Thinking About MAR at a Practical Level
The Market Abuse Regulation (MAR), which took effect on 3 July 2016, introduces harmonised measures across the European Union’s member states. MAR replaces the Market Abuse Directive (MAD), which was primarily implemented in the United Kingdom through various sections of the Financial Services and Markets Act 2000 (FSMA).
MAR makes significant changes to the United Kingdom’s civil market abuse regime (but does not alter the UK criminal offences of insider dealing and market manipulation) and replaces the market abuse provisions in Part VIII of the FSMA. As a consequence, there are also changes to the Listing Rules of, and certain other areas of, the Financial Conduct Authority’s FCA Handbook.
Amongst the key changes, MAR extends the civil market abuse regime to new markets and instruments, adds extraterritorial scope and introduces a new offence of attempted market manipulation. There are also important changes for issuers to address concerning disclosure and transparency and when conducting market soundings.
Although these changes are significant, they are nevertheless technical changes to the scope and application of the requirements and are by definition broadly legally based.
What, practically, should organisations and their employees that are involved in trading and dealing in securities consider as they embed the requirements in their processes and systems? The following discussion sets out some areas to consider.
MAR makes some very specific points about trade surveillance and the fact that the European Securities and Markets Authority (ESMA) believes that without an effective surveillance platform, effective monitoring is almost impossible. This assessment is driven by the high volume of trade and reference data that requires processing every day for every trade, which is a challenge that particularly relates to the sell side of the market – investment banks.
Over the last 2-4 years, therehas been significant activity with regard to the implementation of surveillance technologies. However, while these products are proven platforms – a number of them started life in the anti-money laundering space – there is an inherent weakness in their effectiveness: their dependency on the completeness and accuracy of the data feeding into the surveillance systems.
Data and System Architecture
Front office architecture is historically complex due to the bespoke nature of the products and processes; it can, therefore, be a jumble of databases, applications and interfaces, featuring technology ranging from mainframes to open source platforms.
The challenge is how to obtain complete and accurate data from such a complex environment. Given recent tight timelines, it is understandable that many surveillance operations will compile what they can – from sources ranging from trade capture systems to middle office valuation systems – and will often rely on front office IT teams that are already more focused on maintaining operations and responding to ever-present front office demands. There is a significant risk that various books, trade types and risk classes are inadvertently taken from the feeds and dropped into the surveillance platform, which is not visible to those executives responsible for front office activity.
Similar issues and challenges exist that relate to any surveillance logic applied to the trade data. For example, monitoring of off-market prices can be performed in a variety of ways, and this logic is not always transparent to those monitoring the front office. On the flip side, this task can result in a lot of frustration, leading to time-consuming volumes of false positive data, resulting in a general frustration about the lack of effectiveness of the surveillance systems.
Governance and Oversight
When combined with responsibilities under the FCA’s Senior Managers Regime (SMR), individuals accountable for the conduct of the front office will need to think carefully about market abuse and must respond to potential and crystallised client-related conflicts of interest. How comfortable are they that their surveillance capability is effective? How do they provide themselves with the assurance that all trades are being monitored and with the knowledge of what is not being monitored, and why?
Further, is it possible for these individuals to review all relevant surveillance alert logic and assess the validity of that logic? Is this a repeatable activity such that changes to feeds and underlying systems are understood and ratified as to their impact on surveillance processes?
Buy-side firms have traditionally been reluctant to invest in surveillance systems, often arguing that the costs of doing so outweigh the benefits and the impact of the perceived risks. Although this position is beginning to change, buy-side firms face the same implementation challenges as those on the sell side. It remains to be seen whether the SMR, when it is applied to buy-side firms, will bring about a change in attitudes towards market behaviour when accountability and responsibilities are documented and allocated to individuals.
Culture and Motivation
Having reliable and timely data and risk-sensitive, as well as calibrated, systems or sets of algorithms to analyse the data is vital to reducing much of the current frustration and inefficiency. Even so, technology – even good technology – is not a panacea. It will still be possible for a transaction to raise alarms and require manual investigation and still be valid and appropriate. This is true because documenting the intent behind the transaction – understanding why the trader did what he or she did – is not recorded, and by its nature, any investigation is after the fact. Automated control systems that appropriately challenge traders prior to trading and that document their rationale still seem to be a long way off.
Automation may also improve assurances regarding benchmark submissions, but management will still need to give thought to understanding how conflicts of interest are identified and managed and how submissions are collated without being manipulated. Nevertheless, as the number of false positives is much reduced, it is to be hoped that those responsible and accountable for front office activity will have the tools they need to oversee their businesses.
Scott Bolderson is a director at Protiviti (London). Protiviti is a global consulting firm that helps companies solve problems in finance, technology, operations, governance, risk and internal audit.