Market Watch
Markets Division: Newsletter on Market Conduct and
Transaction Reporting Issues
Issue No.16 June 2006
Introduction
This is our sixteenth Market Watch newsletter. If you wish to join our email list to receive future editions,
please contact us on market.watch@fsa.gov.uk. It is also available on our website at:
www.fsa.gov.uk/marketconduct/
Message from Sally Dewar, Director of Markets
The Wholesale Business Unit takes the FSA’s leading role in pursuing our
aim of maintaining efficient, orderly and clean financial markets.
Preventing and combating market abuse is a major part of this. Our view
is that although the majority of individuals and institutions using the
financial markets adhere to high standards, there is a small minority of
both who do not. This raises costs for all market participants: unfair
markets are inefficient ones.
One of our key priorities currently in preventing and combating market
abuse is in respect of institutional market abuse. Since December 2001 we
have had a number of successful cases but it is fair to note that the
majority have been cases from outside the financial sector. While we intend to continue bringing
enforcement action against individuals committing market abuse, we have become increasingly concerned
by the risk generated by institutions exploiting the information they legitimately receive for illegitimate
purposes or engaging in other unacceptable behaviour.
Our future work programme covers pursuing both cases of market abuse and undertaking a series of
deterrent measures. We want to get our message across through a combination of enforcement cases and
through educating and advising firms as to what standards must be achieved in order to maintain clean
financial markets. Already this year we have undertaken several pieces of thematic work focused on
institutions. As reported in this edition of Marketwatch we have recently completed some visits to
participants in the debt, loan and credit markets. Going forward, we will be using the knowledge we have
gained to proactively monitor the credit markets. We have also undertaken a review of convertible bond
issues launched in recent years. Going forward we are planning to carry out some work that will look at
the leakage of inside information ahead of mergers and acquisitions.
Some recent FSA enforcement decisions have also reflected our strategic approach. We are concerned that
key players in the wholesale market ensure that they observe proper standards of market conduct. Recent
institutional cases reflect our determination to act against institutional market misconduct in order to
improve the overall quality of markets. We will continue to pursue cases that ensure our key messages are
made to the market.
This is not FSA guidance.
But it is not just us at the FSA who need to work to achieve clean markets. Firms can help us here and we
have expectations of what firms should do in our collective efforts to combat market abuse. In our view
there are three key ways in which firms can work with us.
1.
Firms need to manage conflicts. The investment banking business model contains inherent conflicts
of interest and we think that the industry recognises the need for it to address the concerns of
regulators and the public. Of course, having a conflict is not the same as abusing that conflict.
Nonetheless, firms need to be able to demonstrate that conflicts are actively identified and managed.
2.
Firms need to comply with their obligation under the Market Abuse Directive to provide us with
suspicious transaction reports. This is an obligation for all firms who arrange or execute securities
and derivatives transactions – not just small retail broking firms but large wholesale banks as well.
Our rules and guidance on suspicious transaction reporting make clear that notifications require
sufficient indications that the transaction might constitute market abuse and that a firm will need to
explain the basis for its suspicion when notifying the FSA. We recognise that identifying suspicious
transactions is not an easy task and it is not realistic to expect that every possible case will be picked
up, but we are now nearly a year into the regime and our statistics show where there are gaps – we
can see firms who have not reported any suspicious transactions where their peers have, and during
the latter part of 2006 we will be following up with these firms to ensure that they have the
necessary systems and procedures in place to meet our suspicious transaction reporting requirements.
3.
Firms need to self report if they uncover wrongdoing by their employees. Very simply if staff engage
in misconduct, and firms know it has happened, we require firms to inform us. If a firm has good
systems and controls, shows that it is complying with them and takes appropriate remedial steps
following any misconduct, then generally we won’t pursue the firm in an enforcement action. Instead
we will pursue the individual. So in all cases we expect to be informed of an individual’s abusive
behaviour. We also expect firms to let us know if they see behaviour by their counterparties that they
think is harming markets.
Sally Dewar
Market management exercises
We have recently received several communications about market management exercises in the
bond market.
This process involves the lead manager of a bond issue (usually on behalf of a public sector entity)
shorting a reference bond (usually a gilt) ahead of the pricing of the deal. The short is then used to reduce
volatility of the reference bond as investors switch from the gilt into the new bond issue upon pricing.
