Market abuse in a time of coronavirus

Speaker: Julia Hoggett, Director of Market Oversight
Event: City Financial Global event
Delivered: 12 October 2020
Note: this is the speech as drafted and may differ from the delivered version

Highlights

• It is hugely important to us that we have the opportunity to give these speeches as they support all market participants to play their part in ensuring our markets are clean.
• Our focus on markets remaining open is driven by the fundamental role they play in supporting the economy – in enabling risk to be priced and managed, but equally, enabling institutions to raise capital at times when they need it the most.
• Whilst the fundamentals of the market abuse offences are constant, the ways in which the risk may manifest are not. The manner of surveilling for them must, therefore, also change. 
• Our expectation is that going forward, office and working from home arrangements should be equivalent – this is not a market for information that we wish to see be arbitraged.
• Market abuse is not an offence that only applies to individuals working in the financial services industry. Any individual in receipt of inside information who trades while in possession of that information, or induces someone else to, is guilty of market abuse. 

There is no doubt, as demonstrated by the fact that this conference is taking place virtually, that we are living in unusual times. Times that provide a great number of challenges for all of us, both personal and professional. The word ‘unprecedented’ has been used in conjunction with the pandemic too many times to count. Whilst, on occasion, historians may accurately be able to say that there are precedents for the times we are living in, there are other experiences and challenges that will be wholly new – in part because every generation lives through a different era in terms of how society and the economy function.

It is however, essential for us as regulators that we maintain a clear-eyed focus on ensuring markets work well for consumers, ensuring that they are orderly and that they are clean whatever the times and whatever the challenges. It is that latter requirement for cleanliness that I want to address today.

At a time where capital raising activity is vital to fuel much needed economic activity, we must be crystal clear that behaviours that risk disrupting that activity will not be tolerated. Not by us at the regulator, but more importantly, not by you – the majority in industry who believe in the important public value of our markets and the need to ensure they remain trusted and respected by all.  

It is hugely important to us that we have the opportunity to give these speeches. We hope they serve one simple purpose: to support all market participants to play their part in ensuring our markets are clean. The FCA is fortunate to sit on top of a great deal of data and to pursue a huge number of lines of enquiry every year, which help to develop and support our own risk assessments. The risks I will outline today are as a direct result of that work.

Talk of dynamic risk assessments clearly takes me into the realm of the risks associated with the pandemic and the need for effective surveillance at all times. I want to focus on the risks created by operating in these market conditions and our expectations of firms. 
 
I want to finish by looking at the critical role that all parts of the market infrastructure have in keeping our markets clean, that individuals have through their personal dealing decisions – the market’s culture if you like – and to the role that technology and data play in that fight.

Risk Assessments

We have sought to place the market abuse risk assessment at the heart of how we encourage firms and venues to think about all the activities they need to undertake to surveil for market abuse. I understand why it is often tempting for firms to look purely to the behaviours described in recitals in the Market Abuse Regulation (MAR) or to utilise ‘out of the box’ alerts from certain technology providers. 

However, whilst that may provide assurance that you have followed a process, it may not provide assurance that you have effective controls in place to mitigate the risks that you actually face.

It is essential in changing times that firms identify the risks associated with the new environment in which we are all operating. 

The FCA undertakes regular assessments of the typologies of market abuse behaviour that we believe give rise to the greatest level of harm. We have, during the crisis, refreshed this analysis to ensure that our mitigation activity is working effectively. 

What this work has proved is not that events such as coronavirus (Covid-19) necessarily give rise to ‘new’ market abuse risks, but that the relative prevalence of certain risks compared to a more steady state scenario changes, as does the manner in which some of these risks may manifest – resulting in us needing to shift our focus and effort too.

All our risk assessments need to be founded in a dynamic understanding of the drivers of market behaviour. To be effective they need to be founded in the reality of how the markets are behaving today, every day.

I would highlight 3 key themes of our risk assessment: that deriving from the scale of primary market activity that has taken place over the last several months; the challenges of surveillance during volatile markets; and the challenges of surveillance driven by our new ways of working and the importance of effective culture to manage those risks. 

Turning to the primary markets

The FCA stated early in the pandemic that we sought to keep markets open and orderly. It is remarkable how well the core infrastructure and participation in the UK wholesale markets functioned as we all transitioned to a world in lock-down. There is no doubt that ticket sizes declined, bid/offers widened, volatility indices increased and liquidity measures also declined, as might be anticipated in a volatile market facing such substantial repricing. However, our markets showed remarkable resilience to transition to new ways of operating.

