In mid-2016, the market abuse regime will undergo significant expansion in scope, when the Market Abuse Regulation becomes law. The directly applicable status of this EU legislation entails removal of large parts of the FCA Handbook, along with statutory changes. This will bring uncertainty to the status of the bank of current UK rules, guidance and established case law. Martin Sandler considers the challenges firms will face on MAR implementation.
Background and timetable
The new Market Abuse Regulation (“MAR”) and the Criminal Sanctions for Market Abuse Directive (“CSMAD”), will replace the 2003 Market Abuse Directive (“MAD”). MAR and CSMAD have been developed in close tandem with other post-financial crisis measures to regulate markets and financial instruments, such as MiFID II/MiFIR, and alongside other national and internationally-coordinated initiatives to tackle misconduct and restore market confidence such as the Fair and Effective Markets Review. There is a degree of interdependence between MAR and MiFID II, with MAR being particularly reliant on definitions contained within MiFID II. Both sets of provisions extend the reach of the European regulatory regime to capture a wider range of markets and instruments and include specific provisions to address the proliferation of technology-driven trading practices.
MAR/CSMAD entered into force on 2 July 2014, and the majority of its provisions become law on 3 July 2016. The UK will not opt into CSMAD, but instead implement UK criminal sanctions for market abuse. MAR, on the other hand, which contains most of the substantive market abuse provisions, being a regulation, will have direct effect in the UK and the other EEA states.
Since MAR/CSMAD entered into force, ESMA has developed and submitted technical advice and draft Level 2 regulatory and implementing technical standards to the Commission, and on 17 December 2015, the Commission adopted a draft delegated regulation supplementing MAR. Most of MAR will become law on 3 July 2016, except for provisions concerning organised trading facilities, small and medium sized enterprises, growth markets, emission allowances and auction products based on them, which will apply from the date MiFID II becomes law (currently expected to be 3 January 2017, although delays are possible).
Key provisions and impacts of MAR
1. Beyond Regulated Markets
MAD applies to financial instruments admitted to trading on EEA regulated markets and related financial instruments, but MAR extends the range of instruments covered, to:
- financial instruments admitted to trading on the other types of trading platform set out in MiFID II – multilateral trading facilities (“MTFs”) and organised trading facilities (“OTFs”); and
- financial instruments the price or value of which depends on or has an effect on the price or value of a financial instrument traded on a regulated market, MTF or OTF.
- MAR will require ESMA to maintain a list of MAR-scope financial instruments, however this list will be neither definitive nor exhaustive. The resultant uncertainty whether specific instruments are covered may lead compliance departments to take the cautious approach that any instruments are potentially covered and non-EU firms may inadvertently be caught if, unknown to them, a certain financial instrument or a linked instrument happens to be traded on an OTF.
2. Commodity Contracts and Benchmarks
MAR’s market manipulation provisions extend the reach of the European market abuse regime further still, to include:
- any spot commodity contract having, likely to have, or intended to have an effect on the price or value of a financial instrument; and
- any type of financial instrument having or likely to have an effect on the price or value of a spot commodity contract whose price or value depends on the relevant financial instrument.
- Through these provisions, MAR plugs a hole in the existing MAD regime: namely, the lack of oversight and visibility of the underlying commodity contracts to which the value of certain derivative financial instruments is referenced. This appears to create inconsistencies between the regulation of those commodity markets that may have an effect on the price or value of a financial instrument and those which do not. Nor may it be apparent, particularly to non-EEA persons trading commodities, if related derivative contracts are traded on OTFs, creating a risk that such persons may inadvertently be caught by MAR.
Not unsurprisingly in light of recent market scandals, the market manipulation provisions in MAR also extend to “behaviour in relation to benchmarks”. Manipulation of benchmarks is already a criminal offence in the UK.
3. Algorithmic Trading and High Frequency Trading (“HFT”)
MAR contains lists of indicators and examples of market manipulation, including some which specifically cover algorithmic trading and HFT. These include the creation of an abusive effect through the placing of orders to a trading venue where the orders:
- disrupt or delay the functioning of the trading system of the trading venue or are likely to disrupt or delay its functioning;
- make it more difficult for others to identify genuine orders on the trading system of the trading venue or are likely to make this more difficult (e.g. by overloading or destabilising the order book); or
- create or are likely to create a false or misleading signal about the supply of, or demand for, or price of a financial instrument (e.g. by entering orders to initiate or exacerbate a trend).
As with insider dealing, MAR also specifically prohibits attempting to engage in market manipulation, whereas the market manipulation provisions of the MAD regime only extended to transactions or orders that had already been placed.
4. Market Soundings
MAR will allow inside information to be legitimately disclosed to a potential investor in the course of market soundings undertaken to gauge interest in a potential transaction or its potential size or pricing. However certain prescribed and detailed steps will need to be taken prior to conducting a market sounding and detailed record-keeping requirements are imposed. These steps and requirements will be set out in regulatory technical standards.
5. Disclosure of Inside Information by Issuers
Issuers who have requested or approved admission to trading of their securities on an MTF or OTF (even where not on a regulated market) will now be brought within the scope of the public disclosure obligation.
Where an issuer wishes to delay public disclosure, it will need to inform its competent authority, who may require a written explanation.
Where a financial institution wishes to delay public disclosure, a new ground for such a delay is where disclosure would risk undermining the financial stability of the issuer and the financial system, delay is in the public interest, confidentiality can be maintained, and the competent authority consents.
6. Directors’ Dealings
The reporting regime is similarly extended to include dealings by persons discharging managerial responsibilities (“PDMRs”) and their connected persons in relation to issuers who have requested or approved admission to trading of their securities on an MTF or OTF (even where not on a regulated market).
The time period for a PDMR or connected person to notify the issuer of transactions has been shortened to three business days. Transactions will need to be reported once a threshold of €5,000 is exceeded in a calendar year. Member states may set a higher threshold of €20,000, although the FCA proposesto keep the threshold at €5,000.
7. Suspicious Transaction Reporting
Investment professionals will need to report suspicious orders as well as suspicious transactions.
Among other provisions aimed at encouraging whistleblowers to report market abuse, member states will be able to provide financial incentives for whistleblowers in some circumstances.
9. Investigations and Sanctions
MAR sets new EEA-wide minimum standards for regulators’ investigatory and sanctioning powers. Regulators must have power to impose fines of up to at least €5 million for an individual and €15 million or 15 per cent of annual turnover for a firm.
In CP15/35, published in November 2015, the FCA set out what the new rules are likely to look like. Large parts of the UK market abuse framework will be amended or repealed to make way for the new directly applicable MAR. In particular, much of FSMA 2000 Part VIII and the Code of Market Conduct will be removed and the Model Code on PDMR dealings will be replaced with guidance. MAR implementation also requires changes to the Disclosure and Transparency Rules, as outlined in CP 15/35 and a further FCA consultation, CP 15/38.
The FCA will provide handbook guidance on and “signposts” to MAR. However, the handbook will be treated as supplementary to the rules and “should not be regarded as the source of all provisions relating to market abuse”.
This leaves some residual uncertainly as to the status of the various forms of “soft” guidance put out by FCA, such as Market Watch bulletins and speeches. This may make compliance much more complicated and firms may make the wrong judgement calls due to reliance on disparate sources of rules and guidance, a problem exacerbated by the removal of helpful examples set out in the Code of Market Conduct.
Firms will need to make substantial changes to their compliance procedures, not only to implement the new rules, but also to reflect the changed references to the sources of existing similar rules. Furthermore, if final FCA rules are issued only a month or two before they are due to come into force, this leaves very little time for these changes to be made.