Good afternoon and welcome to Berwin Leighton Paisner and to the second of our financial crime webinars. In this week’s webinar, I was going to say show, but webinar, I’ll be talking through the market abuse regulation which is coming into effect from 3 July this year, so Brexit or not, a week today we will be dealing with the market abuse regulation and first of all I’m just going to talk through the scope of the regulation as it will apply from 3 July.
So the current market abuse regime which operates in the UK derived from the market abuse directive and we had across the EU different market abuse regimes which applied in different member states and following the crisis there was perhaps the feeling that the market abuse regime didn’t properly respond to the behaviours that we saw through the crisis. In particular the benchmark manipulation investigations and enquiries didn’t look at the market abuse regime as found on the basis of market abuse regimes, and that was criticised by regulators following the crisis and there was the feeling that in fact we had to have a much broader market abuse regime which would effectively cover a far wider range of instruments that were being traded. And there was the feeling that the market abuse directive hadn’t really kept pace with the way in which markets are operating and in particular, that markets have become much more fragmented, so in the UK we have 13 regulated markets and financial instruments which are traded on those regulated markets rather than the scope of the regime so that could be shares listed on the LSE futures contracts traded on ICE and financial instruments which were priced by reference to those products - so called related investments, also fell within the scope of the regime. But the reality is that markets operate in a much more complicated way and securities aren’t only traded on so called regulated markets and we have a lot of securities now traded on MTF’s (Multilateral Trading Facilities) and the most significant thing in my view, as part of the new market abuse regime, is that the scope of the regime would extend significantly so over 70 MTF’s which operate in the UK will fall within the scope of the regime and significantly when MiFID II comes into effect, it will formally recognise the concept of the organised trading facilities and will have a lot of currently OTC traded products which will all effectively fall within the scope of what constitutes an organised trading facility; and so the idea is that when that happens, we will have a market abuse regime which applies across the board to many products, actually all products traded in our financial market.
When we’re looking at the scope of the market abuse regulation we’re going to be dealing with the same two concepts which we’ve been dealing with under the existing market abuse directive implemented into the UK through 118 FSMA, so these two fundamental pillars consist of firstly - information, so the idea that everyone accessing our financial markets should be trading on the basis of the same information, there shouldn’t be a certain group of people who have privileged access to a certain type of information so called “inside information”, because if people are trading on the basis of inside information then that means that our markets risk being distorted and there isn’t integrity in our markets. Similarly, the second pillar of the market abuse regime deals with price manipulation, so the idea that everyone having access to our markets should not suffer from people trying to move prices up or down but there should be fair and accurate pricing.
So those two principles remain in play and I’ll come on to discuss how those two principles will be tweaked as part of the regulation. But, just to flag before we move on, areas of particular focus under the regulation concern the four areas that I’ve just put up on the next slide. So the first concern is commodity markets. Commodity markets are much more squarely in focus through the market abuse regulation - So that operates first through the inside information definition - where market participants have information relating to physical markets which could be published through a normal mechanism through which information is published in a commodity market, whatever that might be, then information ahead of that announcement could constitute inside information. And secondly, any physical transactions in commodities which could be used to price financial instruments i.e. those instruments that we have just been talking about in relation to regulated market MTF’s and OTF’s will be captured within the scope of the new regime. I’ll come on to discuss, when we talk about market manipulation, benchmarks but it is very significant that the abuse of benchmark rates (any benchmarks which are used to price financial instruments which we have been talking about as part of this new regime) will become a civil market abuse offence and that is very significant because a lot of the benchmark manipulation examples and issues that we saw through the crisis, if they were to happen now would be tackled through the civil offence of market abuse in relation to benchmark manipulation.
When MiFID II comes into play then emission allowances will become a financial instrument, so just to flag that if you trade in relation to emission allowances then they will fall within the scope of the market abuse regime. And finally, orders will fall within the scope of the regime, so that means that if you are seeking to manipulate the market in connection with orders that you put on, not only transactions, then that will fall within the scope of the regime.
