Is Trade Compliance really just doing the part of managing risks of trading that the desk heads don’t want to do or don’t have time to do?

Yes, that question is meant to be provocative, but it has a real purpose. It is to illustrate the fundamental role that trade compliance is performing these days. The roles currently seem to be:

1. Head of Desk - in some cases their role is limited to responsibility for the strategy of making what we say we will (or hedging what we say we will hedge) and guiding that execution. In other words, how much do we intend to make and how we will say we intend to make it; and
2. Risk Management – Risk’s role is to look at how much risk you are taking to make that money and ensure you don’t take more risk than the company is willing to tolerate; and
3. Compliance - looks at what you are actually doing to make that money and why you are making trades.

The evolution of the markets has created more and more structured methods, trading strategies, and market forums to capture value. But in the end, fundamental compliance comes back to two primary questions – why are you making money and how did you make it? At the root cause, compliance issues occur when the head of desk and the management either don’t examine and control the answers to those questions, or they don’t care. Or, if the head of desk or company lets the desk activity expand beyond management’s ability to understand strategy or trade complexity or to adequately monitor the risk and that impacts management’s ability to ask those two fundamental questions – “why” and “how”. Risk will always be an integral function because the compliance question of “why” and “how” does not immediately imply they are looking at “how much can go wrong” and “are we willing to take that risk”– which are really the essential risk management questions.
The reality is compliance becomes a very simple function if the head of desk has the interest in examining the staff actions, understands them, and cares if they go off the rails. Then, the compliance function is simply to notice when someone unintentionally steps out of bounds and helps the head of desk correct the mistake before it becomes a major issue.
When the head of desk does not care and understand or, worse, actively supports improper “how” and “why” actions, compliance becomes a game of “find the rat in the basement”. In that case, compliance has to create enough different views and analyses of data to be sure there are no shadows to hide in. The latter case of active or passive encouragement of improper behavior has created what DCM see as the basis for the expansion of compliance into “conduct risk”.
If the original oversight of trade compliance was to keep staff with bad intentions from actively breaking rules on their own, DCM looks to conduct risk compliance as the attempt to keep good staff from doing bad things because “that is the way everyone here does it” or “I didn’t know that was wrong” or “my boss told me I have to get more client revenue or I lose my job”. Look at all those excuses:

1. “That is the way everyone does it here” – this really would indicate a willing blindness to how the desk makes money (or ignores hedging decisions that violate trading rules – this especially occurs when procurement departments are converted to “profit centers”), or management passively agreeing that doing bad things is good or actively encouraging them; and
2. Not knowing what is wrong is an indication no one wanted to train their staff on what is wrong; and
3. The worst is the pressure put on staff to make money in a market that just isn’t going to let you make those dollars without skirting (or breaking) the rules.

All of these come down to a misalignment between management (if they’re are espousing “compliance is a core of our culture”) and what they are telling staff they have to do to keep their jobs. In many cases, the desire to keep the job wins regardless of what background noise you are hearing.
DCM believes it is really that simple. The role of compliance in a company is determined by:

1. the degree to which the desk is willing to own the “how” and “why” questions; and
2. the degree to which the desk is willing to accept the “how” and “why” being guided by an external group if that role is not being served by the desk; and
3. the complexity of the desk’s transactions and what need to be done to detect the “accidental” missteps (this is assuming the “how” and “why” capture intentional violations)

The less responsibility owned in Item 1 and the more the desk has complexity and pushback in Items 2 and 3, the more intrusive compliance will need to be.
One final point – some may quibble about whether the questions I posit cover such things as money pass trades or wash trades to move positions from one account to the other. I would just note that “why you are making trades” would cover trades intended to defraud or hide a shift of positions. So, trades that are executed for reasons other than direct P&L impact should still be detected in standard compliance oversight.
This is the first in a number of pieces discussing why and how desks, risk, and compliance should be seen as supporting, not conflicting, functions. To paraphrase what someone who led the compliance function of a major money center bank once said to an industry group “We are not three walls holding out the barbarians. There is only one wall, we are all on it, and we work together or we fail.”
About us: 
Dynamic Commodity Management is some old guys who traded, managed risk, and wrote compliance oversight from the strategies to policies and procedures to actually pulling the trigger. We are happy to have conversations and provide support from strategy to execution to the C-suite down to the cutting room floor.
​About me (Tom Lord)
By way of explanation - I admit to being a dinosaur – my first trades in the energy industry were for Section 7 “emergency gas purchases” (go ahead, I’ll wait until you look up what that was). This is a way of saying that the trades that are executed today didn’t yet exist when I started (there were no options in natural gas and power in 1977, prices were regulated and the contracts had zero vol). I have the fun claim of being the originator on the first ever prepaid natural gas sale financed by a tax-free bond (with Municipal Gas Authority of Georgia). I have seen many of the ways people break the rules, try to bend them, or just screw up. It is best to keep the core focus simple. That is what we are trying to do here.