Advisers and lead managers involved in such activity have contacted us with queries relating to their
position under the Financial Services and Markets Act 2000 (FSMA) – section 118 (Market Abuse).
Specifically, we have been asked what level of disclosure is appropriate ahead of the shorting activity.
The Code of Market Conduct does not mandate any disclosure or, where such disclosure is made, the
level of disclosure required. Nor does it comment on the content of any announcement of disclosure.
We think issuers and their agents have three basic options:
(i)
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full disclosure including terms, time frame, parties involved, prices etc;
This is not FSA guidance.
(ii)
partial disclosure similar to details required of article 9 (1) (a) of the stabilisation regulation
stating that such activity may take place, perhaps including some of the parameters; or
(iii)
no disclosure.
Issuers of bonds who are subject to the Listing Rules and Disclosure Rules ought to consider if any of
these arrangements constitute inside information. If an issuer concludes the arrangements constitute
inside information then they should announce their details over a Regulatory Information Service.
It is clear that the more detailed the disclosure then the less chance there is of the activity being
considered abusive. However, as more information is disclosed there is also the potential for other
market participants to abuse the disclosure by trading against the issuer’s interests. Our understanding
from the industry is that most participants have opted for the partial disclosure option.
Regardless of the option issuers and agents choose, it is essential that they carry out the trading
activity, both the shorting and the subsequent covering, in an appropriate manner with due regard to
market impact. Firms carrying out market management exercises should be mindful of their
obligations under the Code, for example MAR 1.6. When speaking to participants, we have advised
them to properly document the reasons for and timing of the activity.
If you have any queries, please contact Mark Edmonds at mark.edmonds@fsa.gov.uk
Exchange traded funds (ETFs)
Currently, units in ETFs are not inter-professional investments under our Handbook. This means that
transacting ETFs cannot be conducted on an inter-professional basis. As a consequence of this, and the way
in which our client classification rules work with inter-professional business, firms are not able to classify the
other exchange members they deal with as market counterparties. Instead, these counterparties (other
authorised firms) will need to be classified as intermediate customers, and be provided with appropriate
customer protections, notifications and trading information. But units in ETFs are traded in the UK like
shares which means the regulatory treatment of these units is not consistent with market practice.
As a result, we have made a modification by consent available to all firms undertaking inter-professional
business in units in ETFs. The modification relates to the amendment to the Glossary definition of interprofessional investments to include units in ETFs, and to include of a definition of ‘exchange traded
funds’. Consequently, firms applying for this modification will be able to undertake transactions relating
to units in ETFs within the inter-professional regime.
In addition to this modification by consent, we have recently consulted on amending the Glossary
definition of inter-professional investments to include units in ETFs and to include a new Glossary
definition of ETFs. We expect to finalise the changes to the Glossary by the Autumn. But if your firm
wishes to take advantage of this modification in the meantime, please write to the Waivers Team, FSA, 25
The North Colonnade, Canary Wharf, London E14 5HS.
Suspicious transaction reports
In previous Market Watch issues we gave firms information about the requirement to submit suspicious
transaction reports (STRs). This can be found in the June and December 2005 issues. In summary, the key
test for firms is that there are reasonable grounds for suspecting the transactions involves market abuse.
Although we rely on firms to undertake their own analysis before referring transactions to us, we are
happy for firms to contact us on our market abuse helpline to discuss issues before submitting a formal
This is not FSA guidance.
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STR. We know this can be particularly helpful to firms who are unsure about an issue’s significance or if
they feel it is a borderline case and are unsure whether to submit an STR.
At a recent APCIMS (Association of Private Client Investment Managers and Stockbrokers) seminar,
delegates asked our Markets Division to provide some ‘no names’ examples of suspicious transaction
reports we had received since 1 July 2005 – we are pleased to do this and set out some examples below.
In most instances the underlying information the firms provided has been very detailed and included client
information, a copy of the relevant announcement, profit or loss avoidance, trading history, a copy of the
telephone conversation and details of a connection between the client and the issuer. We have received
several STRs where the client has hinted (on a taped line) to the broker that they are aware of an
impending announcement – in such occasions it helps if we receive a copy of the tape as soon as possible.
• Example 1: The client telephones his broker 15 minutes before the close of market and asks for a price
to buy shares in Company ABC. He decides to purchase x amount of stock and tells the broker there
will be an announcement the following morning. He also describes the specifics of that announcement.
