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The future landscape upon which electronic trading will take place in Britain is instrumental to global financial markets. The nation’s capital, London, is the largest financial center in the world and is currently subject to an evolving regulatory structure due to the impending introduction of the Europe-wide MiFID II rulings and infrastructure requirements which echo those of North America under the European Market Infrastructure Regulation (EMIR).
On this basis, Patrick Spens, Head of Market Monitoring at the Financial Conduct Authority (FCA), spoke at the British Banking Association’s Market Abuse Conference in order to give thorough perspective on the entire regulatory structure which is proposed to be implemented across the financial sector, with a focus on transaction reporting and electronic trading, as well as the modern and high technology approach to ensuring prudent behavior – surveillance.
Real-time surveillance by regulatory authorities is not absolutely new; the Australian Securities and Investments Commission (ASIC) has been successfully operating a surveillance methodology for over a year, with two systems, one being its proprietary SMARTS solution, and the other, First Derivatives’ Delta Stream system. Given that First Derivatives is a British software firm and a pioneer of regulatory surveillance systems, it is perhaps unusual that the FCA had not gone down this route at the same time as ASIC, however the regulator is now placing an emphasis on such means of monitoring irregularities in market activity.
Market abuse remains a high priority of the FCA, ensuring that Britain’s markets are clean and protecting the integrity of the UK financial system. Mr. Spens began his address on the subject of market abuse. “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’ he stated.
“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.”
Firms are required to submit transaction reports, under Article 25 of MiFID, and the FCA receives 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 the FCA’s 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” stated Mr. Spens. “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.”
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” explained Mr. Spens.
“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” he explained. “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” claimed Mr. Spens.
The FCA’s view is that 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. Indeed, LeapRate recently reported that the British authorities have not made any arrests for insider dealing for a significant period of time as they have turned their attention to the allegations which global banks face regarding possible FX benchmark fixing. Mr. Spens categorically stated that insider trading is not a perk of the job. “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?” asked Mr. Spens. “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” he concluded.
Returning to the subject of surveillance, the FCA confirmed that it performs 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” stated Mr. Spens.
“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” he explained.
The intention of the FCA’s 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 the regulatory 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 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.”
In-house proprietary technology
The FCA’s ability to ingest large amounts of data and analyse trading patterns via electronic surveillance in order to to strengthen its 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” stated Mr. Spens.
“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.”
Mr. Spens concluded by explaining that the FCA will continue to develop its 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.
“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!”
For the full transcript, click here.