This article first appeared in Compliance Monitor.

On 6 February 2020, Mark Steward, Executive Director of Enforcement and Market Oversight at the Financial Conduct Authority (“FCA”), spoke at the 19th Annual Institute on Securities Regulation in Europe.1 His speech, summarising the state of market integrity, sets out the FCA’s strategic approach to cleaning up the markets and questions whether the FCA’s role in surveilling market activity and taking enforcement action has had a deterrent effect.

Steward opened his speech by underlining the importance of international co-operation in tackling market abuse, acknowledging that common principles form the bedrock of laws and practices across the UK, EU and US. These comments, made a mere week after the UK exited the European Union, no doubt served as a reminder to his European counterparts of the significance of co-ordination and co-operation in tackling market integrity issues. Thereafter, his speech covered the increased availability of market data; measurements of market cleanliness; the impact of enforcement actions; and the FCA’s recent pivot towards market manipulation cases.

Market Data

The FCA’s increased use of, and reliance on, data points was a key theme throughout Steward’s speech. He highlighted the importance of three such data points:

  • MiFID II transactions reports, of which the FCA received 9.8 billion in 2019. MiFID II increased the scope of transaction reporting to include any transaction relating to cash equities, security derivatives, FX, commodities and interest rate derivatives;
  • the FTSE 300 order book, which generates 150 million order reports per day; and
  • a database of Suspicious Order and Transaction Reports, which are required to be lodged by a trading venue if it suspects that orders and transactions, including cancellation and modifications, could constitute insider dealing, market manipulation or attempts thereof.

In light of this consolidation of data, Steward appears to believe that the FCA has full visibility and, consequently, increasingly sophisticated tools for monitoring the markets, prompting him to observe that, “Little in the cash market is now unobservable or undetectable”.

Market Cleanliness

After touching on the sources of data that the FCA now relies on, Steward moved on to discuss how the FCA measures market cleanliness. He gave an overview of the annual market cleanliness metric (the “MC metric”) which is based on the percentage of abnormal movements in price in the two days preceding a takeover announcement and is perceived to be a proxy for insider dealing. Acknowledging that the small sample size – given that takeovers represent only a small fraction of market activity – and potential for legitimate market speculation ahead of expected takeover announcements were limitations to the MC metric, he went on to describe an additional metric, developed in 2018, known as the Abnormal Trading Volume ratio (“ATV”).

The ATV draws on the sources of data highlighted above, covering not just takeovers but over 1,000 price-sensitive market announcements, including products such as contracts for difference and spread bets, known to have been used by insider dealers and not previously considered in the MC metric. The ATV also accounts for changes in volume, not only price. It is calculated by observing movements in the trading volumes of relevant securities which are the subject of unexpected price sensitive announcements. While this undoubtedly makes better use of the breadth of new data to which the FCA has access, it also highlights how the scope of surveillance is an unending game of “cat and mouse”. Any and all metrics for market cleanliness are only useful if there is, to begin with, an awareness of how the market is being manipulated and what the resulting indicative market behaviour looks like. Nonetheless, Steward notes that the MC metric has shown improvements in market cleanliness in the past decade, with a 20% improvement between 2008’s result of 30% and 2018’s result of 10%. He considers this trend to be supported by 2019’s initial ATV result of 6.4%.

Impact of Enforcement Actions

Given the apparent improvement in market cleanliness, what then may have caused it? Steward attributes the improvement, in large part, to the FCA’s increase in enforcement activity, pointing to increased investment in tackling market abuse and successful prosecutions resulting in substantial custodial sentences and financial sanctions. However, he also offers a more holistic view of how the FCA may have brought about the reduction in insider dealing, pointing specifically to collaborative efforts between Supervision and Enforcement to ensure that market participants properly control information to prevent leakage and report suspicious activity.

Steward concludes this topic by speculating that the FCA’s increased capability to detect market abuse, and the industry’s knowledge of such increased capability, is a significant deterrent in itself. The suggestion that potential market abusers may reconsider whether the risk is worth it in light of the ever-growing likelihood of being caught is nothing new – indeed, one of the main drivers of robust enforcement has long been its usefulness as a deterrent. It will be interesting to see whether, as the FCA gets to grips with its ever-increasing data sources, this translates into fewer instances of potential market abuse.

Market Manipulation

Steward ended his speech by highlighting the increase in market manipulation cases as a proportion of the FCA’s market abuse portfolio. Referring to the fact that the FCA has decided to incorporate the “equity order book” (which includes orders placed but not transacted) into its market surveillance operations he explained that that detection of market abuse is very difficult, if not impossible, when using transaction data alone. This admission suggests that prior to having access to this order book, the FCA was simply not equipped to detect, and therefore unable to effectively bring enforcement action in relation to, any market manipulation. This additional capacity is clearly enabling the FCA to investigate more complex market abuse schemes which do not merely involve “transactional” or “opportunistic” trading but, rather, extend to groups of perpetrators engaged in elaborate and sophisticated strategies over prolonged periods of time.

The detection and enforcement of market abuse has increasingly become a focus of the FCA over the last few years. As Steward points out, in part this focus is born of the regulator’s increased capacity for surveillance and oversight of the markets. More data and international co-operation are no doubt significant factors in tackling market misconduct. However, market abuse is not static; the techniques and products used to manipulate the market will adapt, both to the FCA’s means of detection and to technological development. Data has restrictions, and patterns by which to identify market abuse can quickly become redundant.