In the same week that the Recast Markets in Financial Instruments Directive (MiFID 2) and its companion Regulation (MiFIR) were published, the Market Abuse Regulation (MAR) appeared in the Official Journal. MAR introduces a single directly applicable rulebook governing market conduct throughout the EU to be enforced via Member State administrative sanctions. Many of its provisions are the same as those in the Market Abuse Directive (MAD) but the scope of MAR is greater than that of MAD. MAR has also formalised certain rules and principles, particularly those governing “market soundings” which are of particular relevance to asset managers.
How is MAR’s scope greater than under MAD?
Whereas MAD applies to financial instruments admitted to trading on an EU regulated market, MAR has broader coverage and now includes instruments traded on a multilateral trading facility (MTF) and an organised trading facility (OTF), the new type of trading venue for OTC derivatives to be introduced under MiFIR.
MAR also extends the market manipulation prohibition to instruments whose value relates to the traded instruments, e.g. an OTC derivative referenced to a security traded on the London Stock Exchange. Under MAD, the related instruments prohibition applies only to insider dealing. MAR expressly recognises an OTC credit default swap (CDS) as an example of a related instrument. MAR also extends the scope of the regime to capture emissions allowances.
What does this increase in scope mean for asset managers?
Any asset manager, including a manager located outside the EU, who manages funds or portfolios containing financial instruments or related instruments captured by MAR will need to revisit their policies and practices. An asset manager will need to consider its actions with respect to any instrument that simply happens to be admitted to trading on an MTF located in the EU. Moreover, with the requirement under MiFIR for OTC derivatives to be traded on OTFs, managers may need to consider inside information issues, in particular, with respect to the issuers of, for example, unlisted debt securities, where those securities are referenced under a CDS traded on an OTF.
Are there any new market abuse offences?
Yes. Under MAR, market manipulation will catch any behaviour, not just transactions and orders to trade, that may give a false or misleading signal or otherwise fall within the other categories of market manipulation currently caught by MAD. MAR also seeks to punish “attempted market manipulation” in cases where someone tries to manipulate the market without actually trading. It will also be an offence to cancel or amend an order to trade on the basis of inside information that is received subsequent to the placing of the order.
Has the definition of inside information changed?
Under MAD, insider dealing or unlawful disclosure can only occur with respect to non-public information of a precise nature that would be likely to have a significant effect on the price of the relevant financial instruments. MAR expands this definition to make it clear that inside information includes information that a reasonable investor would be likely to use as part of the basis of his investment decisions.
MAR also confirms the decision of the European Court of Justice (ECJ) in Markus Geltl v Daimler AG [C-19/11], clarifying that, in the case of a protracted process that is intended to bring about, or that results in, particular circumstances or a particular event, those future circumstances or that future event, and also the intermediate steps of that process, which are connected with bringing about or which result in those future circumstances or that future event, may be deemed to be sufficiently precise to constitute inside information.
In this respect, an intermediate step in a protracted process shall be deemed to be inside information if, by itself, it otherwise satisfies the criteria of inside information. The extent to which the recent decision of the Upper Tribunal in Hannam v Financial Conduct Authority FS/2012/0013 will be authoritative in any interpretation of the application of the inside information provisions in MAR in the UK is questionable. However, the comments of the Tribunal regarding the partial accuracy, mistaken beliefs, the realistic prospect of events occurring and the views of a reasonable investor on whether information would have an effect on price are, at least, useful illustrations of principles captured in MAR.
What do the changes in the definition of inside information mean for asset managers?
Asset managers who are in possession of confidential information will no longer be able to limit their enquiry as to whether the information is precise and price sensitive but will need to ask themselves whether a reasonable investor would regard the information as relevant to the decision to trade in the relevant instrument. This may have the effect of further aligning the market abuse regulatory regime with industry standards, such as the Loan Market Association Guidelines on dealing with confidential and price sensitive information, and civil laws governing breach of confidence or misappropriation of information.
What about dealings between an asset manager and sell-side brokers in the course of taking “market soundings”?
MAR introduces a detailed framework for “market soundings” which “comprises the communication of information, prior to the announcement of a transaction, in order to gauge the interest of potential investors in a possible transaction and the conditions relating to it such as its potential size or pricing, to one or more potential investors by,[inter alia, an issuer or a third party acting on behalf or on the account of an issuer].”
In essence, the provisions on “market soundings” create a defence to unlawful disclosure of inside information whereby a person intending to make a takeover bid for the securities of a company or a merger with a company to parties entitled to the securities, may carry out a market sounding without infringing the rules on unlawful disclosure, provided that: (a) the information is necessary to enable the parties entitled to the securities to form an opinion on their willingness to offer their securities; and (b) the willingness of parties entitled to the securities to offer their securities is reasonably required for the decision to make the takeover bid or merger.
What conditions need to be satisfied in order for the “market soundings” defence to apply?
MAR sets out detailed duties, mainly on the disclosing party. Where a disclosing party complies with these duties, he or she will be deemed to have made the communication in the normal exercise of his or her employment, profession or duties.