Our focus on markets remaining open is driven by the fundamental role they play in supporting the economy – in enabling risk to be priced and managed, but equally, enabling institutions to raise capital at times when they need it the most. 

Working with our regulatory and other partners, a range of changes were made to the regime to support this capital raising taking place at pace, whilst ensuring an appropriate degree of protection for investors. Consequently, in the first 6 months of 2020, the UK saw a greater volume of follow-on equity issuance than the next 7 major European bourses combined. 

Such capital raising activity has the potential to give rise to a great deal of inside information which must be appropriately handled. 

The fundamental need for institutions to ensure that they have appropriate controls over inside information and effective information barriers is even more critical at times like these. 

Sometimes it is the simple steps that can make the greatest difference, such as regularly reviewing how many people are permanent insiders in your organisation and whether they are necessary – including in your technology divisions. 

New challenges, including controlling inside information moving within a firm and leaving a firm may also manifest at times like these. Working from home – which many insiders will still be doing even as some trading floor staff have returned to the office, also changes the controls landscape. In initially instituting social distancing in the office some firms were challenged in terms of supporting the appropriate physical distance to maintain information barriers. At home, this is equally important, where inside information may need to be kept from partners or flatmates. It is absolutely the case that this risk has always existed, but when the separation between work and home life is perhaps harder for some people to navigate, it may be all the more important and acute.  

With enhanced primary market activity and potentially indeed mergers and acquisitions (M&A) activity going forward, the importance of strong wall-crossing arrangements is as great as ever. 

In addition, such activity can give rise to greater risks of conflicts of interest. We highlighted at the start of the crisis the importance of lending firms managing those conflicts if they were seeking capital raising mandates, but equally, with the increase in M&A transactions, an increased volume of inside information will be generated and firms should ensure that they are alert to this, and identify when during a transaction, controls become necessary.

Market participants should ensure that they have proper controls in place to recognise the point during transactional discussions with an issuer at which to restrict themselves from trading in relevant securities. This is especially true of firms which invest in distressed debt markets where inside information is not always as clearly demarcated as in equity markets, and there is the potential for misuse of that information to occur, particularly in relation to credit restructuring talks. 

The need for discipline does not just cover the management of that information by issuers and their advisors. It also covers the heightened discipline that issuers with relevant securities need in their assessment of inside information during times of uncertainty or rapid change. As we have stated, it is understandable that many companies with stable business models come to think of certain types of information as more likely than others to constitute inside information. However, this is an area where a dynamic risk assessment is equally important. 

What constitutes inside information may change radically during the pandemic: knowledge that an entire businesses’ operations would have to shut, or indeed could open again; knowledge of whether a company had utilised the furlough scheme or any of the pandemic lending schemes; information about the pace of cashflow burn – all issues that might either not have come up in the past, or not have been material, but which now are. This requires companies and their advisors to be alert to what information is likely to drive their valuation and to bring a potentially wider range of issues to be discussed at their disclosure committees. Equally important is how listed companies consider the controls over this information.

Turning to surveillance alert triage and Suspicious Transaction and Order Reports (STORs) in volatile markets

We have spoken to many firms and trading venues to discuss maintaining appropriate trade surveillance throughout this crisis. Despite the uniqueness of every firm, it is fair to say that there have been some very common themes. The dramatic increase in trading activity and volatility, particularly at the start of the crisis, in most cases leading to a surge in alert volumes across the board. 

Firms and venues have managed the increased output in a variety of ways – some have been able to deal with it with some flexibility, such as by transferring staff across from one compliance discipline to another to help handle sudden short-term increases in alert volume. This demonstrated the value of cross training, and the value of flexible staff, and a nimble approach from managers. Other firms have recalibrated or applied additional filters to their alert generation – to ensure output is meaningful. An example is the use of benchmarking against certain macro metrics like indices to allow for increased volatility in markets. This can help reduce alert volumes, but not at the cost of missing potentially suspicious activity.

There is no doubt that the job of managing alerts is made considerably harder by a rise in the volume of alerts driven by the volatility we experienced and hence appropriate calibration of any alerting protocol to take account of the market context is reasonable. 

Whilst the fundamentals of the market abuse offences are constant, the ways in which the risk may manifest are not. The manner of surveilling for them must, therefore, also change. 

Crucially, any changes to calibration need to be appropriately considered, documented and governed. Where new dynamics do appear to have arisen, firms may wish to consider some form of thematic analysis or retrospective review to ensure those dynamics are captured for future risk assessments. 

