Fixed-Income Compliance Is Moving Upstream
June 9, 2008
Fixed-income products can be a compliance nightmare. Compared to the thousands of equities instruments, there are millions in the fixed-income world, and some of those might not be traded for months--or years--making pricing largely a judgment call.
Firms typically deal with problems late in the process--after a trade is done, or when customers or counterparties complain, or regulators notice something is wrong. But because it takes less money and manpower to catch a problem before an execution occurs, vendors are developing tools to help traders catch mistakes in real time.
The costs confronting firms who are slow to comply go far beyond the fines regulators may levy, according to Adam Honore, senior analyst at Boston-based Aite Group. "You've got the reports and you've got to reengineer the trade," he said. "There are operational costs associated with that. There are also costs associated with providing the regulatory information. If you're not efficient enough to do pre-trade compliance, you're probably not efficient enough to be aggregating enough information for regulators."
Miskeyed entries and other human errors can have financial repercussions. "There are fat-finger instances all over the Street," Honore noted. In many cases, the brokerage has to eat the cost of the mistake.
"At a client visit, we highlighted a trade that was 10 points off the market--the trader had accidentally typed in the wrong bond," said Stephanie Jacoby, managing director at Mill Valley, Calif.-based BondDesk Group, a retail fixed-income platform that counts Wachovia Corp., UBS, Fidelity Investments, E-Trade Financial Corp. and other major broker-dealers as customers.
Jacoby said the client in question was using BondDesk's compliance tools: MarketView and Trade Monitor System. "Catching it the next morning is better than six months from now--or having the client get their statement and see that their bond lost 10 points in value," she noted. And not catching a big error doesn't just mean having to dig up all the information regulators ask for. "You're also talking about the reputational costs of having that type of inquiry," she added.
When a bad trade is caught after the fact, a firm might also need to pay restitution and bear the cost of a damaged client relationship--"It would have been nice to catch it pre-trade," she suggested. Soon, that will be an option for BondDesk users.
Late last year, the platform began pilot-testing a pre-trade compliance tool with a client who now has between 30 and 40 liaison traders using the product, running checks on over 1,000 potential trades every week, according to Jacoby. "They're using it to test before they do the trade, to see if it would be out of line with reported trades or similar offerings in the market," she explained. The firm has made usage of the tool mandatory for each trade, she added.
The product will become widely available in the third quarter. "We're working on some enhancements to it that would make it more applicable to the large base of our clients," said Jacoby. "We're adding some minor things that would make the process go faster." The check currently takes from 5 to 30 seconds, depending on how long a user looks at the data.
Sophisticated Regulators
Financial firms aren't the only ones seeking to identify bad trades earlier, according to Aite's Honore. "Regulators themselves are moving from post-trade surveillance to inter-trade surveillance," he noted, such as the U.K.'s Financial Services Authority and the Financial Industry Regulatory Authority (Finra) in the U.S., which both use automated systems to analyze transaction data in search of unusual trades.
