Commodities trading and brokering: what are the key controls issues for firms?

On 3 September, the FCA published its latest Market Watch newsletter on market conduct and transaction reporting issues. This contains a number of important points for firms involved in the commodities markets, some which are highlighted below.

The FCA reviewed the control structures and practices at a sample of 12 firms: brokers, interdealer brokers and commodities trading firms across the oil, energy, metals and soft commodities (e.g. coffee, sugar and corn) sectors. The emphasis of the review was on front office and market abuse controls. As a result of this review and the FCA’s publication of its findings, all firms (including banks which have a commodities business) should expect a renewed focus from the FCA on potential misconduct and inadequate controls in relation to commodities trading and brokering. Firms should carefully consider the issues below and be aware that the FCA is likely to take very seriously any failings it identifies in the future, now that it has publicly put the industry on notice.

(1) Integrate Compliance with the front office

The FCA’s review found that firms in which Compliance was integrated with the front office and had a permanent physical presence on the trading floor had the most effective Compliance functions. This enabled Compliance to be involved in proactively identifying risk and traders more easily receiving guidance on acceptable market conduct.

(2) Ensure that market abuse is taken seriously

The FCA was concerned that some firms and their senior management were complacent about the risk of market abuse and believed commodities markets were ‘too deep, too liquid, and there are too many participants’ to be manipulated. The FCA underlined the importance of firms learning lessons from recent high-profile examples of its findings of systems and controls failings in relation to benchmarks, as well as historical market abuse cases in the commodities markets, and applying these lessons to their training and surveillance programmes.

(3) Improve market abuse training

According to the FCA, at the majority of firms, traders and brokers had a poor understanding of their responsibilities regarding the use of inside and market sensitive information. For example, traders did not carry out appropriate checks before trading on information they received.

(4) Improve market abuse surveillance

The FCA identified weaknesses in firms’ market abuse surveillance, in particular, choosing whether surveillance systems should be automated or manual, calibrating those systems, the frequency of monitoring, monitoring orders as well as trades, and the selection of samples for review. The FCA suggested that sampling be targeted at higher risk periods and higher risk individuals.

(5) Focus on suspicious transaction reports

The FCA found that only two of the 12 firms in the sample had submitted Suspicious Transaction Reports (STRs) relating to commodities trading, even though many of them described events that may have required a STR. The number of commodities-related STR submissions received by the FCA was low in comparison to other asset classes, which might indicate that transactions meeting the ‘reasonable suspicion test’ were not being reported. In addition, many firms had inadequate STR procedures, with no written procedures and a lack of clarity on what constituted a STR. We have also published a post on the FCA’s more general warning to the industry about STRs, which is available here.