09 November 2016 - Post by:
The latest comments from the UK Financial Conduct Authority (the FCA) on market abuse controls among registered market makers in small and mid-cap equities, in Market Watch 51, bear out the FCA’s continued commitment to improving firms’ preventative measures and, more importantly, recommends those improvements needing to be made most.
The area of small and mid-cap equities is viewed as particularly sensitive to market abuse due to its high exposure to inside information. Notwithstanding this, the results of the FCA’s review are universally applicable and should be seen as making recommendations to the financial services sector as a whole. The FCA’s findings touch on: awareness of market abuse risks; integrity of information barriers; wall-crossing procedures; and monitoring and surveillance. This feedback can be distilled down into the following four key lessons:
Compliance teams were widely praised for their awareness, and articulation of, market abuse risks. The FCA was, however, less impressed with senior management, who were highlighted for not participating more actively in controlling information flows. By participating, management can increase its risk awareness, actively bolstering, not just passively relying on, their second and third lines of defence. The FCA recommended that the best way to demonstrate this participation is for senior management to fully exercise a supervisory role over market abuse risks, controlling information flows and considering risk, with compliance teams monitoring this and challenging senior managers where appropriate.
For both senior managers and compliance teams, it is important to note that, overall, it was those firms with formal risk-assessment procedures that were best able to demonstrate their awareness of market abuse risks to the FCA. It, therefore, pays to be able to produce evidence of effective controls, often quite literally. Indeed, W.H. Ireland’s failure to evidence an effective written policy was a crucial reason for its £1.2 million fine in February of this year .
The FCA’s action against W.H. Ireland in February also demonstrated that having inadequate controls for maintaining barriers between public and private functions are a costly oversight. Seemingly, this lesson has been taken to heart by market makers who were generally praised for their efforts. However, sales and trading, and senior management with access to trading book positions, which are both groups which should not have had access to information about market makers’ activities, were, in many cases, noted to have sat near market making teams. The FCA suggested that such risk is best minimised by thorough physical segregation and training to reinforce the importance of maintaining robust barriers.
(iii) Caution when crossing
The industry as a whole performed poorly when it came to wall-crossing. Echoing previous statements made by the FCA, compliance teams are expected to act as ‘gatekeepers’, only letting appropriate people cross the wall at appropriate times. Diligent gatekeepers must allow only those who ‘need to know’ as part of their “normal exercise of… employment, profession or duties” (Article 10 Market Abuse Regulation (MAR)) to cross. As with risk awareness, it appears that firms could improve by better evidencing their controls in this area. Thorough, documented procedures and up-to-date insider lists can assist compliance and illustrate to the FCA that firms are taking care to reduce the risk every time the gates are opened. The record-keeping provisions of Article 11 MAR should be incorporated into wall-crossing policies both to improve, and to evidence, firms’ diligence.
In its February 2015 thematic review into asset managers’ market abuse controls and in its final notice to W.H. Ireland, the FCA pushed the importance of ongoing, post-trade surveillance. While the criticism in the market makers review was not of the same intensity as in these two previous instances, several areas for improvement were still identified. Firms were encouraged to calibrate post-trade surveillance tools with more specific alert parameters and to use alert-based logic based on observed trading patterns. Continued monitoring of wall-crossed employees was also suggested. This is especially important in light of Article 16 MAR which provides that suspicious orders or transactions should be reported to the competent authority (in the UK’s case, the FCA) without delay.
Focusing on prevention
Overall, the review represents a further emphasis of the FCA’s mission to ensure that “all firms… have the right controls in place to mitigate risk and protect their clients and the integrity of the market”. With the FCA considering continued monitoring, possible firm-specific deep-dives and further reviews, it is important that firms reflect on the lessons outlined above. This is particularly important for those featured in the report because, like in W.H. Ireland’s case, ‘it is one thing to be given a chance; for the chance not to be taken up is especially culpable’.