Market Watch for Market Abuse

Market abuse continues to be a focal point for the Financial Conduct Authority (FCA), who are intensifying their scrutiny of firms’ arrangements in this respect, through a series of questionnaires being sent to firms. Based on the responses received, we have seen the FCA undertaking supervisory visits, desk reviews, and requesting additional information regarding firms’ policies, procedures, and arrangements to prevent market abuse, in accordance with SYSC 6.1.1R.

Drawing from several FCA Market Watch newsletters from over the years, one core area the FCA consistently observes deficiencies in is, firms’ market abuse risk assessments (MARA). Firms are advised to adopt formal frameworks for managing their financial crime risks (including market abuse) as required by SYSC 3.2.6R and SYSC 6.1.1R, as well as per the guidance in Chapter 8 of the Financial Crime Guide. A firm’s market abuse arrangements should also recognise the inter-play between market abuse and money laundering including, the offences of failing to report a suspicious activity report (SAR) to the National Crime Agency (if appropriate) and tipping-off. Compliance with the UK Market Abuse Regulation (UK MAR) transcends mere rule-following and is akin to a mindset, as emphasised by the FCA’s Julia Hoggett. This entails conducting risk assessments tailored to each firm’s specific business model and the asset classes traded.

It’s crucial for these assessments to be reflective of current conditions, recognising the distinct types of market abuse behaviours pertinent to different sectors within financial services and different business models and service offering (e.g. taking into account different execution methods, clients vs house trading, electronic versus voice brokering trading and dark versus lit venues etc.). Concerns arise when firms fail to sufficiently identify all the relevant market abuse risks posed by their firm, which can then lead to gaps in trade surveillance arrangements.

Firms must ensure their risk assessments are continuously updated and refined to effectively address market abuse risks, aligning with ongoing changes in their business environment. The FCA continues to observe the following deficiencies in firms’ MARAs:

1. Some firms address market abuse superficially, treating it as a uniform risk either firm-wide or by individual trading desk, not distinguishing between the various types of market abuse behaviours. Certain firms limit their evaluations to insider dealing and market manipulation, neglecting to consider the underlying behaviours within these categories, such as layering, spoofing, wash trading, flying or printing. MARAs need to be undertaken at a granular level and should also determine which risks prevail and the controls needed to mitigate them.
2. Failure to consider and monitor market abuse risks in non-equity asset classes as well as the correlation between different asset classes (e.g. cash equities and equity derivatives or physical commodities and commodity derivatives etc.), which could lead to cross-product manipulation and thereby, expose firms to market abuse risks that have not been sufficiently identified and therefore not monitored for.
3. Failure to identify all market abuse behaviours. The FCA makes clear that the list of indicators of market manipulative behaviours in the level 1 and 2 regulations should not be treated as exhaustive lists, as has been observed by some firms. Market manipulation can take various forms depending on a firm’s business model and activities. Recently the FCA has highlighted emerging behaviours such as ‘narrowing the spread‘ (as a result of a peer review of CFD firms) and ‘flying’ and ‘printing’ (which are detailed in market watch 57) which firms are failing to identify the risk of in their MARAs, as applicable to their business models, implement appropriate surveillance and submit suspicious transaction and order reports, in relation to these behaviours.
4. Discounting certain risks due to low trading volumes in a particular asset class is an oversight especially without considering existing inherent risks to the business. The different types of market abuse behaviours firms are exposed to require a thorough analysis of each behaviour and each asset class traded. Trading volumes will naturally be a factor in the overall methodology and assessment of market abuse risks, however, low trading volume in its own right should not mean a particular asset class or behaviour is deemed low risk.

Effective trade surveillance requires appropriate and tailored alert calibration, based on the outcome(s) of the MARA, taking into consideration the different characteristics of different asset classes. Most notably, the FCA continues to observe inappropriate calibration of ‘lookback periods’ for insider dealing risks, with some firms only looking at trades that occurred 24 hours prior to the release of inside information, without considering the time the information may have existed prior to publication.

In addition, firms are reminded that surveillance arrangements should include all orders and executed trades, including cancelled, amended and deleted orders. The monitoring of orders (especially those that do not result in execution) is crucial to identifying various forms of market manipulation, such as giving false or misleading signals to other market participants.

The FCA continues to see firms setting generic and/or out-of-the-box parameters and thresholds, which do very little to manage and monitor the market abuse risks a firm is exposed to. This also leads to a high volume of false positives being generated, putting both a strain on the time and resource needed within firms for trade surveillance monitoring as well as sufficient time being dedicated to investigating truly suspicious alerts. It is important firms regularly review their alert calibrations, in order to ensure surveillance remains effective, appropriate and proportionate to the scale, size and nature of their business activity.

With market abuse consistently being included as a priority for the FCA in their business plans, 2024 shows no signs of the regulator retreating from their work in this area. With MARAs underpinning a firm’s market abuse arrangements, including trade surveillance and risk appetite to market abuse risks, firms are advised to review their risk assessments as well as their overall market abuse controls in line with the observations and concerns highlighted in this article.