This article looks at the requirements of the EU's Market Abuse Regulation and the changes UK firms will need to adjust to
The Market Abuse Regulation (MAR) (Regulation (EU) No 596/2014) starts applying in all EU Member States from 3 July. It replaces the Market Abuse Directive (MAD) and its implementing legislation with an updated and more uniform EU-wide legal framework for the prevention of insider dealing, unlawful disclosure of inside information and market manipulation. Where MAR relies on concepts introduced by the recast Markets in Financial Instruments Directive and accompanying Regulation (MiFID 2) (particularly, as discussed below, in relation to its scope), the relevant MAR provisions will not apply until MiFID 2 becomes operational, moment now postponed until 3 January 2018.
The Commission must approve delegated measures under MAR. It has already adopted a Delegated Regulation, dated 17 December 2015, and has yet to adopt the regulatory and implementing technical standards which ESMA submitted in draft to the Commission in September 2015 (draft standards). References in this article to detailed regulation are to the current draft version of the standards, which may yet vary when adopted in final form. ESMA will also publish non-binding guidelines on several aspects of MAR.
MAR (and any EU delegated measures adopted under MAR) will not require implementation by EU Member States, as MAD and its implementing legislation did. The UK's HM Treasury plans to accommodate MAR by removing the provisions in the Financial Services and Markets Act 2000 (FSMA) that set out the civil offences for market abuse under the current UK regime and amending those provisions in the Financial Services Act 2012 on false or misleading statements and impressions. HM Treasury will also amend the provisions in FSMA relating to the enforcement powers of the Financial Conduct Authority (FCA).
In turn, the FCA plans to delete those provisions in the FCA Handbook which are covered by MAR (signposting instead the relevant MAR provision) while retaining any existing guidance which is not incompatible with MAR. Current evidential and conduct provisions in the FCA Handbook, for which there is no equivalent provision in MAR, will be preserved as non-legally binding guidance (unless irrelevant for MAR purposes or incompatible with it).
This article focuses on aspects of interest for investors and providers of financial services. It does not cover aspects of more direct relevance to issuers of financial instruments, such as the provisions on delayed disclosure, maintenance of insider lists or management transactions.
MAR's scope of application is considerably wider than that of MAD. It now extends to financial instruments traded on any trading venue, be it regulated markets, multilateral trading facilities (MTFs, including SME growth markets under MiFID 2) or MiFID 2 organised trading facilities (OTFs). MAR also captures financial instruments entered into over the counter (OTC) when their value depends or has an effect on the value of financial instruments traded in trading venues. MAD did not cover market abuse in relation to MTFs or OTFs, nor market manipulation via OTC derivatives (which is already within the UK's market abuse regime through the concept of "related investments" in FSMA 118A(1)(iii)). The scope will be further expanded to include emission allowances and other financial instruments as defined in MiFID 2.
MAR also expands the ban on market manipulation to include benchmarks (which in the UK have been subject to the market abuse regime since 2013) and spot commodity contracts. Wholesale energy spot contracts are excluded from this ban because they are already subject to the Regulation on Energy Market Integrity and Transparency (REMIT). MAR not only bans manipulation of spot commodity contracts that affects financial instruments, but also the manipulation of financial instruments that impacts on the price or value of spot commodity contracts. Whereas the former form of spot commodity markets manipulation is already caught in the UK by the super-equivalent market abuse provisions, as scoped in FSMA 118A(3), the latter (manipulation of the underlying subject matter through trading in financial instruments) is arguably not yet within the scope of the UK regime.
MAR's territorial scope is therefore defined by reference to financial instruments traded on EU trading venues, regardless of whether the relevant act or omission occurs inside or outside a trading venue and inside or outside the EU, or whether it impacts the price of one of the relevant financial instruments or of the commodities underlying them.
