Allen & Overy – On 3 July 2016, the Market Abuse Regulation (596/2014/EU) (MAR) came into force. Even though guidance and clarity from the European Securities and Markets Authority is still awaited in relation to certain key aspects of MAR, in-house lawyers at financial institutions still need to be ready to manage and advise on various issues and challenges that arise in relation to MAR.
On 3 July 2016, the Market Abuse Regulation (596/2014/EU) (MAR) came into force. However, as firms’ long and complex implementation programmes start to bear fruit, the challenge of living with MAR on a daily basis starts to emerge.
Even though guidance and clarity from the European Securities and Markets Authority (ESMA) is still awaited in relation to certain key aspects of MAR, in-house lawyers at financial institutions need to be ready to manage and advise on various issues and challenges that arise in relation to MAR.
New markets and new trading venues
MAR applies not only to financial instruments admitted to trading on a regulated market, or for which a request for admission to trading on a regulated market has been made, but also to financial instruments traded or admitted to trading on a multilateral trading facility (MTF) and financial instruments traded on an organised trading facility (OTF).
The UK remains bound by EU law following the UK’s vote to leave the EU.
It was the European Commission’s intention to update the Market Abuse Directive (2003/6/EC) alongside implementation of the legislative package that will revise and replace the Markets in Financial Instruments Directive (2004/39/EC) (MiFID), with a view to ensuring that both pieces of legislation were fully coherent and supported each other’s objectives and principles. However, the MiFID II Directive (2014/65/EU) and the Markets in Financial Instruments Regulation (600/2014/EU) (together, MiFID II) have since been subject to a one-year delay in implementation but MAR has continued on its original timetable.
There are obvious consequences of this timing mismatch. For example, concepts used in MAR which are derived from MiFID II, such as the OTF, will not bite until such time as MiFID II takes effect (now anticipated in January 2018). This timing mismatch may yet be further complicated by the UK’s vote to leave the EU.
The UK remains bound by EU law following the UK’s vote to leave the EU. Only on a formal withdrawal, or (if no agreement or extension is agreed) after two years following the service of notice under Article 50 of the Treaty on the European Union, will the treaties cease to apply to the UK.
In the meantime, the Financial Conduct Authority (FCA) has made it clear that EU legislation, such as the Market Abuse Regulation (596/2014/EU) (MAR), continues to apply in the UK and firms should continue to comply with this legislation. The FCA has given a similar message in respect of upcoming EU legislative changes, such as the MiFID II legislative package, and firms are advised to continue with their current implementation programmes.
The FCA’s advice to continue to comply with and implement this legislation is both correct and pragmatic. It is worth noting that, pre-MAR, the UK operated a super-equivalent market abuse regime capturing much of the substantive market abuse offences now covered by MAR. There is no reason that the UK, following its exit from the EU, would not continue to operate a robust market abuse regime similar to that provided for under MAR.
Similarly, in respect of MiFID II, in the absence of any explicit statement otherwise by the government and regulatory authorities, it would be reasonable to anticipate that the UK would implement legislation substantively similar to that provided for under MiFID II, even after the UK’s formal withdrawal from the EU.
In-scope financial instruments
There are also other, less obvious, consequences of the misaligned timetables for MAR and MiFID II. Of particular significance is the impact of ESMA making available a centralised and consolidated list of those financial instruments that fall within the scope of MAR; that is, financial instruments traded on an in-scope trading venue. This consolidated list will be important to market participants as, in theory at least, it will represent a comprehensive list of all in-scope financial instruments.
The value of ESMA’s proposed list has been the subject of much debate.
However, as the operational arrangements for the collection and publication of reference data (which are essentially the same as those required under MiFID II) are complex and require the alignment of IT systems and infrastructures, ESMA has acknowledged that it will not be in a position to provide the consolidated list to the public for some time, despite the fact that MAR is already in force.
The value of ESMA’s proposed list has been the subject of much debate. There are clear and significant advantages to having a single publicly available consolidated list of in-scope financial instruments. However, the value of this list is diminished by Article 4(2) of MAR which makes it clear that users of the list are responsible for any inaccuracy in the list. In practice, this means that, if a firm unknowingly relies on an inaccuracy in ESMA’s list, the fact that ESMA’s list was inaccurate will not constitute a defence in the event that that firm’s conduct comes under scrutiny from a regulator.
Both the delay in the consolidated list and its limitations once it is made available publicly may mean that firms feel they need to take a very conservative approach to deciding which financial instruments are within MAR’s scope. However, while a firm’s decision to treat financial instruments as in-scope in the absence of definitive information to the contrary may appear rational, it can have unintended consequences when considering some of MAR’s more process-driven requirements.
