On 3 July 2016 the Market Abuse Regulation1 (MAR) became effective, bringing a significant change to the regulatory landscape of the European financial services sector. The Market Abuse Directive2 (MAD) ceased to apply and large swathes of national laws were repealed or amended to give way to MAR. By way of example, section 118 of the UK Financial Services and Markets Act was repealed and the provisions of the Code of Market Conduct of the UK Financial Conduct Authority (FCA) were replaced by signposts pointing to the relevant sections of MAR.
In this article we will look at some of the things that investment managers and other providers of financial services need to do (or ideally, have done by now) in connection with MAR. Changes which are of a more direct relevance to issuers of securities (such as PDMR trading, delays in disclosure and insider lists) are outside of its scope.
- Monitor the instruments you trade - changing scope of market abuse regulation
- Start investigating and reporting suspicious transactions and orders (STOR)
- Keep records of "near misses"
- Introduce automated surveillance or be ready to give an explanation to the FCA
- Train staff on STOR
- Market soundings, sell-side: implement the communication and record keeping procedures
- Market soundings, buy-side: implement the system for controlling the flow of market sounding information
1. Monitor the instruments you trade - changing scope of market abuse regulation
Any market participant whether in or outside the EU needs to monitor the instruments it trades (whether issued by EU or non-EU issuer) in order to see whether MAR applies.
MAR has extended the scope of market abuse regulation to cover:
- New markets, ie multilateral trading facilities such as AIM, and organised trading facilities created pursuant to Markets and Financial Instruments Directive3 (MiFID II)
- Financial instruments whose value affects or is affected by financial instruments admitted to trading or otherwise traded in relevant trading venues covered by MAR
- New types of financial instruments such as benchmarks and spot commodity contracts: market manipulation with spot commodity contracts is now prohibited if it affects the price of financial instruments. So is market manipulation with financial instruments that affects the price of spot commodity contracts
Further instruments and trading venues will be added to the scope once MiFID II takes effect.
As a result, some transactions without an obvious nexus to the EU may still be subject to MAR. As new instruments and new markets have been added, a market participant may not always be aware that a particular financial instrument is in fact within the scope of MAR. The consolidated list of all financial instruments traded or admitted to trading on all of the EU's relevant markets will not be available until MiFID II is in force.
In the meantime market participants are advised to ensure that they have policies, procedures and systems in place to check whether the financial instruments they wish to trade are connected to the relevant EU trading and MAR therefore applies.
2. Start investigating and reporting suspicious transactions and orders (STOR)
MAR prohibits a wider range of behaviours than MAD. An attempt to commit insider dealing or market manipulation will itself constitute a completed offence under MAR. Recital 41 of MAR provides an explanation for attempted abuse, referring to the situation where an activity is started but not completed, for example as a result of failed technology or an instruction to trade which is not acted upon.
To ensure that those attempts at market abuse get detected, MAR introduces a new suspicious reporting regime. Not only suspicious transactions but also suspicious orders (including quotes) must be reported by regulated firms within Member States. This dictates the need for analysing all orders received by the firm. Once a reasonable suspicion is formed in relation to an order or transaction, a STOR must be submitted without delay to the national regulator. In the UK, the FCA has clarified that notifications should be submitted to it via the Connect system using the new STOR form to be adopted by ESMA.
It does not matter if the firm is simply passing the order down the trading chain: each relevant market participant in the chain would have an obligation to report its suspicion. Orders or transactions which become suspicious retrospectively, in the light of subsequent events, should also be reported. Even if the suspicious order was revoked or not executed, it still needs to be reported. ESMA has also clarified that an entity who has already submitted a STOR should supplement the submitted STOR with relevant additional information that it becomes aware of subsequently.
3. Keep records of "near misses"
As part of their systems for the prevention and detection of market abuse, firms are expected to keep records of the analysis carried out with regard to suspicious orders and transactions. Where following the initial analysis or a further investigation, a decision was made not to report an order or transaction (a "near miss"), an audit trail should be left showing among other things the reasons for the decision made.
