As a follow up to Market Watch 50, which looked at the systems and controls of firms to prevent market abuse, Market Watch 51 focuses on market abuse systems and controls employed at registered market makers in small and mid-cap equities and Payment for Order Flow (PFOF).
Our commentary covers the market abuse thematic review which focuses on:
- Market abuse risk awareness
- Information barriers
- Wall crossing procedures and Insider Lists
- Ongoing monitoring and surveillance
Who is the Review Relevant to?
Whilst this review focuses on small and mid-cap equity market makers, many of the findings and recommendations are applicable to a wide range of authorized firms.
With the introduction of Market Abuse Regulation (MAR) in July 2016, market abuse is a key risk for all firms and the FCA has indicated its plan to continue market abuse theme based work. Future work may include firm specific deep dives and broader sector thematic reviews.
Key Findings and Recommendations
Market Abuse Risk Awareness
Level of awareness particularly by Senior Management and trading desks varied and was generally below expectations.
The FCA states that regular risk assessments are an important tool in demonstrating an awareness of inherent market abuse risk and evidencing those effective controls to mitigate the inherent risk were in place.
Firms tend to focus on information barriers between their corporate finance/investment banking operations (private side) and the public side. However, awareness and understanding of other information barriers were less apparent. For example, sales and sales-trading staff were not physically separated from the market making team due to their natural working connection.
The FCA recognizes that physically segregating individuals or teams is not always practical and recommends in these instances, firms consider alternative controls. For example, specific Compliance training on how to identify potential conflicts of interest and manage information barriers or Compliance working closely with Front Office to strengthen manual surveillance and information management.
Wall Crossing Procedures and Insider Lists
The level of documentation around wall crossing and insider lists is generally poor. MAR Article 11 includes detailed procedural and record keeping provisions in relation to wall crossed and non-wall crossed market soundings. MAR Article 18 sets out the requirements and content of an insider list and emphasises the importance of the list being accurate, complete and up to date.
The FCA considers an effective approach to managing wall crossings is for Compliance to act as “gatekeepers” in all wall crossings. This enables firms to centralise the wall crossing process, adopt a consistent approach and minimise the number of people on a “need to know” basis.
Market Abuse Monitoring and Surveillance
Some firms were unable to demonstrate how their market abuse surveillance was fit for purpose. Article 16 includes requirements for firms to have effective arrangements, systems and procedures to detect and report suspicious orders and transactions.
Firms which perform enhanced monitoring on the trading activity of market markers during periods when individuals have been wall crossed were viewed positively. The FCA recognizes that post-trade surveillance will vary according to the size and activities of the firm. It is therefore important that firms are able to demonstrate how their surveillance is fit for purpose. Firms should be able to evidence how alerts are selected and how alert parameters are determined. Market Watch 48 provides some guidance around the calibration of alert parameters and logic.
How Duff & Phelps Can Help
Duff & Phelps has a specialist Markets team, staffed by former regulators and enforcement personnel, with deep surveillance and market abuse expertise. Our experts can undertake a holistic review of a firm’s risks, develop a proportionate but effective strategy for managing those risks and help you put in place the appropriate mechanisms for reporting, both externally and internally.
As highlighted in Market Watch 51, firms must be able to demonstrate their awareness of market abuse risks and a Market Abuse Risk Assessment (MARA) is an effective tool in documenting inherent risks, controls and associated gaps. We regularly work with firms to construct a MARA which can then be fed into overall Compliance Risk Assessments and strategic work programs.