Market Abuse Detection and Your Firm

After the 2007-9 financial crisis and the subsequent high profile scandals that followed, it wasn’t long before the problem of market abuse hit the public radar. The fact that market abuse had played such a significant role in crisis (and that existing methods for market abuse detection were clearly insufficient) made restoring market transparency and investor confidence an immediate priority for the industry.

Market abuse is commonly thought to be the same as insider dealing (where a person uses information not available to other investors for personal gain), which was made illegal in 1985. However, market abuse covers a much broader spectrum, and it’s only in the last ten years that legislation has emerged to match its scale.

What is defined as market abuse?

The term ‘market abuse’ can be applied to any action that unfairly disadvantages financial market investors, whether directly or indirectly. It tends to be divided into two aspects: insider dealing and market manipulation. Whereas insider dealing involves the exploitation of information not publicly available to influence shares, market manipulation is about issuing false or misleading information to influence shares.

One of the most common occurrences of market manipulation, for example, is to create a misleading image of a company by providing false information about its financial performance or circumstances. This distorts its economic value to the rest of the world, while the person committing market manipulation knows the real value.

Although the financial crisis wasn’t primarily caused by misconduct in the market, it demonstrated how quickly pricing information could spread and the ease at which the system could be manipulated. In the years after the crisis, the Financial Conduct Authority (FCA) prioritised market abuse detection. The financial watchdog clamped down on relaxed reporting of both standard and potentially problematic transactions, and penalised large corporations like Deutsche Bank and Barclays for inaccuracies in their reports.

Market abuse detection in 2018

Since then, the European Commission (EC) has focused on restoring the integrity of financial markets and increasing investor confidence. In 2011, the EC issued a proposal to impose criminal sanctions on insider dealing and market manipulation, which came into force in 2016.

The European Union’s Market Abuse Regulation not only strengthened the previous framework around market abuse, but extended its scope to new markets and platforms. It also shifted focus to prevention of abuse, as well as market abuse detection, meaning that it’s becoming increasingly important for firms’ systems and controls to actively counter abuse and understand the ways it might occur.

Most recently, the introduction of MiFID II (the markets of financial instruments directive) focuses on protecting investors, by significantly raising the acceptable standards for transparency in investment houses. This, along with the Market Abuse Regulation, aims to create fairer, safer and more efficient markets, and prevent market abuse or manipulation.

The introduction of MiFID II

MiFID II is a regulation that increases the transparency of the European Union’s financial markets. Initially created in 2004, the latest reform (MiFID II) is set to change the entire marketplace as we know it, and affect companies from investment banks and insurance firms to non-financial institutions like energy providers. The impact of the latest directive is likely to spread further than Europe too, given the cross border implications.

The regulation requires investment firms to prove they have acted honestly, fairly and professionally at all times, to make market abuse detection easier. In addition to this, there needs to be evidence that they’ve acted in the best interests of their clients. If a question about a particular trade arises, or a financial regulator receives a complaint, investment firms will need to have evidence they:

  • Understood the investing criteria set out by their clients
  • Provided relevant reports and assessed suitability of opportunities
  • Avoided sale targets that may have incentivised staff to recommend inappropriate opportunities
  • Delivered fair, clear and straightforward information

MiFID II isn’t just about mere compliance either. The strategic implications that come with being compliant could bring market opportunities and advantage, whereas there’s a potential for revenue loss for those who fail to prepare.

Meeting the compliance requirements of MiFID II

When it comes to MiFID II, transparency is crucial. MiFID II represents a drastic improvement in the volume and quality of data that regulators receive on market transactions, which helps to make market abuse detection much easier. Significant fines have also been levied under MiFID I for inaccurate or insufficient reporting, and there have been suggestions that fines will increase under MiFID II.

To be compliant with MiFID II, firms will need to capture all communications that lead to a transaction, and bear in mind that this includes communication on non-traditional platforms like social media. Firms are required to take “all reasonable steps” to ensure that crucial communications don’t happen on channels that can’t be recorded.

Where to start in your firm

Start by identifying how MiFID II is likely to impact your company, particularly any business threats or strategic opportunities that you’ll need to get started with straight away. This will help you to prioritise timings and work streams, ranging from actions that need immediate focus to things you can slowly change down the line.

Assign tasks and responsibilities to a committee or work group to work through your compliance on a project by project basis, but make sure you educate the wider company too.

This education is also incredibly important, since everyone at your firm will be responsible for ensuring you meet regulations. Given how meticulous MiFID II is set to be, it’s vital that everyone considers the methods of communication they use with clients and how casual or offhand remarks might be perceived. Outline the regulations and explain why they’ve been implemented – this will help to drill home that they’re there to make the market a clearer and fairer place to work.

Finding the right software

Having the right software is one of the easiest ways to achieve MiFID II compliance, and firms will struggle to meet regulations around market abuse detection without it. Not only has MiFID II broadened the definition of transaction (to include any transaction with a reportable financial instrument), but it has increased the number of reporting fields from 24 in MiFID I to 65.

In addition to compliance, there is increasing pressure for firms to innovate with their technology, in an effort to make market abuse detection everyone’s responsibility – not just financial regulators. As the FCA put it:

“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.”

Improve your market abuse detection with eflow Global

In accordance with MiFID II, firms need to keep seven years of records relating to services, activities and transactions, whether these were concluded or just intended. All records need to be monitored and easily retrievable, so regulators can access relevant information securely.

Eflow offers the perfect software to help your firm to get organised and become compliant with the latest regulations. With eflow, data search, retrieval and storage is flexible and stress-free, making reporting easy.

To find out more about eflow, the latest market regulations and how you can make market abuse detectioneasier, contact us today.

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