Two and a half years since the Market Abuse Regulation (Regulation 596/2014) (“MAR“) came into effect, the FCA released the 58th edition of its Market Watch newsletter on 17 December 2018 (“Newsletter“) commenting on the latest developments on market conduct and transaction reporting. In this edition, the FCA reviewed firms’ compliance with MAR, reminded firms about the importance of Suspicious Transaction and Order Reports (“STORs“), made observations on market soundings and insider lists as well as warned firms about recent behavior in the Credit Default Swap (“CDS“) market which looked like “manufactured credit events”.
MAR – the background
MAR came into effect on 3 July 2016 and was intended to strengthen the UK’s previous market abuse framework by extending its scope to new markets, platforms and behaviors. It contains prohibitions on insider dealing, unlawful disclosure of inside information and market manipulation, as well as provisions to prevent and detect these. Regulators hope that these rules will increase market integrity and investor protection and therefore enhance the attractiveness of securities markets for capital raising.
Compliance with MAR
The FCA notes that compliance with MAR is “more than adhering to a set of prescriptive requirements” and praised firms who could demonstrate that their approach was responsive to changes to their business, financial instruments, market practice and the regulatory environment. In particular, firms will be expected to respond in future to developments in automated trading, encryption technologies, artificial intelligence and social media. The FCA found that many market participants had a good understanding of their obligations but that firms were struggling to comply with requirements relating to order and transaction surveillance. The FCA re-iterated its expectation that, while some delay for design and implementation of technology was to be expected in the immediate aftermath of MAR, it now expects firms to be fully compliant with their obligations to undertake required surveillance.
Suspicious Transactions and Order Reports
The FCA took the opportunity in the Newsletter to remind firms that any person professionally arranging or executing transactions must establish and maintain effective arrangements, systems and procedures for detecting and reporting suspicious orders and transactions. The FCA emphasized that it expected firms to perform surveillance across all asset classes, including fixed income and commodities, noting that 70% of the STORs it receives relate to equities trading only.
Market soundings play an important role in the functioning of markets by facilitating price discovery and allowing issuers to gauge interest ahead of new issues. The newsletter noted that 76% of issuers responding to the FCA’s survey had said that their appetite for initiating soundings had either remained constant or increased following MAR. The FCA acknowledged that low interest rates and a high demand for new issues were rendering market soundings less necessary, particularly for investment-grade bonds.
The FCA emphasized the importance of good record keeping, staff training and cleansing strategies (i.e. informing market sounding participants when information disclosed ceases to be inside information) in order to ensure compliant market soundings. Interestingly, the FCA noted that a declined wall-crossing could still convey inside information. This may occur where the sell-side only initiates soundings for a small number of securities and the buy-side representative is thereby able to infer the identity of the security. Firms should consider whether declined wall-crossings could have this effect and apply controls.
Once inside information is identified, issuers are required under MAR to create and maintain an “insider list”. This contains details of everyone who has access to such inside information. The FCA noted that it had observed “varying quality” in the insider lists it had received to date and in particular advised firms to ensure that any “permanent insider” or “above the wall” lists remain appropriate and are not disproportionately large. The FCA reiterated its expectation that completed insider lists should be returned within 2 days of a request and that it was good practice for issuers to have service-level agreements in place with HR to ensure the timely production of personal data in order to assist with this.
Manufactured Credit Events
The FCA noted that it had observed recent behavior in the CDS market which appeared to involve intentional or “manufactured” events intended to trigger payments on credit derivative instruments. While acknowledging that the behavior had so far not directly impacted the UK, the FCA noted that that such behavior “may in certain circumstances constitute market abuse” and warned firms that this can severely harm confidence and trust in the credit derivatives market. In making this announcement, the UK regulator is following the Commodity Future Trading Commission in the U.S., which released a statement in April last year warning that such behavior could “damage” the CDS market. The FCA confirmed it was liaising with other regulators and the International Swaps and Derivatives Association and would take “appropriate action” where suspected abuse was uncovered.