Speech delivered by Julia Hoggett, Director of Market Oversight at the FCA, at the ‘Recent Developments in the Market Abuse Regime’ conference.
Speaker: Julia Hoggett, Director of Market Oversight
Event: ‘Recent Developments in the Market Abuse Regime’ conference, London
Delivered: 14 November 2017
Note: this is the speech as drafted and may differ from the delivered version
Highlights
- Effective oversight and compliance cannot and should not stay still.
- The manner in which the FCA is set up to surveil the markets today is very different from our structure several years ago, and will continue to evolve.
- Market abuse impacts the smooth operation of our markets by adding cost or reducing returns for participants and ultimately eroding trust in the UK markets.
- Trust is essential in any society and necessary to ensure markets function well and efficiently.
I have come to the conclusion that at its most effective, compliance with MAR is a state of mind
I have been Director of Market Oversight at the FCA for just over 6 months now and I would like to share with you several of my observations regarding both MAR; the relatively newly minted Market Abuse Regulation[2] (MAR) and more broadly the overall ‘market abuse regime’. My aim is to help frame not just the FCA’s approach, but how we hope the industry is thinking about both MAR and the regime as a whole.
When delivering a speech, it never helps to have two critical terms share the same three letter acronym. It is even less helpful when the subject matter is as technical as market abuse.
I will refer to the Market Abuse Regulation as ‘MAR’ and refer to the market abuse regime in its longhand form as ‘the regime’: The regime being the environment created by the interplay of the full spectrum of laws, rules and guidance aimed at tackling market abuse in our market, including but not limited to MAR.
My first observation may surprise you. I have come to the conclusion that at its most effective, compliance with MAR is a state of mind.
If there had been a poll today of my opening lines, I sincerely doubt that statement would have been on it, but let me try to elaborate and illustrate with an example.
I’ll start with the definition of inside information – something which is central to the market abuse regime – its very definition is both fluid and situational. The information must be of a precise nature, not have been made public, relate directly or indirectly to one or more issuers or financial instruments and fundamentally, if made public, be likely to have a significant effect on the prices of those financial instruments or related derivatives.
Even applying that statement in practice requires a set of situational judgements to be made by relevant parties across the industry (and indeed those who might not even consider themselves to be in the industry at all). Defining inside information cannot be just a set of rules, therefore, it must be a state of mind, a vigilance to identify the potential for such information and the skill to have the capacity to make the assessment as to whether the conditions are met and then, simply put, the awareness of what to do next. There is a risk therefore that systems and controls will only go so far if that critical thinking has not taken place.
So one of the key things we are focused on is how that state of mind is developing. One might argue that this is not a new request of the industry or those in a position to impact the price of securities, more a renewed call to arms in the development of those skill-sets. Indeed the definition of inside information under the longstanding offenses in the Criminal Justice Act 1993[3] is exceptionally similar to the one in MAR. It is fair to say that from our engagement with issuers, sponsors, other industry professionals, advisors and other parties that could hold or generate inside information, the report card (on their ability to identify inside information, or indeed when it is not) is somewhat patchy.
My second observation is that the effective oversight and pursuit of compliance with the regime – across its many strands – cannot and should not stay still – either for regulators or for firms. The manner in which the FCA is set up to surveil the markets today is very different from our structure several years ago and will continue to evolve.
The first difference is in seeing the functioning of the markets holistically, from primary to secondary and from disclosures to trading behaviours, and adjusting our structures accordingly.
Under my Directorate of Market Oversight sit 3 departments that are wholly bound up in the ongoing efficacy of both MAR and the market abuse regime more widely.
Listing Transactions
The new Listing Transactions Department (which is one of two Departments that are responsible for the old UKLA functions of the FCA), encompasses our Transaction Review functions and the management of the Official List through our Issuer Management team. Fundamentally, in the work that the department undertakes in assessing the eligibility of securities to be listed and also in assessing that the necessary disclosures are in place, the team is seeking to ensure that investors have the information they need to assess the investment and are in a position to exercise their rights efficiently.
In our recent publication on the evolution of the IPO process, we have sought to ensure that the prospectus is placed (some might say) back at the heart of both the IPO process and the disclosure regime.
Primary Market Oversight
It has been observed in the media that the FCA now has a greater focus on the quality of disclosures of listed issuers and this is indeed true
We have also created a new department, Primary Market Oversight, which is responsible for the former UKLA functions of the specialist supervision of sponsors and primary information providers; real-time and post-event monitoring of listed issuers and companies traded on MTFs, the short-selling regime, and the post-event review of compliance with certain aspects of the UK Listing Regime.
