Speech by Patrick Spens, Head of Market Monitoring, at the British Bankers' Association Market Abuse Conference. This is the text of the speech as drafted, which may differ from the delivered version.
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Market abuse remains a high priority of the FCA, ensuring that our markets are clean and protecting the integrity of the UK financial system.
Good afternoon and let me start by thanking the British Bankers’ Association (BBA) for hosting today’s conference on market abuse and for inviting me to speak to you.
My name is Patrick Spens. I am Head of Market Monitoring at the Financial Conduct Authority (FCA). It is my pleasure to talk to you today about some of the activities my department does in order to tackle market abuse and some of the tools we have at our disposal. Market abuse remains a high priority of the FCA, ensuring that our markets are clean and protecting the integrity of the UK financial system. This is directly attributable to one of the FCA’s three objectives, which is to ‘protect and enhance the integrity of the UK financial system’.
We take clear and direct action to meet these objectives, and I want to set out some, but by no means all, of the things we do to combat market abuse. I would add here that tackling market abuse requires dedicated and vigilant actions from all market participants and not just the FCA. The conclusion of our enforcement actions demonstrates how seriously we take market abuse and it acts as a credible deterrence to others, however, it is underpinned by a range of other inputs.
I will discuss the importance of why both Transactions Reports and Suspicious Transaction Reports are vital in our tackling of market abuse and how these interplay with both our surveillance visits, to firms and UK platforms, and our in-house proprietary surveillance technology. And of course, I’ll touch on enforcement actions such as our recent fines on Deutsche Bank for transaction reporting failures and the ban and fine for a trader that tried to manipulate gilt prices.
Transaction reporting
Firms are required to submit transaction reports, under Article 25 of MiFID, and we receive on average 13 million transactions reports per day. This is set to increase to between 15 and 20 million with the implementation of MiFIR. Transaction reports currently contain 26 different fields: trade date, trade time, instrument, value, volume and counterparty identification, to name but a few.
With the implementation of MiFIR, there will be significant changes in the transaction reporting space, the details of which have yet to be determined. However, the single client identification code will assist in our ability to investigate market abuse, as well as provide a picture of positions held by entities and individuals from any given start date.
The accuracy of transaction reports is key. We have the capabilities to interrogate the rich data-set that transaction reports provide, which then feeds into our various data analytics. These form the basis of many of our judgement calls on market abuse cases and supervisory action concerning potential risks to a firm.
My department works closely with our colleagues in the Markets Reporting Team to highlight errors that we identify as part of our investigation and surveillance work. We take the obligation on firms to provide high quality data seriously; the FCA recently fined Deutsche Bank £4.7 million for incorrectly reporting transactions between November 2007 and April 2013. It had its buys and sells the wrong way round, which is fairly fundamental. Deutsche Bank is now in the process of resubmitting 29.5 million transactions.
STR regime
Firms’ unique position and proximity to their clients mean they have the ability to perform the most effective market surveillance and are the first line of defence.
As well as collecting transaction reports, we also receive Suspicious Transactions Reports (STRs), which are in the region of 1,500 a year. The STR regime has been operational since 2003, with STRs being mandated by Article 6(9) of the Market Abuse Directive and transposed into the FCA’s Handbook at SUP 15.10. In addition, SYSC 6.1.1R in the Handbook states that a firm must establish, implement and maintain adequate policies and procedures that will counter the risk of activities that may further financial crime.
Phew, that’s a lot of legal speak. The rules are not the relevant part here, and I am by no means expecting you to remember the Article 6(9) or SUP references, so you can breathe easy and, if you prefer, ignore the last 30 seconds or so. The point I want to make is that STRs are a mandatory requirement placed on the industry to inform us (the FCA) of any suspicious, or potentially abusive behaviour that you observe. When I use the word ‘industry’ here, I am referring to all parts of the trading chain. We have noted that some parts of this chain, notably inter-dealer brokers, submit fewer STRs than we would perhaps expect, given their central role in many transactions and markets. STRs should be submitted for all financial instruments defined under legislation, i.e., qualifying investments on prescribed markets and investments related to those, such as bonds, equities, contracts for difference (CFDs), credit default swap (CDS), warrants, options and futures.