Stabilisation trades are exempt from MAR. These are trades which a firm undertakes for a predetermined period of time to support the market price of a security after a significant distribution of that security. MAR defines "significant distribution" as an offer of securities which is distinct from ordinary trading. In its introduction to the draft standards, ESMA explains that block trades are not considered primary or secondary issuance and cannot benefit from the exemption. MAR sets requirements, which the draft standards develop, that stabilisation measures must meet to benefit from this exemption. The stabilisation programme must be disclosed in advance and include references to the length of the exercise, the name of the stabilisation manager and the characteristics of any over-allotment option.
3. Insider dealing: definition of inside information
Insider dealing arises where a person possesses inside information and uses that information when buying or selling financial instruments to which that information relates. The definition of inside information in MAR is very similar to that in MAD and its implementing legislation, broadly being information that:
- relates directly or indirectly to issuers or financial instruments;
- has not been made public;
- is precise, ie. specific enough to enable a conclusion to be drawn as to the possible effect of circumstances or events on the prices of financial instruments; and
- if it were made public, it would be likely to have a significant effect on the prices of the relevant financial instruments because it is information a reasonable investor would be likely to use in his investment decisions.
The definition in relation to commodity derivatives is still more restrictive than that applied to other financial instruments: MAR requires that, to be inside in nature, information related to commodity derivatives (or related spot contracts) should be such that it is disclosable on the markets in accordance with legislation, market rules, contract or custom.
The definition now also clarifies that intermediate steps in a process leading to circumstances or events may also be precise enough to qualify as inside information. This clarification echoes the decision of the European Court of Justice (ECJ) in Markus Geltl v Daimler AG (Case C-19/11), where the ECJ held that discussions at a German company between the Chairman and the Supervisory Board regarding his early departure constituted disclosable inside information when the discussions first took place, and not only at the later stage when the Supervisory Board confirmed the early departure.
Recital 25 of MAR now also enshrines the ECJ's jurisprudence in Spector Photo Group (Case C-45/08). In that decision the ECJ held that if a person who is in possession of inside information deals on the related financial instruments there is a rebuttable presumption that he has dealt on the basis of that inside information.
MAR sets out several legitimate behaviours to which the ban on dealing on the basis of insider information does not apply. They include, inter alia, dealing where Chinese Walls ensure that that the person who took the decision to deal was not in possession of inside information, dealing as market-maker and dealing to execute orders on behalf of third parties. Using information relating to clients' pending orders in the context a firm's own trading, however, amounts to insider dealing.
ESMA's introduction to its draft market sounding standards points out that information providing important context to a proposed transaction, rather than that directly related to the transaction, is inside in nature. This observation is useful when assessing the risk of insider dealing: market participants must beware of providing too much colour about a transaction when making an offer to enter into it. These remarks on the context of a transaction seem to echo the distinction under the current UK market abuse regime between trading information, which may be disclosed and dealt upon when an offer to trade is made, and strategic information which would require wall-crossing and cleansing before it can be acted upon. The concept of trading information itself mirrors that of market information under the UK's Criminal Justice Act 1993, which offers a defence from the insider dealing offence for persons who act on the basis of market information in the context of a transaction being considered or negotiated. ESMA's remarks have not been incorporated into the actual provisions of the draft standards so it remains to be seen whether ESMA will publish guidelines capable of offering the comfort provided by the trading information definition once the relevant provision in the FCA's Code of Market Conduct is removed (as a consequence of FCA's assessment that the concept of trading information is beyond the scope of MAR, and therefore not appropriate either as evidential provision or guidance).
4. Unlawful disclosure and the new market soundings regime
Unlawful disclosure of inside information arises where a person discloses inside information other than in the normal exercise of his employment, profession or duties. A novelty in MAR is the detailed regulation of market soundings. Compliance with certain requirements during a market sounding will enable sell-side firms to prove that disclosure of inside information has not been unlawful. Market soundings are defined as communications of information in order to gauge the interest of investors in a possible transaction and the conditions relating to it. The definition only refers to market soundings carried out by issuers and their sell-side advisors. It is therefore uncertain whether the legislator intended that the market sounding rules should apply in buy-side driven operations, such as in the context of a reverse accelerated book build. What is clear is that the new regime will not apply to intermediaries along the distribution chain: a broker who has been approached by an issuer would not be subject to (nor be able to benefit from) the rules when contacting its clients to gauge interest in the placement of securities. ESMA's introduction to its draft standards also helpfully explains that the regime does not apply where the parties are actually trying to conclude a transaction.
