Market Abuse – COVID and Beyond
August 2, 2021
Over the last 18 months the Financial Conduct Authority (“FCA”) has set out its expectations in relation to systems and controls to be employed by regulated firms when it comes to identifying and reporting on potential Market Abuse. Some of this communication has been through formal written communication such as Market Watch publications and “Dear CEO” letters but much of it has been communicated in speeches given by key members of the FCA. Theses speeches should not be ignored as they can set out some useful insights into how the FCA will be reviewing firms from a practical perspective and the sort of information they are likely to request.
So, before we delve into the recent tone of the FCA communication lets make sure we are all aware of what Market Abuse actually is.
There are 3 main categories covered under the Market Abuse regime; these are:
- Insider Dealing – Taking advantage of inside information in order to generate profit by making, changing, or cancelling deals;
- Market Manipulation – A term for a series of actions which can distort market performance and mislead investors. It looks at the outcomes of actions rather than intent; and
- Unlawful Disclosure – Releasing inside information to the public without appropriate permissions
They are all covered under the Civil Law set out in the Market Abuse Directive/Regulations (“MAR”) and the first two behaviours (Insider Dealing and Market Manipulation) are also covered under the Criminal Law; the Criminal Justice Act and Financial Services Act. These laws apply to activity in relation to:
- Financial instruments* admitted to trading on a regulated market, MTF or OTF, (or where a request for admission has been made) or where the price or value of the instrument depends/has an effect on an instrument in the first two categories;
- Auctioned emission allowances and auctioned products;
- Commodity derivatives and related spot commodity contracts; and
*Financial Instruments: Includes transferable securities; money market instruments; units in collective investment undertakings; various options, futures, swaps and forward rate contracts; derivative instruments for transfer of credit risk; and financial contracts for difference. It does not include loans and loan trading.
FCA direct communication with firms
As a compliance consultancy we speak with firms who have received direct communication from the FCA in relation to potential Market Abuse enquiries. These enquiries tend to take the form of written requests including:
- Information around a specific trade and whether the Firm had identified the trade as suspicious.
- Details of any communication around particular transactions, events or times. As well as information around monitoring of employee communications across various modes of communication such as voice, email, social media, whatsapp etc.
- Provision of internal policies around Suspicious Transaction and Order Reports (“STORs”), they are particularly interested in the reporting of these STOR’s, for instance do you have a policy of how many STOR’s are “acceptable” before an external report is made?
- Copies of your Market Abuse risk assessment: Have you undertaken one? How often is it reviewed? Who has signed it off? Can the FCA see a copy?
- Information around remote working arrangements including whether this has impacted your financial crime controls.
At a basic level firms need to be comfortable that they could respond to these types of requests for information.
FCA market monitoring
The FCA monitor both primary and associated secondary market activities to identify behaviours which may impact the integrity and orderly functioning of the market. They have several tools for monitoring this behaviour and they also expect firms to performing internal monitoring.
This internal monitoring includes maintaining appropriate records of interactions with market participants and assessing whether any of those interactions has disclosed inside information, and if it has, your obligations around this. Monitoring of all forms of communication as well as the transactions themselves are vitally important in identifying market abuse, as well as other compliance concerns. While in the past the smaller firms have relied upon individuals manually monitoring this area, going forward automated systems will become an essential tool no matter the size of the regulated firm..
In addition, the FCA has previously discussed the role of a gatekeeper (a person with the specific duty to provide an opinion to the issuer) in controlling the receipt and internal dissemination of market soundings, if you haven’t identified this person, now is a good time to consider who your gatekeeper should be. Personal Account Dealing is also something to be kept in check to ensure it’s in accordance with COB 11.7 and 11.7A, including assessing how conflicts of interest and the risk of market abuse are managed.
Market Communication – Market Watch 63
If you haven’t already read Market Watch 63 we strongly recommend that you do. This publication was issued in the middle of the pandemic and so is focused around this topic but is a good reference point for reviewing your internal controls during this time, something we believe the regulator will also be interested in. Here are some of the key messages:
- COVID-19 has created uncertainty and operational challenges, but the FCA expects all participants not to undermine the integrity of the market.
- Participants will be expected to comply with obligations under MAR, among other matters.
- The FCA anticipates that many issuers will need to raise capital, leading to increase in primary market activity.
- Increased primary market activity and increase in working from home heightens the importance of having the right controls around market abuse, conduct and managing conflicts.
