The new regime shares the same aims as its predecessor—to ensure the integrity of EU financial markets and enhance investor confidence—and keeps pace with market developments such as new trading platforms, new technology, and the upcoming overhaul of market regulation under MIFID II due early 2018.
The market abuse regime in the United Kingdom and Europe is changing. On 3 July, the European Union's Market Abuse Regulation (MAR) took effect across the United Kingdom and the rest of the European Union. MAR has replaced the existing regime under the European Union's Market Abuse Directive (MAD), establishing a common regulatory framework for EU market regulation and bringing the new regime into line with the structural changes to be wrought by the second Markets in Financial Instruments Directive (MIFID II), which will take effect in January 2018.
MAR’s changes relate to insider dealing, market manipulation, recipients of market soundings, suspicious order and transaction reporting, and investment recommendations, all of which are especially relevant to buy-side and sell-side firms. Furthermore, MAR imposes additional obligations and requirements on the issuers, and the managers of issuers, with shares and other financial instruments traded on EU trading venues. We will shortly publish a LawFlash that focuses on the implications of MAR for issuers.
MAR is an EU regulation and, as such, it takes direct effect in every EU member state without the necessity for member states to implement it through their own local laws. This has the benefit of increasing harmonisation across the European Union but substantially reduces the role of individual country regulators in terms of providing guidance and interpretation. Such guidance and interpretation is instead left to the European Securities and Markets Authority (ESMA), which can be more of an unpredictable quantity and more difficult to engage with than national regulators; certainly more so than regulators such as the Financial Conduct Authority (FCA) in the United Kingdom, which historically has taken a lead on market abuse issues. In the United Kingdom, the current laws on civil market abuse in the Financial Services and Markets Act 2000 (FSMA) have been repealed by the Financial Services and Markets Act 2000 (Market Abuse) Regulations 2016, which also ensure compatibility with MAR and that MAR is fully effective and enforceable in the United Kingdom. The existing rules in the FCA’s Code of Market Conduct have been replaced with signposts to relevant provisions of MAR.
New Behaviours, Platforms, and Markets
Because MAR carries forward key elements of the previous regime, it is worth reminding ourselves of the key continuing elements of that regime. The previous regime sought to prohibit abusive behaviour in the form of
- insider dealing;
- the communication of inside information and the manipulation of markets in relation to securities and other financial instruments that are admitted to trading on a regulated market in the European Union; and
- regulated disclosure of inside information by issuers of securities.
The scope of MAR builds on the above elements and is far broader than that of its predecessor, MAD. Specifically, MAR’s scope has extended the previous regime to
- all financial instruments admitted to trading on EU multilateral trading facilities (MTFs) or organised trading facilities (OTFs) to be introduced by MiFID II in January 2018 for the trading of nonequity instruments, such as bonds and derivatives, or any other financial instrument that depends on or affects the value of a financial instrument traded on any MTF or OTF;
- abusive behaviours and transactions concerning the auctioning of emission allowances on an auction platform authorised as a regulated market or other auctioned products traded on such a platform;
- create a new prohibition on manipulating the calculation of a benchmark rate;
- an expanded definition of what is caught by the term “insider dealing” from the simple, binary definition of acquiring or disposing of a financial instrument to include the amendment and cancellation of orders on the basis of inside information where the order was placed before the inside information was acquired;
- market manipulation relating to spot commodity contracts where it is likely or intended to have an effect on the price or value of commodity derivatives;
- attempted insider dealing and attempted market manipulation; and
- certain high-frequency electronic trading activities.
The expansion of scope to all EU trading venues will make it difficult for buy-side market participants, such as hedge funds and other fund managers, to identify whether a particular financial instrument is within the scope of the market abuse regime. MAR provides that ESMA must compile a centralised list of financial instruments that are admitted to trading but, somewhat unhelpfully, makes clear that the regime applies to financial instruments regardless of whether they are included in ESMA's list, which means that it will not be possible to use the list for compliance purposes as a definitive indication of whether or not any particular financial instrument is within scope.
Application of MAR outside the European Union
Importantly, MAR applies to persons wherever located (inside or outside the European Union) in relation to behaviour concerning financial instruments that are admitted to trading on an EU trading venue. Market participants based outside the United Kingdom and European Union will need to be alert to the extraterritorial application of MAR. For example, where a US investment adviser trades with a US broker in the shares of an issuer whose shares are listed on the New York Stock Exchange, the adviser and broker will each be subject to the regime if, say, the shares also happen to be admitted to trading on an MTF in the United Kingdom or another EU country. This is potentially challenging because EU market abuse standards differ from those applicable under the equivalent US regime.
The Rebuttable Presumption
Market participants accused of using inside information in connection with activities that amount to insider dealing will bear the burden of proving their own innocence. The following behaviours are described as “legitimate behaviours” under Article 9 MAR and remove the rebuttable presumption that insider dealing has occurred, placing the burden of proof back on the relevant national regulator:
- Chinese walls—when a legal person has established, implemented, and maintained adequate and effective internal arrangements and procedures that effectively separate those who hold inside information from those who (i) took part in or influenced the decision-making process and (ii) acquired or disposed of relevant financial instruments to which the inside information relates on behalf of that legal person
- Where the person for the financial instrument in question is a market maker or an executing broker carrying out orders legitimately and in the normal course of his or her duties
- Where a transaction is conducted owing to a preexisting legal obligation
- Where the inside information was obtained in the conduct of merger and acquisition activities; to avoid doubt, this carve-out does not apply to stakebuilding
Accepted Market Practices
As with insider dealing, MAR also provides market participants with protections from falling within the scope of market manipulation. Under the new regime, national competent authorities can establish “accepted market practices” that allow market participants to carry out certain types of behaviour when dealing in financial markets that are customary for a particular national market, even though such activities may potentially constitute market abuse in another national market. Thus, what is an accepted market practice in one particular market may not be an accepted market practice in another. Market participants should therefore pay close attention to the type of activities they wish to carry out in each trading venue they wish to operate in.
