Written by
Katie Pollock
It is no secret that financial services firms globally are experiencing difficulty keeping pace with the ever-evolving regulatory landscape and increase in enforcement, which has had an impact on the day-to-day workload of most employees. Regulators globally have sent strong messages to financial institutions operating manipulative trading practices. In the most recent Business Plan, the UK’s Financial Conduct Authority (“FCA”) has committed to delivering assertive action on detecting and preventing manipulative trading practices through its creation of a new dedicated non-equity manipulation team. The FCA has also increased enforcement resources to bolster its response regarding market abuse and counter concerns that it does not focus on market abuse in the debt markets. This commitment stems from its most recent Annual Report, where it reported 71 open investigations of insider dealing and 13 open market manipulation cases, despite the UK regulators historically publishing fewer enforcement outcomes regarding manipulative trading practices than their US counterparts. In 2021, the European Securities and Markets Authority (“ESMA”) reported 366 administrative sanctions and measures and 29 criminal sanctions for infringements of Regulation (EU) No 596/2014 on Market Abuse (“MAR”). The value of the financial penalties imposed for the administrative sanctions reached EUR 54m, while the financial penalties in relation to criminal infringements of MAR amounted to EUR 5m. While the number of administrative sanctions and measures under MAR significantly decreased compared to 2020, the financial penalties significantly increased. In the US, in a recent enforcement case, the Securities and Exchange Commission (“SEC”) reiterated its focus on “detecting misconduct by financial industry professionals, and we will continue to use our resources to bring them to justice and bar them from the securities industry when appropriate.” Thus, the trend of regulators globally increasing focus, and thus their use of technology to ingest, review, and dissect vast amounts of industry data to detect insider trading and other securities law violations is also increasing.
Market Abuse Detection and Prevention
Manipulative trading patterns, including insider trading, can occur at both the firm level and the employee level: portfolio managers and traders may have access to material, non-public information (“MNPI) and use to boost performance and benefit the firm, whereas individual employees may trade on insider information with the goal of receiving illicit profits in their own investment accounts. If found acting on MNPI, or trading on any other method for the purposes of manipulating the market, not only can the sanctions be costly, but the reputational damage to a firm will exceed the fine. Although financial services firms need written policies addressing market abuse, these documents alone are ineffective in eliminating manipulative trading behavior. Firms can take steps to lower this risk beyond disseminating trading policies. Technology solutions can help detect and prevent this type of activity on both levels, allowing firms to monitor both firm-level and personal trades and identify trends. These types of technology can also play a key role in helping firms reduce human intervention in trade surveillance, freeing up capacity for its employees and lessening the chance of covering up manipulative behavior. These tools can also help meet record-keeping requirements and prepare for regulatory examinations.
Because manipulative practices vary across different markets and instruments, it can be difficult to determine what makes a particular practice manipulative or deceptive. For example, UK MAR also sets out in Annex I indicators of manipulative behavior but also confirms that these indicators are non-exhaustive and do not, in themselves, constitute market manipulation, but they are taken into account when transactions or orders to trade are investigated by the FCA. They have also cited firms who maintain basic market abuse alerts such as insider dealing or layering and spoofing but do not consider other types of market manipulation as poor practice. There are times when trades are executed for legitimate purposes but may appear unusual and abusive, especially where the market is illiquid or volatile. In its Market Watch 67, the FCA noted that its internal surveillance algorithms had identified trading by an algorithmic trading firm which raised potential concerns about the impact the algorithms responsible for executing the firm’s different trading strategies were having on the market. As a result of the FCA’s examination, the firm adjusted its algorithm and its control framework to help avoid the firm’s activity having an undue influence on the market. Thus, a firm’s monitoring and surveillance systems need to be flexible and should be tailored to the specific risks within its trading activity, along with suitable market abuse training should be conducted for all relevant members of the firm.
Conclusion
When considering potentially abusive behaviors and measures to put in place to help prevent, firms should create robust controls and procedures, which may include:
- A systematic approach to monitoring anomalous trading patterns, which may mean that firms need to invest in more sophisticated and automatic surveillance tools. Alerts are generated through these surveillance tools and then evaluated by appropriate independent individuals(s) in conjunction with other relevant contextual data.
- An appropriate written methodology for investigating alerts, as well as appropriate levels of sign off for the closure of alerts and proportionate sample testing of alerts and escalations and proper documentation
- Independent supervisory controls and procedures that address the creation, modification and testing of trading algorithms for manipulative, deceptive or suspect trading practices.
- Regular updates to policies and procedures including in relation to the escalation of any suspicious activity.
It is prudent that firms must have adequate systems in place so that they are able to comply with their regulatory obligations at all times, including if there are changes to a firm’s business model, and these controls should be refined continuously to accommodate external factors, such as new regulations, products or customers to augment a firm’s ability to increase its business in a safe and compliant manner.
How b-next Can Help
Our trade surveillance and market abuse modules are designed to help multi-venue, multi-asset buy and sell-side firms manage in a way that meets global regulatory expectations and industry best practices, and can drive trading and operational efficiencies.
For questions or to discuss how b-next can strengthen its surveillance program, increase efficiencies through technology, and help ensure regulatory obligations are met, contact us here.
Important Disclosures
This document is for informational purposes only. Nothing herein shall constitute a recommendation, solicitation, invitation, inducement, promotion, or offer for the purchase or sale of any investment product, nor shall this material be construed in any way as investment, legal, or tax advice, or as a recommendation, reference, or endorsement by b-next. b-next makes no representation or warranty with respect to this communication or such content and expressly disclaims any implied warranty under law. At the time of publication, the information herein was believed to be accurate, however, such information is subject to change without notice. By reviewing this material, you acknowledge that neither b-next nor any of its third-party providers shall under any circumstance be liable for any lost profits or lost opportunity.
Bio
Katie Pollock has over 14 years of experience in various cross-asset class trading/trading operations roles for several large Investment Managers in London and the U.S. She began her career on the sell-side working for JP Morgan Cazenove as a Business Analyst in the U.K. and Pan European Equity Sales Desk. Katie received her BBA from the University of Missouri – Kansas City, her M.B.A. from Regent’s College (Webster Graduate School – London), and her Masters in Law and Finance from Queen Mary University of London.