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It is not just the big fish that are caught – A brief look at manipulation, best execution and principles, principles, principles…………………………….

[fa icon="calendar"] 21-Aug-2017 07:44:00 / by David Woolcock

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You would be mistaken if you thought enforcement notices were just the preserve of big banks and individuals. Many smaller regulated banks fall foul of the FCA’s and other authorities’ scrutiny. For FCA regulated firms this is mainly around two important principles of business (Principle 3 & Principle 11). Principle 11 deals with relations with the regulator but the most important one is number three (and in terms of fines a costly one!).

Principle 3 - Management and control - A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems.

This theme is taken up in the Global Code of Conduct for FX, (80% or so of the Global Code principles also equate equally to markets other than FX), and in particular Principle 4.

Principle 4 - The body, or individual(s), that is ultimately responsible for the Market Participant’s FX business strategy and financial soundness should put in place adequate and effective structures and mechanisms to provide for appropriate oversight, supervision, and controls with regard to the Market Participant’s FX Market activity.

The cost of ignoring these important principles can be high, with the FCA fining even small banks a few million pounds plus! With the FCA looking to embed the Global Code into the Senior Manager & Certification Regime, now more than ever, banks should be looking to evidence that they are adherent and operating to the highest standards.

If you take a more global look at what is happening in the regulatory enforcement arena, you see the same recurring concerns. Multiple banks in Africa are facing prosecution, mainly for market manipulation of one form or another, along with similar ongoing activity from FINMA in Switzerland.

The main areas of concern for regulators are ones of the big themes: “risk management, lack of controls, compliance, conduct risk, culture, market abuse and governance”. To stay on top of this, bank’s need to be monitoring activity in real-time with dashboards and intelligent automated warnings when suspicious events require further investigation. While some of the others are dealt with through training and education, banks should not overlook the real value of effective deterrence through deploying technology that can spot malfeasance in real-time.

Europe is not silent on the subject either when it comes to the Market Abuse Regulation –

“2. Any person professionally arranging or executing transactions shall establish and maintain effective arrangements, systems and procedures to detect and report suspicious orders and transactions. Where such a person has a reasonable suspicion that an order or transaction in any financial instrument, whether placed or executed on or outside a trading venue, could constitute insider dealing, market manipulation or attempted insider dealing or market manipulation, the person shall notify the competent authority.”

For the FX market, this point has been rammed home with the various global market manipulation events. FX market manipulation issues were so prevalent, that global fines exceeded USD10bn in a single year. Certainly, we will be hearing more from the FICC Markets Standard Board (FMSB) as they issue guidance to achieve fair and transparent markets beyond FX.

Detection of market manipulation sits very close technologically speaking to best execution. Best Execution is an obligation across jurisdictions, regulations, and products but in particular, as noted in my earlier blogs, MiFID II raises the bar for compliance. Also, as previously noted, banks should not leave products that are out of scope of MiFID II (spot FX for example) from their best execution arrangements.

It is in the opinion of the FCA that “not enough is being done by firms to ensure best execution is being consistently delivered to clients”. In keeping with the Senior Managers & Certification Regime which notes “senior management with responsibility for trading activities to take greater responsibility for ensuring that policies and arrangements remain fit for purpose”, it is no wonder that for best execution and market manipulation detection banks are turning to technology to provide the answers.

Like with MiFID II, the Market Abuse Regulation - MAR (which took effect in July 2016) is very broad in its application and banks must consider two types of data (as they have to for best execution), namely transaction data and order data. Banks are obliged to surveil their own activities against market abuse. So when deploying best execution technology, care should be taken to make sure it covers executed deals as well as quotes that do not lead to a deal and orders.

The time for action is now with the best execution requirements going into effect in January 2018 and market manipulation regulation is already with us. The scope of the problem hit home to me when I opened one of my morning emails keeping me up to date with the legal aspects of regulation and saw the following –

“London (July 5, 2017, 8:54 PM BST) -- Insider trading and market abuse is rampant across London, the U.K. Financial Conduct Authority revealed Wednesday, warning firms that it will step up enforcement after determining that suspicious activity occurs in nearly one in every five deals.”.

Regardless of the sensationalism of the headline, regulators regard robust controls as mission critical. They will surely be stepping up their inspections into the effectiveness of banks market surveillance systems. As noted by ESMA, European regulators will implement fines and measures that are are “effective, proportionate and dissuasive” (my emphasis). Banks who do not have the technology in place to fulfil their responsibilities can be assured they face the ongoing risk of “significant regulatory and reputational costs”.

In summary, banks need to buy in to this principle led, regulatory and code of conduct-based approach. Rather than looking for ways round the letter of the law, banks should look to follow in the spirit of the new direction. This means taking responsibility at an individual level and exercising sound judgement based on good detection systems. This cultural and conduct change alongside robust systems and processes must allow for proof of adherence to the new principles. Given the scale of fines and a new determination of inspectors to examine how banks are proving adherence at the senior manager level, an examination into if your technology stack is fit for purpose may well yield dividends.

Topics: Banking, Regulation, Compliance

David Woolcock

Written by David Woolcock