Julia Hoggett, FCA's Director of Market Oversight, last week gave a speech on the implementation of the Market Abuse Regulation in the UK.
This builds on her November 2017 speech, ‘Effective compliance with the Market Abuse Regulation – a state of mind’, which considered recent developments in the Market Abuse space. It also follows on from the recent publication of three FCA Market Watch alerts on market conduct and transaction reporting issues, versions 56 (issued in September 2018), 57 (issued in November), and 58 (issued in December).
Over the past five or so months, we’ve seen a succession of communications from the FCA on the importance of robust market abuse controls to prevent and detect misconduct. It’s clear that the regulator is continuing its focus on this topic in an attempt to improve standards.
In her speech, Hoggett reiterated the fundamental elements of an effective market abuse framework and provides greater clarity on the regulator’s expectations of market participants compliance with the Market Abuse Regime. She highlights areas of concern where the FCA believes that relevant risks have not been appropriately considered by stakeholders.
Hoggett reminds the market of the basic steps that firms need to take in order to implement and maintain comprehensive and effective market abuse systems and risk controls. The speech also highlights the importance for firms, and their personnel, to embrace a culture of compliance that recognises what constitutes manipulative behaviour. It’s a state of mind for firms and individuals, with those that appropriately discharge their responsibilities leading to improved conduct of business. It is clear that the FCA wants market participants to ensure that abusive behaviours do not occur in the first place, as they are of the opinion that a detective system is never going to be as effective as a preventative one.
Key topics discussed by Hoggett include:
- The tone must be set from the top – there is an emphasis on the importance of firms’ having “good” culture, as Hoggett builds her speech through referencing the previous FCA publication on the 5 Conduct Questions approach.
- Failure to observe proper standards of market conduct would entail a breach of the conduct rules under COCON and SM&CR. The concept of proper standards market conduct is to be supported with the recognition by the FCA of certain industry codes of conduct and for firm’s to actively demonstrate that they comply with such.
- The importance of detecting and preventing financial crime, by establishing appropriate systems and controls and reminding firms of their obligation to submit Suspicious Transaction and Order Reports.
- Stakeholders are encouraged to properly assess the risks that their institutions could be used to facilitate financial crime taking place. As previously suggested, the starting point for this should be well detailed and thoughtful risk assessments, driving the establishment of appropriate systems and controls. Hoggett states that “Firms need to undertake a proper assessment of the nature of their businesses, the market abuse risks that may arise as a consequence, and the systems and controls that are most suited to mitigate those risks”.
- A reminder to relevant stakeholders that market abuse risks could become apparent in a variety of scenarios, especially when a firm is going from private to public and vice versa. The latter is very often disregarded by the parties involved in the transactions. Similarly, firms need to control (and monitor for) information leakage externally, as well as within their own walls.
- The importance of education and training was emphasised. This includes ensuring that employees understand the consequences of certain behaviours and appreciating that all staff, regardless of their level of seniority, are alive to the risks of market abuse.
- The need to implement appropriate and proportionate governance and organisational arrangements with regards to market soundings and inside information. Such should be aimed to mitigate misuse and inappropriate dissemination of information by firms and their personnel.
- Information access risks are often overlooked and not proactively reviewed. Firms should think critically about the front-to-back information management controls that they need to have in place. The FCA provided four questions for firms to ask themselves in order to assist with this assessment:
- “Do firms think appropriately about the conduct risks that exist in holding inside information?
- Do they have the right protocols in place to determine who the insiders should be and do those insiders fully understand their responsibilities?
- Have they though carefully about who should actually access to that information?
- Finally, do the systems and controls genuinely mitigate the risks of the misuse of that information?”
- The importance for firms to proactively monitor Personal Account Dealing trades undertaken by employees. In addition, firms should consider the risks and conflicts that may arise with personnel who ‘follow’ the trading behaviour of clients of a firm. The questions regarding why employees are following, what they might seek to gain and the risk appetite of the firm to allow this practice should be asked. This is an area where the FCA sees a significant risk in firms and employees being able to comply with their regulatory obligations.
- The equal significance of both pre- and post-trade controls and surveillance. Of course, such surveillance shall be bespoke to the nature, strategy, and instruments traded by the firms in question.
- A reminder that market abuse surveillance should not be limited to equities, but must consider all instruments traded by the firm. The FCA has stated on a number of occasions that the industry has not fully responded to this, although recognises that a number positive steps have been taken. Improvements have been made in the Fixed Income, Currencies, and Commodities (“FICC”) sector, although much more could be done to break the assumption that market abuse only happens in equities.
- All systems and controls implemented by market participants must be effective. For instance, as explained in Market Watch 56, off-the-shelf calibration for alert parameters, or settings used by peers, are not necessarily effective for all firms, due to the unique characteristics of each, as well as of the instruments traded and strategies involved.
- Given the large volumes of executions conducted by algorithms, firms utilising this trading method should review their algorithms in the context of market abuse and the related manipulating behaviours. The FCA cannot hold a computer to account, however can seek to prosecute the people who provided the governance over that computer.
- Of key importance is technological evolution. The rapid manner in which markets are evolving should be forcing all relevant stakeholders to frequently review their arrangements, in order to ensure they keep up with the pace of change and market developments (i.e. increasing use of technology, data and AI). While evolution presents opportunities, it also presents risks. A firm’s risk assessment should consider these and ensure the implementation of adequate and up-to-date controls. The FCA is committed to remaining “fully focussed” on keeping pace with these developments in order to identify new challenges which face the markets and their integrity, and encourages firms to do the same.
- As with Market Watch 57, the regulator reminds that market facing employees should not be engaging in manipulating behaviours such as disseminating misleading statements and impressions. As such the terms of “flying” and “printing” were discussed.
- Flying – “involves a firm communicating to its clients, or other market participants, via screen, instant message, voice or other method, that it has bids or offers when they are not supported by, or sometimes not even derived from, an order or a trader’s actual instruction”.
- Printing – “involves communicating, by one of the above methods, that a trade has been executed at a specified price and/or size, when no such trade has taken place”.
- Firms' risk assessments are expected to have considered that staff may be misrepresenting the market to their clients.
- The topic of manufactured credit events was also discussed, as with Market Watch 58, re-emphasising the fact that manipulating behaviours have been observed in the global Credit Default Swap (CDS) markets and that the FCA considers these activities to be ‘the wrong side of the line’.
The underlying message from Hoggett’s speech is that prevention is better than detection, and this is a job for all market participants and not just the Regulator. Firm’s need to be alive to the risks present in their own organisation, and the effect that the evolution of technology will have on its activities. While improvements have been made – there is still a way to go.
How Can ACA Help
Connect with ACA to learn how our expertise can deliver a comprehensive and integrated approach to governance, risk and compliance across your firm.
Our market abuse solutions include:
- Market Abuse Thematic Review: a deep-dive review, benchmarking, and testing of your firm’s market abuse arrangements to help mitigate the risk of insider dealing, improper disclosure, and market manipulation.
- Market Abuse Controls Review: focused and cost-effective assessment of your firm’s policies, procedures, monitoring programme, surveillance techniques, and controls environment.
- Trade surveillance technology: Provides automated in-depth trade surveillance to help identify items of interest and non-compliant trading and investment activity. The system offers a case management tool that can track and store emails, reports, and research related to each investigation.
In addition, we offer SM&CR implementation planning and support services, as well as other solutions to help guide investment managers through this new regime.