When It Comes to Market Abuse, the FCA is Casting a Wider Net

Blog Post by Paul Cottee on 9 June in category Regulations

Summary of FCA Market Watch 73

Last month, the FCA published a new Market Watch newsletter (MW73) in which the UK regulator discusses the observations and findings from a recent market abuse peer review of firms that offer Contracts for Difference (’CFDs’) and spread bets (’CFD providers’), which the FCA notes are particularly vulnerable to being used for insider dealing due to their speculative and leveraged nature. The FCA also draws a link between this latest newsletter and Market Watch 69, which covered trade surveillance more generally, and broader requirements for adequate policies and procedures to meet obligations to help prevent financial crime (SYSC 6.1.1R).

The FCA analysed data from CFD providers and selected nine firms to review, asking each to provide information about their business models, market abuse risks, and arrangements for detecting and reporting market abuse, and reviewed documentation. The FCA then went on to visit seven of the firms.

Whilst the FCA’s assessment was mostly positive, the review did identify a number of weaknesses. The FCA noted that all firms reviewed had maintained effective surveillance arrangements to detect insider dealing. However, the regulator noted that most of the firms had not fully considered and assessed the risks associated with ’non-equity assets classes’ and market manipulation more broadly, which could potentially lead to gaps in surveillance. The FCA distilled these into seven principal areas that required improvement. I’ve summarized the first five of these, and implications related to market abuse surveillance and detection, below.

1. Market Abuse Risks

All firms covered in the review recognised the predominant market abuse risk to be insider dealing. This should not surprise, as CFDs and spread bets provide an easy way for a person possessing inside information to position themselves without having to outlay the full cost of trading in the underlying cash market.

The FCA also noted that, beyond insider dealing, there appears to be limited appreciation of market abuse risks across all asset classes. In particular, the FCA drew attention to order-based manipulation in the context of a client:

  • having direct market access;
  • being able to affect ’indirect’ manipulation by way of a CFD provider hedging in the underlying market;
  • trading with multiple CFD providers in order to manipulate prices in an underlying asset.

2. Market Abuse Surveillance Responsibilities

All firms reviewed maintained policies and procedures for market abuse surveillance and escalation of issues. However, the details of those policies and procedures varied from firm to firm. The FCA found that firms that were most effective in this area had considered potential conflicts of interest around responsibilities, and had conducted assessments of alert handling.

3. Surveillance Systems

The review noted widespread use of in-house systems that were designed to detect insider dealing, based on price movement, news or profit, using differing lookback periods. The FCA, however, was concerned that some firms appeared unable to monitor for potentially profitable outcomes, either directly, or by analysing news or price movements, and indicated that firms should review (and by extension, be able to adjust) the lookback periods used for analysis. The review also advised that firms "consider whether their surveillance coverage is adequate for market manipulation and in non-equity asset classes."

4. Surveillance And Market Manipulation – Narrowing the Spread

The FCA was concerned that no firms covered in the review had considered a ’narrowing the spread’ market manipulation scenario in their risk assessment, or were equipped to detect it as part of their surveillance. In this scenario a trader attempts to narrow the price spread of an underlying asset, so as to influence the price of the CFD on that asset. The trader places an order (or orders) in a CFD or the cash equity, which in turn improves the bid or offer (narrows the spread). The trader then trades in a CFD on the opposite side (potentially with another CFD provider), and then cancels the original order(s). This is a form of cross-product spoofing. The FCA recommends that firms rely on their compliance function to detect this type of market manipulation activity, not on their front-office. If nothing else, the compliance function should look for a pattern of price improvement.

5. Surveillance Alert Investigations

Amongst other factors, the FCA noted that, "Some firms routinely captured data on clients’ IP addresses and advertising IDs (unique user ID assigned to a device), and used this data to identify potential collusion or links with previously off-boarded clients when investigating suspicious transactions." The FCA further recommends that firms use "all relevant information available to them" to tie related parties together and identify undisclosed client relationships.

This latest edition of Market Watch shows, once again, that the FCA isn’t just casting a net for the ’usual suspects’ (banks and brokers, stocks and bonds); it’s on the lookout for market abuse across all types of financial services firms, scenarios and products. Any firm that offers financial products to customers (especially retail customers) is expected to comply with the FCA’s regulatory obligations, not just in terms of how they treat their customers, but also from the standpoint of having appropriate controls in place to detect when customers are up to no good. Being a small sized firm is not an acceptable excuse for neglecting these obligations.

With Compliancentral, NICE can help you stay in compliance with FCA regulations. Compliancentral offers a suite of solutions that can help any firm, of any size, detect all types of market abuse, and comply with obligations around recording communications, recordkeeping, AML and surveillance.