02 Dec 2015

Why ESMA’s market abuse regulation needs fine-tuning

ESMA’s Market Abuse Regulation (MAR) takes effect on 3 July 2016, with publication of the final wording coming early in the new year. But  further refinement is still needed to create effective, efficient regulation that identifies market abuse.

ESMA’s Market Abuse Regulation (MAR) takes effect on 3 July 2016, with publication of the final wording coming early in the new year. But further refinement is still needed to create effective, efficient regulation that identifies market abuse.

ESMA’s Market Abuse Regulation (MAR) will replace the current Market Abuse Directive (MAD) for EU Member States. And unlike MAD, MAR is directly applicable regulation that both banks and regulators will have to comply with once it goes live in July.

That means putting in place new processes, training and systems. But with the final wording imminent, some last minute fine-tuning of the draft technical standards is needed if the final regulation is to be effective and practical in July.

The first area to tackle is the overly broad definition of investment recommendations. MAR stipulates that both marketing communications and traditional investment recommendations have detailed and thorough disclosure notices.

Substantive, independent research based on models and rating systems may benefit from in-depth disclosures. However, it is doubtful whether this is appropriate for marketing communications.  Indeed, a five word sales note with pages of disclosures could be considered excessive.  A more elegant, user-friendly solution would be a simple link saying “click here for the disclosures”.

Including marketing communications within MAR could lead to distributors being more reluctant to offer their daily insights that form an important part of their ongoing relationship with investors, and creates more efficiency for fund holders by improving information flow – less market information available, so less trading volumes, liquidity and, ultimately, less growth.

Similar tweaking of ESMA’s definition of ‘order’ is also needed in relation to tracking suspicious transactions. Quotes, requests for quotes – ESMA has included them all in its definition of ‘order’ for MAR, contrary indeed to the original MAR Level 1 text. If all quotes and requests for quotes are treated as orders, banks will be building systems well beyond the July 2016 go-live date.

An understanding of context is needed. For example, proposals to use automated systems to spot suspicious trading behaviour are not appropriate in all settings. Despite the rise of online trading, trades can still be executed over the phone. Automated systems have the potential to miss nuance in speech, raising erroneous ‘red flags’ when trigger words are mentioned. Automated trading systems do have a role to play in identifying market abuse. But the draft requirements should reflect the differences between trading systems – whether electronic or human – rather than assuming automation. Similarly, order definitions should not too broad as to hinder the practicalities of trading and back-office processes.

There are also data protection issues. Banks will be required to record sensitive personal data of all individuals not directly employed by the institution. For example, contractors or outside agencies brought in to work on specific, short-term projects.  This requirement needs to be on a best efforts basis. Banks should be able to trust the information supplied by contractors as being accurate. Do regulators really need all this data? Are regulators are creating a rod for their own backs by collecting reams of data, which has the potential to obscure actual market abuse?

Building new systems, training staff and ensuring a business is fully compliant with MAR by July 2016 is a big task. Progress has been made and we are getting closer to having appropriate processes in place. Refining MAR is not a case of weakening regulation. Rather, it is about creating efficient, implementable processes that effectively prevent market abuse. It is vital to get this right. Thus, the text needs to be clarified to accord with the timeframe (and the Level 1 text).