One component of the forthcoming ESMA MiFID II regulations that hasn’t received the headlines that the impact on research has received is the mandate to record “electronic communication.” Like much of the preparedness levels for the sweeping regulations set to impact the financial services industry come January 2018, clarity can be wanting. As the deadline approaches, automated recording systems and artificial intelligence could work to solve the problem in a post big brother world.
ESMA Mifid II mandate all communications must be monitored
Come January, financial services professionals could have the extra burden of big brother watching over them. This is when ESMA MiFID II regulations require monitoring of all “communications that are intended to lead to a transaction” as well as certain conversations between employees.
The ESMA MiFID II mandate, which requires phone conversations to be stored for five to seven years, was particularly vague in specifying the type of communication devices covered. This was done for good reason. The European Securities and Markets Authority (ESMA), in a report out in June, noted that the rapidly expanding list of potential communication methods is one reason attempts to define specific devices could be outdated before the regulations even take effect. That partial list at that time included "video conferencing, fax, email, Bloomberg mail, SMS, business to business devices, chat, instant messaging and mobile device applications." When a conversation took place face to face, employees are expected to take notes.
The compliance department at a participating financial institution, under which the eavesdropping technology is supervised, is also responsible for communicating to employees what devices are appropriate for business communications. Business can be conducted on a personal cell phone, for instance, so long as the company has the ability to monitor that communication.
The ESMA MiFID II rules place more value on the content of the conversation, not the method upon which information was transferred. Any communication “intended to result in transactions” or that “relates to” execution of orders on behalf of clients is where the rules most obviously apply. But it is not just direct buy and sell orders that should be recorded in full. Any phone call that pertains to “wider regulatory obligations” that go past account dealing obligations and moves into “the deterrence and detection of market abuse.”
The ESMA points to a wide variety of issues:
The approach should consider the likelihood of misconduct in relation to market manipulation or non-compliance with the obligation to act in the best interest of clients in connection with the reception, transmission and execution of client orders and when dealing on own account. In any case, the following criteria should be taken into account when determining the appropriate frequency and scope of monitoring the records: (i) volume and frequency of dealing on own account, (ii) volume, frequency and characteristics of client orders, (iii) characteristics of clients, (iv) financial instruments and services offered and (v) current market conditions with regard to specific securities. This list is non-exhaustive. Furthermore, the results of any monitoring activities (including the risk assessment carried out by the compliance function) and of any relevant internal or external audit findings on the recording of conversations and electronic communications should be taken into account to determine the frequency and scope of the monitoring.
How might firms handle such ESMA MiFID II issues? In short, follow the trend of financial services and let the computers do the work.
ESMA Mifid 2 Aside, Get ready for computers to know more about your conversations than anyone else in the world
Artificial intelligence is all around us. Google and its YouTube subsidiary are using artificial intelligence to automatically monitor and flag inappropriate communications posted on the site. Facebook recently ended an experiment in artificial intelligence when it discovered that two computers communicating with each other had created their own short-hand language that humans could not understand.
Algorithms are in the process of transforming financial services at every level. According to JPMorgan’s Marko Kolanovic, algorithms are not responsible for up to 90% of market transactions. The “Robo Advisor” is offering investors clear choices for lower cost investment advice without that pesky human overhead.
In the land of compliance, firms such as Palantir, which was seed-funded by the CIA, are currently monitoring Credit Suisse. JPMorgan launched a program in 2016 to use algorithms to catch bad actors.
Such systems are built not just based on simple keyword identification and flagging but are at their best when they recognize the context around conversations. Even more sophisticated are those systems with the ability to pick up slang or nuanced coded conversations that are difficult for even human compliance agents to recognize.
In the recent past, bank employees involved in wrongdoing have been somewhat obvious if not brazen in their traceable digital communications. In trader chat conversations one Barclays trader told another “if you ain’t cheating, you ain’t trying,” for instance.
With the new ESMA MiFID II algorithmic cop on the beat, taboo communications are not only likely to be identified more readily, but also acted upon.