Private banks and asset management firms with trading functions are getting to grips with the European Union's Market Abuse Regulation. Philip Naughton, the director of Cordium’s compliance consulting team in the United Kingdom, looks at the way in which the EU has extended its regime and examines the implications for training.

You could be forgiven for thinking the Brexit vote – and its continuing fallout – was the only thing happening in the world right now. With the UK’s future relationship with Europe up in the air, it can feel as though national life has come to a juddering halt. Look beyond the cataclysmic headlines, however, and the old adage – ‘life goes on’ – rings true. And, of course, we are still a full member of the European Union and are likely to remain so for the next two years at least.

As if to illustrate this, the EU’s new Market Abuse Regulation (MAR) came into effect in the UK on 3^rd July replacing our own civil market abuse regime. Although the news was understandably buried under a metric ton of Brexit developments, it has major implications for financial services firms.

The road to MAR

The implementation of MAR should be understood in the light of the Financial Conduct Authority’s evolving approach to market abuse. The FCA conducted its own thematic review on the topic, the findings of which were issued in February 2015. Although it came to the general conclusion that the existing regime was working well, it identified a number of ways in which financial firms might not have been performing adequately.

Most of its criticism related not to an absence of policies or procedures at firms, but rather to a failure of those firms to apply these vigorously. For instance, it found that firms in general had effective policies to help them identify and avoid instances in which they might receive inside information, but it found also that their efforts to do so were often too informal and/or inconsistent. Similarly, all the firms that the regulator reviewed had a policy to limit the spread of inside information within their organisations on a 'need-to-know basis,' but only a minority monitored the effectiveness of this policy.

The FCA uncovered failings in two other areas. One was post-trade surveillance, where it thought that some firms were finding it too difficult to investigate potentially suspicious transactions either because the documents in which their staff described meetings and front-office research activity were poor in quality or because they were not keeping such records at all. The second – and crucial – area of inadequacy was the training of staff.

MAR – what’s changed?

There are a number of quite specific changes in MAR and to gain a truly comprehensive understanding of how MAR affects your firm it is best to speak to an advisor. However, it is worth stating that the European Union's definition of ‘inside information’ (and of other important terms) remains largely unaltered.

Many of the changes, instead, relate to an extension of the regime into new areas. For instance, the definition of 'inside information' has been broadened to capture spot commodity contracts. MAR also stipulates that the use of inside information to amend or cancel an order will now count as insider dealing and that the act of inducing or recommending another person to transact on the basis of inside information amounts to unlawful disclosure. MAR also extends the reach of the market manipulation offence to capture attempted manipulation and applies the offence to benchmarks such as Libor, the London Interbank Offered Rate.

Firms on the 'sell side' (issuers of stock as opposed to the exchange-facing asset managers and private banks that deal in it) must also now abide by far a more prescriptive process when it comes to market soundings (approaches that issuers make to selected investors in advance of new issues in the capital market with the aim of predicting their success). The rules for disclosing inside information legitimately during the course of soundings are now much more specific and include some additional recordkeeping requirements to ensure that everyone manages and controls the process effectively.

Probably the biggest change, however, relates to Suspicious Transaction Reports or STRs. Firms now notify to the FCA three times more of these than they did in 2011, with nearly 90% relating to the misuse of information in 2015. This is probably, in part at least, a consequence of the Greenlight case in 2011, in which the regulator made it clear that a failure to report suspicious transactions could result in hefty fines for the individuals in question. MAR, however, extends STRs to cover not just transactions but also orders, turning them into STORs (Suspicious Transaction and Order Reports). This is because firms can pull or amend orders on the basis of inside information – something that the old regime would not have detected and stopped very easily.

This is a reasonable extension of the regime, but it will definitely cause an increase in reporting. With this in mind, MAR suggests that firms should use automated systems to ensure compliance, in accordance with the size and breadth of their activities.

The need for face-to-face market abuse training

However, to return to the FCA’s thematic review, one clear lesson is that the mere existence of up-to-date policies on paper relating to the current regime is not enough. Relevant staff members throughout each firm ought to take these policies and requirements on board. Only then can the firm ‘instil a culture of compliance,’ as the FCA puts it, instead of treating compliance as a peripheral box-ticking exercise.

This has major implications for market abuse training, especially now that MAR has a longer reach than its predecessor and calls on firms to employ more granular processes which are new and unfamiliar. The FCA thematic review cited face-to-face training as an example of 'best practice,' in contrast to over-reliance on online training which it described as 'poor practice.'

The online training route can be tempting – it is cheap in the short term and intrudes less on the day-to-day work of staff. On certain topics – such as anti-money laundering rules – it can be effective and appropriate on its own. When it comes to a topic such as market abuse, however, the potential instances of people inadvertently ‘leaking’ or receiving inside information are so numerous, varied and specific to the idiosyncratic ways in which different firms operate, that generic online courses simply won’t cut it.

To take an example, a firm may be focused on, say, Latin America. One of its analysts might fly to the region every quarter to meet the senior managers of firms in which he is thinking of investing. Such meetings would be fertile ground for an accidental receipt of inside information. Face-to-face training could help him avoid this danger and help the firm develop a concrete set of procedures for managing the risk (e.g. recording all contents of said meetings, and sharing these summaries with the compliance department). The firm might not realise the need for added controls if it used an off-the-shelf, one-size-fits-all online course. As the FCA says, face-to-face training ‘encourages debate of real-life scenarios and a full understanding of how market abuse rules apply in practice’. With online training, not only is the practical element lost, but effectiveness is harder to ensure: the FCA noted that at one firm that used it, the training log showed that some staff members had completed the market abuse module in less than half the stipulated time, with nobody trying to find out afterwards why this was the case, or whether the staff had truly understood the material.

More and more firms are subscribing to rigorous, face-to-face market abuse training each year. They have good commercial, as well as regulatory and reputational, reasons for doing so. The Greenlight case resulted in Casper Agnew having to pay a large personal fine, but not his employer, JP Morgan Cazenove. This was because he ‘had received extensive regulatory and compliance training, and significant compliance resources were at his disposal.’ In other words, the firm did everything it could to train him thoroughly and took all the reasonable steps required. As a result the fault, and punishment, lay squarely with the individual concerned.

It is impossible for any firm to guarantee that none of its staff will engage in insider dealing, but through effective, up-to-date and relevant face-to-face training, firms can guarantee that they will not be left carrying the can if their employees stray from the path of righteousness. It may be slightly more expensive in the short term to 'get up close and personal' with your staff when it comes to market abuse, but a tick-the-box web module is only a cheap option before the fine hits.