So just before we move on to talk about inside information it would be good to just conduct a quick poll, and you will see on your screens a poll which should pop up now, so if you click on the polling question, the question that I’m just posing is:
‘In 2015 the FCA received over 1,800 suspicious transaction reports - so they are transaction reports where firms thought that there was suspicious conduct either in relation to inside information offences or in relation to market manipulation offences - and I’d just be interested in your views on the percentage of those suspicious transaction reports which related to inside information?’
a) less than 30%,
b) between 30% and 50%,
c) between 50% and 80%; or
d) 80% and above, so please cast your votes and then we will just discuss the result quickly.
Ok. Well there’s quite a good result there. 40% think that there were between 50% and 80% of suspicious transaction reports relating to inside information. This is an interesting point because only 5% thought it was 80% and above, where actually the number was 87% in 2015, which I was quite surprised about but there were 1800 or so, suspicious transaction reports and 1600 related to the misuse of information, only 200 or so related to manipulation offences and I think that really shows that inside information is critical to our market abuse regime, it is really at the heart of what the regulators are looking at when they’re looking at market abuse and I guess to a degree, that’s because it’s relatively easy for a regulator to spot if there has been an inside information offence because the FCA has sophisticated software, it can identify unusual transactions ahead of market announcements, so for example, if someone usually has been trading in one particular direction ahead of an announcement, changes the direction in which they are trading, then the FCA can launch an enquiry and it can relatively easily identify the manipulation of inside information.
So what are we going to be dealing with under the new regulation? Well the words on the page are quite similar to the ones that we’re used to in section 118, so we deal with “do we have information which is precise, which is non-public, which relates to issuers faulty financial instruments?” and “does the information have, or is it likely to have, a significant effect on price?” and we know that through our regime we decide when looking at whether or not information has a significant effect on price, “is that information which a reasonable investor would be likely to use as part of his or her investment decisions?” And in the UK the FCA has interpreted these words in a particular way. So we know that ‘precise’ means is there information about an event which is more likely to happen than not? is there more than a fanciful chance of this particular event happening or not? and is this information likely to have an impact on price? It doesn’t matter if you don’t know if the price is going to go up or down but is there or could there be an impact on price and if so then under our FCA cases we know that that information would tick the ‘precise box’. But does it relate to issuers? If it were made public, would it be likely to have a significant effect on price? So we’ll be dealing with this same test, as the regulation says that when you’re looking at whether or not precise information is likely to have a significant effect on price or not, you need to think to yourself “would a reasonable investor be likely to use that information when they’re deciding whether or not to place a trade?” and I think we’re going to be dealing with the same problems that we have already, in interpreting these words under our existing 118 regime because it might be that a reasonable investor would be likely to use information which does not have a significant effect on price, and so we’re going to be dealing with the same tensions that we have at the moment in terms of interpreting these tests /these meanings, and we know that the FCA, when it’s examining what has a significant effect on price, thinks to itself “does this information/would this information be likely to have a non-trivial effect on price?”. I think the real risk when we’re looking at these new rules (the same words but in a new context) under the regulation, is that potentially the FCA might take a different view in terms of how these tests are to be interpreted, because there must be some consistency in terms of how this test is interpreted by the FCA, just in the same way that Consob in Italy or AMF in France interpret the same words, because we’re dealing with a regulation which is directly effective across the EU and therefore there should be some consistency in terms of how these terms are interpreted.
So what are the inside information offences. Well we’re used at the moment under 118 to the dealing offence. If you deal on the basis of inside information, that is a market abuse offence. Under the new regime, if you cancel or you amend an order, that will constitute a market abuse offence. Or if you recommend to another person that they should engage in insider dealing, then that will constitute a market abuse offence, so they’re two effectively new offences which is part of the inside information offence. Similarly under the new regime there will still be the market abuse offence of unlawfully disclosing inside information. So if you are part of an issuer and you have material information which is likely to be inside information, and you discuss that outside the course of your normal employment, then that would be a market abuse offence. It’s important to bear in mind that under the regulation there are legitimate behaviours around the way in which inside information can be disclosed into the market. So legitimate behaviour would mean that if you are a financial institution and you have some inside information around an issuer, if that information is held behind an information barrier and properly protected and secured, then there will not be the presumption that a firm then putting on a trade in relation to a financial instrument in that same issuer would be trading on the basis of that information, and that’s quite an important distinction because of a European case, Spector Photo, there was a rebuttable presumption that where a firm had inside information, there would be a presumption that that firm was trading on the basis of that information, and that rebuttal presumption effectively goes under this new regime.
