Market Abuse: Anticipating Regulatory Investigations and coping with Regulatory Reform Financial Markets & Regulatory Group Chris Borg, Rob Falkner, Brett Hillis & Rosanne Kay
Case Studies
Background facts • Clearer is a clearing broker which offers a direct market access service enabling clients to trade on ICE Futures Europe (“ICE”) in its name. • Client 1 is the FCA regulated trading subsidiary of an integrated oil and gas group with interests including upstream physical assets. A year ago Client 1 was the subject of an FCA Skilled Person appointment following an unsatisfactory supervisory review of its conflicts of interest (client v proprietary trading interests) policies and procedures. The Skilled Person’s remit included a report on the firm’s corporate governance arrangements and compliance culture. • Client 2 is an FCA regulated broker–dealer and market–maker which specializes in energy product investments for itself and for clients.
Scenario A • The Brent Crude spot price has been trending upwards but market fundamentals are mixed with respect to likely market direction. Client 1 has a substantial long position in the ICE Brent Crude Futures front month contract, which closed at USD 63.02. • The Client 1 senior energy derivatives product trader, John, participates in a permanent chat with traders at two other market participants and just before the open of the following trading day one of the traders in the chat room messaged that it was rumoured that there were take profit orders in the market at around the 63.92 level. During the trading day John asks a member of his team to assist him with the following: In order to test, or getter a better feel of, where actual market resistance levels might be - enter bids in small size at prices which are higher than the previous bid at least until the price hits 63.90 but where practicable withdraw or cancel the bids before they are executed to avoid materially increasing their long position; Subject to detecting lower resistance levels from the activity at (a) take profits at 63.90. • When 63.90 is reached John and his team member close Client 1’s long position.
Scenario B • The next day, the immediate supply-demand fundamentals for Brent Crude indicate an apparent over-supply. However the market view of the futures trader at Client 2 is that this is likely to be short-lived and he decides to take a significant long futures position based on his analysis. • From time to time the trader at Client 2 uses an IDB to find a counterparty for a transaction as a block trade where the trade is likely to have market impact. Broker 1 and Broker 2 at the IDB sit in the same office, each dealing for a number of different customers. • The trader from (Client 2) calls Broker 1 and places a significant block trade buy order on the phone for front month Brent Crude futures on ICE Futures Europe to be shown to a limited number of market counterparties. Broker 1 repeats the order back to Client 2. While Broker 1 is doing this, Broker 2 on the same desk overhears the conversation and sends an instant message to another customer which is a clearing member of ICE (Market Participant), telling him about it.
Scenario B (continued) • Market Participant places a large buy order for immediate exchange execution with Broker 2 for front month Brent Crude futures. Broker 2 places a small Brent Crude futures spread bet using his personal mobile phone for his brother-in-law’s account, for which he has a power of attorney, and enters the Market Participant buy order into the IDB’s trading system which is executed on exchange with a consequent upward movement in the exchange traded price. • Soon after this Broker 1 posts the block trade order for Client 2 on the IDB’s screen for the eyes only of selected counterparties which happen to include Market Participant. There are price negotiations through the IDB and a bilateral block trade is agreed between Client 2 and Market Participant at or about the then exchange traded price.
Scenario C • A bond issuer, X plc, is in the initial stages of negotiating a restructuring. T is X plc’s corporate trustee. As part of the restructuring, X plc needs to renegotiate its position with its existing bondholders. The bonds and X plc’s shares are listed in the UK. • One proposal under consideration is an offer under which existing bondholders could elect to receive longer term bonds with a lower nominal value (80%) than the original. • Bondholders need to be consulted as part of the restructuring process. X plc sends a notice to existing bondholders to inform them of the proposal. • After receiving the notice, one of the bondholders contacts T late on a Friday evening to request more information about the proposed restructuring, the reasons for it and the other proposals under consideration. The only person at T available to speak to the bondholder is a junior graduate trainee who has recently joined T. The graduate trainee knows about the restructuring and tries to be as helpful as possible.
Scenario C (continued) • A second bondholder decides that he does not like the proposal and reduces his bondholding. He sells half of his bondholding in the market. • The second bondholder also tells Y, a shareholder of X plc, about the proposed restructuring and that he does not like the look of the proposal on the table and is thinking of reducing his bondholding rather than electing to receive the new longer term bonds. Upon receiving that information, Y decides to sell his shareholding in X plc. Investor Z purchases the shares from Y at the current market price of GBP 1.04 per share. • A day after Investor Z has purchased the shares, the bondholders vote in favour of the restructuring at a bondholder meeting and the restructuring is announced via the RIS to the market. The market price of the shares falls to GBP 0.52 per share. • B is a corporate broker and notices the share sale by Y immediately prior to the announcement. B submits a Suspicious Transaction Report and the FCA decides to take a closer look.
Market Abuse Regulatory Reform Financial Markets & Regulatory Group Chris Borg, Partner, Reed Smith LLP + 44 (0)20 3116 3650 cborg@reedsmith.com
Market Abuse Regulatory Reform EU Agenda • MAR/CS MAD • MiFIDII Position limits • MiFIDII HFT/DMA requirements • EU Benchmark Regulation Domestic Agenda • FS Act 2012 • FEMR • SMR & Certification Regime
MAR Extension of Scope MAR Extension of Scope • New behaviours Attempts o Orders & Transactions o Other behaviours (cancellations, modifications) o • New trading venues RMs, MTFs, OTFs o • New products FIs under MiFID2 o Underlying spot commodities o Emissions auction o • New area Benchmarks o
MAR Extension of Scope Recalibration of existing offences: • Insider dealing widened to cover: More commodities, emissions • Cancelling/amending orders • • Manipulation widened to cover: Spot commodities : Where the transaction, order or • behaviour is likely to have an effect on the price or value of an FI FIs : “the price of value of which depends on or has an effect • on the price or value of an FI … including but not limited to credit default swaps and contracts for differences” Benchmarks • • Collaboration (Recital 39), includes: Brokers devising/recommending abusive strategies • Software developers collaborating to facilitate market abuse •
MAR New Obligations New Disclosure Requirements (Commodities/Emissions): • Disclosure of “inside information” o “Issuers” of financial instruments: where inside information it “directly concerns” the issuer obligation applies only where issuer has “requested or approved” admission to trading “Emission allowance market participants” o where inside information concerns emission allowances they hold in respect of their business subject to minimum CO2 or thermal input threshold June 2012
MAR STOR Reporting New STOR Reporting Requirements Trading venues (RMs, MTFs, OTFs) • • Systems for preventing and detecting abuse Intermediaries (“ STOR ” obligation) • • persons professionally arranging or executing transactions • systems for detecting and reporting suspicious transactions and orders • on trading venues or OTC
MAR Automated Surveillance Mandatory automated surveillance (for intermediaries) ESMA proposal: • Proportionality • Bids/offers • Near misses • Telephone markets • Cross-market activities • Timing: • Draft RTS to be submitted to the • Commission by 3 July 2016. Possible delay...? •
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