The broker executes the trade and the announcement is made the next morning. The broker informs
his compliance officer who then reviews the trade and ascertains the client works for a subsidiary of
Company ABC. The firm reports the trade to us, providing tapes of telephone conversations, details of
client occupation and trading history.
• Example 2: The client starts heavily buying in Contracts for Difference (CFDs) in XYZ plc a month
before a positive announcement. The client closes immediately after the announcement, making a
considerable profit – this triggers the firm’s suspicions, prompting it to check if the client had any
potential connection to the company. The firm finds a potential connection and reports to us –
providing details of client and potential connection to XYZ plc, announcement, profit realised and
history of trading.
• Example 3: The client is prepared to accept a price 13-14p below the prevailing share price of 100p to
sell a large amount of stock as quickly as possible. An hour later the company issues a negative trading
update. The firm spots that client’s former email address links him to the company, so it submits an
STR to us.
• Example 4: Firm A is the broker to Company XXX. Firm A enters into a lot of buy transactions,
which are larger in size than its usual trading pattern, in Company XXX just before a positive
announcement. The firm identifies large profits for Firm A. The firm submitting the STR provides a
lot of information, including trading history, relevant company announcement and price chart.
Most of the STRs we have received have related to equity insider dealing. However, we have also received
several calls about trading in bond and credit derivative markets before possible takeovers, re-financings etc.
In addition to reviewing market data and transactions reported to us, we also typically request insider lists
from firms, complete breakdowns of all related trading, historical positions and trading and in some cases,
voice tapes and emails. Firms should have regard to not just the Code of Market Conduct but also FSA
Principles and Conduct of Business rules. We would like to encourage firms to proactively look to identify
this type of case and to review their STR procedures to ensure they are able to identify cases like these.
We handle each STR on a case-by-case basis, so the outcomes may differ depending on the full facts of the
case. In some cases the individual who traded may be asked to attend an interview conducted by either
Enforcement or by Markets Division. In other cases, further analysis may identify a legitimate reason for
the trade – for example, hedging a position.
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This is not FSA guidance.
Proposed changes to the Transaction Enquiry Form
When conducting a preliminary review of dealings in a specific security we currently request that firms
complete a Transaction Enquiry Form (TEF) to gain sufficient detail of the nature of the trading activity.
This request is always made to firms in writing and is made under section 165 (1) of the Financial Services
and Markets Act 2000.
Market Monitoring have recently undertaken a review of procedures to determine whether there are ways
in which we may become more efficient and to help firms manage our information requests. We consider
that, in some instances, the completion of a full TEF is not required. We propose instead to ask firms to
provide the most basic information with regard to the transaction(s) under review. We envisage this would
be the following information:
• client name, date of birth, occupation and contact details including contact person if the client is a firm
or fund;
• nature of transaction; and
• any other information you believe is relevant to our preliminary review.
We are proposing to request this information by way of a standard email to the compliance officer of the
firm rather than by post to speed up the process. By requesting only this brief detail we would hope we
can receive a response within 48 hours instead of the current ten working-day turnaround.
As this request will continue to be made under section 165 (1), we are required (by Regulation 5 of
Financial Services and Markets Act 2000 (Service of Notices) Regulations 2001) to gain confirmation in
writing from the person we wish to contact that they are willing to receive relevant documents
electronically. We will shortly be contacting compliance officers to ask them to confirm they agree to this
and check we have correct contact details.
If you have any concerns about this proposal or wish to make any comments, please contact Jo Goodman
at joanna.goodman@fsa.gov.uk.
Credit Market Surveillance
During 2005 a number of press articles commented on the continued growth of the credit markets, the
increasing involvement of hedge funds (and other new investors) in these markets and the perceived abuse
of material non-public information (MNPI) in linked public markets.
In the light of developments in this area, our Market Conduct team arranged visits to participants of the
debt, loan and credit markets. Our objectives were to increase our understanding of the loan and credit
markets; increase firms’ awareness of the FSA team responsible for market conduct issues; test allegations
of market abuse with market participants; and develop a structured approach to monitoring and
surveillance of the credit markets. We visited firms from both the buy and sell sides of the industry.
