Originally published on www.complinet.com
The Financial Services Authority has recently brought a swathe of enforcement action against firms for transaction reporting failures, with fines totalling more than £9m in the last 18 months or so. Prior to this there had been very little enforcement action in this area. This change of approach seems to have coincided with the increase in insider dealing cases being brought by the FSA ? this may be coincidence or it could reflect the importance of transaction monitoring when the FSA is building market abuse cases. Whatever the reason, the FSA has made it clear that it will no longer tolerate transaction reporting failures.
As the FSA increases its focus on transaction reporting, it is important that firms carefully consider what their obligations are and how to meet them. This article looks at what the regulatory obligations are for investment managers and what this means on a day-to-day basis.
Why the need to transaction report
The FSA has identified transaction reporting as a vital component in its battle against market abuse and, in particular, insider dealing. When the FSA receives an allegation of market abuse or it identifies an issue that needs to be followed up, interrogation of transaction reports is a major part of the work. Transaction reports are also very important as evidence if and when market abuse cases are brought, providing an audit trail of the complete transaction.
When a firm executes a transaction in any financial instrument admitted to trading on a regulated market or prescribed market or in any over-the-counter derivative, the value of which is derived from or otherwise dependent upon an equity or debt related financial instrument admitted to trading on a regulated market or prescribed market, it must report the details of the transaction to the FSA. There are, however, the following exceptions to this requirement: transactions in OTC derivatives, the value of which derives from or is dependent upon multiple equity or debt related financial instruments, e.g., indexes; transactions in commodity, interest rate and foreign exchange derivatives; and transactions which are reported directly to the FSA via an approved reporting mechanism (ARM) by a regulated market or multilateral trading facility through whose systems the transaction was completed. Firms that provide portfolio management no longer need to transaction report inter-fund transactions (cross trades).
Transaction reports must be submitted through an ARM. The majority of small firms use the FSA's web-based Transaction Reporting System, which allows firms to upload excel spreadsheets (XML file) into the system and then submit the reports to the FSA; firms have until T+1 to report transactions to the FSA.
Investment management exemption
Most managers can take advantage of the "reasonable belief" exemption which allows the manager to rely on a broker to report a transaction. Where firms undertake a transaction on a discretionary basis and the firm has reasonable grounds to be satisfied that another party (typically the broker) will report to the FSA, there is no requirement for the manager to submit an additional report. A "reasonable belief" may arise if the manager can be sure that the broker is subject to the Markets in Financial Instruments Directive, e.g., it is regulated in the European Union, but it is advisable that management firms get further confirmation from their brokers. The transaction reporting requirement is commonly included in the terms of business, but where it is not firms should ask brokers to confirm in writing that they will report relevant transactions on their behalf. Once the manager has satisfied itself that the broker is MiFID-compliant it need not conduct due diligence to ensure that reports are being submitted accurately.
Where a firm executes a transaction through Direct Market Access, it is the firm whose facilities are being used to make the trade that should report the transaction. Managers using a broker's DMA, therefore, will not need to transaction report.
If a manager executes a transaction outside the EU with a non-EU broker, and therefore a non-MiFID compliant broker, but the instrument has a dual listing on a RM, the transaction will need to be reported to the FSA. It is unlikely that the broker will report the transaction so the manager will need to either report the transaction itself (via an ARM, as mentioned earlier) or it may rely on a third party to do so. If a manager engages a third party to submit transaction reports on its behalf, the manager does not relieve itself of the obligation to transaction report. In other words, it retains responsibility for the transaction reports. In this circumstance, it is important that the manager periodically reviews a sample of the transaction reports submitted on its behalf, to confirm the reports are being submitted and the data's integrity.
The FSA has started to clamp down on transaction reporting failures; between August 2009 and January 2011 the FSA used its enforcement tools and fined seven firms where the transaction reporting breaches were particularly serious. The largest of these fines, £2.45m, was levied against Barclays. Even if the transaction reporting failure does not lead to public censure and a fine, it is likely that the FSA will conduct a comprehensive review of the firm's historic reporting and their current reporting arrangements.
When assessing breaches of the transaction reporting rules, the FSA will look at the firm's systems and controls to see if the firm is meeting its obligations under the Senior Management, Systems and Controls sourcebook as well. If the firm has the appropriate systems and controls in place, but did not follow them, it is likely to be treated more leniently than a firm which has breached the transaction reporting rules because it does not have appropriate systems in place.
Transaction reporting failures are likely to create a suspicion that the firm is non-compliant in other areas and could lead to an FSA visit. It is important, therefore, for all firms to have appropriate systems and controls in place to manage their transaction reporting obligations, whatever they may be.
- A list of trading venues that report directly to the FSA.
- A list of ARMs.
- If you want to check transaction reports are being filed on your behalf and the integrity of the data submitted, click here.
Richard Timms is an associate director of ACA Compliance (Europe) Limited (formerly know as Blueprint Compliance), the compliance consultancy firm for wholesale financial services companies with a client focus of hedge fund managers, fund of funds managers and private equity fund managers and institutional brokers. Contact - email@example.com