Under surveillance: Complying with the FCA’s Market Abuse regulation

The Headlines

Giving itself a good, solid pat on its own back, the FCA have been highlighting successes in combatting market abuse and how well the Authority has coped in this area during the Covid-19 pandemic.

Although it’s good to reflect on the apparent reduction of market abuse through improved surveillance and recent initiatives, we must accept that perhaps those involved in this part of the trade haven’t adapted to home working yet, or worse, they have, and the FCA is yet to catch up.

In a speech given by Mark Steward, Executive Director of Enforcement and Market Oversight, the FCA gave an overview of the market abuse scrutiny that has taken place in the past turbulent year.

With this speech, the FCA have drawn attention to where they might see industry falling behind their own initiatives.

Increasing Trade Volumes

2020 paradoxically saw an increase in trade volumes in the investment sector, despite the double-whammy of Brexit and Covid-19. The FCA have attributed this to considerably heavier trading as the impact of the virus began to become apparent and investors adjusted their strategies. In fact, over the course of the year trading increased by more than a third on 2019.

The FCA are keen to point out that their market data processing capabilities, swift transaction monitoring and the FCA’s ‘algorithmic radar’ are now providing pointers to market abuse activity across trading venues in close to real time.

With a large increase in trade and improved monitoring, at the FCA at least, there was one aspect of the monitoring system that didn’t come up to scratch.

There was a sizeable reduction in Suspicious Transaction and Order Reports (STORs) during the middle part of 2020. It is unclear if this related to a reduction in market abuse opportunities in a pandemic-focussed market or whether this was an indication of internal systems in firms not being ready to cope with so many people largely working from home.

A third, and more troubling option that is not highlighted in the Mark Steward speech - Some organisations may have deliberately chosen to reduce reporting, perhaps considering it ‘a good day to bury bad news’.

Apparently, STORs have not yet returned to pre-Covid levels and total volumes remain lower than previous years. Given the overall increase in trades this is unexpected, and although the FCA are radiating confidence now, we can imagine that there will be further investigation into this.

The big question that remains is whether the figures demonstrate the success of the FCA in removing the bad guys from the market (and is a great success for the increased surveillance and investigation work they initiated), or if STORs have just not been that important to firms hit by Brexit and Covid-19.

Future Development of Market Abuse Monitoring

Identifying that there have been some truly unusual conditions in 2020, the FCA adoption of short selling reporting on their new Electronic Submission System (ESS) does appear to have given positive additional and timely data to the regulator. This now provides them with automated alerts on potential issues for manual follow up on short selling, and the FCA have indicated that they intend to roll this out for long position reporting as soon as they can.

Given ESS was in place before the pandemic took hold in the UK, it was already embedded prior to lockdown which provided them with a solid ‘before and after’ viewpoint.

The recent Gamestop incident gave them a good test of an unusual market trading situation where there was a sudden increase in the value of net short positions driven by social media. The UK market wasn’t as severely affected as the US, but this event did demonstrate to the FCA that they could place confidence in early identification of abnormal trading and the subsequent response.

Although abusive shorting can lead to distortions in a market, especially when there is insufficient cover and inevitable squeeze opportunities arise, the converse is also true, leading to the conclusion that we can expect a swift roll out of long position reporting in 2021.

Retail Trading

Another trend that the FCA are concerned about is the increase in retail trading accounts used by people in the UK during 2020. There was already a movement towards this prior to lockdown but it accelerated during the second quarter of 2020- perhaps with people bored watching re-runs of Frasier and Homes Under the Hammer.

As always, the FCA see this as a double-edged sword. They welcome the opening up of participation in the marketplace, whilst stressing that there is a risk that new retail investors will be exposed to misleading online marketing. This would be continuing the unfortunate vogue for online scams and frauds that increased throughout 2020.

In Conclusion

Covid-19 has impacted the investment market in strange ways, while changes from Brexit and new trading relationships are continuing to affect internal compliance monitoring and external reporting.

This isn’t going to change in the near future, and although automated reporting assists in identifying outliers, the introduction of yet more new technology is not going to be any easier with reduced workforces present in the heart of the IT department.

Expectations from the FCA remain high and internal analysis of external reporting should be carefully monitored to help avoid a (virtual) knock on the door.

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