So just moving on to one important area concerning how inside information can be disclosed into the market - The regulation recognises that there are certain circumstances in which it’s appropriate for inside information to be shared into the market. So you could be an issuer conducting a secondary issuance of shares into the market and you might want to have your advisor go out into the market and work out, is there going to be any appetite for this secondary offering of shares, and if so what size should the secondary offering be in and what should the price be of the offering? And the regulation recognises that is a completely legitimate use of inside information. But importantly, the regulation sets out very clear and stringent criteria around market sounding, so the ability of market participants to go out into the market and to share that inside information and so where you have inside information and want to wall-cross someone, to get information from them about how, for example, your secondary issuance might be perceived into the market, you need to make a written record of your decision to disclose the inside information, and then when you’re about to wall-cross someone, you need to have their consent that they are happy to receive the inside information. Many people won’t want to receive inside information because they won’t want to be prohibited from trading in the securities that you’re about to talk to them about. Where you’re going to give inside information you need to give the person you’re giving the information to, you need to warn them that they are prohibited from using that inside information and they’re obliged to keep that inside information confidential. You need to produce a detailed note of the information provided to the person you wall-cross and ideally have that person sign the note, so that there is a record in relation to the inside information which is being passed over. And of course the regulator wants to have this information so that if there is a suspicion of trades being conducted on the basis of inside information, then it would be quite easy for the regulator to come along to a market participant/ to an issuer/ to authorised firm to ask them for details of their records and of their marketing soundings, and so it would be much easier for regulators to conduct enquiries.
One significant aspect of this regime is that when market soundings are made then people receiving the inside information should be told when it’s likely that that information will be cleansed, and then when the inside information has ceased to be inside information, so for example, the inside information referred to a new transaction which a company is considering undertaking, and where that transaction is then announced publicly into the market, one might take the view that that inside information has been cleansed, and it’s important to be mindful that there’s a tension between the primary regulation which says that where inside information has been cleansed the person who has gone out into the market and provided that inside information, should go to the people that they have wall-crossed and let them know that that information has ceased to be inside information. ESMA has issued guidance which indicates that the person who is disclosing the said information ‘should’ rather than ‘shall’ go and cleanse that information and it’s indicated that where the announcement contains only the inside information which has been passed to someone who has been wall-crossed, then potentially that might be sufficient to cleanse that person, but ESMA says that firms need to go back and to check effectively what information was passed as part of the sounding and if there’s any inside information out there which hasn’t been cleansed though the announcement, then the firm needs to go back and to effectively cleanse the person who has been wall crossed. And I think that’s all fine and good where transactions happen and where they’re successful. I think the difficulty will come where firms have decided that actually they are not going to ahead/ where issuers have decided they are not going to go ahead with a particular transaction, and the fact that that transaction is a potentially failed transaction, might in itself be inside information and so the handling of the cleansing around that information is likely to be an area of particular difficulty.
I would be really interested in your views and I’m just going to conduct another poll now just on:
“How far have your firms got with updating compliance manuals for MAR?”
It will be really interesting to know if you have completed all of your work in relation to updating manuals, if it’s still a work in progress or if a firms haven’t yet started to update their compliance manuals. The updating of compliance manuals will cover the new definitions of inside information, market soundings and behaviours in relation to this slide that we’re going to come on to discuss shortly. I’ll just give you a moment to tap in with your polling data.
Well 25% of you have completed your work - it’s just gone down to 23% - in relation to updating your manuals. Most people, over 50% still have a work in progress, around 28% haven’t yet started. We’re working with several firms at the moment updating their compliance manuals, helping them with training, helping them to work out what sorts of surveillance they need to be doing in relation to market abuse and so, the majority of people here, who are still updating their compliance manuals and preparing them, are in accordance with our own experience - that people are still working in relation to this project which inevitably is an ongoing piece. Yes, the FCA haven’t yet finished producing all of their information guidance in relation to how we should be interpreting MAR, which of course is pretty unsatisfactory given we’re about to hit the “go live date” for MAR.
