TThe FCA recently released the findings from its thematic review of how asset management firms control the risk of committing market abuse with the publication of ‘TR15/1: Asset management firms and the risk of market abuse’.
The FCA’s review covered 19 asset management firms (including long-only asset managers, hedge fund managers and an occupational pension scheme), with global assets under management ranging from approximately £200 million to over £100 billion, and considered how firms control the risks of insider dealing, improper disclosure and market manipulation.
The regulator examined the market abuse policies of all the firms in the sample whilst the on-site review at each firm focused on the key aspects of an effective framework to manage market abuse risk which included ways to:
The FCA concluded that although firms have put in place some practices and procedures to control the risk of market abuse, these are only “comprehensive” in a small number of firms and that “further work” is required to ensure these operate effectively and cover all material risks. In order to aid senior management of asset management firms to meet the required standards, the FCA has provided examples of good and poor practice which are detailed below.
MANAGING THE RISK THAT INSIDE INFORMATION COULD BE RECEIVED BUT NOT IDENTIFIED
Although the FCA concluded that firms “generally” have effective policies to identify and control inside information in “clear” situations, the regulator highlighted that firms need to “pay more attention” to the possibility of receiving inside information during “all aspects of the investment process” and “take appropriate steps to manage this risk”. In relation to wall crossings, examples of good practice were: an initial point of contact for soundings that was independent from the fund managers, or where an independent assessment of any information received was carried out where fund managers decided not to take up a wall crossing which verified that it did not constitute inside information. The regulator also highlighted that firms could reduce the risk of inside information going undetected by requiring fund managers to make a documented assessment of whether inside information had been received following any declined soundings. Examples of poor practice included processes that did not require fund managers to confirm whether inside information had been received following a sounding, which resulted in the company not being added to the restricted list and compliance being unaware of the situation.
Although all firmshad practices to avoid the unnecessary receipt of inside information when conducting company-specific research, the FCA concluded that these were “typically informal” and “inconsistently applied”. In one firm, interaction with independent industry consultants was not controlled in the same way as interaction with consultants who were part of a formal expert network – despite the risk being similar in both situations. In other firms, although some fund managers had decided not to meet any investee companies in the period immediately before results announcements, compliance had failed to be informed of this decision which resulted in there not being a consistent “firm-wide approach” in place.
Examples of good practice cited by the FCA include the procedure whereby fund managers at one firm reduced the risk of receiving inside information from investee companies by avoiding any meetings with them during close periods other than in exceptional circumstances (and following pre-clearance from compliance). Another firm prevented fund managers from meeting with consultants who had recently worked for a listed company because of the possibility they could be in possession of inside information. Another example includes a firm that required consultants to confirm they would not disclose inside information before meeting with a fund manager whilst, in another example, a senior fund manager regularly asked his staff about the content of meetings and whether there was any concern that inside information could have been received. This is a good example of the first line of defence taking ownership of risks.
Firms should always consider the benefit relative to the risk of attending meetings where there is a significant possibility that inside information might be inadvertently received (e.g., meeting with a consultant who is likely to possess inside information). Where firms choose to attend such meetings, the FCA expects them to consider additional practices to promote the identification of any inside information by documenting any topics discussed.
Controlling access to inside information
Although all firms had a policy to limit the sharing of inside information, the FCA found that only a minority of firms monitored the effectiveness of this policy. Limiting the number of people who have knowledge of inside information to those “who need to know” manages the risk of improper disclosure and reduces the risk of insider dealing. Examples of good practice included keeping a detailed log of who “knew inside information” whereby knowledge of the information was not shared beyond the person wall crossed, other team members who needed the information to fulfill professional responsibilities and compliance. An example of poor practice in the report involved a firm notifying all traders when inside information had been received as an interim control to prevent trading until a system block was in place. In addition to being notified of the company name, the traders also received the detail of the inside information. This unnecessary dissemination of inside information was contrary to the firm’s “need to know policy” and resulted in an increased risk of market abuse.
The FCA found that firms generally had good pre-trade controls to reduce the risk of market abuse. The majority of firms in the sample used a block or warning prompt to prevent trading of securities that had been restricted and had segregated equity dealing functions whereby the dealers had a reporting line that was independent of the fund managers. This enabled the dealing function to query any suspicious or anomalous trades. Examples of poor practice resulted in no independent checks being carried out prior to an order being placed. Firms should ensure they have effective controls to prevent trading when it is known that a portfolio manager has access to inside information about the security to be traded. Pre-trade documentation of investment rationale can enhance the monitoring of market abuse risk whilst the recording of telephone lines provides an audit trail of activity should one be required for post-trade surveillance or enquiries.
Post-trade surveillance has a key role to play in both detecting and deterring market abuse. The FCA expects senior management to have processes to satisfy themselves that controls to identify and manage the risk of market abuse are working effectively. They concluded that firms need to “generally” improve the effectiveness of post-trade surveillance as only a minority of firms had appropriate controls for these matters. Examples of good practice were found where firms used a systematic process to identify and assess potentially suspicious trades – which included trades preceding price moving corporate announcements, as well as any trading patterns that could be indicative of market manipulation.
Personal account dealing policies
All of the firms in the review had a personal account dealing policy which generally included measures to reduce the risk of front running and insider dealing (e.g., a pre-trade check against the restricted list and a minimum holding period). Further examples of good practice included a post-trade review to monitor for any suspicious activity. The dangers of poor controls to prevent ‘front-running’ were highlighted, including the absence of a process regarding timing between a PA trade and fund trade.
Market abuse training serves to bring employees’ understanding of market abuse rules up to date and allows for the discussion of recent cases whilst also providing senior management with the opportunity to reinforce the firm’s approach to market abuse risk. Most firms included market abuse training as part of their new joiner process and had annual training for all employees that covered market abuse. Examples of good practice included instances where “face to face” training complemented online training which encouraged the debate of real-life scenarios and a full understanding of how market abuse rules apply in practice. Where there is a reliance on online training, the FCA stated this should be effective. The training log for one firm which relied solely on online training for market abuse showed that some of its staff had completed the market abuse module in less than half the stipulated time and there had been no follow-up to understand why this was the case or whether the staff had understood the material. Firms should consider the frequency and quality of training on market abuse and, where appropriate, make improvements to ensure staff knowledge is sufficiently current.
More work for firms and the regulator…
Thematic Reviews such as this are an important touchstone for firms and, as such, we recommend close attention is given to the FCA’s findings on market abuse practices and procedures. In outlining good practices via thematic reviews, the FCA intends, nay expects, firms to benchmark their processes against them. Such publications allow for firms to examine the robustness of their market abuse practices and also consider any weaknesses that may lie in the eyes of the regulator. Firms should focus on flows of information, pre and post-trade compliance controls in place and ensure that training is a regular feature on the compliance calendar. With the new Market Abuse Regulation (MAR) set to replace the Market Abuse Directive in July 2016, and an increasingly proactive FCA – the regulator intends to follow up on this particular work through its routine supervision, complemented by market surveillance and enforcement – firms must ensure they are suitably prepared for the sustained focus on this key issue.