MAR not only captures financial instruments traded on a trading venue (that is, a regulated market, an MTF or an OTF), but can also capture financial instruments traded off venue where the price or value of those financial instruments depends on, or has an effect on, the price or value of financial instruments trading, or admitted to trading, on an in-scope trading venue.
The inclusion in MAR of the additional limb of “or has an effect on” likely broadens the list of off-venue financial instruments caught. However, there is very little guidance available to firms to assist them in deciding where the cut-off point is in this context. One thing that is clear is that the ambiguity of the scope may open the door to regulatory authorities pursuing more market abuse cases.
One example of MAR’s process-driven requirements is the new market soundings regime. MAR sets out procedural conditions that have to be followed when a firm takes market soundings, including the disclosure of inside information, before a significant securities transaction. This regime includes detailed notification and record-keeping requirements around the disclosure of inside information.
Consider a scenario where an issuer has already issued debt securities and the issuer is anticipating issuing a further tranche. The issuer has not requested that the originally issued securities be admitted to trading on an MTF, but it may be the case that those instruments are nonetheless traded on an MTF.
Without the aid of ESMA’s list, a firm taking a conservative approach could conclude that the new tranche of securities are in-scope financial instruments on the ground that they depend on, or have an effect on, the price of the originally issued securities (and are presumed to be traded on an MTF). As a consequence, the highly prescriptive market soundings regime would apply to any communication of information made to potential investors in order to gauge their interest in the proposed transaction.
Notifying suspicious transactions and orders
The reporting of potentially suspicious transactions has been a focus for the Financial Conduct Authority (FCA) over the past few years. The FCA has warned the industry that the reporting of potentially suspicious transactions is inconsistent across all areas of the industry, and that submission levels are too low in some places. This is despite the fact that the FCA received over 1,800 suspicious transaction reports in 2015, a 13% increase from 2014.
Under MAR, firms are still required to report potentially suspicious transactions to the FCA without delay. However, MAR also requires firms to report potentially suspicious orders to the FCA (again, without delay). The ability to report potentially suspicious orders relies on firms capturing trade order data. Earlier in 2016, the FCA acknowledged on its website that not all firms capture this kind of trade data, and may not be able to do so in time for MAR coming into force. Firms that fall within this category are required to have robust and realistic implementation plans in place so that they are able to capture and monitor trade order data as soon as possible.
Reporting obligations aside, there are still some outstanding questions about what may constitute an “order” under MAR. The definition of “order” goes beyond its ordinary meaning and has been framed in a way that includes “each and every quote”. At first glance, this may seem unnecessarily broad. However, when considering the nature of some of the behaviours indicating market abuse, which include quote stuffing, placing the orders with no intention of executing them, layering and spoofing to name but a few, the policy intention becomes clear. The difficulty for firms is in the consequential systems that are required to enable them to capture quotes in a manner which means they can be monitored effectively for market abuse.
Increased enforcement risk
Over the past few years, the FCA has brought only a relatively small number of market abuse cases. In 2015, the FCA acknowledged that market abuse cases had become significantly more complex and were taking longer to conclude. However, the FCA’s enforcement division noted that there was a strong pipeline of future market abuse cases.
As well as focusing on cases where substantive market abuse offences have been committed, the FCA has also turned its enforcement focus to look at firms’ market abuse controls. Earlier in 2016, the FCA took enforcement action against a firm, WH Ireland, in connection with a number of weaknesses identified in relation to its market abuse controls in areas including: the handling of inside information; personal account dealing controls; conflicts of interest; compliance oversight of market abuse risks; governance; and senior management engagement with market abuse risks and training. WH Ireland was fined £1.2 million and restricted from taking on new clients in one of its business areas for 72 days.
Shortly after that case was announced, the FCA sent a stern warning to financial institutions about their market abuse controls, emphasising that it will take stringent action against firms that fail to identify or mitigate risks associated with market abuse, or fail to report to the FCA instances where market abuse has occurred.
MAR has introduced more stringent and prescriptive requirements for financial institutions in terms of the systems and controls they must have in place to manage the risk of and detect market abuse. Additional process-driven requirements have also been introduced, including, for example, the market soundings requirements (see “Market soundings” above). If firms fail to implement and maintain these systems and controls in accordance with MAR, they may face the risk of the FCA taking enforcement action against them. As a result, ensuring that market abuse systems and controls are, and remain, fit for purpose, and are regularly reviewed by compliance and internal audit functions, will be particularly important in the future.
This article first appeared in Practical Law and is published with the permission of the publishers.