In addition to the legitimate behaviours described above, MAR allows for certain practices involving the disclosure of inside information, known as “market soundings”, to exist. The introduction of the new market soundings regime is a further development on MAD and allows issuers, secondary offerors, emission allowance market participants, and any party acting on behalf of the above to disclose inside information to one or more potential investors in order to gauge interest in a transaction and the terms and conditions relating to it. Disclosing parties must ensure that all such information disclosed is recorded and includes the identity of (i) the proposed investor to which it is disclosed and (ii) the individuals representing the investor. In addition, that record must be made available to the relevant regulator upon request.
Under MAR, recipients of market soundings are under an obligation to assess for themselves whether they possess inside information, and if in possession of inside information, when they cease to possess that inside information. ESMA considers that such an assessment should take into account all information that an investor possesses, including information received from sources other than the disclosing party. The investor cannot rely on an assertion by the issuer that certain information received is not inside information or, if it participates in a market sounding, on it having indicated to the issuer that it does not want to receive inside information. Additionally, ESMA proposes that investors keep a record of their assessments, and the reasons for such assessments, for five years.
We will consider market soundings from the issuer perspective in more depth in our upcoming LawFlash on the implications of MAR for issuers.
Suspicious Order and Transaction Reporting (STOR)
MAR requires all persons who professionally arrange or execute transactions to maintain effective systems and procedures to detect and report suspicious transactions and orders and cancellations thereof. Any such orders, transactions, or cancellations that could constitute insider dealing, market manipulation, attempted insider dealing, or attempted market manipulation must be reported to the trading venue’s regulator without delay. Whilst there is some debate surrounding who falls within the definition of a person professionally arranging or executing transactions, ESMA and national regulators appear to be including portfolio and fund managers within this definition.
The new regime goes beyond the obligations placed on market participants under MAD. The requirement to maintain systems and procedures to detect suspicious transactions and report them to the relevant regulator may require some market participants to make significant changes to their current technology infrastructure.
In addition to the above, MAR also regulates persons who make investment recommendations and how such investment recommendations may be disclosed or disseminated in the media. In short, persons who make investment recommendations must take reasonable care to ensure that their investment recommendations are “objectively disclosed” and note any conflicts of interest in relation to the relevant financial instruments. In March 2016, the European Commission issued regulatory technical standards that cover the technical arrangements for the objective presentation of investment recommendations and disclosure of particular interests or indications of conflicts of interest.
MAR requires EU member states to put into place effective mechanisms to encourage whistleblowing and to provide whistleblowing protections. MAR further introduces a set of investigative powers that national regulators should be given, including powers to obtain documents and telephone and data communication records from third-party providers, to compel attendance at interviews, and to exercise entry, search, and seizure powers. In this regard, the United Kingdom is ahead of other EU states, and in these respects, MAR brings the rest of the European Union up to the UK position. In addition, MAR provides for a range of penalties that regulators should have the power to impose, which include disgorgement of the profits gained or losses avoided as a result of the breach, a fine of up to €5 million for an individual guilty of insider dealing or market manipulation, and a fine of up to €15 million or 15% of annual turnover for a corporate guilty of insider dealing or market manipulation.
Cooperation with Third Countries
MAR states that, where necessary, national regulators should enter into cooperation agreements with the supervisory authorities of third countries concerning the exchange of information, and the enforcement of obligations arising under MAR, in third countries. National regulators proposing to enter into an arrangement of this kind must inform ESMA and the other national regulators with which they wish to cooperate.
The Criminal Offence of Insider Dealing
In light of MAR, the expanded UK market abuse regime now includes the expanded definition of insider dealing and the wider range of financial instruments and markets. However, MAR does not touch in any way the UK criminal insider dealing regime under Section 56(1) of the Criminal Justice Act 1993. The United Kingdom is therefore left in a position where insider dealing by amending or cancelling an order after coming into possession of inside information, or insider dealing on an MTF or OTF, is capable of being punished by a fine under the civil regime but is not a criminal offence. The UK government has indicated its intention to bring the criminal regime into line with MAR.
The Implications of Brexit
Regarding the Brexit vote, pending the United Kingdom’s actual departure from the European Union, the United Kingdom remains an EU member country and must abide by its legislation. This obligation also exists under the United Kingdom’s own legislation. On 24 June 2016, the day after the United Kingdom leave/remain referendum, the FCA released the following statement: “Firms must continue to abide by their obligations under UK law, including those derived from EU law and continue with implementation plans for legislation that is still to come into effect”. It is worth noting that the United Kingdom was the first European country to enact a civil market abuse regime, doing so via FSMA, which took effect on 1 December 2001. In the wake of the United Kingdom’s move, the EU authorities soon identified the value of a common approach to market regulation, which led to MAD in 2003, whose provisions required implementation in member states by 1 July 2005.
Notably, the United Kingdom’s previous market abuse regime was super-equivalent to MAD’s requirements, and the United Kingdom’s own implementation of MAD retained most of that super-equivalence. For example, the scope of the UK regime back then included nonregulated markets, such as the UK Alternative Investment Market (AIM). It is prudent to note that the UK government and the FCA certainly believe in tough market regulation, and following any Brexit, market abuse will, in our view, not likely be a target for deregulation.
In sum, MAR introduces a range of significant changes for investment managers, buy-side firms, and sell-side firms (and listed issuers). Firms on the buy side and sell side, wherever they are located in the world, must consider their potential obligations under MAR and ensure that their systems and controls and training programmes protect against breach of the expanded regime.