So what is the point of an STR? An STR is a report by an authorised firm to highlight cases where it suspects that market abuse may have occurred, either by itself, its clients or a counterparty.
Why are they important? Well, STRs are a crucial intelligence asset in the detection of market abuse, and contribute significantly to the investigative work conducted by the FCA and potential enforcement actions. Firms’ unique position and proximity to their clients mean they have the ability to perform the most effective market surveillance and are the first line of defence.
The FCA will continue to build on the result of previous action, both public and private, and target, where appropriate, those individuals or entities that threaten market confidence and stability. In this respect, I am confident that we’ve made a good start. The evidence – including numerous arrests and public outcomes in ten of our Enforcement cases since the FCA was formed – backs up our commitment to detecting and deterring abusive behaviour. What you don’t know is that we have also conducted nearly 100 private outcomes.
We have observed an increase in quantity of high quality STRs as a result of our supervision of the STR regime. High quality STRs are a key driver in our ability to be successful in combating market abuse. With STRs and our own proprietary systems, which I will discuss in more detail in a moment, we are able to form a ‘virtuous circle’ of surveillance.
STRs, notifications from platforms, whistle-blowers, foreign assistance requests and alerts from our proprietary system are all received into our market abuse inbox. These can be reconciled to check both the participant’s submissions of STRs and notifications as well as our alerting system. This exercise feeds into our STR supervisory programme and the development of our in-house technology, with the ultimate goal of capturing abuse across the market space. We take STR and notification failings seriously as they impact our ability to protect against abusive behaviours in the markets. We have taken, and will continue to take action where individuals and firms fall short of their obligations, including failure to submit an STR. I would just like to make note here thought that I am not looking for defensive reporting by firms, I am looking for quality STRs on suspicious activities across the asset classes under legislation.
Traditionally, insider dealing and other forms of market abuse had, perhaps, been seen in some circles as being a victimless crime or even a perk of working in the City. It isn’t. Recently there has been growing recognition of the very serious damage to market confidence such offending can inflict. Take the recent gilt manipulation case as an example, the outcome of which was published in March this year.
How did Mr Stevenson, in this gilt case, manipulate the bond market? There is an important point here. A common mis-conception is that the gilt market can not suffer the effects of market abuse; this is simply not the case. A takeaway from today is a reminder that the fixed income markets, like all asset classes that fall under the market abuse regime, are just as important to safeguard for market integrity as the equity markets, because they are also susceptible to manipulation.
Mr Stevenson, on the 10 October 2011, did just that: he manipulated the gilt market to try and benefit from an announced reverse auction by the Bank of England as part of the quantitative easing operations. Stevenson identified a particular security as cheap, having bought the said security months before. Stevenson’s initial position was around £500 million nominal. He considered that the security was 12 to 13 basis points cheaper than his considered ‘fair value’. With the quantitative easing programme in play, Stevenson thought this could be the catalyst to trigger the move of the security up to his considered ‘fair value’.
On the day of the buy-back (10 October), Stevenson bought a further £331 million bonds. This constituted 91% of that day’s volume for that particular security, and represented several months’ worth of normal volume. Stevenson then offered his position the Bank of England at a lower price than he was buying at in the market. It was hardly a subtle attempt to manipulate the market. Fortunately, for the Bank and UK taxpayers, the Bank of England decided to reject all offers in Stevenson’s chosen bond, owing to the sharp intra-day change in yield. Activity of this nature is exactly what we would expect to receive an STR on. If you don’t get this point, then I would be concerned.
Surveillance visit
We perform our own surveillance of the markets, which enhances the intelligence received from STRs and other sources. As part of our surveillance activities, we have installed our own in-house proprietary technology, but we also conduct surveillance visits. These visits form part of our STR and platform supervision, and are a vital source of intelligence to the FCA.
