Block trading, whereby an investment bank privately trades a large batch of shares of a given company, has not been immune to criticism over recent decades. Much of the negativity surrounding block trading is routed in its inherent lack of transparency, which leaves the practice open to an elevated risk of insider trading and market abuse. While it is hoped the European Parliament’s recent decision to approve new amendments to MiFID II will help increase transparency, the recent news that Morgan Stanley has had to pay $249m to settle long-running investigations into misconduct surrounding its block trading business will do its public image no favours.

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That said, the acts of a few bad players should not dissuade institutions from engaging in block trading. It is important to keep two simple facts in mind. Firstly, the Morgan Stanley case is an isolated – and fairly rare – incident. Secondly, and perhaps most importantly, block trading is not a fundamentally harmful market mechanism. Rather, it plays a crucial role in protecting investors from unfair fluctuations in the value of stocks when large trade orders are executed.

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Most block trades are executed because an investment bank’s client – typically an institutional investor such as a hedge or pension fund – wants to sell a vast quantity of shares at a fair price, without negatively impacting the market price of that stock in the run up to the trade. If, for instance, a hedge fund sold 100,000 shares of Coca-Cola on an exchange, the hundred-million-dollar transaction would drive the price of Coca-Cola shares down dramatically if executed as a single market order. Additionally, the sheer size of the order means it would likely be executed at incrementally less favourable prices after demand for the initial price of the stock is exhausted – a poor outcome for the end investor.

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The risk of market abuse arises in the potential for those with inside knowledge of the upcoming transaction to trade ahead of it – which is precisely what Morgan Stanley was found to have done. After all, even discreet block trades can result in some price fluctuation. The general rule of thumb is the larger the trade, the greater the potential for it to move markets. As a result, even so much as a whisper of a significant block trade can act as an incentive for wrongdoers to trade ahead of the official execution, benefiting themselves at the expense of others by shorting the stock.

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With this in mind, it is crucial that financial institutions engaging in block trades ensure they maintain solid oversight of their employees’ communication surrounding trade activity, rather than rule out the practice altogether. Given the hefty financial penalties watchdogs are all too willing to impose, oversight must go beyond simply monitoring traders’ communications over email, phone, and instant messaging platforms.

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Firms should also look to establish fully automated trade reconstruction capabilities, which can enable them to gain instant access to reconstructed trades that can be exported at the click of a button. The advantages from a regulatory compliance standpoint are manifold.

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By leaning on the support of automated technology solutions that connect communication and trade data, compliance teams can check exceptional trades – such as those made ahead of a block trade – almost instantaneously. The ability to axe the amount of manual leg work usually required in this process permits a complete shift in approach towards regulatory investigations – from reactivity to proactivity.

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Indeed, rather than waiting for watchdogs to come sniffing, compliance officers are empowered to proactively approach regulators to demonstrate that no foul play has taken place surrounding a block trade. With this approach, financial institutions can conduct block trades with greater peace of mind, while satisfying growing client requests for large trade orders, block stock and barrel.