Original article published in City AM.

MPs coming back to Westminster after the summer recess will be returning to financial markets that have shown levels of volatility not seen since the banking crisis. While it is unlikely that the recent share rout will lead to another global meltdown, it will give added impetus to MPs’ efforts to pass legislation aimed at cleaning up the markets.

Curbing bad behaviour among traders is one of the major aims of the Fair and Effective Markets Review (FEMR), launched at the Mansion House by Mark Carney earlier this year. The FEMR aims to toughen regulation of the Fixed Income, Currencies and Commodities (FICC) markets to achieve better conduct. Just yesterday, writing in City A.M., the chancellor lauded the Review as part of his ambition to restore “integrity in financial markets”. But while a major step forward, the FEMR is fundamentally flawed in one key and vitally important area. Why?

The FEMR starts by saying that, although parts of the financial markets appear remote, they actually affect us all as individuals or consumers. So far so good. But the only solutions to misconduct it proposes are actions to be taken by the financial industry and regulators. Punitive actions include investigations by the FCA, the imposition of enormous fines, potential clawback of bonuses and the prosecution of individual perpetrators. But the FEMR fails to address compensation for the victims of market abuse.

The Review provides no new recourse for ordinary companies that have suffered disastrous losses from being sold inappropriate products – for instance, based on benchmark rates which may have been manipulated. This year alone, the Treasury has received a windfall of £1.4bn in FCA fines, but without achieving any reduction in the barriers to compensation. So does the FEMR do anything to protect these victims of wrongdoing?

It appears not. The existing opportunities for compensation for victims are very restricted. These include a claim to the Financial Ombudsman Service. However, there is a compensation limit of £150,000 – completely inadequate for many claims by businesses, which have often suffered losses that run into millions of pounds. Claims for damages can be made under the Financial Services and Markets Act 2000 (FSMA) for breaches of FCA regulations, but such claims can only be made by individuals, not businesses. Even then, that person must take the claim through the courts. Not only does this involve uncertainty because of the state of the law, but at a time when access to justice is under threat from various directions, it requires the claimant to incur substantial costs, including the possibility of liability for the costs of the financial institution should the claim be unsuccessful.

The FCA has in the past recognised that existing remedies are inadequate by setting up ad hoc compensation schemes, like that for mis-sold interest rate swaps. But these have been criticised as being too limited in scope and for their rules being agreed in advance between the FCA and the banks themselves.

Thus, the FEMR has two major flaws. First, it is silent on victim compensation or is, for want of a better word, victim-lite. It is all well and good that banks are fined and senior management prosecuted, but what about the victims who may have suffered life-threatening damage to their companies? They are left having to fight alone against powerful banks. Not only this, but victims also have to overcome the major litigation hurdle of the bank’s exclusion clauses that apply even where the bank is in breach of regulatory obligations.

Second, the FEMR ignores the effect that market misconduct has on ordinary companies. It assumes that most participants are highly sophisticated and can look after their own interests and, therefore, “caveat emptor” should apply. It suggests that “only 9 per cent of the forex market involves non-financial counterparties”. However, that is in no way insignificant – it amounts to $500bn traded per day.

Part of the problem with the FEMR is that it appears to have been written mostly by and with the help of insiders – the regulators and market participants. The “owners” of all but one of the Review’s recommendations are regulators, governmental bodies or financial firms. There is only one reference to end users – that they should be represented on the proposed Market Standards Board – and who exactly will be represented remains to be seen.

In short, the FEMR does not go far enough to strengthen markets and achieve better conduct because further criminal offences and fines will not directly compensate the victims of future misconduct.

What should be done? A regime is needed that reduces the barriers to compensation, by allowing all victims to bring direct claims of market misconduct, and that provides regulators with the power to direct market participants to compensate the victim without the victim having to face the uncertainties of litigation against a powerful opponent.