Market Watch 69 – Market abuse surveillance for small and medium sized firms

Market Watch 69 – Market abuse surveillance for small and medium sized firms

The UK Financial Conduct Authority (“FCA”) published its latest Market Watch newsletter on 17th May 2022, setting out key observations on the market abuse surveillance arrangements in small and medium sized firms. A common conundrum for such firms is the requirement that surveillance arrangements, systems and procedures are appropriate and proportionate to the scale, size and nature of their business activity. What does the regulator mean by appropriate and proportionate? The latest Market Watch gives us some useful insight into the FCA’s expectations.

Assessing the risk of market abuse

An effective surveillance framework starts with a comprehensive, accurate and up-to-date market abuse risk assessment. This should consider the risks for each business area, the method of execution and the asset classes and instruments traded. For example, the risk of spoofing would typically be higher on electronic markets than voice markets due to the ease with which orders can be cancelled.

Assessing market abuse as a single risk, or under the two categories of insider dealing and market manipulation, is not going to produce an appropriate risk assessment. There are many behaviours that can be defined as market manipulation, each with distinct characteristics e.g. spoofing vs wash trades. Firms need to ensure these differences are accounted for in the risk assessment.

When identifying the market abuse risks relevant to your firm, ensure that you look beyond the examples listed in primary legislation. To quote a previous FCA Director of Market Oversight, “whilst the fundamentals of the market abuse offences are constant, the ways in which the risk may manifest are not. The manner for surveilling them must, therefore, also change.”

Key questions for firms:

  • How do you consider the different risks to each business area and asset class?
  • Are you updating your risk assessment following changes to your business model and significant market events to ensure they remain effective?
  • Can you demonstrate how you identify market abuse risks beyond the examples listed in relevant legislation? (e.g. assessing enforcement cases, regulatory and exchange publications, historical in-house incidents)

Order and trade surveillance

The FCA has observed firms applying generic alert calibration across (and within) asset classes, where the nature and scale of the metrics involved (e.g. price movement) are significantly different. This is unlikely to ensure effective monitoring since firms will either be setting thresholds too wide and dealing with increasing false positives, or too narrow and not detecting potential abusive behaviour. The newsletter suggests that the tailored calibration functionality offered by third party system vendors has progressed in recent years. Whilst we agree there has been progress, particularly in securities markets, we know that certain vendors are yet to provide this functionality at a product level in currency and commodities markets. We would encourage all firms to engage with their surveillance system vendors on this topic, and if they are not currently offering product-level alert calibration, find out when they plan to introduce it.

Another example of inappropriate calibration was found in the ‘look-back period’ firms have been using for insider dealing alerts. A system may have a default setting of 24 hours, but firms need to justify any period that is used and demonstrate how that threshold considers the time that information might exist prior to its release.

Some firms are not monitoring orders, including cancelled and amended orders. These are integral in identifying behaviours such as spoofing which encourage other participants to trade.

Periodic review of order and trade surveillance arrangements are critically important. Firms need to understand their alert parameters/logic and demonstrate that their alert analysis and escalation is effective.

Key questions for firms:

  • Are your alerts tailored to fit your business model?
  • Are changes to calibration appropriately considered, documented and governed?
  • Can you show effective oversight of alert analysis and escalation?

Policies and procedures

There is nothing new to report when it comes to best practice around policies and procedures. The focus is on ensuring these documents are clear, detailed and up to date.

Procedures should give clear guidance on the signs of market abuse, or what materials/information to use or consider. If they do not, surveillance alerts may be inappropriately closed. Our view is that procedures and training play a vital role in ensuring effective alert investigation. Both should be used to communicate the fundamentals of market abuse offences so that employees can identify and escalate suspicious orders and transactions.

Key questions for firms:

  • Are your policies and procedures up to date?
  • Have you evaluated a new employee’s ability to understand and follow your policies and procedures? This is often an effective way to identify where changes are needed, or additional training is required.

Outsourcing

Outsourcing trade surveillance should come with a warning. Firms must ensure the person responsible for trade surveillance in the UK can demonstrate effective oversight of the outsourced function. It is vital that the team conducting surveillance has sufficient understanding of UK MAR. Where firms outsource to group companies in foreign jurisdictions, be aware that they may be assessing alerts through the lens of their local regulation as opposed to UK MAR.

Key questions for firms outsourcing surveillance:

  • How do you demonstrate effective oversight?
  • Do you understand the alert logic and calibration?
  • What quality assurance reports or management information do you receive?

Front office

The size of some firms may mean staff performing dual roles in the front office and as part of compliance. Where firms do this, they need to ensure they have adequately assessed any potential conflict of interest and taken steps to mitigate them.

Effective training must be tailored to the risks associated with the desk, asset classes traded, client types and other relevant factors.

Key questions for firms:

  • Have you considered and assessed potential conflicts of interest arising from your surveillance framework?
  • Is your market abuse training sufficiently tailored to the risks that are directly relevant to the training participants?
  • Are escalation policies written in a way that is easy for front office staff to understand as opposed to being carbon copies of market abuse legislation?

Market abuse-related Financial Crime

Chapter 8 of the FCA Financial Crime Guide sets out guidance for firms in relation to market abuse-related financial crime. The newsletter reminds firms of their obligation to follow this guidance and ensure that market abuse is considered alongside their financial crime programme.

Investigations into potential market abuse by firms’ employees

Firms who suspect their employees of potential market abuse should submit a STOR without delay, once they have reasonable suspicion that the relevant conduct could constitute market abuse. Care must be taken not to inform the subject of the STOR that a STOR will be submitted.

Market abuse surveillance support

Market abuse remains front and centre of the UK regulator’s focus. We are well placed to assist firms with their surveillance frameworks. We offer health checks on surveillance programmes, STOR policies/procedures and bespoke training solutions to firms and venues. Contact us with your requirements if you need assistance in this area.

References

2022. Market Watch 69. Financial Conduct Authority, available at https://www.fca.org.uk/publications/newsletters/market-watch-69 (last accessed 7th June 2022).

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