Why Innovation and Resilience are Critical to Protecting Market Integrity

The way people trade has radically transformed in recent years, along with the dangers they face. Low cost and freely available app brokers, alongside the explosion of meme stocks and financial influencers, has resulted in new types of market abuse, like social media driven pump and dump schemes. New technologies, such as digital assets and artificial intelligence, have also created threats and opportunities, while events such as the recent CrowdStrike incident demonstrate the importance of resiliency and security for our critical infrastructure.

It’s a substantial challenge for regulators, market operators and market participants to keep pace with the changes we’re experiencing, but it’s vital that they do.

Global capital markets fulfil a vital service, helping to foster development, growth and wealth-creation across economies and communities globally. Preserving the rich ecosystem around those markets is therefore essential, with market integrity the critical component to any successful marketplace. Without trust in the system, willing buyers and sellers will simply withdraw from the market, imposing a substantial cost to global prosperity.

But the integrity of marketplaces is under constant threat as bad actors gain access to increasingly sophisticated tools to gain an unfair advantage. That necessitates a relentless focus on market integrity across exchange groups and other financial institutions, with an enduring commitment to investing and innovating to fight financial crime.

Changing market dynamics

Market surveillance is the process of monitoring and analysing market activity to prevent, detect and investigate potential insider dealing and market manipulation. It is essential to market integrity and therefore the foundation of fair and efficient markets. Integrity ensures that investors can trust the prices and information they see, and that they can participate in the markets with confidence. It also protects the reputation and credibility of market operators who have a responsibility to uphold the highest standards of conduct and compliance.

However, surveillance is not a static process. It evolves with the changing dynamics of the markets, the emergence of new technologies, and the sophistication of market participants. As such, as an industry we must continually innovate to enhance and upgrade our collective market surveillance capabilities, to keep pace with the challenges and opportunities of the modern financial landscape.

A new wave of surveillance innovation

The pump and dump scheme is one of the most well-known forms of market manipulation. Historically the schemes were performed through boiler rooms, using high pressure sales tactics as seen in the “Wolf of Wall Street.” More recently, social media has turbo-charged the scheme, allowing it to reach thousands of new people. The behaviour is so prominent, the Hong Kong SFC reported that 20% of its open investigations involved pump and dump social media schemes, and multiple regulators globally have issued official warnings. These scams continue to grow more elaborate, with widespread evidence of the use of generative AI to create fake messages and images.

On the flip side, one of the most promising innovations in market surveillance is the incorporation of AI to enhance analyst investigation when wrongdoing is suspected. AI can help analysts to sift through large volumes of data, identify patterns and anomalies, and generate insights and alerts. AI can also help analysts to reduce false positives, prioritise high-risk cases, and automate repetitive tasks. This can improve the efficiency and effectiveness of market surveillance, and free up analysts to focus on more complex and value-added activities.

At Nasdaq, we have been investing in AI for market surveillance for many years, and we have seen the benefits of this technology in our own operations and services we provide to our clients. For example, we have developed an AI-based system to streamline the triage and examination process involved in investigating suspected market manipulation and insider dealing, empowering regulator and marketplace clients to more effectively monitor and detect potential market abuse. During proof-of-concept testing, surveillance analysts estimated a 33% reduction in investigation time, with improved overall outcomes. This represents a substantial gain in investigation efficiency.

No silver bullet

AI is not a silver bullet for market surveillance. It is a powerful tool that can augment human intelligence, but it cannot replace it. Analysts still need to apply their domain expertise, judgment, and intuition to interpret the outputs of AI, and to validate and verify the findings. They also need to keep abreast of the latest market developments, regulatory changes and best practices to ensure they are using AI in a responsible and ethical manner.

In addition, regulators have released guidance on the use and development of AI in financial markets, which adds an additional layer of complexity. They have flagged that the industry needs to manage risks relating to governance, robustness, transparency, explainability and non-discrimination. It is not sufficient to build an AI surveillance tool that catches bad behaviour; it is equally important to build one that meets industry and regulatory standards.

Moreover, AI is not the only innovation that can enhance market surveillance. There are other technologies, such as cloud computing, blockchain and data analytics that can offer new possibilities and solutions for market integrity. Market operators and financial institutions need to be open and agile, to explore and experiment with these technologies, and to collaborate and learn from each other. They also need to engage with regulators, policymakers and stakeholders to foster a conducive and supportive environment for innovation, while maintaining the highest standards of compliance and governance.

Digital resilience is also a key component of this story and another clear area of regulatory focus, with initiatives like the EU’s Digital Operational Resilience Act demanding the focus and attention of management teams. The recent CrowdStrike outage demonstrated how quickly things can go wrong and reinforces the importance of combining innovation with rigorous systems and controls around mission-critical technology.

Market surveillance is vital for the health and stability of the financial system, and to maintain the trust and confidence of investors. Market operators and financial institutions have a duty to conduct market surveillance, and to continually innovate to enhance and upgrade their market surveillance capabilities. By embracing innovation and resilience together, market operators and financial institutions can not only safeguard market integrity, but also create value and opportunities for themselves and their clients.