The FCA has now completed its thematic review of asset management firms and the risk of market abuse (TR 15/1), which it announced in its 2014/15 Business Plan. Alongside client conduct risk, market conduct risk is a key component of the FCA’s conduct risk agenda.

In TR 15/1, the FCA identified examples of “good practice” and “bad practice” as well as making general observations. In addition to the obvious utility of the issues highlighted in TR 15/1 for buy-side managers, TR 15/1 contains useful observations for sell-side brokers both in their dealings with the buy-side and in examining their own systems and controls for mitigating the risk of market abuse.

The FCA’s observations in TR 15/1 are significant in light of the following cases:

  • the enforcement action in Einhorn and Greenlight Capital (January 2012) on insider dealing;
  • the criminal prosecution in Milsom (March 2013); and
  • the enforcement action on improper disclosure in Hannam (February 2012 confirmed by the Upper Tribunal in October 2013).

The FCA would expect firms to take these into account and take steps to address the types of risk which materialised in those cases. This also highlights the relevance of TR 15/1 to controlling criminal risks that may arise for individuals under the Criminal Justice Act 1993 (insider dealing) and Financial Services Act 2012 (market manipulation).

TR 15/1 will also be useful in examining steps under the EU Market Abuse Regulation (MAR), which comes into effect in June 2016, and the implementation of the Recast Markets in Financial Instruments Directive (MiFID II), which is due to come into effect in January 2017. For example, firms will have to reconsider issues governing the control of inside information in the context of market soundings under MAR and voice recordings and monitoring under MiFID II.

We have set out below our views on the next steps which sell side firms should be taking to apply these examples and observations.

1. Wall Crossing

The FCA found that firms generally had effective policies to identify and control inside information intentionally received from sell-side firms, such as investment banks. However, it also found that most policies did not address the unintentional receipt of inside information.

Points for sell-side firms to note

  • Buy-side firms will be expected to check whether the initial point of contact for soundings is independent of the relevant manager. This is to enable soundings to be rejected without sharing any information with the manager.
  • Buy-side firms will be expected to check the requirements for managers to confirm whether inside information has been received following a sounding and check consequential procedures. This would include adding the relevant issuer to the restricted list and notifying compliance.

2. Company-specific research

The FCA found that firms had practices to avoid the unnecessary receipt of inside information when conducting company‑specific research. However, these were typically informal and inconsistently applied. The FCA stated that firms should consider the benefit relative to the risk of attending meetings where there is a significant possibility that inside information might be inadvertently received.

Points for sell-side firms to note

  • Buy-side firms will be expected to check their policy on avoiding any meetings with specific companies during close periods, other than in exceptional circumstances and following pre clearance from compliance.
  • Buy-side firms will be expected to check the policy on meeting consultants who have recently worked for an issuer and the requirements in that policy for: (a) consultants to give undertakings before any meeting that the consultants will not disclose inside information and (b) for managers to document the topics discussed during meetings.
  • Buy-side firms will be expected to check that compliance is aware of any systems (such as alpha capture systems) that may involve the input of data from sell side firms, in order to monitor whether the sell-side firm is improperly disclosing inside information or front running.
  • Buy-side firms will be expected to check that managers do not rely solely on the sell-side firm’s assessment of whether any information passed to a manager is inside information.

3. Controlling access to inside information/managing risk of improper disclosure

The FCA found that all firms had a policy to limit the sharing of inside information to those who need to know it. However, only a minority of firms monitored the effectiveness of this policy.

Points for sell-side firms to note

  • Buy-side firms will be expected to check the processes for keeping a detailed log of who has inside information.
  • Buy-side firms will be expected to check the restrictions on sharing information beyond those who have been wall crossed and on limiting information to those who need the information to fulfil professional responsibilities.

4. Pre-trade controls to prevent insider dealing

The FCA found that most firms used system-based pre‑trade controls to prevent trading in restricted securities. This included recording the fixed telephone lines of staff directly involved in the investment process and, with a minority of staff, their mobile phones lines as well. Firms also documented the rationale for investment decisions before trading.

Points for sell-side firms to note

  • Buy-side firms will be expected to check that system based trade restrictions operate on a timely basis following the receipt of inside information.
  • Buy-side firms will be expected to check that any order management system prevents an order being placed until the relevant issuer is removed from the restricted list (a hard block) or has a warning prompt that has to be overridden to trade a restricted security.
  • Buy-side firms will be expected to check that policies address the placement of large trades relative to the volume of the security being traded, because knowledge of these trades could be inside information.

5. Post-trade surveillance – Insider dealing

The FCA found that only two firms demonstrated post-trade surveillance that effectively highlighted and properly investigated potentially suspicious trades. In a number of firms, effective investigation was difficult due to a lack of documentation and poor awareness of front office research activity.

Points for sell-side firms to note

  • Buy-side firms will be expected to check the process for documenting the rationale for trades, so that the documentation can be used in independently assessing any trades highlighted by post trade surveillance.
  • Buy-side firms will be expected to consider using statistical analysis systems which identify post trade price movements outside a set probability range to trigger surveillance follow up, adapting these systems to the markets to make the data output useful.
  • Buy-side firms will be expected to consider systems which highlight a manager’s patterns of successful trading prior to non routine company announcements, with mechanisms for the thorough review of all communications and follow-up interviews with the manager.
  • Buy-side firms will be expected to consider regular monitoring of the recorded telephone lines of fund managers and traders, listening to a sample of conversations.

6. Role of senior management

The FCA stated that the senior management of asset management firms need to satisfy themselves that their firm’s practices to manage the risk of market abuse are appropriate. The FCA indicated that it will follow-up on the TR 15/1 issues as part of its routine supervision.

Points for sell-side firms to note

  • Buy-side firms will be expected to ensure that senior management is fully briefed on TR 15/1 and the steps to be taken to address any issues arising from it. They should be put in a position that they are able to confirm that practices address any TR 15/1 issues appropriately.