In our last update on MAR we highlighted the broadening of the scope of the Market Abuse rules that come into force on 3 July 2016. We focused on how the new regime significantly extends the prohibition on abusive activity, capturing new instruments and behaviours.
In this update, we analyse how MAR imposes obligations to detect abusive activity and how also it broadens the requirements to report such activity.
The reach of MAR is much greater than that of the existing rules. In particular, many firms will find they will be subject to onerous surveillance obligations that will create significant operational and technological challenges.
The obligation to report abusive activity
Under the existing Suspicious Transaction Reporting (STR) regime, there has been a long-standing obligation for authorised firms in the UK to report suspected Market Abuse to the FCA.
MAR replaces the STR regime with the Suspicious Transaction and Order Reporting (STOR) regime. This broadens the reporting obligation to include suspicious activity in any instrument traded on any of a Regulated Market, Multilateral Trading Facility (MTF) or, come the introduction of MiFID II in January 2018, an Organised Trading Facility (OTF). Additionally, any instrument that derives its value from any of the above is also captured.
Firms will also be newly required to report suspicious orders as well as suspicious transactions (largely reflecting that many abusive activities involve the placing of orders without any intention to trade).
The reporting obligations apply to firms arranging and executing trades and also to companies operating trading venues.
The obligation to conduct surveillance
There is no explicit obligation under the existing Market Abuse regime to conduct surveillance to identify suspicious activity. However, in the UK there has been an expectation for some years that certain firms should conduct surveillance as part of their obligations to control Market Abuse risks.
MAR, however, imposes an explicit surveillance obligation, requiring firms to “establish and maintain effective arrangements, systems and procedures to detect and report suspicious orders and transactions”.
ESMA has set out quite detailed requirements, the highlights of which are:
- Entities will need to have in place a system which is capable of the analysis of every transaction and order, individually and comparatively, and which produces alerts for further analysis
- In the large majority of cases, ESMA considers that this will necessitate an automated surveillance system
- The surveillance system, whether automated or not, should cover the full range of trading activities undertaken by the entity.
The application of the new regime is very broad, applying to those who “professionally arrange or execute transactions”. ESMA recently clarified this scope is not limited by any MiFID definitions and that it extends to the buy-side, including asset management firms (AIFs and UCITS managers) as well as proprietary traders.
MAR creates a number of significant technological challenges for the regulated community.
For banks that already have surveillance systems, the key challenge will be to broaden their capabilities to capture all products across their trading operations.
Meanwhile, many asset managers, proprietary trading firms and commodity firms will be faced with installing a surveillance system for the first time.
Lastly, it may be very challenging to design systems to detect certain manipulation behaviours involving abusive orders, especially those associated with algorithmic and HFT activity.
The good news is that the FCA has said that it will continue to take a “risk-based” supervisory approach that takes “into account the position of particular market participants and the markets in which they operate”.
Next Week – How MAR dramatically tightens the rules for conducting market soundings.
Charles Hastie is Regulatory Head at Clutch Group, working out of the company’s London office. Charles harnesses his long-standing regulatory investigation experience to develop strategic solutions for Clutch’s financial services clients. He establishes ongoing liaisons with key opinion leaders, government officials, and regulatory bodies to ensure that significant developments in the field are monitored and relayed to clients. For more information, contact Charles at firstname.lastname@example.org.