Next month the UK’s Financial Services Authority (FSA) will bring to a close almost three years of heated debate on the country’s new market abuse regime. So far its bright young policy advisers have had a torrid time trying to win over the City’s great and good to the proposed reforms and there is no reason to believe that their lives should get any easier as the deadline for comments draws near.
Causing the most trouble are some of the City’s most respected lawyers, who are questioning the FSA’s proposals as they attempt to clarify and quantify what all the upheaval actually means to them and their clients.
Under the Financial Services Act, the FSA has the statutory power to monitor all market activity in the UK and to turn over those individuals and firms it believes are guilty of insider dealing or market abuse to an independent tribunal.
This tribunal, which will be chaired by a senior FSA staffer, has the power to impose a hefty fine and a life-long ban from trading. The UK government’s public timetable is that the FSA’s market abuse powers will come into force over the summer, but if a UK general election is called in May, the timing could be pushed back into the autumn.
From this reasonably simple starting point, the FSA’s policy advisers are trying to construct a practical code to determine what will and will not be considered insider dealing or market abuse on a day-to-day basis.
One of the most vocal lawyers is Clifford Chance partner Chris Bates, who as a member of the FSA’s practitioner group and head of his firm’s market conduct group is well placed to have an opinion.
He says legal and compliance officers should begin to prepare themselves, their front office staff and senior management for what will be a very new, very proactive and very complicated regulatory regime.
The devil is, as always, in the detail. Bates’s main area of concern is the uncertainty created by some of the proposals within the market conduct code as it presently stands.
One example he gives is the code’s position on squeezes – price positioning or distortion by a market participant that has control over a particular asset class.
The draft code states an “unacceptable” squeeze takes place when a range of factors are met, but for Bates this list of factors is not exhaustive and gives no guidance on the weighting that will be applied to each factor.
It also introduces the code’s controversial “reasonable regular user” test, which takes into account the difference in expectations between say a hedge fund and a small corporate user to determine what is acceptable and unacceptable behaviour.
For Bates, this is a huge grey area. Lawyers and their clients will inevitably have to make a judgement call but they cannot adopt a blanket approach as they will need to be sensitive to the specifics of each case.
A senior FSA official admits this is one area of the draft code that has attracted a lot of comment and describes the idea of adding weightings to the various factors as “interesting”.
But he adds: “No-one we’ve spoken to is in a position to make any really constructive suggestions – they are saying ‘You haven’t got it right’, but we have not seen anyone produce anything better.”
Bates also picks out the uncertainty created by the draft code’s treatment of public corporates that trade in the commodity derivatives markets.
Previously, such corporate activity fell outside the regulatory regime as corporations were not authorized firms. But a company could now fall foul of the proposed insider dealing rules if information held by the company on its own supply of a particular commodity is deemed to have been misused. “The suggestion in the draft code is that firms that hold information about their own supply difficulties might be restricted from dealing, merely because they are listed companies,” he says.
If the company had supply difficulties it would have to debate whether to announce this information to the stock exchange and, if it did, whether to halt any planned dealing that would rebalance its position before the stock exchange made its decision. Once again, the position the code is taking, Bates says, is unclear.
The extra-territorial reach of the new regime is also important, especially with the growing levels of co-operation between various regulators. In principle, the FSA could investigate a Japanese share listed in Japan but also traded in London and sanction those people associated with the trading decisions in Japan.
The FSA says it recognizes the local regulatory regimes in Japan and the US and compliance with those regimes will offer a “safe harbour” from prosecution by the FSA.
The European regulatory framework is, however, still evolving and the FSA has not granted any “safe harbours” in Europe. It is backing European Commission efforts to introduce a market abuse directive and is helping the Forum of European Securities Commissions (FESCO) in its brief to present practical common European regulatory policy proposals.
Bates says market misconduct is definitely an issue all the regulators are moving up their agendas. But he worries that if the national regulators each have their interpretation of EC rules, as they have done in the past, the industry could end up facing 15 different, proactive and extra-territorial market abuse codes across Europe. The current FESCO proposals, he adds, could be described as “the UK regime across Europe with all the good bits left out”.
His final main concern is the political environment into which the new UK regulator is being born and the pressure it may be under to conduct a witch-hunt ending with a very public dunking of a high profile financial institution in the River Thames.
“What’s clear is that the spotlight is going to go on market conduct,” he says. “The government has invested a lot of political capital in this regime. They need a regime that delivers results and for the FSA that will mean people being sanctioned for market misconduct and results identifying insider dealing.”
Whether the FSA’s new regime turns out to be a gun-toting US marshal like Wyatt Earp or not, private practitioners and in-house legal and compliance officers should probably be prepared for the worst.