Our main findings were as follows:
• As expected, the larger firms have stronger systems and controls in place to prevent inappropriate use
of MNPI.
• There has been an increasing desire on the part of the buy-side firms to remain on the public side, i.e.
most firms do not want to receive MNPI due to the restrictions this places on the business. The
consensus was that, in any case, investment grade issuers rarely provide any new information.
This is not FSA guidance.
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• There is a financial cost associated with hedging via credit default swaps (CDS) to the extent that
many firms would simply prefer to sell on the loan. However, relationship issues often meant that
loans were kept and hedged via CDS.
• All firms acknowledged that the credit markets are very difficult to police: there is less transparency
than in the equity markets (particularly when one considers the protection of MNPI and the
maintenance of insider lists) and credit market participants appear less likely to report suspicious
behaviour to the appropriate authority.
• One aspect that makes it more difficult for us to trace ‘insiders’ is the ability for participants to obtain
MNPI by signing confidentiality agreements for – but never actually buying – a loan. Without a trade
the buyer never gets onto the lender’s record and so might slip through the cracks unless accurate
records of confidentiality agreements are kept. So it is important that firms’ systems and controls
properly record who has signed confidentiality agreements, even if no trade is undertaken.
• The credit market has been maturing steadily in recent years. Particular strides have been made in the
CDS market which now appears to be transparent, liquid and clean. The market has started to create
solutions to (mainly) operational problems in addition to the Fed/FSA work on reducing outstanding
confirmations.
• The collateralised debt obligation (CDO) market lags here but it is improving. A particular risk that
remains in the CDO market is in valuations. Some firms have experienced problems here and until
independent pricing / valuations systems are available this requires careful oversight within firms that
trade CDOs. Often new entrants do not seem to fully understand the correlation risks with the product.
We conclude that the CDS market appears to have reached a high level of maturity. Risks do still exist,
but these appear most relevant to the correlation effects of the CDO market. Index-linked credit products
have made the market more accessible, increasing liquidity and transparency. We are also seeing an
increase in the amount of ‘real money’ entering these markets as funds become more confident in
investing in credit products. Of course, the risk of abuse of MNPI remains and so we will be proactively
monitoring the credit markets and continuing to enhance our systems and strategies, in line with the
market, to mitigate this risk.
You may want to see the brief comment made in Market Watch issue 10 about the handling of MNPI.
Marketwatch 10 is available on our website at
http://www.fsa.gov.uk/Pages/Library/Other_publications/market/index.shtml
Programme trades
In the July 2004 edition of Market Watch (No. 10) we noted that ‘Programme trading often involves
transactions representing significant proportions of the average daily volume in individual securities. As a
result, firms generally take a number of precautions to ensure that the market impact of the transactions
is minimised. We welcome this, but would point out that effective monitoring of a transaction’s impact is
best done at the level of the individual securities, rather than on an aggregated portfolio basis. We
recognise that this is an art rather than a science.’
Since the Market Abuse Directive was implemented in July 2005 the UK’s market abuse regime has
applied to qualifying investments admitted to trading on a prescribed market and also to related
investments (section 118(1) of FSMA). The regime applies whether these shares are traded
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This is not FSA guidance.
simultaneously, as in a programme trade, or individually. Hence, market participants are responsible for
complying with the regime in respect of each and every share they trade.
Market participants need to be aware that while a portfolio might show an insignificant price movement
on an aggregated portfolio basis, there may be significant movements in individual securities within a
portfolio. Our concern is that these less liquid shares may be given less attention by firms because they
amount to only a small percentage of the entire portfolio when, because of their very nature, they may in
fact require more attention. When assessing whether potential market abuse in breach of s.118(5) has
occurred, we will consider the behaviour on a share-by-share basis.
The factors we will take into account when assessing whether a false or misleading impression or market
abuse (manipulating transactions) has occurred are outlined in MAR 1.6.2 to 1.6.3 and 1.6.9-10.
Bulletin board postings of non-public information
An issue we are currently focusing on is the publication of non-public information on a bulletin board
website by people with inside information, including senior executives. We remind insiders that under the
Market Abuse Directive this behaviour may amount to disclosure of inside information other than in the
proper course of a person’s employment, profession or duties. Those posting such information should also
ask themselves whether information that is non-public and material to the firm it concerns ought to be
disclosed in line with any legal or regulatory requirements, for example, through the proper channels such
as a regulatory information service (RIS).
