Trading Controls – Lessons Learned and Strategic Imperatives

By Craig Butterworth

In an era of increasing regulatory scrutiny, the landscape of trading controls has become a focal point for banks around the globe. It has been over two years since the UK Prudential Regulation Authority (PRA) released SS5/21, a document initially focused on the supervision of international banks’ branches and subsidiaries. However, it soon became clear that sections within it laid the groundwork for intensified regulatory examination of banks’ trading control frameworks, specifically concerning trader mandates, booking model controls, and client readiness to trade.

At the core of this scrutiny is the banks’ ability to ensure compliance with regulatory and policy requirements through robust preventative controls (both hard- and soft-blocks) and to systematically evidence that these controls are applied at a granular level.

With the recent publication of CP11/24, the PRA has provided further guidance on their heightened expectations. Similarly, the European Central Bank (ECB) and the Office of the Comptroller of the Currency (OCC) have also turned their focus toward this critical area.

This blog post aims to summarize the key lessons learned over the past two years and offer strategic guidance to help banks navigate this evolving landscape and meet regulatory expectations effectively.

Lesson 1 – Prioritize Trading Controls, Regardless of Size

In the early days after the publication of SS5/21, many banks believed that previous investments in compliance, such as those for the Volcker Rule, would suffice for the new PRA expectations. However, as regulatory engagement increased, it became clear that this assumption was incorrect. By early 2024, even the most confident banks realized they had significant work to do.

Smaller banks or “national champions” with modest UK presence also thought they could avoid prioritizing investment in this area. This notion has been debunked. While these firms may not lead the charge, they must still implement robust, evidence-based preventative controls.

Key Takeaway: Regardless of your bank’s size or complexity, prioritizing trading controls is crucial to meet regulatory expectations.

Lesson 2 – T0 Detective Controls Are Not Sufficient

At the start of 2024, a growing number of banks believed that T0 detective controls (controls that identify issues after a trade is executed but on the same day) would suffice to meet the new regulatory expectations. However, it has become evident that while T0 detective controls are a valuable component of a bank’s control framework, regulators are insisting on the implementation of true preventative controls.

Preventative controls are designed to prevent non-compliant trades from occurring in the first place, rather than merely detecting them after the fact. The argument that technological challenges make preventative controls unrealistic is not being well received by regulators. To maintain client experience and trader agility, particularly with voice trades, it is advisable to implement a dual approach:

1. True Preventative Controls: These should be applied to electronic trades before execution.
2. Immediate Detective Controls: These should be applied to all trades (both voice and electronic) as they hit the trade blotter, ensuring immediate identification of any issues.

This “belt and braces” approach ensures compliance without compromising on efficiency or client experience. Our clients integrate the Droit Adept decision engine into both pre-trade systems and trade blotters to achieve this dual-layer control.

Key Takeaway: While T0 detective controls are important, they are not a substitute for true preventative controls. Implementing a combination of both ensures a robust and compliant trading control framework.

Lesson 3 – Data Quality Should Not Delay Implementation

Clean data is essential for making consistent and accurate trading control decisions, but it should not be used as an excuse to delay upgrading a bank’s trading controls infrastructure. Regulators expect banks to address data issues proactively and not postpone necessary improvements.

Investing in the right decision engine can help systematically identify and address data quality issues. This approach ensures that essential upgrades to a firm’s trading controls framework are not delayed, and it enables banks to prioritize the most critical data issues first rather than attempting to overhaul the entire data set at once.

Many firms that take this approach start with “soft blocks” to avoid incorrect trade blocks due to poor data quality. As confidence in data accuracy grows, firms can gradually transition to “hard blocks” where appropriate.

Our clients and partners consistently report that regulators appreciate a proactive approach to identifying and resolving data challenges. In contrast, firms that delay action due to data issues often face increasing regulatory pressure.

Key Takeaway: Data quality is crucial, but it should not delay the implementation of robust trading controls. Start with soft blocks and progressively enhance data quality to transition to hard blocks.

Lesson 4 – This Is Just the Beginning of Regulatory Scrutiny

The pre-trade regulatory scrutiny we’ve seen over the past two years is not a fleeting phase; it’s the start of a new, enduring chapter. With each passing month, the intensity of regulatory oversight in the pre-trade space increases. Adjacent areas such as back-to-back controls, credit checking for Delivery Versus Payment (DVP) bond business, and client readiness to trade are also coming into focus.

Navigating this ongoing scrutiny requires a long-term, strategic approach. The firms that will succeed are those that invest in a comprehensive decision-making infrastructure now. This infrastructure should be capable of adapting to new regulatory requirements as they emerge, rather than approaching each new requirement as a separate, discrete (and costly!) project.

For our clients, we recommend integrating these evolving requirements into a unified decision engine. This approach not only simplifies compliance but also reduces complexity and cost over time. By embedding new rules into an existing framework, banks can maintain agility and responsiveness to regulatory changes without the need for extensive new builds or implementations.

