8 minute read 13 May 2020
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COVID-19 implications: market abuse

Authors

Glenn Perachio

EY UK&I and Global Assurance Trader Surveillance Solution Leader; EY UK Forensic Technology Leader

Experienced legal and regulatory industries leader working in digital technology and data analytics.

Patrick Craig

EY EMEIA Financial Crime Technology Lead

Helping banks get the most out of their financial crime risk management programs. Experienced with compliance and AML technologies.

Tom Goodman

EY UK Capital Markets, Surveillance & Market Abuse Advisory Lead

Data scientist focused on addressing challenges in financial crime and trader surveillance through better analytics.

8 minute read 13 May 2020

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Minds made for protecting financial services

Market volatility and unprecedented changes to the working environment resulting from the COVID-19 crisis continue to have an impact on market abuse risks and related surveillance operations. In light of the current situation, the Financial Conduct Authority (FCA) has published information for organisations on COVID-191, clarifying that it expects they “should take all reasonable steps to meet the regulatory obligations which are in place to protect their consumers and maintain market integrity” and continue to “take all steps to prevent market abuse risks.” The FCA has suggested that organisations could undertake enhanced monitoring or retrospective reviews. 

Other regulators, such as the Financial Crimes Enforcement Network (FinCEN), have received reports regarding suspected COVID-19-related insider trading2 and are advising financial institutions to remain alert about malicious or fraudulent transactions similar to those that occur in the wake of natural disasters. There is currently limited published regulatory guidance to organisations to help with decision-making surrounding operational risks and compliance with market abuse obligations; however, the FCA has highlighted that it continues to take action against market abuse. While information and guidance for organisations develops, we encourage them to assess the risks associated with the current market and new working arrangements, and to consider their measures (tactically and in the medium term) to ensure continuation of their control environment.

1 https://www.fca.org.uk/firms/information-firms-coronavirus-covid-19-response.
2 https://www.fincen.gov/news/news-releases/financial-crimes-enforcement-network-fincen-encourages-financial-institutions.

Interim measures that might be needed

Changes in trading strategy or employee operations resulting from the COVID-19 pandemic could increase market abuse risks, resulting in the need for interim measures. For example:

  • Short-term versus long-term behaviours:

    Global markets are seeing increased volumes of trading and volatility as clients respond to rapidly changing circumstances. Not only does this pose opportunities for increased revenue and profits, but traders may also change their trading strategies: e.g., by moving toward a shorter-term style of trading by locking in profits at an earlier opportunity compared with taking a longer-term approach. Organisations need to be ready to challenge themselves and traders as to whether their behaviour was a fair response to market conditions. Regulators have indicated that, while they do not expect perfection, they expect organisations to be thoughtful about their approach and able to articulate their rationale.

  • Increased alert volumes:

    Increased trading volumes predictably cause an increase in the number of alerts being processed on a daily basis. Some regulators, such as the Commodity Futures Trading Commission (CFTC), have recognised this by temporarily relaxing regulatory obligations. However, during such volatile conditions, some market participants may take advantage and seek to hide market manipulation among wider market activities. Organisations will need to avoid the assumption that spikes in alert activity reflect increased or volatile activity and be prepared to challenge the trader. 

  • Disclosure of insider information:

    With a large number of employees working remotely, there is a greater risk that those in possession of insider information may inadvertently disclose it to family or friends in shared accommodation. Organisations may need to perform enhanced monitoring for insider dealing and sharing of confidential information to aid in mitigating this risk. They should give consideration to sectors that have been particularly impacted and seek to understand whether traders have traded ahead of large market movements.

  • Surveillance challenges:

    With a greater number of alerts being generated and employees working in isolated locations, it may be more difficult to conduct trade surveillance and monitoring, increasing the risk that potentially illicit market behaviour goes undetected and potentially unreported to regulators. Organisations should consider not only whether there is adequate resourcing in surveillance teams, but also how they incentivise employee to focus time on high-priority alerts, rather than feeling obliged to close down larger volumes of alerts quickly. Organisations should be assessing skillsets in their control functions to fill gaps where their surveillance resources become depleted. Technology and analytics could be deployed quickly to allow teams to identify and prioritise higher-risk alerts, or to group certain alerts together to allow for an efficient workflow.

  • New communication channels:

    More traders working remotely or increased use of video conferencing technology (such as Zoom, Microsoft Teams, Skype and Webex) heightens the risk that inappropriate communications may take place. Traders can use their personal mobiles while working remotely, whereas on the trading floor, they are prohibited. In some instances, employees may be using interim or new communication channels that are not yet set up to be recorded.

