Yesterday, the Financial Conduct Authority (FCA) published its 48th Market Watch newsletter covering three areas of regulatory focus:
- Trade volume advertising and risk considerations relating to market abuse
- Observations from the FCA’s Suspicious Transaction Reporting (STR) Supervisory Visits
- Direct Electronic Access (DEA) Pre-Trade Controls
We have summarized below the key messages that investment firms should take into consideration when assessing the adequacy and effectiveness of their market conduct systems and controls.
Trade volume advertising and risk considerations relating to market abuse
- Market participants have raised concerns to the FCA of firms publishing incorrect or inflated trading volumes in the equity market. Incorrectly advertised volumes could create false or misleading impressions as to the supply/demand of stock traded by a firm, which in turn may encourage market participants to trade the stock through the firm.
- Some market participants have also pointed out that they generally do not rely on advertised trading volumes because they believe the methodologies for measuring and advertising trading volumes are inconsistent.
- Firms have a number of options for the methodologies they can choose to adopt when advertising their equity trading volumes. These options can create inconsistencies in reported volumes between firms, and also within the firm if it uses different methodologies on different occasions.
- Firms and individuals should be aware of the risks involved and ensure they appropriately mitigate these risks. A number of questions are suggested for firms and individuals to consider to ensure they do not breach FCA rules.
Observations from their Suspicious Transaction Reporting (STR) supervisory visits
- Remediation plans have been requested by the FCA to a number of firms where the FCA believe they are at risk of breaching market abuse requirements and further actions may be considered in particular cases.
- The FCA will continue its STR supervisory visits to better understand and assess the way in which potential instances of market abuse are being identified and escalated by authorized firms.
- They outlined some observations from their supervisory visits in 2013 and 2014:
- Market abuse risk assessments: some firms have undertaken detailed market abuse risk assessments: (1) across asset class; (2) at granular business unit / desk level and (3) considering the risk of each market abuse behavior as detailed in the Code of Market Conduct and ESMA guidelines.
- The FCA has seen effective results from this approach to allow proportionate and appropriate surveillance to be designed and to flag up any surveillance gaps that may require remediation.
- Front office escalations: Some firms have under-invested in market abuse training provided to front office staff, leading to proportionately low reporting of potential instances of market abuse.
- The FCA has seen effective results from firms combining online theory training with face-to-face tailored discussions, reporting STR management information, and adequately documenting and reporting escalations of suspicious behavior to the Compliance or Surveillance team.
- Integrity of data: FCA identified concerns around the integrity and completeness of data used by firms for their surveillance routines, which adversely affected the quality of surveillance performed and potentially suspicious behaviors being missed.
- Calibration of surveillance systems: Effective surveillance programmes have involved significant and careful calibration of alert parameters and alert logic. Constant refinement and testing of the alerts and surveillance routines are important.
- Firms who appear to conduct the most effective surveillance tend to use a market abuse risk assessment to identify where gaps may lie and have developed remediation programs in those areas at highest risk.
Direct electronic access (DEA) pre-trade controls
The FCA set out their high-level observations from their review of pre-trade controls for cash equity DEA trading:
- Pre-trade controls: The FCA observed significant variance in level of sophistication of pre-trade controls. More sophisticated controls included: stock specific limits, e.g. percentage of average daily volume, stock specific aggregate exposure limits, aggregate limits broken down into separate time segments, participation alerts, automated restrictions on market orders, and market impact controls. The FCA noted that observed market incidents could have been avoided if these controls had been implemented.
- Control setting and amendment procedures: The process of setting control at appropriate levels varied considerably across the firms visited by the FCA. Firms demonstrating a greater sophistication in control parameter setting considered both expected market impact and clients’ anticipated trading activity. The FCA observed that controls remained effective throughout an amendment process when pre-arranged extensions to parameter levels could be approved by the trading/client coverage desks under specific conditions, e.g. during periods of market volatility.
On-going monitoring and incident surveillance: The FCA observed dedicated real-time monitoring teams with detailed knowledge of control parameters and expected client trading activity, controls with alerts to provide warning before control levels are breached, clearly defined procedures to ensure monitoring is performed in a time sensitive manner with suitable escalation and documentation, and formal reviews of MI including control breaches and limit utilization.
The FCA will continue to monitor the effectiveness of DEA controls within authorized firms as part of their risk based supervisory approach, including firm specific deep dives, broader thematic reviews, and investigations into the causes of market disruptions.