Market Abuse: Anticipating Regulatory Investigations and coping with - - PowerPoint PPT Presentation

Market Abuse: Anticipating Regulatory Investigations and coping with Regulatory Reform Financial Markets & Regulatory Group

Chris Borg, Rob Falkner, Brett Hillis & Rosanne Kay

Case Studies

Background facts

• Clearer is a clearing broker which offers a direct market access service

enabling clients to trade on ICE Futures Europe (“ICE”) in its name.

• Client 1 is the FCA regulated trading subsidiary of an integrated oil and

gas group with interests including upstream physical assets. A year ago Client 1 was the subject of an FCA Skilled Person appointment following an unsatisfactory supervisory review of its conflicts of interest (client v proprietary trading interests) policies and procedures. The Skilled Person’s remit included a report on the firm’s corporate governance arrangements and compliance culture.

• Client 2 is an FCA regulated broker–dealer and market–maker which

specializes in energy product investments for itself and for clients.

Scenario A

• The Brent Crude spot price has been trending upwards but market fundamentals are

mixed with respect to likely market direction. Client 1 has a substantial long position in the ICE Brent Crude Futures front month contract, which closed at USD 63.02.

• The Client 1 senior energy derivatives product trader, John, participates in a

permanent chat with traders at two other market participants and just before the open

• f the following trading day one of the traders in the chat room messaged that it was

rumoured that there were take profit orders in the market at around the 63.92 level. During the trading day John asks a member of his team to assist him with the following:

• In order to test, or getter a better feel of, where actual market resistance levels

might be - enter bids in small size at prices which are higher than the previous bid at least until the price hits 63.90 but where practicable withdraw or cancel the bids before they are executed to avoid materially increasing their long position;

• Subject to detecting lower resistance levels from the activity at (a) take profits at

63.90.

• When 63.90 is reached John and his team member close Client 1’s long position.

Scenario B

• The next day, the immediate supply-demand fundamentals for Brent Crude indicate an

apparent over-supply. However the market view of the futures trader at Client 2 is that this is likely to be short-lived and he decides to take a significant long futures position based on his analysis.

• From time to time the trader at Client 2 uses an IDB to find a counterparty for a

transaction as a block trade where the trade is likely to have market impact. Broker 1 and Broker 2 at the IDB sit in the same office, each dealing for a number of different customers.

• The trader from (Client 2) calls Broker 1 and places a significant block trade buy order
• n the phone for front month Brent Crude futures on ICE Futures Europe to be shown

to a limited number of market counterparties. Broker 1 repeats the order back to Client 2. While Broker 1 is doing this, Broker 2 on the same desk overhears the conversation and sends an instant message to another customer which is a clearing member of ICE (Market Participant), telling him about it.

Scenario B (continued)

• Market Participant places a large buy order for immediate exchange execution with

Broker 2 for front month Brent Crude futures. Broker 2 places a small Brent Crude futures spread bet using his personal mobile phone for his brother-in-law’s account, for which he has a power of attorney, and enters the Market Participant buy order into the IDB’s trading system which is executed on exchange with a consequent upward movement in the exchange traded price.

• Soon after this Broker 1 posts the block trade order for Client 2 on the IDB’s screen

for the eyes only of selected counterparties which happen to include Market

• Participant. There are price negotiations through the IDB and a bilateral block trade is

agreed between Client 2 and Market Participant at or about the then exchange traded price.

Scenario C

• A bond issuer, X plc, is in the initial stages of negotiating a restructuring. T is X plc’s

corporate trustee. As part of the restructuring, X plc needs to renegotiate its position with its existing bondholders. The bonds and X plc’s shares are listed in the UK.

• One proposal under consideration is an offer under which existing bondholders could

elect to receive longer term bonds with a lower nominal value (80%) than the original.

• Bondholders need to be consulted as part of the restructuring process. X plc sends a

notice to existing bondholders to inform them of the proposal.

• After receiving the notice, one of the bondholders contacts T late on a Friday evening

to request more information about the proposed restructuring, the reasons for it and the other proposals under consideration. The only person at T available to speak to the bondholder is a junior graduate trainee who has recently joined T. The graduate trainee knows about the restructuring and tries to be as helpful as possible.

Scenario C (continued)

• A second bondholder decides that he does not like the proposal and reduces his
• bondholding. He sells half of his bondholding in the market.
• The second bondholder also tells Y, a shareholder of X plc, about the proposed

restructuring and that he does not like the look of the proposal on the table and is thinking of reducing his bondholding rather than electing to receive the new longer term bonds. Upon receiving that information, Y decides to sell his shareholding in X

• plc. Investor Z purchases the shares from Y at the current market price of GBP 1.04

per share.

• A day after Investor Z has purchased the shares, the bondholders vote in favour of the

restructuring at a bondholder meeting and the restructuring is announced via the RIS to the market. The market price of the shares falls to GBP 0.52 per share.

• B is a corporate broker and notices the share sale by Y immediately prior to the
• announcement. B submits a Suspicious Transaction Report and the FCA decides to

take a closer look.

