Nasdaq rolls out new fixed-income trade surveillance alerts

For some years, the Financial Conduct Authority (FCA) has said that wholesale brokers in fixed income are not reporting enough suspicious activity on their platforms. Part of the challenge for these firms is that over-the-counter fixed income instruments trade infrequently and so have less associated transaction data. Additionally, many platforms connect to venues via web-based user interfaces that do not systematically record order and trade messages.

“A number of regulators have been quite direct in saying to the market, ‘What you are doing in fixed income is not good enough—we are not seeing enough suspicious transaction reports. Your systems are not really fit for purpose because they don’t reflect how fixed income is traded’,” says Michael O’Brien, vice president of product management, global risk, and surveillance at Nasdaq. 

Nasdaq is introducing new alerts to better align its trade surveillance solution, Nasdaq Trade Surveillance, with the suspicious activity reporting needs of OTC fixed-income market participants. The additions were made after a review begun about 18 months ago, during which Nasdaq found that the nearly decade-old surveillance service for OTC fixed income that was designed for instruments traded on an exchange.

“[In these markets] you’ve got plenty of market data, you’ve got auditable logs of orders and trades timed down to the millisecond and more. The data available did not necessarily reflect how price discovery in fixed income takes place,” O’Brien says.

Nasdaq Smarts delivers data and alerts to clients through an online interface. When a user logs into the application, they can review a list of alerts, with the choice to either escalate them for further investigation or close them. The company has added a new data field into the application with calculations for yield to maturity (YTM) for fixed-income trades. YTM is the percentage rate of return for fixed-rate securities like bonds. It is calculated on the presumption that the holder will keep the security until its maturity, and coupon and interest payments are made on time. 

O’Brien says most bonds are priced by their yield, which reflects the interest rate, the coupon rate, and the maturity of each bond. “Most trade surveillance systems were very much price-focused. One of the upgrades that we made was that we are now calculating the yield on every order and trade,” O’Brien says.

Users can now generate surveillance alerts based on both price and yield for a fixed-income instrument,

The FCA said in a 2018 newsletter that some firms use price-driven surveillance for products where yield is the primary basis on which pricing and trading are undertaken. If this is the case, they’re not carrying out meaningful monitoring, as alerts should be derived from yield.

Nasdaq has also introduced dollar value per 01 (DVO1), a trading risk measure within the asset class that is used to identify large volumes and unusual trading risks. “If you buy a bond that’s maturing in six months versus buying a bond that’s maturing in 50 years, even though they both have the same nominal value, the actual value of the trading risk is quite different. So DVO1, is a way that takes into account that maturity, and is, therefore, a much better way to identify unusual volume in bonds, and identify unusual levels of trading risks,” O’Brien says. 

A rules-based surveillance alert could be set to generate an alert when the value of a particular trade exceeds $500,000, for example. However, O’Brien says this cannot be translated into surveillance for a fixed income trading environment because the nominal value for a trade does not reflect how value and risk would be assessed for a transaction. 

“What you do now is you create this DVO1 field, and that is then put into those alerts. So rather than saying the nominal value of the trade needs to be more than, for example, $500,000, you can now set the DVO1 of this trade or order needs to be more than a defined value. That particular level represents an unusually large level of trading risk.” 

Both YTM and DVO1 are currently being rolled out to clients. 

Nasdaq is also adding front-running alerts for fixed income and FX. Front running is the trading of financial assets by a broker with future knowledge about a transaction that could influence its price.

O’Brien says the alerts reflect the fact that there’s a completely different flow around how price discovery happens in the bond market. “Because of the nature of that trading, there can be a higher level of risk of front running. An RFQ comes in from a trading client, where they are wanting to buy or sell a particular quantity of bonds. The [bank or broker] is then going off to the dealer market, whether it’s to a platform or an intermediary, and they’re dealing in their own capacity. There is the risk there that they will make use and take advantage of the RFQ or that order information, and front-run it,” O’Brien says.   

He says the front running alerts are being progressively rolled out, depending on each client’s timeline.