The UK Financial Conduct Authority (“FCA”) recently released a paper setting out the findings of its Thematic Review: Asset management firms and the risk of market abuse (TR15/1). This focused on systems and controls to mitigate the risk of insider dealing, improper disclosure and market manipulation. Their Thematic Review should be viewed as a wakeup call for firms to review the effectiveness of their existing procedures.
The Thematic Review looked at the trading activities of a range of investment firms, comprising long-only asset managers, hedge fund managers and occupational pension schemes. The sample of firms selected for review was also varied by size, with global assets under management ranging from £200 million to over £100 billion.
The FCA’s findings include a mixture of good and bad practice. They note that only a small number of firms have “comprehensive” procedures to adequately control market abuse. The majority of firms therefore have further work to do.
In the FCA’s view, an effective control framework must consider specific individual risks – for example, the failure to contain inside information which has been received through non-disclosure agreements (“NDA”) or inside information inadvertently received, but not identified as such. The FCA also highlights the importance of pre-trade restrictions and post-trade surveillance to investigate suspicious trades.
A synopsis of good and bad practices is detailed below:
Identifying and managing inside information
The FCA found few firms with effective policies for handling inside information outside of situations where they may expect to receive it. The FCA cites the scenario of a firm declining an offer to be wall-crossed as an example of where inside information may be unintentionally received. The paper provides the following examples to assist firms in enhancing their controls:
- Contacting counterparties to ensure they are aware of the firm’s policies and practices relating to wall crossings;
- The appointment of an individual independent of the portfolio management function, as a contact point for pre-soundings;
- Compliance or other non-investment staff undertaking an independent assessment of information received by investment personnel.
The FCA notes a too informal and inconsistent approach to avoiding the unintended receipt of inside information when meeting corporate issuers. The FCA emphasises that firms must consider the benefit relative to the risk of attending meetings where there is a possibility of receiving inside information.
Enhancements in this area may include:
- Avoiding meetings during closed periods (i.e. close to company results), apart from exceptional circumstances and with pre-clearance from Compliance;
- Establishing appropriate controls regarding the receipt of information from consultants and/or expert network, including the review of contemporaneous analyst notes for possible improper disclosure.
Pre-trade controls against the risk of market manipulation & insider dealing
In most cases, the FCA notes, firms have implemented a segregation between portfolio management and dealing functions. A separate dealing team, which is the FCA’s preference, can act as a line of defence where anomalous orders are received from portfolio managers. In smaller firms, where segregation is impractical, independent pre-trade checks and post trade monitoring (by a COO, for example) should be considered.
The FCA highlight the following controls as good practice:
- Systems-based controls with “hard blocks” on restricted securities; and
- The recording of telephone lines / electronic communications to allow for detailed retrospective enquiry.
A key aspect of the review was the FCA’s finding that the majority of the firms had ineffective post-trade surveillance techniques.
The FCA recommends that firms take a more active approach to investigating non-routine, successful trading patterns or anomalous trades. The FCA advises that tools utilised by firms to achieve this may include:
- Statistical analysis on post-trade price movements outside of set probability ranges to trigger follow up;
- Retrospective analysis of conversations by fund managers on recorded lines (we think this would extend in principle to electronic communications); and
- Media searches for false or misleading dissemination – for example, a fund manager giving a positive interview about a share shortly before disposing of the fund’s holding.
The FCA acknowledges that the suitability of post-trade surveillance techniques will vary according to a firm’s size and activity and calls upon senior management to make an assessment of what it considers effective.
Senior management should reflect on these findings and draw up an appropriate action plan. This may include:
- Review (and update, where necessary) controls to identify and correctly handle inside information and make staff aware of escalation protocols. This may also include personal account dealing procedures to ensure an appropriate time distance between fund managers dealing on their personal accounts and trading on behalf of the fund.
- A review of the details captured in the firm’s insider list / log should be undertaken and consider expanding this to identify specific ‘insiders.’
Consider implementing further market abuse related controls, such as:
- Establish guidelines for research analysts around close-out periods and the documentation of discussions with company management and consultants / experts;
- Encourage fund managers to probe junior staff about the content of meetings with companies, consultants / experts;
- Establish a segregation of function between fund managers and traders if not already in place, or at least consider independent pre-trade controls; and
- Enhance post-trade surveillance processes to identify anomalous or non-routine trading activity (particularly where profitable) and ensure follow up of any patterns that are flagged.
- Look at the method used for delivering market abuse training to staff to ensure that this allows for genuine engagement and meaningful content.
We will shortly be sending out invites to our next webinar:Monitoring for market abuse / insider trading – Meeting the SEC / FCA’s expectations.
Please contact Vibhuti Vakharia, Martin Lovick or your regular ACA consultant with any questions on this e-mail.
ACA Compliance (Europe)