Firms should continue to escalate and report instances of potentially suspicious activity by considering whether the bar of ‘reasonable of suspicion’ has been met. While we understand that the exceptional market conditions may have an impact on what is judged to constitute unusual, or anomalous, the process should be the same. Firms should assess the evidence, apply context and make informed decisions. In other words, we do not expect firms to submit poor quality STORs, simply because they have had more alerts. I am happy to say that whilst we saw a reduction in the number of STORs in the early months of the crisis, we did not observe a reduction in the quality of STORs or observe a significant number of ‘missing STORs’ compared to our own surveillance of the market. In recent months, we have also observed the pattern of STOR submission returning to more normalised levels and typologies. 

We do however recognise that backlogs were and can be created in these circumstances, and that it is entirely possible they could be created again. If your firm has a significant backlog, please promptly advise our STOR Supervision team of the issue, its scale and anticipated timescales for clearance. In addition, while you should always aim to submit without delay, we recognise this might be difficult from time to time. If you submit a STOR and it is outside the normal timeframe, we would ask you to advise us of the cause of the delay at the time of the submission as that may obviate the need for us to contact you. 

Surveillance and new ways of working

The pandemic has caused a great many changes to the way we all operate. I am, for example, delivering this speech from my home – not something I ever anticipated doing before! 

We have all had to find, and have found, many new ways of working in the last few months that we previously did not think possible. We will also have to navigate huge amounts of change over the coming months, depending on the path of the virus, as we work through Return of Office models that will no doubt include both hybrid ways of working and indeed, over time, potentially long-term changes to the way we all work. This also requires firms to adjust the way in which they think of the range of surveillance tools available to them.

While scenarios emerged early in the pandemic where the usual levels of recording and surveillance were not possible, our experience suggests firms have now overcome these challenges. Our expectation is that going forward, office and working from home arrangements should be equivalent – this is not a market for information that we wish to see be arbitraged.

We expect firms to have updated their policies, refreshed their training and put in place rigorous oversight reflecting the new environment – particularly regarding the risk of use of privately owned devices. These policies should be demonstrable to us and to your audit teams. It should go without saying that policies should prevent the use of privately owned devices for relevant activities where recording is not possible. New communication mechanisms, before they are used, should have controls in place where required and their use be approved by firm management. The regulatory obligations have not changed, the how may be changing, but the what remains the same.

Another concern arising from remote working is the oversight and provision of advice from Compliance Advisory teams. Where firms are operating back in the office, it is important to consider whether the compliance support to those desks is appropriately structured and staff have access to the relevant materials and support. 

There is also a risk of less self-policing amongst front office staff. As an example, consider a pre-crisis situation where a front office employee observes, or overhears, something questionable involving a colleague nearby. In normal – pre-crisis – circumstances, we would hope, and expect, that the activity would be questioned, or reported to Compliance. With people working remotely, especially when staff are working from home, that type of first line control may be diminished, or absent. 

An important factor here is the role that good culture plays within firms. Compliance teams – indeed management and leaders throughout firms – should consider how they can reiterate, and reinforce their expectations. Staff should be in no doubt about the standards expected of them. And they should be in no doubt that these standards apply whether they are in the regular office, a disaster recovery site or at a makeshift workstation at home. Culture matters, and it matters most when the risks are highest.

Having a culture that minimises the risk of poor conduct taking place in the first place remains critical. It is important that staff are conscious of the role they play as the first line of defence. 

Personal dealing

There has been a great deal of public commentary regarding the risk of personal dealing whilst people are working from home. There has also been a significant increase, particularly amongst slightly younger generations, in the opening of new personal trading accounts over the course of the pandemic. It is essential that where firms facilitate the access of private individuals to regulated markets, they are alive to the risks this type of trading may pose in their monitoring as well.

I want to make two points on this. 

Firstly, long before the pandemic, the FCA had observed the risk of an uptick in what we define as ‘single stock events’ – the potential that individuals within listed companies, or with access to information about listed companies – were inappropriately utilising that information to make a profit or avoid a loss in the relevant securities. 

We remain exceptionally focused on this type of event. To be very clear. Market abuse is not an offence that only applies to individuals working in the financial services industry. Everyone must comply with MAR and criminal law. Any individual in receipt of inside information who trades while in possession of that information, or induces someone else to, is guilty of market abuse. 