More simply put, PMO, live and breathe the core tenets of the disclosure obligations of MAR each and every day. This can be in ensuring that through the Sponsor Regime[4], Premium Listed firms have the appropriate systems and controls in place to ensure timely and accurate disclosures. However, it also applies to our on-going monitoring of issuers’ disclosures and occasional intervention to ensure that issuing firms are placing the correct information in the public domain, through the right channels, in the appropriate fashion.
An increasing part of this role is not just in assessing the systems and controls components of ensuring effective MAR compliance, but also thinking more broadly about the wider stakeholders with whom the FCA needs to engage as competent authority to enhance the efficacy of the regime in the UK.
It has been observed in the media that the FCA now has a greater focus on the quality of disclosures of listed issuers and this is indeed true. Whilst one of the most visible indicators of that focus is our enforcement action, the simple reality is that it is reflected across the supervisory, monitoring, investigation and enforcement activities – much of which is undertaken by Primary Market Oversight.
Here we are focused on ensuring that issuers meet the expectations that MAR, we as regulators and indeed investors set for timely and accurate disclosures. We view issuers as having an essential role to play in upholding the obligations of MAR. In understanding the regime, having the appropriate systems and controls in place to ensure they can make timely and accurate disclosures and this is about state of mind, being conscious of their obligations to be both aware of and manage the conflicts of interest they may feel they manifest when potentially challenging business results should be disclosed.
We also recognise that with the introduction of MAR, the sense is that obligations on issuers have increased and therefore as part of our ongoing assessment of the implementation of MAR, we are seeking to understand the areas where issuers (and indeed any other parties captured by the regime), are finding compliance with the regime most complex. It is fair to say that of all the communities with whom we engage, often the issuers are the most disparate - and hardest therefore for the FCA to communicate with - so we would very much welcome more engagement with the issuer community on MAR.
There will be a great many firms where the adaptation to the expectations of MAR is a challenging task, but one nevertheless that they are putting a great deal of time and effort into. However, where listed institutions have not met their obligations, be that under the listing rules or indeed under MAR or more broadly, we will seek to take action where it is appropriate. We will also however, increasingly seek to coordinate with other institutions such as the FRC[5] and the Insolvency Service in order to ensure that the appropriate suite of powers available in the UK has been applied to those cases where institutions have not organised themselves in a fashion that means they are able to make accurate and timely disclosures to the market.
One of the fundamental elements of the state of mind of the market abuse regime is the recognition that all elements of the capital markets chain play a critical role in the appropriate functioning of markets. Issuers are just as vital to us a part of this chain as those who underwrite or advise issuers, and those who ultimately invest and trade in their securities.
Secondary Market Oversight
Insider dealing may be the poster-child of market abuse, the behaviour that comes to mind the most, but clean markets rely on participants having faith in appropriate price formation taking place, and tackling market manipulation is clearly critical to this
The role of Secondary Market Oversight is in some ways unchanged from the days when it was called Market Monitoring, but we are constantly seeking to evolve.
One of the major evolutionary steps directly in our sights is the move from ‘MiFID I’ to ‘MiFID II/[6]MiFIR’ data – a step change in both the volume and quality of data that we will receive regarding transactions taking place in the market and critical to our pursuit of market abuse. We have been undertaking extensive technological work for many years now to be ready to receive, ingest, digest, interrogate and ultimately learn from this dataset, and there is a growing air of excitement within MO about its possibilities. Just to give you a flavour of the volumes sizes I am referring to, we currently capture around 20 million transaction reports per day - we estimate this will increase under MiFID II to around 30-35 million transactions, in excess of 50 million orders per day, or a total of over 1 trillion data points per year. As a regulator, we have to invest and stay as up-to-date and indeed as visionary as we can in our own development of tools to identify and pursue market abuse: something we hope the industry will aspire to do as well in its monitoring and controls.
It is worth noting that the introduction of MiFID II also introduces the second tranche, so to speak, of MAR implementation. January will see new obligations crystallise regarding instruments listed on OTFs and Emission Allowance products, which we hope the industry is well ready to meet. There are also changes for issuers listed on the newly designated SME growth markets.
In seeking to constantly evolve, the FCA has also significantly adapted its organisational structures, in order to ensure we are looking for an appropriately broad range of market behaviours. Yes we will continue to and always focus on insider dealing, however it manifests, both in individual instruments and cross-market, but we have significantly bolstered our resources allocated to market manipulation as well.