4. Introduce automated surveillance or be ready to give an explanation to the FCA
MAR requires that effective arrangements, systems and procedures are established to detect and report suspicious orders and transactions. It does not prescribe automatic surveillance systems to all market participants.
However ESMA has delivered draft regulatory technical standards (RTS) implementing the provisions of MAR. According to RTS, firms will need to have in place a system which:
- Provides effective monitoring of every on- and off-market transaction executed and order placed, modified, cancelled or rejected
- Produces alerts for further (human) analysis
- Covers the full range of trading activities undertaken
In ESMA's opinion these RTS requirements mean that "large majority" of firms would need an automated surveillance system. The higher and more complex is the level of activity of a firm, the more difficult it will be for it to justify to the FCA the absence of automated surveillance.
FCA recognizes that the new regime may require a number of significant technology changes depending on the size of the firm and the current IT systems in place. For instance, the surveillance of quotes in particular would present a significant technical challenge. Nevertheless, the FCA has clarified that it would expect firms to exercise a level of surveillance on quotes from 3 July 2016. Those firms which are unable to deploy fully effective surveillance across all types of quotes as required by MAR by 3 July 2016 are expected to demonstrate that they have made best efforts to achieve full compliance. They must be ready to explain how approaches will be further developed. Detailed and realistic plans need to be in place, which the FCA may request to see at any time.
5. Train staff on STOR
Among other things, firms are required to provide effective and comprehensive training to the staff involved in the monitoring, detection and identification of suspicious orders and transactions, including the staff involved in the processing of orders and transactions. Such training must take place on a regular basis and be appropriate and proportionate in relation to the scale, size and nature of the business.
Firms need to ensure that their staff have an understanding of what suspicious activities look like, the level of suspicion required to make a report, and what information should be taken into account when deciding whether or not to report. STOR templates need to be introduced and new or updated guidelines need to be circulated.
6. Market soundings, sell-side: implement the communication and record keeping procedures
Article 11 of MAR (Market Soundings) gives a new safe harbour to those sailing the treacherous seas of disclosing inside information. In a nutshell, disclosure of inside information is not unlawful when it is made for the purpose of gauging interest of potential investors in a possible transaction. To rely on the defence, the disclosing market participant (DMP) must comply with certain requirements, and keep a paper trail to document its compliance.
Record of decision making:
Firstly, DMPs would need to consider whether any inside information is going to be disclosed as part of the market sounding. In either case, a record needs to be made reflecting the conclusion and the rationale behind it; such records must be available to the competent authority upon request.
Consent and script:
Secondly, DMPs must obtain consent from the potential investor and bring him "over the wall" subject to certain conditions including confidentiality and prohibition on using the inside information for dealing in relevant financial instruments. The script to be used for sounding investors is described in detail in ESMA's RTS.
DMPs must draw up sounding lists with details of investors approached during the soundings; where the sounding is conducted on unrecorded telephone lines or in personal meetings, it has to be minuted using the template proposed in the RTS.
ESMA is of the view that market sounding records should be kept, and the script should be used, whether or not DMP considers that the market sounding does not involve disclosure of inside information.
7. Market soundings, buy-side: implement the system for controlling the flow of market sounding information
ESMA has issued draft guidelines for market soundings which are addressed to recipients of market soundings (MSRs). Although not binding, the guidelines may prove helpful in showing that the MSR is in compliance with insider dealing rules and disclosure rules in the context of receiving market soundings.
The focus in the guidelines is on the MSR's internal policies and procedures that need to be put in place or updated to limit the spread of inside information associated with market soundings.
In particular, MSRs are expected to have a designated person receiving market soundings and a specific function or body responsible for assessing whether the information received from the market sounding is "inside information".
MSRs should establish, implement and maintain internal procedures to ensure that information received from a market sounding is communicated internally on a "need to know" basis and through predetermined reporting lines only. It is recommended that MSRs maintain lists of staff who have access to information received from a market sounding. This recommendation applies to all information received from market soundings, and not only information identified by the DMP/MSR as "inside information".
Finally, buy-side firms must appropriately train staff who receive and process information from soundings on internal procedures and the relevant provisions of MAR.
ESMA is expected to publish final guidelines for MSRs in the third quarter of 2016.