The person carrying out the market sounding (the disclosing market participant (DMP)) will be required to (i) consider whether the process will involve the disclosure of inside information, (ii) keep a written record of his conclusion as well as of all the information disclosed, and (iii) provide those records to the competent authority upon request.
Before disclosing any inside information the DMP must obtain the consent of the investor and wall cross him by highlighting the investor's obligations to refrain from dealing on the relevant financial instrument and keep that inside information confidential. ESMA's draft standards set out in more detail the contents and sequence of the script that the DMP must use when sounding investors. DMPs must draw up sounding lists containing the names and contact details of the investors approached during the sounding. This is a less burdensome and intrusive requirement to that applying on issuers' insider lists, which may have to provide sensitive data such as private address and contact numbers. The draft standards also regulate the form in which such information must be minuted when communicated in unrecorded meetings or telephone conversations.
The DMP must also provide the investor an estimate of when the information will cease to be inside information and inform him as soon as possible after this has happened (for example, after the information has been cleansed by announcing it to the public by means of a press release or publication in the relevant regulatory information system). This will be important for the investor when deciding whether to accept being wall crossed or not.
A DMP must also use a script, and keep records and sounding lists, even when it considers that no inside information is being relayed during a market sounding. There is no sanction for non-compliance with this requirement, however domestic regulators will likely be interested in seeing an audit trail of the occasions when DMPs have concluded that they were not disclosing inside information. The investor receiving the market sounding must also assess for himself whether or not he has received inside information. ESMA is currently consulting on guidelines for investors receiving market soundings. It is proposing that, where an investor disagrees with the DMP's assessment of the nature of the information relayed, he should tell the DMP only where the discrepancy of opinion is based directly on the information received from the DMP (rather than on other information available to the investor). If, contrary to the opinion of the DMP, the investor assesses that the information is not inside in nature, that investor, even if wall-crossed, can disregard the DMP's assessment and the prohibition on insider dealing (although at the risk of having made a wrong assessment).
5. Prohibition of market manipulation
Market manipulation consists of behaviour which gives false or misleading signals as to the supply or demand of financial instruments or secures their price at an abnormal or artificial level, unless that behaviour is carried out for legitimate reasons and conforms with an accepted market practice (AMP). Market manipulation can also involve the use of fictitious devices or the dissemination of information or rumours.
MAR provides an indicative list of behaviours that amount to market manipulation, such as collaboration to secure a dominant position on a financial instrument, attempts to disrupt the functioning of a trading system or the taking advantage of media access to voice an opinion on a financial instrument and subsequently profiting from that opinion's impact on the price of the financial instrument.
Annex I to MAR provides indicators of market manipulation that relate to, inter alia, the volume of transactions, the aggregate position of the person entering into them, the time span over which transactions are entered into, whether beneficial ownership of the financial instrument has changed, or whether positions are been reversed within a short period. The annexes to the Commission's Delegated Regulation contain useful descriptions of practices that may lie behind the Annex I indicators. Apart from more widely understood practices such as "layering and spoofing" and "pump and dump", the annexes comment on other practices such as "smoking". ESMA's technical advice, from which those annexes originate, also included an interesting discussion of the approach adopted in developing the list of practices. It commented on recital 39 of MAR (on market abuse collaboration) and suggested that firms offering trading software (such as a direct market access provider) may be held directly liable for market abuse in relation to the trades of their clients. It also commented on the definition of "orders", which should be interpreted as including rejected orders that have not been entered into the order-book but can still provide useful information to the market participant submitting them.
