01 February 2013

FSA/Lawton: Four building blocks of efficient capital markets

David Lawton, Director of Markets, FSA, focused on four specific components or prerequisites to efficient capital markets:

• Promoting ethical market behaviour in the market area – We are pursuing this through monitoring the integrity of participants’ behaviour in trading and having the right deterrents in place to help assure market cleanliness.
• Effective corporate governance – We are making sure the Listing regime remains relevant in the current market context.
• Effective intermediation and resilience to deliver market stability – Greater transparency and better risk management of OTC derivatives is a major goal here.
• Delivering investor protection – A strong client asset regime that delivers investor protection at the right level is an important element here.

Ethical market behaviour

One aspect of this is maintaining market cleanliness. It is easy for discussions on market cleanliness to become academic and abstract, but the goal is clear: it is important that market participants and investors have confidence in the fairness of UK markets, because bluntly, no one wants to operate in a market where they cannot trust the other side.

The work on restoring confidence will not end when the Government’s regulatory regime for Libor, with new requirements for governance and systems and controls around the various processes is implemented. These requirements are only tools to help firms ensure their staff act with integrity. The less easy to define part is firms working to build cultures where their staff are encouraged and rewarded for acting with integrity. Bringing about this kind of change may be costly, but that cost needs to be weighed against the consequences we have seen firms having to face when they do not give due attention to culture, and the damage done to the integrity of the whole industry.

Market abuse regulation

A key component of ensuring high standards of market cleanliness is our robust approach to market abuse. I’m told that the queue of taxis outside this building used to be seen as a sign of M&A activity, but they’re just as likely now to hint at the amount of Enforcement action we’re undertaking. The latest ruling by the Upper Tribunal on the Swifttrade case highlights that we are willing to take on tough cases.

And we’re not alone in taking a tougher approach. There is a general impetus in the EU among all the Member States to move to a much more robust and ambitious market abuse regulatory framework.

We are working with other Member States to ensure that the negotiation on the Market Abuse Regulation in Europe will result in strong deterrents and sanctions for market abuse. A couple of critical areas for us include:

• Pushing for a suitably strong framework that ensures we can take action against dealing abuses – I know that this brings us on to the thorny issue of having a clear definition of inside information but it is equally important that regulators have the flexibility and ability to take action against all unacceptable behaviour in the markets.
• Addressing pre-soundings within the regulation – These, as you will know, are the interactions between market participants which are carried out in order to gauge potential investor appetite in a potential transaction. This is an important and valuable practice, but it is appropriate for regulation to ensure that the market avoids committing market abuse when conducting soundings.

Effective corporate governance

In the sphere of corporate governance, regulators, firms and investors continue to work to find the right balance between encouraging growth and providing for a suitable level of investor protection. This work is done in the challenging context of changing market conditions and the introduction of new business models to the UK-listed market.

Efficient and resilient secondary markets

I said in a speech a year ago, that if we are to deliver market stability – that is, both efficient price formation and the smooth functioning of markets – then the shortcomings in transparency and risk management in OTC derivative markets must be addressed.  That point remains true and, in Europe, EMIR will move us significantly forward in that task by introducing central clearing and reporting obligations for OTC derivatives.

MiFID II

The proposed revisions to MiFID will help further. They complete the EU’s implementation of G20 commitments by introducing an obligation to trade certain OTC derivatives on organised trading venues. We will also have a stronger, more structured framework for the trading of derivatives on organised trading venues through the introduction of a framework of pre and post-trade transparency and the creation of the new category of venues, Organised Trading Facilities (OTFs).

The details of those changes have yet to be settled and the views are still quite diverse.  We are supporting the Treasury in seeking to ensure that the changes promote stability without damaging the ability of corporates to finance their businesses and manage their commercial risks. There should be sufficient flexibility in the transparency regime to reflect the fact that the liquidity profile of derivatives is often very different from that of blue chip shares.  

There has also been extensive debate about the impact of high-frequency trading (HFT) on market behaviour and stability. We have the significant benefit of the work of the Foresight Programme on computer trading in helping us to understand what has been happening and where developments might go next.   

Following on from the ESMA-automated trading guidelines, we support using the MiFID review to introduce more detailed, robust and legally enforceable risk controls for all firms and trading venues in relation to their automated trading. And all participants that have the potential to pose significant risks to the system should be regulated. We therefore welcome proposals for the regulation of HFT firms that currently fall outside of the scope of MiFID I.

Protecting client assets

Alongside the need to ensure market cleanliness and stability, we need to support these components with the maintenance of appropriate investor protection. For this reason I would like to expand on our work on the client asset regime. Martin Wheatley recently gave a speech in which he highlighted the extent to which we rely on the quality of the protections afforded by the client assets regime. The regime is particularly important because it has a direct impact on the full spectrum of consumers, retail to wholesale.  The strength of this regime assures investors of the high quality of the UK markets and puts in place important barriers to a firm failure spreading financial detriment to counterparties and investors.

Full speech

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