What has happened?
The FCA has published a paper entitled “Asset management firms and the risk of market abuse” , which sets out findings from its Thematic Review of how asset management firms control the risk of committing market abuse. The FCA considers that its work in this area is key to its objective of protecting and enhancing the integrity of the financial system. The review looked at the activities of 19 asset management firms with assets under management of between £200m and £100bn and considered how asset managers control a number of risks, such as insider dealing, improper disclosure and market manipulation. The report also contains suggestions of good and poor practice that the FCA observed as part of its Thematic Review. This will be extremely helpful for firms in reviewing their systems and controls to ensure that they are in line with the FCA’s current expectations of best practice in this area.
Generally, the FCA found that, in the majority of firms reviewed, work needs to be done to ensure that practices and procedures cover all material risks and that they operate effectively. The FCA focused on what it perceives to be the key aspects of an effective framework to manage market abuse risk. These include ways to:
- Minimise the risk of receiving inside information but not identifying it as such;
- Control access to inside information when it has been received;
- Use pre-trade controls to reduce the risk of market manipulation and insider dealing;
- Conduct post-trade surveillance to monitor and investigate potentially suspicious trades;
- Control personal account dealing; and
- Train staff to ensure awareness of market abuse issues.
What are the key points?
Managing the risk that inside information could be received but not identified
The first step to protecting against misuse of inside information is for a firm to identify when it has received price sensitive information. The FCA found that most firms it reviewed did not have effective policies where market soundings are made and felt that firms should improve their practices here. The conduct of market sounding exercises is an area of particular focus given the fines against David Einhorn and Greenlight Capital Inc in 2012. Furthermore, there will be significant new requirements imposed on firms conducting market soundings when the updated EU market abuse regime comes into force in January 2017.
- Good practice: A documented assessment following declined soundings could be made to ensure that any receipt of inside information is detected.
Controlling access to inside information and managing the risk of improper disclosure
The FCA noted that the vast majority of firms it reviewed used a restricted list to document the receipt of inside information. All firms limited the sharing of information to those who needed to know.
- Good practice: Firms should keep a detailed log of who has received inside information. This can help in monitoring how effective the firm is at restricting the spread of inside information.
Pre-trade controls to prevent market manipulation and insider dealing
Segregated equity dealing functions were a key feature of the majority of firms. Most had a reporting line for dealers which was independent of the fund managers. The FCA makes it clear that, in order to reduce trading errors and market manipulation, an independent check should be carried out. The FCA’s guidance on good and poor practice recognises that differently sized firms may justify different approaches and that there is no expectation that “one size” should fit all.
- Good practice: The review of fund managers’ orders by an independent colleague provides the opportunity to raise concerns before execution.
Only two firms had an effective post-trade market abuse surveillance programme. Those firms had a systematic process to identify and assess trades for suspicious characteristics. They also looked periodically for trading patterns which could indicate market manipulation.
- Good practice: Regular monitoring of recorded phone lines increases the probability of detecting market abuse and encourages staff to raise concerns that inside information may have been received.
Personal account dealing policies
The FCA’s rules require firms to have personal account dealing policies and all the firms reviewed had them in place. The FCA reiterates its requirements in COBS 11.7, including the need to put in place adequate arrangements aimed at preventing market abuse.
- Good practice: Pre-trade approval and post-trade reviews should be in place to monitor suspicious activity in relation to personal account dealing.
All except one of the firms reviewed provided training on market abuse. However, it is important for this to take place on a regular basis to enable up-to-date information to be provided to employees; to discuss recent changes; and to allow senior management to reiterate the company approach to market abuse risk. Firms should ensure that training they provide is tailored to their particular business.
- Good practice: Face-to face-training should complement online training as it allows discussion of scenarios and enables people to have a full understanding of how the rules work in practice.
What does this mean in practice?
All firms need to be acutely aware of the FCA’s increased spotlight in this area. Firms should review their market abuse policies to ensure that they are sufficiently robust on the points identified in the thematic review. In addition, firms should consider both the good and bad practices identified in the review to ensure that they are not carrying on any bad practices. The FCA reminds firms that their review is complemented by routine market surveillance and enforcement action.
Whilst the Thematic Review which led to this report was focused on the asset management sector, the guidance that the FCA provides in it will be of relevance to a much wider range of firms, including corporate finance firms, broker dealers and issuers. All firms which generate or potentially received inside information should consider the contents of this report and review their existing procedures to make sure that they are sufficiently robust to protect the firm against the risks of misuse of inside information.