First, the disclosing party must specifically consider whether the market sounding will involve the disclosure of inside information and make a written record of its conclusion and the reasons for this conclusion.
Secondly, he or she must:
- obtain the consent of the person receiving the market sounding to receive inside information
- inform the person receiving the market sounding that he is prohibited from using that information, or attempting to use that information, by acquiring or disposing of, for his own account or for the account of a third party, directly or indirectly, financial instruments relating to that information
- inform the person receiving the market sounding that he is prohibited from using that information, or attempting to use that information, by cancelling or amending an order which has already been placed concerning a financial instrument to which the information relates
- inform the person receiving the market sounding that by agreeing to receive the information he is obliged to keep the information confidential.
Thirdly, the disclosing market participant must make and maintain a record of all information given to the person receiving the market sounding and keep that record for a minimum of five years. Finally, where information that has been disclosed in the course of a market sounding ceases to be inside information according to the assessment of the disclosing market participant, the disclosing market participant must inform the recipient accordingly, as soon as possible.
What about the duties on the asset manager receiving the information as part of a market sounding?
MAR makes it clear that the person receiving the market sounding must assess for himself whether it is in possession of inside information or when it ceases to be in possession of inside information. In this respect, MAR reinforces the views of the UK Financial Services Authority (as it was then) in the David Einhorn Final Notice dated 15 February 2012 that an asset manager cannot simply rely on the implied suggestion by a disclosing broker that the information which he is receiving does not preclude it from dealing in the securities to which that notice relates.
What do the addition of the market sounding provisions mean for an asset manager’s procedures?
Under the current regime under MAD and particularly in light of the Einhorn Final Notice mentioned above, an asset manager will need to ensure that it has appropriate “wall-crossing” and other procedures for dealing with information received from sell-side brokers. However, ESMA is expected to issue regulatory technical standards amplifying the market sounding requirements for those receiving information. Asset managers will, therefore, need to monitor the ESMA proposals and, once these are final, adopt their procedures accordingly.
Does MAR add any express defences with respect to allegations of insider dealing?
MAR does not reverse the decision in Spector Photo Group v CBFA [C-45/08] in which the European Court of Justice (ECJ) held that, if a person deals whilst in possession of inside information, there will be a rebuttable presumption that the person used the inside information when dealing. However, MAR creates an express defence to this presumption for firms which have put in place effective market abuse controls, including policies, procedures and information barriers, and which have not influenced or otherwise encouraged their employees to engage in insider dealing.
MAR also sets out other defences including those for market makers, agreements entered into before a person came into possession of inside information, information about one’s intention to deal, stabilisation and activities relating to monetary and public debt management and climate policy activities.
What about the exemptions for share buy-backs?
MAR retains the exemption for share buy-back programmes with the strict requirements regarding disclosure and the reasons for which the programme is being undertaken. Those managing investment trusts or similar corporate vehicles that wish to buy-back shares from investors.
What about safe harbours and defences from market manipulation?
“Accepted market practices” will now only provide a defence to the market manipulation offence of placing an order to trade or other behaviour which gives or is likely to give a false or misleading impression as to the supply of, demand for, or price of a relevant investment or secure or be likely to secure its price at an abnormal or artificial level.
The order to trade or other behaviour will have to be undertaken for a legitimate purpose and the accepted market practice will need to be established by a competent authority and notified to ESMA and other competent authorities. The “accepted market practices” will not apply with respect to other types of market manipulation.
What about algorithmic and high frequency trading?
MAR extends the market abuse regime to capture algorithmic or high frequency trading undertaken without an intention to trade but for the purpose of, inter alia, disrupting or delaying the trading system. In this respect, MAR reinforces the efforts under MiFID II, which seeks to impose duties on regulated firms with respect to high frequency trading.
What about the types of financial instruments subject to the prohibition on market manipulation?
MAR extends the market manipulation provisions (but not insider dealing) to spot commodity contracts, excluding wholesale energy products, which are related to or have an effect on financial or derivatives markets.
With respect to commodity derivatives, MAR also aligns the definition of inside information with the general definition of inside information with respect to financial instruments generally thereby capturing information which is relevant to the related spot commodity contract.
What impact is the increased scope of the market manipulation provisions likely to have for asset managers?
For asset managers who employ algorithmic or high frequency trading as part of their strategies and those whose strategies allow them to trade in the spot commodity markets, MAR introduces further elements of regulatory risk that their systems and controls will need to address.
All relevant guidelines and draft regulatory technical standards required under MAR are to be submitted by ESMA to the Commission by 3 July 2015. MAR enters into force on the twentieth day following its publication in the Official Journal of the European Union (i.e. 2 July 2014) and shall apply from 3 July 2016. All member states must therefore have taken all necessary measures to ensure that their national laws comply with MAR by that date.
What about criminal sanctions?
Directive 2014/57/EU on criminal sanctions for market abuse (CSMAD) is also to be implemented in national legislation by 3 July 2016, although the UK and Denmark have opted out of CSMAD. The original market abuse directive (2003/6/EC) will cease to have effect from the same date. In the UK, insider dealing and market manipulation are criminal offences under the Criminal Justice Act 1993 and the Financial Services Act 2012.