Key Takeaway: Regulatory scrutiny in the pre-trade space is here to stay. Investing in a scalable, adaptable decision-making infrastructure now will position banks to efficiently manage ongoing and future regulatory demands.

Lesson 5 – Choose the Right Partners

Despite the recent publication of CP11/24 providing a bit more clarity, the lack of prescriptive, granular guidance from the PRA can still pose significant challenges for banks. Navigating these ambiguities alone can be daunting, and no one wants to be in a position of guessing how to meet regulatory expectations for something as critical as trading controls.

Given this environment, it is crucial for banks to engage with the right mix of consultants, vendors, and industry forums. These partners can provide valuable insights, share best practices, and offer tailored solutions that align with the latest regulatory expectations.

Here are a few considerations for choosing the right partners:

1. Expertise and Track Record: Select partners with proven expertise and a track record of successfully implementing trading control frameworks. Their experience can help avoid common pitfalls and ensure a smoother implementation process.
2. Regulatory Knowledge: Ensure that your partners have a deep understanding of current and evolving regulatory requirements. They should be able to provide proactive guidance and help you stay ahead of regulatory changes.
3. Industry Collaboration: Being part of industry forums and working groups can provide additional benefits. These platforms facilitate knowledge sharing and allow firms to stay updated on industry standards and regulatory expectations.
4. Comprehensive Solutions: Look for partners who offer comprehensive solutions that can be integrated into your existing infrastructure. This approach minimizes disruption and ensures that new controls can be seamlessly incorporated.
5. Ongoing Support: Choose partners who offer ongoing support and updates. Regulatory requirements will continue to evolve, and having a partner who can provide continuous guidance and updates is invaluable.

Our clients consistently relay that they see real benefits from being “part of the pack”. It ensures that they are acting on the most complete and up-to-date information, thereby reducing the risk of non-compliance.

Key Takeaway: Engaging with the right mix of consultants, vendors, and industry forums is essential to navigate the complexities of trading control regulations effectively. Choose partners with expertise, regulatory knowledge, and the ability to offer comprehensive, ongoing support.

Lesson 6 – Start Implementation Without Delay

When implementing new trading controls infrastructure, there are two primary approaches that firms can take: i) focusing narrowly and deeply on a specific set of products and/or entities, or; ii) implementing controls widely and shallowly across many asset classes and entities. Both strategies have their merits, and the right choice often depends on a firm’s unique data challenges and broader trading architecture.

Narrow and Deep: This approach involves initially focusing on a limited scope—such as a specific product line or a particular entity—but ensuring that full front-to-back controls are in place from the start. This method allows for a comprehensive and thorough implementation within a confined area, making it easier to rollout. It can be particularly beneficial for firms with complex data environments, as it allows for in-depth refinement and optimization before scaling up.

Wide and Shallow: Alternatively, some firms may choose to implement basic controls across a wide range of asset classes and entities as quickly as possible. While this approach may initially involve more limited functionality, it ensures that all areas of the business are covered to some extent. This can be advantageous for firms looking to achieve broad compliance quickly, even if further enhancements and refinements are needed over time.

Regardless of the approach taken, the most critical factor is to have a clear vision of the desired end state and to begin the implementation process without delay. Delaying action while waiting for perfect conditions or complete data sets can result in increased regulatory scrutiny and missed opportunities for early compliance.

Key Takeaway: Both “narrow and deep” and “wide and shallow” approaches have their benefits. The most important thing is to have a clear end-state vision and to start implementing your trading controls framework without delay. Early action is better than perfect action in the face of evolving regulatory expectations.

Conclusion

In the months and years ahead, the topic of trading controls is poised to ascend even higher on the priority list for COOs and Heads of Controls. Over the past year, many firms have come to realize the scale, importance, and urgency of investing in this area. However, a handful of others have yet to experience this epiphany.

Regardless of where your firm currently stands, it is evident that regulatory scrutiny—and, in due course, potential fines—in this area are only set to increase. The regulatory landscape is becoming more stringent, and the expectations for robust trading controls are rising.

We urge our clients to seize the initiative and invest in a future-proof decision engine that provides ultimate auditability, traceability, and transparency. Such an investment not only ensures compliance with current regulations but also reduces the long-term marginal cost of change. A robust decision engine can adapt to evolving regulatory requirements, providing a scalable solution that grows with your firm.

The lessons learned over the past two years highlight the need for proactive, strategic planning and execution. By prioritizing trading controls, securing senior management buy-in, engaging the right partners, and starting the implementation process without delay, firms can position themselves to navigate the complexities of regulatory compliance effectively.

Final Thought: The journey towards enhanced trading controls is not just a regulatory necessity but a strategic imperative. Firms that take a proactive approach and invest in scalable, adaptable solutions will be better equipped to meet current and future regulatory demands, ensuring long-term success and resilience.