So in relation to inside information, I’ve talked about legitimate behaviours in our market soundings. I just want to mention briefly insider lists, again as part of this idea that the regulator should have quite an easy job in terms of trying to work out if there has been inside information offences or breaches, any issuer (this is the case at the moment, effectively the requirements have been bulked up) will need to maintain very detailed insider lists confirming who has had access to inside information, when they got access to inside information, what their national security numbers are /national identification numbers, so it’s a lot of information which needs to be maintained and there are pro-forma lists so it’s very important that firms do keep those insider lists very carefully updated. As with the current regime there is an obligation on firms to ‘push out’ their inside information quickly into the market, so as soon as possible issuers should be publishing their inside information and again, this goes back to the idea that everyone trading and having access to our markets across the EU should be trading on the basis of the same information - there shouldn’t be some people with privileged or inside information in relation to certain events that they know about. And so, where issuers don’t have to disclose their information straightaway, they can withhold information but only if the disclosure of information would be likely to prejudice their legitimate interests, so that could be for example where they’re thinking about a fresh corporate transaction, they don’t want to disclose that into the market because that could knock the transaction over before it’s started. The second criteria is that the public mustn’t be miss-led if there is going to be a withholding or a delay in the disclosure of inside information. And thirdly firm’s must be able to ensure the confidentiality of that information, and so where there has been a delay, and the information is then going to be put out into the market, the FCA needs to be updated and told that there has been a delay and given information as to why there has been a delay.
For listed financial institutions there’s a different set of criteria which apply - disclosure can be withheld where disclosure would be likely to undermine the financial stability of the issuer, or of the financial system and where it’s in the public interest to delay that information. And again where confidentiality can be assured and also importantly, where the FCA has consented to that delay.
Just in relation to the criminal regime, we’ve been talking about the civil market abuse regime through MAR. I just wanted to flag that the criminal regime set out in section 52 of the Criminal Justice Act 1993 remains in place and is not affected by this new regime and so there are still three criminal offences if you deal on the basis of listed securities, if you encourage others to deal or if you disclose insider information. If you’re abusing inside information then those criminal offences still apply.
Moving on now to market manipulation. We’re still dealing with the same fundamental concepts in relation to the manipulation of markets. The principles boil down to two points - Are you through your trading activities seeking to move a price artificially in the market for illegitimate reasons or your own benefit? Or, are you not in fact through your own trading activities moving the market, but are you disseminating false information into the market or using deceptive devices as part of your trading activities or to supplement your trading activities? If you’re doing that then the manipulation offences will apply to you. I think a difficulty with the new regime is that we’re used to dealing with the code of market conduct set out in the market abuse section of the handbook, known as MAR, which might be confusing going forward! That code of market conduct will cease to have the same effect that it has at the moment. It would still remain in place, but in a truncated format, and will provide some guidance but fundamentally, we’re not going to be having the same examples or so called safe harbours or examples of acceptable behaviours in relation to market manipulation. And so that means that there will be some further uncertainty in relation to what the FCA and other regulators mean by market manipulation. We do have a delegated regulation which is a shorter form of regulation, which supplements the main market abuse regulation, which provides examples of the types of behaviour that regulators will deem to be manipulative but fundamentally there is going to be more uncertainty because we don’t know, absolutely, how regulators are going to be interpreting the new manipulation offences which are effectively the same as we’ve had already in the UK. But, the same types of behaviour will be the same, so if you have a dominant position in a particular security, then a regulator can look at that position and consider are you seeking to manipulate the market through having that large position? And significantly, attempted manipulation will fall within the scope of the new regime - that is a departure of what we had under the market abuse directive. Although practically in the UK, we would have said that a lot of attempted types of manipulation would still have fallen within the regime, but nevertheless attempted manipulation will be more at the forefront of the new regime and the regulators have given examples that attempted manipulation would be where you are trying to manipulate the market but for whatever reason you can’t manipulate it, perhaps it’s been a technology failure or something of that nature.
In relation to market manipulation I do think that a very significant new feature of the market manipulation regime is the manipulation of benchmark rates. Following a crisis, we had a criminal regime which was introduced for the manipulation of LIBOR, that was set out in section 91 of the Financial Services Act 2012 and through the Fair and Effective Markets Review (FEMR) last year, seven other benchmarks were added to that, such as the WMR 4pm Fix and repo rate benchmarks SONIA and RONIA, so we now have eight benchmarks in the UK which the FCA regulates and where the manipulation of those rates constitutes a criminal offence.