Domestic regulators can, following prior notification ESMA, establish AMPs taking into account criteria provided in MAR. Domestic regulators must notify ESMA of AMPs established before 2 July 2014 and those AMPs will be grandfathered until ESMA has issued an opinion on them. A negative opinion from ESMA can be disregarded by domestic regulators if they set out their reasons for going ahead with establishing the relevant AMP.
6. Investment recommendations
Related to the ban on market manipulation are the requirements on persons who disseminate investment recommendations. Those persons must ensure they present information objectively and disclose their interests concerning the financial instruments to which that information relates.
ESMA's draft standards follow the same structure as the relevant MAD implementing legislation (implemented in the UK by COBS 12.4 of the FCA Handbook) and develop the requirements as regards the:
- identity of producers of recommendations;
- objective presentation of recommendations;
- disclosure of interests or conflicts of interests; and
- arrangements for dissemination of recommendations produced by third parties.
Although the main requirements remain broadly unaltered, firms need to carefully compare the current requirements with those under the draft standards and adapt their systems accordingly. By way of example, the draft standards:
- in addition to requiring analysts and experts to disclose whenever their recommendations have changed over the course of the previous year, now also require them to facilitate a list of all their recommendations for the preceding year; and
- reduce to 0,5% the threshold for disclosing positions (be it long or short) in the total issued share capital of the issuer to which a recommendation relates.
7. Suspicious order and transaction reporting
Operators of trading venues and persons who professionally arrange or execute transactions must have systems to detect suspicious transactions and orders (even if cancelled or not executed), and report them without delay to their competent authority. Reporting of suspicious orders is a new requirement under MAR, as MAD implementing legislation (implemented in the UK through SUP 15.10 of the FCA Handbook) only required reporting of suspicious transactions. Reporting should follow the harmonised template for suspicious transactions and orders reports (STORs) that ESMA proposes in its draft standards. ESMA also suggests that reporting should take place without delay once a firm has formed reasonable suspicion. However if preliminary analysis is required to determine whether a transaction or order is suspicious, firms should carry out that analysis as quickly as practicable. Entities must base their decision to report on all the information available to them, including public information on other trades by their client, though firms should avoid making presumptions about other activities.
The draft standards require that firms, as part of their market abuse detection systems, should keep record of the analysis carried out with regard to suspicious orders and transactions which have been examined and the reasons for submitting a STOR or not. This means firms will also have to keep an audit trail of near-misses. ESMA has provided no indication as to what amounts to a near-miss so firms will to have assess what records to keep in view of the regime's regulatory objectives (which include the improvement of surveillance systems and STOR submissions). Firms should also consider keeping a record of near-misses, and the rationale for not submitting a STOR, where the decision to submit or not hinged on an assessment of whether relevant information was price sensitive or not.
ESMA recognises that automated surveillance may not always be appropriate or proportionate and firms should be able to rely on manual detection where the front office is still involved in order dealing. Entities must, however, ensure that the systems they implement are effective to meet their monitoring and reporting obligations. Persons who professionally arrange or execute transactions may delegate their obligations within their group. They may also outsource data analysis and alert generation, provided they are able to keep the services received under assessment and have direct access to the data subject to outsourcing. In both situations the arrangements must be documented and the person delegating or outsourcing remains fully responsible for compliance.
MAR orders Member States to facilitate whistleblowing in relation to market abuse and allows them to provide financial incentives to whistle-blowers whose information results in the imposition of sanctions for MAR infringement. Although FCA has already established that it will not offer such incentives, their adoption by other Member States could affect the behaviour of employees at UK firms.
8. Final remarks
As usual when faced with recast legislation, compliance officers are well advised to not only undertake a gap analysis to identify the key action points relevant to their organisation but also use the opportunity to carry out a full review of the organisational measures needed to comply with both old and new requirements. For MAR this should involve a review of corporate access policies, watch and restricted lists, personal account dealing policies, Chinese Walls, pre- and post-trade surveillance and reporting systems, and training. Such warning calls to compliance officers are however probably unnecessary by now: FCA has sought to focus minds by showing that it will fine and adopt prohibition orders against compliance officers if they do not take steps to prevent, challenge and report market abuse.