Market Abuse Regulatory Reform

Financial Markets & Regulatory Group

Chris Borg, Partner, Reed Smith LLP

+ 44 (0)20 3116 3650

cborg@reedsmith.com

Market Abuse Regulatory Reform

EU Agenda

• MAR/CS MAD
• MiFIDII Position limits
• MiFIDII HFT/DMA requirements
• EU Benchmark Regulation

Domestic Agenda

• FS Act 2012
• FEMR
• SMR & Certification Regime

MAR Extension of Scope

MAR Extension of Scope

• New behaviours
• Attempts
• Orders & Transactions
• Other behaviours (cancellations, modifications)
• New trading venues
• RMs, MTFs, OTFs
• New products
• FIs under MiFID2
• Underlying spot commodities
• Emissions auction
• New area
• Benchmarks

MAR Extension of Scope

Recalibration of existing offences:

• Insider dealing widened to cover:
• More commodities, emissions
• Cancelling/amending orders
• Manipulation widened to cover:
• Spot commodities: Where the transaction, order or

behaviour is likely to have an effect on the price or value of an FI

• FIs: “the price of value of which depends on or has an effect
• n the price or value of an FI … including but not limited to

credit default swaps and contracts for differences”

• Benchmarks
• Collaboration (Recital 39), includes:
• Brokers devising/recommending abusive strategies
• Software developers collaborating to facilitate market abuse

MAR New Obligations

New Disclosure Requirements (Commodities/Emissions):

• Disclosure of “inside information”
• “Issuers” of financial instruments:
• where inside information it “directly concerns” the

issuer

• bligation applies only where issuer has

“requested or approved” admission to trading

• “Emission allowance market participants”
• where inside information concerns emission

allowances they hold in respect of their business

• subject to minimum CO2 or thermal input

threshold

June 2012

MAR STOR Reporting

New STOR Reporting Requirements

• Trading venues (RMs, MTFs, OTFs)
• Systems for preventing and detecting abuse
• Intermediaries (“STOR” obligation)
• persons professionally arranging or executing transactions
• systems for detecting and reporting suspicious

transactions and orders

• on trading venues or OTC

MAR Automated Surveillance

Mandatory automated surveillance (for intermediaries)

• ESMA proposal:
• Proportionality
• Bids/offers
• Near misses
• Telephone markets
• Cross-market activities
• Timing:
• Draft RTS to be submitted to the

Commission by 3 July 2016.

• Possible delay...?

MAR Automated Surveillance

Article 12(5) & Annex 1 MAR (Level 1)

Indicators of manipulation

• Non-exhaustive
• Non-determinative
• Searchable, objective data, e.g.:
• relative size of orders/trade v daily volume in market

(esp if there is a price impact);

• price impact of orders/trades placed by those with a

long/short interest

• position reversals over a short period
• concentration of orders/trades over a short period

leading to a price change (which is then reversed)

• whether orders which are removed early have

changed best bid/offer

• rders/trades affecting prices at the close…
• …and more

Draft Delegated Act : (Level 2)

• Searchable objective data
• Long list describing potentially abusive practices
• “Colluding in the after market of an IPO”, “creation of a

floor or a ceiling in the price pattern”, “ping orders”, “phishing”, “abusive squeezes”, “inter-trading venue manipulation”, “cross-product manipulation”, “wash trades”, “painting the tape”, “improper matched orders”, “concealing ownership”, “pump and dump”, “trash and cash”, “quote stuffing”, “momentum ignition”, “marking the close”, “layering and spoofing, “placing orders with no intention of executing them”, “excessive bid-offer spreads”, “smoking”.

• Commission Non-Paper 13 May 2015

MAR & New EU Environment

Increased Investigation Risks

• Transaction reporting
• MiFIDII, EMIR, REMIT
• Position limits
• MiFIDII
• Increased Automated Surveillance & STOR
• Whistleblower protections under MAR
• anonymity
• employment protections
• right to go direct to NCA

ESMA & NCAs under MAR

• ESMA/FCA Guidance?
• ESMA/FCA enforcement decisions?
• FCA relationship…?

CSMAD/MAR – Timeline

September 2015 Delayed Draft RTS and ITS on MAR to EU Commission

• Accepted Market Practices
• Buy-backs and Stabilisation
• Market soundings

By 3 July 2016 (no delay indicated) Draft RTS on MAR to EU Commission

• ESMA/NCA co-operation/information-sharing

3 July 2016 CSMAD transposition MAR and Delegated Acts apply

• Includes detailed indicia of market manipulation

After 3 July 2016 (potential delay) Draft RTS on MAR to EU Commission

• STOR: systems and notification templates
• Disclosure of inside information
• Insider lists (format and updating) and reporting manager’s transactions

3 January 2017 MAR provisions on OTFs, SME growth markets, emissions (etc) apply

UK Fair and Effective Markets Review (FEMR)

Objective: to restore confidence in FICC markets

• April 2015: addition of 7 benchmarks to

the FS Act benchmark regime

• FEMR Report, June 2015
• 6 Principles, 21 Recommendations

UK Fair and Effective Markets Review

Headline Recommendations

• New body: FICC Markets Standards

Board (FMSB)

• New UK civil and criminal conduct

regime for FX spot trading

• International agreement on single

global FX code

• Extension of individual accountability
• Criminalisation across “wider range of

instruments”

• Extension of SM & Certifications Regime

Principle 1

Raise Standards, Professionalism and Accountability of Individuals

Principle 2

Improve The Quality, Clarity And Market-wide Understanding of FICC Trading Practices

Principle 3

Strengthen Regulation of FICC Markets in the UK

Principle 4

Launch International Action to Raise Standards in Global FICC Market

Principle 5

Promoting Fairer FICC Market Structure While Enhancing Effectiveness

Principle 6

Forward-looking Conduct Risk Identification and Mitigation

FEMR Recommendations – Known Timeline

Autumn 2015 Open Forum at the Bank of England Before March 2016 FCA and PRA consultation on mandatory form for regulatory references for individuals’ conduct records (template ready for SM&CR commencement) March 2016 Senior Managers & Certification Regimes in force By June 2016 Full implementation update to Chancellor of Exchequer and Governor of Bank of England

Market Abuse: Anticipating Regulatory Investigations and coping with Regulatory Reform Financial Markets & Regulatory Group

Chris Borg, Rob Falkner, Brett Hillis & Rosanne Kay