A Deep Dive into FCA's Market Watch 73
Enhancing Market Abuse Enforcement: A Deep Dive into FCA’s Market Watch 73
Market abuse is a broad term referring to various unfair and manipulative practices occurring in financial markets. Such activities include insider dealing, market manipulation, false or misleading disclosures, and the misuse of private, or ‘insider’ information. These illicit practices can significantly undermine the integrity of financial markets, erode investor confidence, and compromise the fairness of market transactions by distorting prices or fostering unfair advantages for certain participants.
Detecting and preventing market abuse is crucial if we are to maintain a level playing field for investors and protect genuine actors from fraudulent practices. In order to turn the tide on bad actors, the public and private sector must leverage a combination of regulation and technology to identify and prevent manipulative practices.
The Financial Conduct Authority (FCA) is the UK’s main regulatory authority for these issues. Their long-standing “Market Watch” series is a mechanism by which information and guidance are relayed back to the private sector. Practically speaking, this series sees the FCA share its observations and findings from various reviews, investigations and research spanning a multitude of regulatory topics, including market abuse.
Overview of Market Watch 73
Market Watch 73 covers the FCA’s recent review of firms offering Contracts for Difference (CFDs) and spread bets, products considered increasingly vulnerable to insider dealing and consequently major contributors to Suspicious Transaction and Order Reports (STORs). The review strives to understand and elevate the standards of CFD providers’ strategies to identify and report potential market abuse. The FCA undertook a comprehensive methodology, including:
- Questioning firms about their business models, market abuse risks and arrangements for detecting and reporting market abuse.
- Reviewing firms’ documentation including policies and procedures, risk assessments and relevant management information.
- Supervisory visits to take a closer look at firms’ risks and controls.
Areas of improvement for firms
While the FCA acknowledged that all firms have existing surveillance systems in place to detect insider dealing, a number of areas still require improvement and the regulator has provided practical guidance to enhance their market abuse detection capabilities.
Market abuse risk
The prevalence of insider trading in single stock equities was recognized as the primary market abuse risk among firms. However, not all firms demonstrated a comprehensive consideration of all relevant market abuse risks in their business. Firms that conducted thorough risk assessments, accounting for different types of manipulation, trading platforms, and methods, were more effective in identifying applicable risks. The FCA emphasised that in order to maintain effective arrangements, systems and procedures to detect and report suspicious orders and transactions, firms need to understand how they could facilitate market abuse. If done properly, undertaking a risk assessment is an effective and efficient way of achieving this.
The review identified that most firms use a mix of in-house and third-party solutions for insider dealing surveillance, relying on various “triggers” to prompt alerts. However, there were inconsistencies in lookback periods (ranging from 1-30 days) and monitoring of unrealised profits, which may undermine effectiveness. The FCA thus encourages firms to evaluate their surveillance coverage, particularly regarding market manipulation and non-equity asset classes.
“Narrowing the spread”
The FCA highlighted “narrowing the spread,” a manipulative practice affecting spread bets or CFDs, particularly in illiquid stocks. Despite some firms recognising this, it remains absent from risk assessments and surveillance systems, emphasising the need for CFD providers to more effectively detect and report such behaviour. While trading desk detection has had some success, the implementation of surveillance alerts could ensure more consistent identification.
Front office and the tipping off risk
The FCA emphasises striking a balance in engaging front office staff on surveillance matters, mindful of ’tipping off’ concerns. Essentially, compliance departments need to confidently challenge and educate front office staff, despite reservations about revealing suspicious client behaviours. Sharing of Suspicious Transaction and Order Reports (STORs) should be on a need-to-know basis, without stifling necessary dialogue and learning.
What does this mean for enforcement activity?
The focus on formalisation and documentation within the FCA’s review indicates a broader push for consistency and the ability to demonstrate compliance. Firms should actively show adherence to regulatory standards, with a keen focus on comprehensive market abuse risk assessments. No longer can ignorance of risks be a fallback - proactivity in risk identification and management is crucial.
Additionally, the FCA is urging enhancement of order and trade surveillance capabilities, warning that certain emerging behaviours may not be adequately captured by existing technologies. This call demands firms to account for all asset classes and execution methods, underlining the necessity of staying abreast with the evolving risks in the market to avoid regulatory enforcements.
The FCA’s Increasing Scrutiny over Market Abuse Violations
This edition of the FCA’s Market Watch is part of their ongoing engagement with the CFD market, demonstrating their continuous efforts to address issues and ensure market integrity. In December 2022, the FCA issued a “Dear CEO” letter that highlighted some common problematic behaviours in the industry. These included scam/churn activities, circumvention of FCA rules, and the use of affiliate marketers/introducers. Firms were explicitly warned to take action to mitigate these risks and meet regulatory requirements. The FCA emphasised their commitment to scrutinising firms’ responses to the letter and any actions taken, with a clear message that swift and assertive action would be taken to protect consumers and maintain market integrity.
In previous editions of the Market Watch, the FCA stressed the significance of effective order and trade surveillance that caters to different asset classes and instruments. This encompasses all-inclusive monitoring of all transactions, including modifications and cancellations, along with appropriate analysis of surveillance exception alerts, reinforcing the ongoing and growing emphasis on vigilance and comprehensive surveillance in the market landscape.
In addition to these publications, the FCA has been actively enforcing regulations in the market. They fined Sigma Broking Limited £530,000 and imposed bans and fines on its former directors due to market abuse reporting failures. Furthermore, the FCA revoked UK CFD permissions for Cyprus-based CFD firms Maxiflex Ltd (trading as EuropeFX), Maxigrid Limited (trading as Dualix & AGM Markets), and Reliantco Investments Ltd (trading as UFX). The FCA also intervened by stopping BDSwiss from offering CFDs to UK customers.
Key Takeaways for CFD Providers
In response to the growing pressure and regulatory scrutiny faced by CFD providers, there are several key takeaways that firms should consider implementing:
- Risk Assessments: CFD providers should conduct thorough risk assessments that encompass the wide scope of threats outlined by the FCA’s recent publications. This includes considering different types of market abuse, business areas, asset classes, and trading methods.
- Training and Escalation Policies: Firms should ensure comprehensive staff training, especially for front office personnel, to bolster awareness of market abuse risks and the appropriate escalation protocols, fostering a proactive culture of vigilance.
- Implement State-Of-The-Art Trade Surveillance Technology: To effectively monitor trading activities and detect suspicious behaviour, CFD providers should invest in advanced trade surveillance technology. These tools can help firms capture and analyse vast amounts of data, enabling them to identify potential market abuse more efficiently and accurately. The use of specialised technology also ensures the level and consistency of information capture and documentation, enabling firms to meet regulatory requirements and demonstrate their compliance efforts.
By taking these actions, CFD providers can enhance their risk management practices, strengthen their surveillance capabilities, and demonstrate their commitment to maintaining market integrity.