The primary purpose of our STR programme visits is as an educational tool for the industry regarding use of their post-trade surveillance systems. The programme was initiated in 2012 when we wrote to firms requesting their most recent three near-misses in relation to submitting an STR. The point of the exercise was to highlight to firms that had previously failed to ever submit an STR or infrequently submitted STRs, of their obligation to conduct surveillance of their clients and their own trading.
The intention of our visits is to help firms understand our requirements. Firms, on the whole, have agreed that our expectations of their surveillance systems are valid and that our approach is both fair and transparent.
We also, in conjunction with our counterparts in Supervision, look at market abuse systems and controls in relation to pre-trade activities. This is a workstream that ties in with the ESMA guidelines ‘Systems and controls in an automated trading environment for trading platforms, investment firms and competent authorities’, which state that firms need to consider both pre-trade and post-trade controls.
It is important to highlight that we function here in a supervisory capacity and as such, where we identify failings, we will and have taken serious actions. Just because these are not public acts, be assured that we do not tolerate poor surveillance performance, and where necessary, may look to take formal enforcement action.
We have several engagements, for example buy and sell-side forums focused on market conduct issues, while the investment bank surveillance forum and the surveillance practitioners group, both of which bring together the largest market participants, discuss surveillance methods. We continue to see how we can extend and expand the use of forums, while maintaining their relevance and use to both sides.
It is our intention to try and reach out to most of the market through these forums but also through firm-specific visits, thematic visits, crystallised risk visits, and online questionnaires. One such project, where we will be reaching out to all sectors of the market, is our educational campaign, which we plan to kick off towards the latter end of this year. We will be focusing on, and targeting the educational needs of the industry and investors, in relation to market abuse: the rules, the regulations and the effects. Watch this space.
As you know, STRs are required from firms in all financial instruments either admitted to trading or listed on a prescribed exchange. I will be writing to all firms engaged in fixed income trading to provide me with their three near ‘misses’ for fixed income STRs and their reasons for not sending. Expect my letter to cross your desk shortly.
In-house proprietary technology
Our ability to ingest large amounts of data and analyse trading patterns to strengthen our market abuse cases is an invaluable tool in tackling financial crime.
To support both our investigations and our supervisory functions, we have developed and are continuing to develop our in-house proprietary technology for the changing landscape and also for specific individual cases.
Take the gilt case, which I discussed earlier. My technology team were able to digest a large dataset of tic data from multiple comparator bonds, that is, bonds with similar durations, for the 1,580 days of trading from 2008 to 2012, to show that the movement in price and yield on the 10 October 2011 was wholly anomalous. This evidence solidified our case and was a large contributing factor to solidifying our case.
Our ability to ingest large amounts of data and analyse trading patterns to strengthen our market abuse cases is an invaluable tool in tackling financial crime.
The system which currently collates the 13 million, soon to be 15 to 20 million per day, transactions is our purpose-built system, Zen. Zen has a number of characteristics that make it globally unique among the major financial datasets. It can ingest a breadth of securities, all those captured under MAD, soon to be MAR; it has historical longevity, holding data since November 2007; and, it is subject to data enrichment with the use of reference and market data underpinning all ingested transactions. Zen also sends 8 million transaction reports to ESMA for onward forwarding to relevant competent authorities.
Closing remarks
Firms should continue to ensure that they have adequate systems and controls to detect suspicious transactions.
The FCA continues to put a great score on the importance of all market abuse systems and controls, but especially pertinent for the audience here today are those related to STRs, particularly fixed income and other non-equity asset classes captured by legislation. Firms should continue to ensure that they have adequate systems and controls to detect suspicious transactions, either through proprietary or client trading in all asset classes and behaviours captured by the market abuse regime.
We’ll continue to develop our in-house proprietary technology to detect suspicious behaviour in the marketplace. This technology will of course expand in line with the widening scope coming with the implementation of MAR, (which was discussed earlier today). And where we see firms falling short in their obligations under the FCA rules, we will endeavour to use the full suite of regulatory tools available to us. Get ready for MAR.
Thank you for listening I hope you’ve understood more about what we do, why we do it and what is expected of you.