Insider dealing may be the poster-child of market abuse, the behaviour that comes to mind the most, but clean markets rely on participants having faith in appropriate price formation taking place, and tackling market manipulation is clearly critical to this. We have therefore also developed our capacity to collect and consolidate order book data from all equity venues along with equity derivatives into a single view. The logistical challenge of aggregating this data is no small obstacle, but thanks to technological innovation and heavy lifting, it is now possible.
The next observation I would like to make is that the prevention of market abuse is a multi-asset exercise, and therefore, by definition a complex one. Equity insider dealing has been a clear focus in the past, which is reflected by many of our outcomes to date being focused on that behaviour. However, all relevant markets are vulnerable to both insider dealing and manipulation, therefore we are now even more focused on seeking out evidence of market manipulation across asset classes and combatting abuse wherever we find it.
London is a critical global trading centre across the asset classes and our pursuit of secondary market abuse must reflect the scope of our markets; and it does.
This is also where we feel we need to work on the industry’s state of mind all the more. As many of you here already know, firms and individuals professionally arranging or executing transactions in certain financial instruments, and operators of a trading venue, must report suspicious transactions and orders (STORs)[7]. A suspicious transaction or order being one where there are ‘reasonable grounds’ to suspect it might constitute market abuse. The evidence from the STOR submissions we receive is that they are dominated by equity insider dealing, representing well over 70% of all submissions we receive.
There are fewer STOR submissions in equity manipulation than in equity insider dealing, and the number of STORs referencing behaviour in fixed income and commodity markets is only a small fraction of the total.
Now, without 20:20 vision on the baseline level of market abuse in any market, we can only correlate STORs to outcomes and our own alerting analysis and therefore the FCA would not necessarily assert an implied ratio of STORs between asset classes that we feel will be appropriate. However, the limited number of non-equity insider dealing STORs does feel like a leading indicator of the capability of the industry to identify potentially manipulative behaviour in equity markets and to monitor and perform surveillance for all types of abuse in fixed income and commodity markets.
If compliance with the market abuse regime is a state of mind, then the state of mind that market abuse only takes place in equities, which still feels like an unreconstructed assumption in certain areas of the market, needs to be thoroughly broken.
Going forward: preventing abusive behaviour
We expect firms to ensure that their systems are in constant evolution to meet the changing nature and needs of the businesses within which they operate
From a secondary market activity point of view, we are focused on the constant development of our capabilities to surveil the market. Our focus however, is much broader than the optimisation of our surveillance and our follow-up enquiry work to the STORs we receive; we are increasingly focused on using as many disruptive techniques as we can to prevent abusive behaviour from impacting the integrity of the UK markets.
Whilst on this topic, it is also worth highlighting that the need to improve and optimise surveillance and disruption capabilities cannot be seen as a role reserved solely for the regulator. We expect firms to ensure that their systems are in constant evolution to meet the changing nature and needs of the businesses within which they operate, including evolving regulatory demands. One example of this is the expectation that firms fully comply with the requirement under MAR to have quote surveillance solutions in place. When MAR went live, industry told us that some of the surveillance requirements, notably around quote surveillance, required additional technical development by firms, and we recognised that this would take some time to build. More than a year since then, we now expect firms to be compliant with all the requirements under MAR.
Aside from the regulatory expectations firms must ensure that as they innovate, they ensure that their surveillance and reporting capabilities keep in lock-step with developments in their business. This applies to whether it’s a change in the nature of products they provide, or indeed, the cross-asset execution platforms they develop.
Preparation
Why are firms not aligning their efforts to combat financial crime with their efforts to combat market abuse? They are inextricably linked
In order to be prepared to mitigate the risk of market abuse in the UK’s markets, we must remain focused on ensuring that the regulatory regime is fit for purpose and gives us the necessary tools to identify and take action against those perpetrating market abuse.
Many of those capabilities do not necessarily arise from MAR, but from, for example, MiFID II, and indeed the wider suite of rules, regulations and powers that exist under the wider market abuse regime. I would say that for issuers, the Listing Rules[8] can also be a vital component of this.
There have been times in the past where we have not necessarily connected fully in the minds of the regulated community all of the regulations that exist in the UK, which can act in service of market integrity.
Let me give you an example. The definition of a Financial Crime under the Financial Services and Markets Act (FSMA) very clearly captures the mirror criminal offences of market abuse and yet often we observe that the systems and controls that exist within the industry to combat financial crime and those that exist to combat market abuse do not interplay appropriately or sufficiently within firms.