What’s happened or will happen under the market abuse regulation is that any benchmark which can be used or is used to price a financial instrument that falls within the scope of this regime (so financial instruments which are traded on regulated markets or traded on MTF’s or OTF’s) will become a civil market abuse offence. It’s therefore very important that firms, as part of preparing for MAR, identify what benchmarks are used as part of their businesses and what systems and controls they have in place in order to protect, prevent and mitigate against the risk of the manipulation of those rates. That is a really important area for firms to be aware of. Just to flag that, the FCA as with other regulators has the right to produce so called ‘accepted market practices’ - behaviours which do not constitute market manipulation. The FCA has already had that right and it hasn’t produced any accepted market practices and we don’t know of any at the moment, but there might be some accepted market practices which are issued. Finally I just wanted to flag in relation to manipulation that the criminal offence of manipulating the market listed securities still applies and I should say that this criminal offence is very broad indeed, it’s broader than the scope of the products which apply under the civil market abuse regime, the criminal offence is set out in sections 89 and 90 of the Financial Services Act 2012, so if you create a misleading statement or give a misleading impression to the market in relation to any form of share, private share, public share, any form of debt instrument, that could constitute a criminal offence.
I’m now going to move on to how firms should conduct surveillance for the potential manipulation of markets and how firms who are arranging transactions/executing purchasing sales of listed securities which fall within the scope of this regime, how they should conduct their surveillance and this also applies to trading venues as well as firms who operate trading venues to give access to market participants to trade on their MTF’s, for example. The most significant change in relation to the obligation to file suspicious transaction reports is that the obligation becomes an obligation to file a suspicious transaction and order reports, so it applies, as flagged at the start, to orders as well as transactions. I just wanted to flag that a few weeks ago the FCA announced a market watch paper and it said “we place as strong an emphasis on identifying weaknesses in regulated firms controls, as we do in pursuing market abuse”. I think that is really a strong message to the market that the FCA is looking to regulated firms who are conducting trades on behalf of their clients, to fight the fight against financial crime, to identify potential breaches of this regime and that is as important to the FCA as pursuing market abuse offences themselves. So there is a lot of guidance around suspicious transaction and order reporting - there is a delegated regulation which applies specifically to how firms should be conducting suspicious transaction and order reporting. I don’t have time to go into this in detail but I would be very happy to follow up with any of you if you have any further questions about the new requirements on firms but effectively, the obligation to file a suspicious transaction and order report applies where you have a reasonable suspicion. So where you’ve formed a reasonable suspicion, you have to notify without delay. We’ve been talking to clients - there’s a lot of uncertainty over how surveillance should be carried out, but I think the key thing is that firms need to bear in mind that they need to have adequate surveillance systems so that they can identify potential manipulation suspicions in relation to transactions which they are arranging or executing , that is really critical and the FCA has said that regulators don’t want to receive every single internal alert that a system might pick up to show suspected market abuse, the FCA want to have humans involved in identifying and following up on these alerts, and working out if there is a reasonable suspicion or not. It’s worth bearing in mind that the FCA have said that separately (and recently in a market watch letter) that it thinks there is little to no defensive reporting of suspicions in relations to suspected market abuse, and it wants to see more reporting (albeit it wants to see high quality good reporting) and it thinks that generally, the level of reporting across different asset parties is too low. It’s very important that firms have robust front office training systems in place, particularly so that front office business people understand what can constitute suspicions.
I’ve just received a question in relation to whether or not there is any guidance on what orders cover? The answer is “yes”, there is guidance on that. The delegated regulation talks about orders covering quotes as well as formal orders and we know that it is very difficult for firms at the moment to carry out automated surveillance in relation to quotes, largely because firms systems don’t have sufficiently advanced technologies to identify suspicions in relation to quotes. A lot of firms are building out their systems in order to identify and report and comply with the obligation under MiFID II or pre and post trade reporting obligations, and at the same time we are aware that firms are looking to build up their systems so they can report suspicions in relation to quotes and orders, so it’s important that firms work with their providers in relation to that.
