In September 2011, an unofficial draft of the European Commission’s (the Commission) proposals for a new market abuse regime covering insider dealing and market manipulation (MAD II), was received by certain market participants. MAD II is intended to amend and update the existing Market Abuse Directive 2003/6/EC (MAD).
The primary function of MAD was the introduction of a framework for tackling market abuse. However, over the 8 years since MAD came into force, the Commission has identified a number of problems that have emerged as a result of regulatory, market and technological developments, including:
- gaps in the regulation of new markets, platforms and over-the-counter instruments;
- gaps in the regulation of commodities and related derivatives; regulators lacking certain information and powers;
- sanctions either lacking or insufficiently dissuasive, meaning regulators cannot effectively enforce under MAD; and
- the existence of numerous options and discretions in MAD, as well as a lack of clarity on certain key concepts, undermines its effectiveness.
It was in the context of these problems that the Commission undertook to carry out a review of MAD and then in turn published its MAD II proposals. The major, and for the purposes of this note, most important provisions will be set out in a new market abuse regulation (the Regulation), which will be directly effective throughout European Union member states from when it is passed, on a par with national laws. The elements of MAD II dealing with criminal sanctions will be set out separately in a new directive (the Directive), which will require separate legislative implementation by the government in each member state within two years of coming into force.
Key changes proposed by the draft of MAD II are explained below, including the provisions that extend its scope to cover commodities derivatives. These include a specific definition of what constitutes “inside information” with respect to commodities, the categorisation of emission allowances and a broader range of commodities derivatives as “financial instruments”, and the extension of the market abuse offences to cover spot physical commodity markets.
1. Increased Scope of MAD II
The Regulation extends the range of financial instruments susceptible to market abuse, and hence captures a broader range of behaviours than previously applied. The relevant instruments include:
- any financial instrument admitted to trading on a regulated market or traded on a multilateral trading facility (MTF) or other new types of organised trading facilities (OTF)1 in at least one member state, irrespective of whether or not the behaviour or transaction takes place on that market;
- other financial instruments whose value depends on the financial instruments traded on a regulated market, MTF or OTF.
Therefore, activities / behaviour relating to the following financial instruments, which may not have fallen foul of MAD, will fall under the spotlight of MAD II:
- financial instruments, including derivatives and credit risk transfer instruments where the transaction, order or behaviour has or is likely or intended to have an effect on a financial instrument traded on a regulated market, MTF or OTF;
- spot commodity contracts where the transaction, order or behaviour has or is likely or intended to have an effect on a financial instrument traded on a regulated market, MTF or OTF;
- a financial instrument traded on a regulated market, MTF or OTF where the transaction, order or behaviour is or is likely or intended to have an effect on spot commodity contracts; and
- emissions allowances, which are expected to be categorised as financial instruments.
Market reaction to this expansion has been mixed. While some commentators are broadly in favour, others have said that the Regulation should only focus on conduct which has an effect on the instruments that are admitted to trading on the target markets, i.e., a regulated market, MTF or OTF, and not contracts traded on the underlying spot markets.
2. Inside information definition
The definition of “inside information” in the Regulation is broader than it was under MAD. In particular, there is now a specific definition in relation to derivatives on commodities, namely:
“Information.... relating directly or indirectly, to one or more such derivatives or to the related spot commodity contract, and which, if it were made public, would be likely to have a significant effect on the prices of such derivatives or related spot commodity contracts; notably information which is required to be disclosed in accordance with legal or regulatory provisions at the Union or national level, market rules, contracts or customs, on the relevant commodity derivatives or spot markets.”
Inside information on emission allowances is specifically covered at Article 6(1)(c).
3. Market Manipulation definition
The Regulation sets out a new definition of market manipulation, which captures:
“(a) entering into a transaction, placing an order to trade or any other behaviour:
– which gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument or a related spot commodity contract; or
– which secures, or is likely to secure, by a person, or by persons acting in collaboration, the price of one or several financial instruments or a related spot commodity contracts at an abnormal or artificial level;”
The inclusion of spot commodity contracts is a new concept for the market abuse regime.
Moreover, both actual and attempted market manipulation are now prohibited under the Regulation. Attempted market manipulation is defined as: “trying to enter into a transaction, trying to place an order to trade or trying to engage in any other behaviour [that constitutes market manipulation]”.
This broadening of the scope to cover attempted manipulation is consistent with the position under U.S. law, where almost all enforcement actions by regulators have been brought under the attempted manipulation offence.
4. Administrative Measures and Sanctions
With respect to enforcement of the Regulation, competent authorities will have a number of administrative measures and sanctions available to them, including:
- cease and desist orders;
- public censure;
- withdrawal of MiFID authorisation;
- suspend trading of relevant financial instruments;
- freezing / sequestration of assets;
- a fine of up to €5,000,000 (for a natural person), or 10% of its total annual turnover (for a legal person) or twice the amount of any financial benefit obtained or loss avoided (if this can be determined).
Under the Directive, member states are required to take the necessary measures to ensure that insider dealing and market abuse are criminal offences, punishable by criminal sanctions that are “effective, proportionate and dissuasive”. Inciting, aiding and abetting market abuse will be similarly punished.
The Regulation requires that member states put in place adequate arrangements to encourage whistleblowers to alert the authorities as to possible breaches of the Regulation and to protect them from retaliation. Whistleblowers may be provided with incentives for doing so, where they bring to light new information which they are not already legally obliged to notify and where this information results in a sanction for a breach of the Regulation.
Article 2(5) of the Regulation states that it will apply to actions carried on inside or outside of the European Union that relate to instruments covered by the Regulation. This extraterritoriality correlates with anti-manipulation rules set out in the Dodd-Frank Act, which applies to activities occurring outside the US which have an effect on US markets.