    Organisations should consider limiting new forms of technology to trading and sales employees. Other employees who are under surveillance will need to have controls put in place for technology that cannot yet be monitored, such as mandatory addition of meetings to calendars or even enforced supervisors' access to video calls.

  • Existing detection:

    Increased market volatility enhances the risk that surveillance and monitoring capabilities may not be as effective as in normal markets. In assessing exposure to market abuse risk, organisations may also consider whether existing detection methods are actually required in this type of market. For example, should new techniques, tuning and questions be used to spot potentially abusive behaviour? Organisations may need to carry out a tactical review of their scenarios to identify priorities to amend in line with new market conditions and to manage the volume of false alerts.

Red flags: what to look out for right now

  • Hidden abusive activities

    Organisations should be prepared for market abuse activities hidden among the increased trading volumes. There is a greater ability and incentive for opportunist or unscrupulous actors to commit market abuse activity. Organisations will need to be ready to challenge explanations that trading behaviour is in response to market conditions. This can be supported by looking at behaviour relative to peers and creating a set of indicators relating to:

    • Trade execution trends (frequency, average trade size and daily maximum size) 
    • Order trends (average order size, level of deviation versus peers and level of participation versus the market)
  • Increased motivation and opportunity:

    With more volatile prices and greater trade flow, there may be heightened opportunity and motivation for certain risks, such as front-running client orders. Organisations may want to focus enhanced monitoring on these behaviours.

  • Conduct risks:

    For many organisations, the grayer area of conduct risks is as concerning as the black-and-white abuse risks. Ensuring that spikes in profitability are understood, pricing is proportionate to risk, and all activity is carried out in line with mandates and institutional purpose is key in supporting employees and the markets, to maintain an effective control environment and manage reputational risk.

  • Value of information:

    Inside information garnered by corporate insiders may hold an even greater value than in normal market conditions. 

What does this mean for you?

Managing market abuse risks through this period requires consideration of four aspects: risks, controls, operation and regulation.

  • Risks:

    Organisations should balance increased trading volumes and revenues with a proportionate control framework and perform a focused risk assessment based on the changing market conditions, market profile and the existing controls in place to identify temporary gaps. The results of this assessment can be used to define appropriate tactical measures, such as enhanced reviews or lookback exercises.

     If alternative arrangements in response to the pandemic become embedded over several months, or permanent features, organisations should perform and document a broader risk assessment, as potentially weaker supervision as some controls (e.g., mobile phone bans on the trading floor) may become impossible to apply.

  • Controls:

    Organisations should consider the need for additional controls such as deep-dive or proactive conduct reviews to ensure that trader behaviour and revenue generation is in line with management expectations. They may also need to consider tactical methods such as record-keeping requirements for orders and trades to comply with  Market Abuse Regulation (MAR). 

    Organisations should develop interim first line of defence policies that factor in remote working conditions and increase communications emphasising employees’ requirements to comply with existing obligations. Bulletins may remind employee of the organisation’s requirements in trading remotely and maintaining a robust market conduct environment and the responsibilities on all employees to adhere to them.

  • Operation:

    Organisations should develop a plan for coping with operational challenges as the ratio between alert volumes and investigator capacity flexes over the coming months. Where this involves risk prioritisation or bulk closure, ensuring this is well documented and run through the appropriate governance channels is key. 

     Organisations should avoid increasing workloads to unrealistic levels and decreasing the time available for investigators to perform reviews. Finally, they should look at key-person risk in the surveillance team (e.g., absence due to illness or caring responsibilities) and what short-term strategies can be put in place to support team resilience over the coming months.

  • Regulation:

    Organisations should have an open and proactive dialogue with regulators as they respond to COVID-19 challenges. They should also consider how they are developing the recommended enhanced monitoring and retrospective reviews in line with regulatory expectations and ensure that they document and can explain rationale for their response to the pandemic.

Summary

In light of the current situation, the FCA has published information for organisations on COVID-19 clarifying that it expects they “should take all reasonable steps to meet the regulatory obligations which are in place to protect their consumers and maintain market integrity” and continue to “take all steps to prevent market abuse risks.” This article provides insights into interim measures that might be needed, red flags: what to look out for right now and what this means for your business.

About this article

Authors

Glenn Perachio

EY UK&I and Global Assurance Trader Surveillance Solution Leader; EY UK Forensic Technology Leader

Experienced legal and regulatory industries leader working in digital technology and data analytics.

Patrick Craig

EY EMEIA Financial Crime Technology Lead

Helping banks get the most out of their financial crime risk management programs. Experienced with compliance and AML technologies.

Tom Goodman

EY UK Capital Markets, Surveillance & Market Abuse Advisory Lead

Data scientist focused on addressing challenges in financial crime and trader surveillance through better analytics.