If a firm has established a reasonable suspicion that insider dealing as defined by MAR may have occurred then, in almost all circumstances, it will also have established reasonable suspicion that the criminal offence of insider dealing may have occurred. If this is the case, why are firms not aligning their efforts to combat financial crime with their efforts to combat market abuse? They are inextricably linked.
Where institutions have had repeated concerns about the trading behaviour of a client, such that they have raised multiple STORs, then it is wholly legitimate of us to also ask whether the institution has properly considered its regulatory obligations (set out in SYSC6.1.1R[9]) to counter the risk of financial crime. This might include, for example, whether the firm has refreshed its risk-based analysis of that client from a financial crime point of view, whether enhanced monitoring of that client is necessary and ultimately, if the institution is comfortable in continuing to maintain that client relationship.
The appropriate preparation by the FCA in minimising the risk of market abuse taking place in the UK markets may not simply therefore be in the enactment of legislation, or in the writing of rules, but in the application of the rule sets that already exist.
Prevention
We need to take all the steps we can to prevent market abuse from taking place within our markets
Equally, we need to take all the steps we can to prevent market abuse from taking place within our markets.
In many regards this is also a question of state of mind: how do we adapt and address the culture and understanding of market participants, regarding firstly what constitutes market abusive or manipulative behaviour, but also how critical keeping it out of our markets is for their effective functioning?
Ensuring that we as the regulator, issuers, market participants and venues all have a shared understanding of the harm to our markets that market abuse can cause is arguably the essential first step in a preventive strategy. Greater engagement with industry on this is therefore a clear area of our focus.
Protection
Our markets will be at their cleanest when the footfall of the regulator on this particular beat is amplified by a society of market participants who all share the same interest
In terms of protecting the markets from the risk of market abuse and manipulation, we all play a part in this - in ensuring that venues and market participants have the necessary systems, controls (and dare I say it), culture in place, to detect market abuse and therefore report suspicious behaviours to us, and restrict market access where appropriate.
But, however hard my staff work to pursue cases of market abuse and to supervise the capability of the industry to surveil for market abuse itself, our markets will be at their cleanest when the footfall of the regulator on this particular beat is amplified by a society of market participants who all share the same interest.
Pursuit
We must continue to adapt both to technological change and to the evolution of market behaviours, in order to remain as capable as we possibly can be of catching those perpetrating market abuse
Finally, in hot pursuit, the FCA itself needs to ensure that it has the necessary systems and that we do not stand still. We must continue to adapt both to technological change and to the evolution of market behaviours, in order to remain as capable as we possibly can be of catching those perpetrating market abuse.
This means not only will we invest in the evolution of our technology, but that we will also not shy away from pursuing those hugely important but inevitably complex market abuse cases where they arise.
As Mark Steward, FCA Director of Enforcement and Market Oversight, has said in recent speeches, and as the FCA has made clear, our decision to investigate using our enforcement powers is triggered by the FCA having reasonable grounds to suspect that serious misconduct has taken place. With regard to market abuse, we will not shy away from investigating activities taking place in the market that meet this test. It is important to recognise that ignorance of the requirements of MAR, or the absence of intent to commit market abuse, are not a defence to breaches of MAR. Abusive conduct committed in ignorance of the rules can be every bit as serious in its consequences as deliberate, dishonest conduct, and we will pursue it accordingly. Market participants should therefore take all necessary steps to understand their obligations under MAR and ensure that they conduct themselves appropriately.
Harm
Trust is essential in any society
Ultimately, the test of a clean market is one that has efficient and effective price formation and provides a venue that attracts those seeking to raise or invest capital, because its behaviour is reliable and trusted by all parties. Market abuse, in all its forms, impacts the smooth operation of our markets by adding cost or reducing returns for participants and ultimately eroding trust in the UK markets.
Trust is essential in any society. For example, me taking the DLR is an act of trust on many levels. Without trust in the safety of the service, the quality of the construction of the elevated tracks, the reliability of the service and its inevitable termination at Bank Station, I would not be here today and you would not have had the fortune or misfortune to have had the opportunity to hear me speak.
My point however, is that without that trust, I would have been at best ineffective at worst, frozen with inertia.
Markets require a dynamic allocation of capital and responsiveness to the needs of its participants in the context of global events. The multiple decisions of trust that are made in the market each, and every day, are essential to its functioning and efficacy – as arguably we found out, for other reasons, during the financial crisis.
Whilst it is easy to think of MAR and the market abuse regime more broadly, as a series of systems and controls and sometimes frustrating components, I hope that I have illustrated that at its most effective compliance with the regime is indeed a state of mind that we all - as either market participants, or members of society who benefit from the activity in the UK markets - would do well to understand, and seek to uphold.