In addition to posting the non-public information, a second concern arises if the person who has posted
the information has already dealt or subsequently deals in the qualifying investment in question, or in a
related investment, and whether they have a legitimate reason for the dealing.
Roll-over trading
Under the rules of the equities exchanges and the market known as OFEX, member firms are permitted to
roll over unsettled trades one time only if they encounter settlement difficulties. In the LSE’s May
Regulation Briefing, it set out a case of disciplinary action it has taken against a firm for breaches of its
rule under Paragraph 3050.
The possible effect of rolling over unsettled positions is that it may give the impression of large volumes
being traded in the market which may give a false or misleading impression of the price of the security in
question. Concern over this practice may arise where it is used in less liquid securities and the market may
be under the impression that the roll-over trades, which may form a significant percentage of the trading,
are new or proper trades. Market participants should comply with the exchanges’ rules on roll-over trades
and consider their behaviour under the Financial Services and Markets Act 2000 – section 118 (Market
abuse) section(5)(a) and the Code of Market Conduct, particularly MAR 1.6.2(2) and 1.6.2(4).
This is not FSA guidance.
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Contact details
This newsletter is produced periodically by the
Market Conduct team in our Markets Division.
Previous copies, and other relevant material, are
available on the dedicated webpage:
www.fsa.gov.uk/marketconduct. If you would like
to receive this newsletter by email, or have any
comments on it, please contact
market.watch@fsa.gov.uk.
Steven Clark (Market Abuse and Public M&As)
020 7066 2692
steven.clark@fsa.gov.uk
Simon Dixon (Market Abuse)
020 7066 1698
simon.dixon@fsa.gov.uk
Transaction Monitoring Team Details
Individual contact details are as follows:
Michael Somes (Manager)
020 7066 3436
michael.somes@fsa.gov.uk
Cassandra Williams (Manager)
020 7066 8230
cassandra.williams@fsa.gov.uk
David Nowell (MiFID)
020 7066 1086
david.nowell@fsa.gov.uk
Evan Benge(Market Abuse), 020 7066 1660
evan.benge@fsa.gov.uk
Jo Grant-Wilson (TRS)
020 7066 2870
jo.grant-wilson@fsa.gov.uk
Stewart Devine (Market Abuse), 020 7066 5916
stewart.devine@fsa.gov.uk
Mark Edmonds (Market Abuse, Stabilisation
and Credit Products), 020 7066 2180
mark.edmonds@fsa.gov.uk
Julie Elbourne (Market Abuse & IPC)
020 7066 5904
julie.elbourne@fsa.gov.uk
Gary Brook (Market Abuse and Credit Products)
020 7066 5888
gary.brook@fsa.gov.uk
Jo Goodman (Market Abuse), 020 7066 3072
joanna.goodman@fsa.gov.uk
Ruth Dent (Manager)
020 7066 5866
ruth.dent@fsa.gov.uk
Don Groves (Market Abuse), 020 7066 5858
don.groves@fsa.gov.uk
Anju Khanna (Market Abuse), 020 7066 0524
anju.khanna@fsa.gov.uk
Elizabeth Murphy (Market Abuse, Public M&As
and Share Buy-Backs), 020 7066 5044
elizabeth.murphy@fsa.gov.uk
Margot Marshall (Market Abuse and Public
M&As), 020 7066 5772
margot.marshall@fsa.gov.uk
David Hudson (Transaction Reporting)
020 7066 5922
david.hudson@fsa.gov.uk
Cassandra Fuller (Transaction Reporting)
020 7066 2414
cassandra.fuller@fsa.gov.uk
Ewan Ingram (Transaction Reporting)
020 7066 2524
ewan.ingram@fsa.gov.uk
Sujitra Krishnanandan (Transaction Reporting
and Market Abuse), 020 7066 7920
sujitra.krishnanandan@fsa.gov.uk
Vivienne Bannigan (Transaction Reporting
and Market Abuse), 020 7066 2348
vivienne.bannigan@fsa.gov.uk
New this Year
The Transaction Monitoring Unit (TMU) has
launched a new helpline to handle transaction
reporting queries and issues relating to the FSA’s
Transaction Reporting System (TRS).
Please contact the TMU for further details.
TMU helpline: 020 7066 6040