Ok I will move on just to talk very briefly about other areas that are changing as part of the new market abuse regulation. For listed companies, any managers (so persons discharging managerial responsibilities who are conducting transactions in their own securities), they need to notify their companies within three business days and those companies need to make an announcement to the market about any transactions within three business days. There is a closed period of 30 days prior to an announcement where managers should not be conducting any transactions in shares in their own companies, apart from in exceptional circumstances. That is a change as under the model code there is a 60 day period for the listing rules which has been amended so it is consistent with MAR. Importantly, there’s a co-operation requirement among regulators, I think that is significant. There hasn’t been much coverage of that requirement but effectively it means that where we have cross-border enforcement actions, we can expect that it’s going to be more likely that we have an AMF, Consob – whoever, looking at activities which take place in the UK and it’s going to be more difficult for the FCA to push back on those other regulators and just say “no actually this is our market” so I think that it’s only really in exceptional circumstances that regulators cannot co-operate effectively with other regulators and ESMA will be co-ordinating cross-border co-operation.
Just in relation to whistleblowing, authorised firms will need to have their own policies in place so that employees can flag suspected breaches of the market abuse regulation competent authorities across member states will have to have mechanisms and processes in place whereby people can go to them and identify any suspicions in relation to market abuse.
One area of particular consternation is in relation to investment recommendations, so where firms are making the recommendations suggesting investment strategies, firms need to objectively handle the information that they have and disclose their own conflicts, disclose their own interests in relation to issuers where they are making investment recommendations. That’s a very important area and lots of market participants are really focussed on that.
Just in relation to sanctions, there will be uniformity, well there should be uniformity, in relation to the sanctions regime as set out in the regulation, so firms can be fined up to €15,000,000 or 15% of their annual turnover for conducting market abuse offences and individuals can be fined up to €5,000,000.
Finally I just wanted to flag that there are exemptions that will remain exemptions, for buy-backs and stabilisations (so where firms want to buy-back their own shares because they are reducing their capital or perhaps they need to fulfil their obligations under convertible debt securities, or perhaps where they have share option programmes that they need to fulfil) it will be appropriate for firms to buy-back shares without risk of market abuse, provided they announce that effectively and their behaviour is legitimate. And similarly, where firms are putting out secondary placements into the market and need to do some price stabilisation (so, buying shares in themselves are trying to manage the price of their shares around the secondary placement), that is an acceptable behaviour provided its done for legitimate reasons.
So where do we come out with all of this? Well, I think it’s going to be good that we have, subject to what happens a week today, a consistent regulation which operates across the EU, that’s easier for firms operating across different offices across the EU as it is effectively one rule book that they are applying - I think that that will be an upside for firms. We know that, for example, in relation to some activities we have been looking at the AMF takes a very different view to the FCA in certain types of trading behaviour and those differentials should hopefully disappear when we have the new regulation. I know our experience when we’re dealing with enforcement actions, FCA enforcement actions, when the FCA is looking at a suspected breach of a regulation, that actually we are on a much better playing field in going to the FCA and saying “well actually we think that your interpretation of the regulation is wrong” and it’s right that the FCA should feel a little bit more on the back foot in terms of how they’re interpreting the market abuse regulation as they would in relation to interpreting part of their handbook; and that’s because the whole point of this regulation is that it is directly effective and that there should be uniformity consistency in terms of how that regulation is interpreted. One downside is that the reality is, that there is more uncertainty now in relation to the inside information offences. Whilst we’ve got the same test effectively, we don’t have the same knowledge that the FCA seems to be interpreting the words in the same way, we don’t know the extent to which the FCA will have to have regard to the way in which other regulators are interpreting the new regulation and I think that that is the level of uncertainty.
So I will be very happy to follow up with anyone who might have any further questions. I appreciate that was quite a whistle stop tour of the regulation. Thank you very much for listening in and if you have any further questions please do contact a member of our financial regulatory team or you can contact me, I will be very happy to answer any questions or discuss with you any particular points about the new regulation.
I just wanted to flag that next week we have the last webinar in this current financial crime series. My colleague Kate Ison will be talking about the new corporate offence for failure to prevent tax evasion, and what it really means for you. That will be on Tuesday at 9am so please do tune in to that. I appreciate we have an important football match coming up now, so thank you very much for your attention and listening to this discussion.