Interim Manager, Market Surveillance, the Dutch Authority for the Financial Markets (AFM).

It was moderated by the ex-FCA regulator, David Blunt, who added comments from discussions he had had with UK FCA’s Jamie Bell, who was due to attend but was absent through illness.

The session began with a pretty direct audience survey question asking – what frustrates you most about regulators (only pick one)?

• Inconsistent regulator responses – 64%.
• Lack of clarity of regulator expectation – 30%.
• Lack of clarity of regulatory requirement – 23%.
• Slow responses to emerging issues – 7%.
• Retrospective regulation – 7%.
• Insufficient feedback – 6%.
• Ineffective international collaboration – 7%.

The panel were asked how regulators can balance the need to foster innovation while ensuring stability. Knook started and said that this needs to be tackled internally as well as cross market. Regulators need to understand what drives market sentiment. He referenced MAR and the misleading element within it especially with regards to algo trading. He felt that it is key to understand how algos work, how they might mislead, and how the human might mislead an algo. 

Regulatory approach

Blunt questioned how regulator perspective of AI could converge with that of trading firms. Allen said that the NFA is a member-driven organization with a variety of members of different size, complexity and sophistication. Its regulatory approach is to foster innovation and expect evolution but understand that one size does not fit all. The CFTC regulations it enforces are prescriptive but the NFA looks at individual facts and circumstances, and is pragmatic as to the way that it applies the regulations.

Swaps dealers have wrestled with how best to comply and surveil for the last 10 years, with trade reconstruction of voice a particular challenge. The regulator has been sympathetic to the technology limitations and focused on the efforts of all to comply. Fortunately the tech has evolved considerably and there is the ability to tie different data types together to complete an audit trail.

NFA is becoming much more familiar with tech capability, and assesses any shortcomings and lack of controls when a new technology is deployed to ensure integrity. Good recordkeeping is very important. NFA adopts a ‘trust but verify’ approach to its work. 

Perhaps the desire for more prescription is not a world that people should want.

The 70 or so global swap dealers all seem to have a different way of doing the same thing. NFA does not reference technology when it cites a breach, unless a firm has put an emphasis on this itself. NFA wants a firm to demonstrate how it complies with regulation. 

NFA hears regularly about a lack of clarity from regulators but perhaps the desire for more prescription is not a world that people should want. NFA is resistant to define what materiality is, and firms would probably not benefit from knowing. NFA doesn’t want to encourage an approach that leans towards doing the bare minimum.

Blunt spoke on behalf of Jamie Bell and said his comments had been that no one wants a tick-box regulator but everyone wants a list to tick. He echoed the view that there is always a trade-off between allowing some parameters, and very defined requirements. 

Generative AI

The audience was asked a survey question – are regulators a help or a hindrance with the adoption of generative AI?

• Generally helpful but could offer more; still a lot in the air – 68%.
• A hindrance; need for more clarity on regulatory risk and expertise in adoption – 32%.

Knook was asked to opine on the issue of fragmentation and the need for more collaboration among regulators. He said that MiFID has achieved one of its goals in making markets more competitive but it has been enormously complex for regulators. TRS has taken a few years to get right and is now a good window but the transparency of orders is still an issue and requires cross-border collaboration and data sharing. The lack of arrangements post-Brexit also complicate this.

The same theme was then addressed with regards to operational resilience. NFA does its best to work with regulators in different jurisdictions, especially from a surveillance perspective. Dialogue with local regulators is key if this occurs, to add appropriate context.

Allen used the recent swaps dealer rules that fall under the SEC as an example and stated that while it is not their area of review, the NFA does not always turn a blind eye. He added that around operational resiliency, the NFA does not usually comment on rulemaking unless it feels that its members are going to be unduly burdened by new rules that might be costly or duplicative.

In this case, NFA was obliged to comment on recent proposed CFTC rules. These are more prescriptive than any previously, and this is not viewed as ideal but the agency has no control over what happens next. 

Jamie Bell felt that while UK regulators had struggled to cooperate openly in the immediate aftermath of Brexit, that was no longer the case.

Again, Blunt spoke on behalf of Jamie Bell and said that while UK regulators had struggled to cooperate openly in the immediate aftermath of Brexit, that was no longer the case. He used recent work together on criminal market activity as a good example (the use of overseas broking accounts as specified in MarketWatch 80). He qualified this and added that data privacy across borders was often tricky to navigate.

Allen added that NFA respects privacy but will not allow firms to use it as an obstacle in case of enforcement. NFA will state clearly the legal obligations and then work around any concerns (for example swap valuation disputes for non-US counterparties).

The topic moved to the top emerging risks. Allen said that AI is the core focus here, explaining that firms need to be able to demonstrate compliance and define the scope of their use of AI. The regulator is scouring the landscape to see how it is being used in finance, as opposed to trying to actively regulate it. The main interest is in the governance framework, use of models, model validation, accuracy and completeness. Vendors need to offer transparency to their customers and to regulators. 

Jamie Bell’s list of emerging risks, via Blunt, was wider but did repeat one theme: structural increase in market volatility; growth in passives; end of day liquidity; AI and crypto.

This summary is not a full transcription of the session, but contains the sense of it as interpreted and reported by the GRIP subject matter expert who attended, who is an ex-compliance officer and regulator.