The Fair And Effective Markets Review: Recommendations For Further Legislative And Regulatory Change
The Fair and Effective Markets Review (FEMR), which was designed to reinforce confidence in the wholesale Fixed Income, Currency and Commodities (FICC) markets, unveiled its Final Report on 11th June.
- As well as attempting to analyse the root causes of recent FICC misconduct and assessing the impact of significant reforms either completed or underway, the Report makes a series of recommendations to fill the remaining gaps in the regulatory perimeter. It does so pre-emptively in the sense of identifying areas that (still) will not be covered, even after the implementation of the Market Abuse Regulation (MAR) in July 2016.
- The overall message from the Review is that the UK authorities should “extend the regulatory perimeter, broaden the regime holding senior management to account, and toughen sanctions against misconduct”.
- Some of the Review’s recommendations, notably that the UK regulatory framework, originally applied to Libor, as well as criminal penalties for manipulation, should be extended to cover seven additional major UK FICC benchmarks, have already been accepted and implemented by HM Treasury (on 1 April 2015).
- The Review’s recommendations for further legislative and regulatory change include:
To extend UK criminal sanctions for market abuse for individuals and firms to a wider range of FICC instruments.
- The Review notes that gaps in the application of the criminal sanctions regime to those engaging in market abuse in FICC markets may have contributed to the sense of impunity that prevailed before the financial crisis and have undermined overall confidence in market integrity.
- The implementation of the Market Abuse Regulation (MAR) in July 2016 will extend the scope of the UK civil market abuse regime to financial instruments on all regulated trading venues, including Multilateral Trading Facilities (MTFs) and Organised Trading Facilities (OTFs). In the context of market manipulation, MAR also specifically captures behaviour in relation to spot commodity contracts which are related to, or have an effect on, financial instruments traded on a venue.
- Since many FICC instruments are often not admitted to trading on the limited number of prescribed markets covered by the current regime, MAR will mean that a greater range of FICC instruments will be covered. MAR will also introduce a new civil offence of benchmark manipulation. This will cover any financial benchmark by reference to which the amount payable under or value of a financial instrument is determined, which should include all FICC benchmarks.
- In 2014 the Government announced that the United Kingdom would not opt into the rules set out in the Criminal Sanctions Market Abuse Directive (CSMAD), but that the UK criminal sanctions regime for market abuse would be updated, and would be “at least as strong”. CSMAD creates new minimum criminal standards for the offences of insider dealing and market manipulation, and makes manipulating or attempting to manipulate any benchmark a criminal offence.
- Recognising that the existing UK regime would allow individuals involved in market abuse to target instruments that fall outside the scope of criminal sanctions in the United Kingdom, the Review recommends that, as part of the forthcoming necessary changes to the UK’s criminal sanctions regime (to make that regime just as strong as CSMAD), that regime should be updated and extended to a wider range of FICC instruments, by including all of those covered under MAR.
To create a new statutory civil and criminal market abuse regime for spot foreign exchange.
- The main areas of FICC that will not be covered be by MAR are likely to be limited to:
- The spot FX market (except in respect of behaviour that has a manipulative effect on a financial instrument admitted to trading); and
- Other markets which trade exclusively OTC (for example bespoke derivative contracts) and where the price or value of such instruments does not depend on or affect the price or value of traded financial instruments.
- Other than the WM/Reuters benchmark (the manipulation of which was made an offence as a result of the Review’s August 2014 recommendation) spot foreign exchange markets remain outside the scope of UK market abuse legislation, and will continue to do so even after the introduction of MAR.
- The Review therefore recommends the creation of a new standalone legislative (civil and criminal) regime that could be applied to spot FX and, as required, any other OTC FICC instruments specified via secondary legislation. At a minimum, the regime should cover a similar range of behaviours as those covered under MAR, and also include parallel criminal offences.
- It is envisaged by the Review that the statutory regime should be accompanied by a requirement on firms to keep records of orders and transactions, and report suspicious cases to the regulator, and that particular attention should be given to improving the controls and transparency around FX market practices where there may be scope for misconduct, including ‘last look’ and time stamping.
- The design of the new regime will need to draw upon the global foreign exchange code, which it is hoped will provide a comprehensive set of principles to govern trading practices around market integrity, information handling, treatment of counterparties and standards for venues; comprehensive examples and guidelines for behaviours; and stronger tools for promoting adherence to the code by market participants.
To extend the UK criminal regime to apply criminal liability to firms in respect of insider dealing.
- The UK regime applies criminal liability to firms in respect of market manipulation, but it does not apply criminal liability to firms in respect of insider dealing. The Review therefore suggests that the criminal regime should be extended to apply criminal liability to firms for insider dealing, to ensure consistency of approach with market manipulation.
To introduce legislation to lengthen the maximum sentence for criminal market abuse from seven to ten years’ imprisonment, aligning it with that for fraud and bribery.
- The Review notes concerns that firms might increasingly be treating fines, however large, as costs of doing business (i.e. too much enforcement not enough prevention). To increase the focus on the accountability of individuals and deterrence, the Review recommends that HM Treasury introduce legislation to increase the maximum sentence for market manipulation and insider dealing from 7 to 10 years’ imprisonment. These offences are, it is suggested, comparable, in terms of seriousness and the harm caused to society, to other economic crime offences such as fraud or bribery, and so should carry the same maximum sentences of imprisonment.
- The Review notes that no criminal market abuse case to date has involved a significant number of the specified aggravating features and that the highest sentence imposed has been 4 years’ imprisonment. However, an increase in the maximum sentence, is, it concludes, necessary since “at present there would only be a limited amount of headroom under the maximum sentence for judges to impose an increased custodial sentence in order to mark the seriousness of the offence and send an appropriate general deterrent message”.
To extend elements of the Senior Managers and Certification Regimes to a wider range of regulated firms active in FICC markets.
- The new Senior Managers and Certification Regimes (SM&CR), which will hold traders and other staff in covered institutions personally accountable for observing ‘proper standards of market conduct’ apply on the current draft only to UK banks, building societies, credit unions and PRA-designated investment firms.
- The Review recommends that elements of the SM&CR should be extended to a broader range of regulated FICC market participants, including authorised firms that are active in FICC markets (such as MiFID investment firms, including asset managers and interdealer brokers; hedge funds under the EU Alternative Investment Fund Managers Directive (AIFMD); and fund managers under the EU Undertakings for the Collective Investment of Transferable Securities Directive (UCITS). The elements to be extended would include: regulatory pre-approval and statements of responsibility for senior managers; certification of individuals with the potential to pose ‘significant harm’; and enforceable Conduct Rules for individuals. Significantly, the Review did not judge it proportionate to extend the ‘presumption of responsibility’ to this class of firms.
To consider whether further changes to corporate criminal liability for market abuse offences are appropriate and desirable.
- The Review suggests that HM Treasury should consider whether further changes to corporate criminal liability for market abuse offences are appropriate and desirable once the Ministry of Justice has concluded its examination of the case for a new statutory offence of a ‘corporate failure to prevent economic crime’, and the rules on establishing corporate criminal liability more widely.
- Although the Review’s recommendations, the product of a year’s consultation and analysis, are likely to prove persuasive, they will now form the basis only for proposal and consultation by the UK authorities in the usual way.