2018 – The year that Europe’s Market Abuse Regulation bites back!
5 October 2017
The article below first appeared on Bovill UK’s website. Europe’s Market Abuse Regulation applies to issuers (wherever they are based) with financial instruments admitted to trading on an EU regulated market, and therefore is relevant to some players in Asia.
Market Abuse Regulation (“MAR”) came into effect on 3 July 2016 and seemingly, little happened. Life went on as usual, many firms didn’t update their practices, embark on a full market abuse risk analysis or, truthfully, really notice any difference. Firms and regulators alike have been single-mindedly focusing on MiFID II implementation, other new regulations, or perhaps digging a hole in the sand big enough to bury their collective heads.
We think that is about to change
Since March of this year we have seen a renewed interest in Market Abuse from the regulator. The most recent warning to Interactive Brokers by the Financial Conduct Authority (“FCA”) outlined that Interactive Brokers failed on three separate occasions to identify and report to the FCA transactions which it had reasonable grounds to suspect amounted to market abuse, that its systems and controls were inadequate, and that there was a resulting breach of Principle 3 (Management and Control). In March of this year, we saw Tesco pay redress for market abuse, and shortly after that the FCA fined and banned two individuals for market abuse. Combine this with the increased criticism of the FCA for failing to convert its large number of cases under investigation into action, the increasing obligation for some firms under MiFID II could leave firms with an unpredictable regulatory terrain to navigate.
Why should your market abuse framework matter to you?
Simply put, breaches of MAR can attract unlimited fines, or even prohibit regulated firms or approved persons from undertaking regulated activity. Criminal prosecution for insider dealing and market manipulation can incur sentences of up to 7 years. So what should you put in place to ensure you avoid this stark outcome?
Market Abuse Regulation and Governance
The culture and governance structure of any firm are always at the top of the list of considerations when approaching the implementation of any new regulation. Good culture embedded through training (that is both compulsory and relevant) can help staff and senior management to understand their responsibilities with regards to MAR. Great training helps staff understand their responsibilities and helps them understand the risks inherent in the business and their role in mitigating them. Strong, clear and well-formulated policies and procedures for the handling of inside information, expected trading behaviours, and the handling of STRs (of which many firms policies are inadequate) will also help to set firm ground rules for staff.
At a more senior level, setting the tone from the top is important, senior management that openly espouse a compliant culture typically see a trickle-down effect, encouraging an environment that promotes escalation of issues and concerns. Ultimately it is senior management that have the responsibility for what behaviours firms will report to the FCA, so it remains imperative that issues can be escalated to them immediately when required.
Pre Trade Controls
The FCA continues to show its preference for automated pre-trade controls as a means of preventing potentially abusive trading in financial instruments, especially those linked to companies where the firm may be in the possession of inside information. Other controls include trade double entry which prevents unnecessary cancellations and user permission profiles that prevent trading in excluded asset classes or outside hard limits on notional or volume. Firms can even consider adding logic to pre-trade controls to prevent a trade in the opposite direction to the last within a given timeframe. These hard limits reduce the risk of both market abuse and that of human error.
Automated Post Trade Surveillance
Automated trade surveillance can form a central tenet to monitoring your organisations activities in the market, but is generally only cost-effective for firms with a significant scale and volume in their trading operations . For firms operating an automated surveillance system, consideration should be given to the different asset classes and markets in which you are active, and the associated risk of abusive behaviours in context. This should then shape the type of alerts to put in place, and assist with setting tolerance levels and parameters.
Firms also need to consider whether they have the right skills and expertise to perform historical analysis on the trading data, review market events and corporate actions as well as assess the individual trading behaviour of staff or members. Firms should make sure this information regularly feeds into senior management and they should also receive regular clear updates as to the volume of alerts being triggered, STRs and other behaviours observed.
Although evolving fast, trade surveillance systems are still unable to understand unusual trading behaviour beyond exception based rules and cluster analysis – this is why they typically only form the first line of defence against potentially abusive behaviours. Trading behaviours are infinitely complex and vary based on asset class, strategy, time, and market. For example, a defaulting bond may set off a number of automated alerts, but a small FX trade just outside the standard bid and offer may only set off one. This is why the human element of this process is important – having well trained staff with expertise in the asset classes and instruments traded, and with a sufficient level of authority to escalate issues, is fundamental to effective trade surveillance. Staff need to not only triage alerts generated by automated surveillance, sorting the ‘wheat from the chaff’, but also continually challenge the trading behaviours and suspicions. They need to be able to identify what may be a trading strategy, an algorithm gone rogue or just a fat finger error. These staff will also need to be able to produce a well drafted suspicious transaction report with all the relevant information for the regulatory authorities in quick order.
How Bovill can help
Bovill are experts in establishing effective, efficient models for detecting and preventing market abuse. We can help you to:
- Perform a full assessment of the market abuse risks in your business
- Design effective market abuse policies, procedures and controls, and
- Help you interpret and refine the outputs of your automated trade surveillance.
For some firms, performing your own market abuse monitoring is simply not a cost effective option. We also offer a full managed service outsourcing model for firms who need to get assurance that they are meeting their regulatory requirements under MAR, without the burden of establishing an in-house monitoring function.