It also set out some of the key regulatory controls issuers should have in place which must be reviewed in light of the changing market environment such as:
Have you re-affirmed that persons on insider lists continue to be aware of when they have access to inside information and their legal and regulatory duties in relation to insider dealing and the unlawful disclosure of that information.
has the nature of information that is material to a business’s prospects changed? Information that could have a significant effect on companies’ share price could include, for instance, details on future financial performance (e.g. government schemes, changes to dividends or buy-back schemes); arrangements for staff returning to work; and supply chains.
Disclosure of inside information
Where financial reporting deadlines have been extended, meeting obligations to disclose inside information as soon as possible will ensure markets remain informed and are not misled. Has the current economic climate impacted your financial forecasts?
Julia Hogget (Oct 2020)
Market Abuse risk assessment is a key control the FCA expects firms to have and update as the market environment changes. This includes encouraging firms to look beyond scenarios simply set out in MAR and to use technology to set up alerts that may be more ‘out of the box’. In fact it is expected that during the pandemic firms should have been forced to think about the risks they face and how the impact of these risks may have changed.
Ms Hogget noted that in the first 6 months of 2020, the UK saw a greater volume of follow-on equity issuance than the next 7 major European bourses combined which potentially could give rise to a great deal of inside information which must be appropriately handled. Having appropriate controls over inside information and effective information barriers has been a critical control with firms being encouraged to regularly review how many people are permanent insiders, including for instance your IT department. Working from home has also created other challenges. Inside information may need to be kept from partners or flatmates as the separation between work and home life is harder to navigate. How has your firm adapted its controls to address these issues?
What constitutes inside information may have also changed radically during the pandemic: knowledge that an entire businesses’ operations would have to shut, or could open again; knowledge of whether a company had utilised the furlough scheme or pandemic lending schemes, pace of cashflow burn – issues that might either not have arisen in the past, or may not have been material, now are.
Mark Steward (March 2021)
Following on from Julia Hogget’s speech a few months later Mark Steward also highlighted the FCA’s concerns around Market Abuse during the pandemic.
In 2020, despite COVID and Brexit, there was a 34% increase in transactions in UK markets and yet there was a reduction in STORs, even though the level of market miscommunication had also jumped. This perhaps reflected the initial challenges faced by firms when being forced to work from home but was quickly rectified with STORs returning to “normal” levels.
Over the course of 2020 and 2021 the FCA has drastically increased its proactive market monitoring, its short selling requirements and surveillance tools. They have outlined in several speeches and discussion papers their concern regarding a wave of new, and potentially vulnerable, retail investors who could be subjected to misleading online marketing and fraud and therefore the expectation is that this is also something firms should be monitoring more closely.
They have introduced a new approach to short-selling reporting on the Electronic Submission System, with automated alerts identifying delayed notifications. Mr Steward did note that abusive shorting can lead to distortions in the market, especially where there is insufficient cover which can lead to inevitable squeeze opportunities arising, a reference to GameStop perhaps? In addition to short-selling reporting the FCA has increased their surveillance tools with the introduction of the new Potentially Anomalous Trading Ratio (“PATR”) which, unlike the Abnormal Trading Volume ratio (“ATV”), focuses on underlying trading behaviour around specified sensitive announcements to assess “whether the behaviour can be deemed anomalous”. As these tools get further refined it is expected that the number of alerts and associated STORs will reduce meaning that both firms and the regulator can focus on the real issues without the distraction of the false positives.
The key message for the FCA is that “tackling market abuse ensures the mechanisms for efficient and reliable value and price, for genuine supply and demand, continue to work well and this is integral to ensuring our capital markets offer the highest levels of protection for global capital”. Market Abuse is a key item on the agenda for the FCA even as we come out the pandemic and as such should be a key area for Compliance Officers to focus their attention.
So, what should firms be doing now? Is this time to look back or look forward? Well I guess the answer is both. Are you comfortable with your response to potential Market Abuse issues arising during the pandemic and has this forced certain changes to practices and policies? Has your response impacted your controls going forward and are your systems still adequate in this new environment?
Whilst the regulator will be looking back over this period and firm’s ability to cope with the changes thrust upon them, firms should also be considering how well they have coped with these changes. The need for automated surveillance systems to be able to demonstrate true oversight of communication and transactions has become a critical issue for trading firms, without it monitoring for Market Abuse is becoming much more difficult. In addition to implementing surveillance systems Compliance officers should also be looking at their internal documentation to ensure their policies remain fit for purpose and internal Market Abuse Risk Assessments are up to date and approved by senior management.