We can see activity down to the individual account level. If you trade suspiciously and you receive a letter from us asking for your reasons for trading, it is because we are watching. Where we have not sent a letter, it may be because we have other plans to address the behaviour. If the individual in question works for a regulated firm or an issuer, we will most often contact their employer in order to understand whether, in the course of their duties, they had access to the relevant inside information. Even where they did not, this may nevertheless give rise to the employer becoming aware that an individual has breached their Personal Account (PA) dealing policy. We have seen instances where our enquiries have led to an employer terminating an employee following disciplinary action. Misuse of inside information that anyone receives during their work or indeed as a consequence of an inappropriate conversation on the golf course or at the pub (now that such activities are allowed again), is a criminal offence. 

The companies these individuals work for should be equally concerned about the loss of integrity to our markets that such behaviour represents.

The second point I wanted to make on this issue, is that it is essential that firms also conduct their enquiries into these matters with appropriate levels of discretion to avoid tipping off. 

In a recent Market Watch we discussed how inappropriate handling of information requirements issued by the FCA can hinder, or even compromise, our preliminary reviews of, and investigations into, suspected market abuse – particularly where subjects are tipped off due to the inappropriate handling of an information requirement by a firm. 

Whilst it is fair to say many firms carefully handle our requests and prove very helpful to our enquiries – this risk crystallised in one of our cases not long ago – where the mishandling of one of our confidential information requests led to a suspect fleeing the country. In that case, unknown to us, the content of our request was shared with a manager of the firm’s deal team, who then decided to question an individual who had accessed inside information without a ‘need to know’. The individual was the suspect in our investigation and upon being challenged, resigned from the firm and left the country, severely hindering our ability to take action.

Investigating and prosecuting market abuse is difficult, and events such as these make it even more challenging – ultimately harming our markets for everyone.

Data

On a more positive note, it is worth noting the progress made on our surveillance datasets. While we have said this privately to many firms, we are very grateful to all those people across the industry who work so hard to ensure that we receive accurate transaction and order reporting. I view the provision of accurate transaction reporting data as a public good – it enables us to surveil the market, follow up where we find suspicion and, as a result, minimise the risk of future market abuse. 

Firms dedicating resources and energy to good reporting actively contribute to the system being safer for everyone. By extension, those who do not, are benefitting from strong markets enabled by others, but without any positive contribution themselves.

This precious data enables us to assess more holistically the risks in the market and the effectiveness of our vigilance. The growing suite of market cleanliness stats that we produce derive from the use of this data – including the new Potentially Anomalous Trading Ratio (PATR). The metric enables us to attempt to scale the possible prevalence of potentially anomalous trading in UK markets. Our PATR data suggests that only 0.8% of all relevant trading in 2019 met the necessary prerequisites to justify further review by the PATR metric. Of that 0.8%, 6.7% of that activity was considered potentially anomalous and worthy of further enquiries. While it is very early to draw conclusions from this new metric, on one level, the results likely indicate that discipline in UK markets is overall strong and effective. On another, we know that the PATR results worsen slightly between 2018 and 2019, reflecting the need for all of us to maintain our focus.

As someone who joined the FCA in the midst of the LIBOR scandal and before the foreign exchange (FX) enforcement outcomes were made public, I am keenly aware that conduct crises can follow financial crises. No one wishes to see that again, so our continued vigilance in combatting market abuse must continue.

We will remain focused on the tools that we have to fight market abuse – including working with government on potential changes to the criminal market abuse regime to ensure that the UK’s regime for combatting market abuse continues to work effectively in an evolving market. In addition, the UK aspires to clean and orderly markets that encourage participants to join venues to enable capital to be raised and deployed. The FCA has collaborated closely with other EU and global regulators over the years to ensure that the markets remain clean and safe and that collaboration and focus remain undimmed. I am very sorry that I will not be able to join my European colleagues on the panels later, but I know that we will continue to work extremely closely together in service of common goals. 

Having rattled my sabre (I hope) just the right amount, I want to end on a positive note. A great many people have worked tirelessly to ensure that our markets have remained orderly and open over the last few months and to ensure that they have been a platform to enable effective risk management and capital raising.

The capital markets, some might say the ‘virtual’ location I have worked in every day of my professional life, play a pivotal role in supporting the UK, its people, its economy and its prospects. When transactions of millions or billions of pounds are translated into flickers on a screen, it is sometimes easy to forget that. To forget that behind each trade is someone’s pension money, or a company’s future working capital, that an FX trade could include workers’ remittances to their family or the shape of the curve could impact mortgage pricing for families starting on the housing ladder.

I hope, as with many things in this pandemic, it is possible for everyone in the market to see quite how vital their work is, but also how essential it is that we all do our work well, with integrity and with the bigger picture in mind.