Quants to police trading fraud

Regulatory requirements have at last spurred the major investment banks to hire new teams of Quantitative Analysts (Quants). The new hires have been taken on to create models to capture the systematic risks that exist across all of their trading businesses.

These teams are tasked with building new trade surveillance frameworks that statistically model trade data to highlight “out of the ordinary” behavioural patterns enabling efficient application of rules and regulations tied to escalation procedures.

How these teams fit in is interesting. Typically there are at least two lines of defence implemented. It is the first line that is driven by the Quants – there to build and operate an exceptions modelling capability to identify unusual behaviour patterns by traders in real time. Whilst this might sound straight forward, it isn’t. A fit for purpose capability at an Investment Bank means being able to analyse several million data events per day, covering actual trades, trade events and amendments to trades. As a result, this involves recruiting teams of Data Scientists (the Quants) who will either build a bespoke internal modelling methodology or adapt an off the shelf software, such as SAS. 

Owing to its direct market connectivity, this first line activity will normally sit with Operations or Operational Risk. Talent as always is at a premium, and recruitment involves competing with the likes of Google and Amazon as well as the broader Big Data market, and therefore comes at a greater premium than other functions in Operations or Operational Risk. Optimally, senior talent comes in the form of ex-Quant Strategists with strong coding backgrounds, meaning a premium at this level too.

The second line of defence is a Compliance function, defining the internal policy in response to regulation and in the event of escalations driven by line one will coordinate investigations into rogue trading activity.

Regulatory rule sets for OTC Derivatives trading activity such as EMIR and Dodd Frank have now been in play for some time. It is also more than a rumour to say that some of the earlier efforts to build trade surveillance frameworks were not perceived as satisfactory by the regulators. Accordingly, there is now serious pressure from on high within the major Investment Banks to get this right.