20 March 2012

ECON Committee published draft report on MAD/MAR

Explanatory statement:

This report proposes a number of amendments to the Commission text to create a more robust and strong market abuse framework.

Regulators raised concerns that increased market fragmentation resulting from the creation of multiple trading venues has contributed to an expansion of the potential for market abuse and made the detection of such abusive practices substantially more difficult. Asian markets, for example, are not as fragmented as in those in the EU and as a result supervision and insider manipulation surveillance is less complex for authorities to perform. Since the Organised Trading Facility (OTF) category introduces another trading venue and could exacerbate this situation, all references to this facility have been removed.

A number of stakeholders have raised legitimate concerns regarding the current definition of inside information. The text has been amended to clarify the definition and provide legal certainty while retaining the scope necessary for competent authorities to effectively combat market abuse.

Strong deterrent measures are crucial to ensuring that market participants are prevented from engaging in abusive practices. The introduction of an obligation on the operators of trading venues to have in place rules to avoid abusive order entry is considered appropriate.

The report will introduce the concept of a "trading window" which prohibits managers from conducting any transactions on their own account during certain periods. The Commission, with input from ESMA, will adopt measures outlining the design and conditions for the application of these "trading windows", focusing in particular on the start and the end of the time period, as well as the possibility of banning trade outside the "trading window" in certain circumstances.

All transactions carried out by managers will need to be reported, as was the case under the original Market Abuse Directive. The threshold for reporting of managers' transactions over €20,000 introduced by the Commission has been removed because such a figure needs to be justified.

Provisions for the protection of whistleblowers have been strengthened.

As a general rule, the EU should continue to seek ways of reducing administrative burdens and bureaucracy on SMEs. However, in the case of market abuse this would constitute an inappropriate derogation to this Regulation's fundamental principle which is designed to protect investors. All market participants should apply the same rules. Small businesses could be in charge of billions of euros in turnover and therefore this would not warrant an exemption from rules to keep insider lists, a key tool for supervisors.

In the current equity trading landscape, it is very difficult, not to say impossible, for competent authorities to detect cross-venue market manipulation. National competent authorities have cited cases of market abuse involving participants in up to seven Member States.

As markets become more intergated, there is an increasing trend towards more cross-border market abuse. Ensuring effective cooperation and data exchange is vital to allow national competent authorities to fulfil their surveillance tasks. Failure to establish cross-border survelliance mechanisms will only exacerbate the exisiting gaps and loopholes and aid those who wish commit abuse cross borders.

In order to address this shortcoming, the competent authority of the most relevant market in terms of liquidity for a financial instrument should be provided with daily comprehensive order book data from all the MTFs and Regulated Markets where the share is actively traded. The objective is to ensure that a competent authority has all the necessary information to be able to detect cross-market manipulation through order books.

Having access to order book data from Regulated Markets and MTFs and, as already foreseen, by receiving transaction reporting by all firms (therefore covering OTC trading), competent authorities will have the necessary information to build the global picture, including OTC. A consolidated view of all significant order books in a given instrument is crucial to enable effective market surveillance. In order to maintain a certain flexibility, this proposal foresees, as stated in Article 48(2) of the current MiFID, that competent authorities can delegate surveillance tasks to third parties. Moreover, this proposal would allow any other national competent authority to request this data should they need it for investigation purposes. Finally, the proposed text requests ESMA to draw up a report assessing the functioning of cross-market order book surveillance, including how ESMA could assist and support the execution of this task.

IOSCO's report, 'Regulatory Issues raised by the Impact of Technological Changes in Market Integrity and Efficiency', identifies three areas which are exposed to risks linked to High Frequency Trading (HFT):

1. market efficiency (negative impact on the price discovery process, motivation for non-HFT to move to dark trading, lack of depth of the HFT liquidity);
2. fairness and integrity of markets (non-discriminatory access to co-location, technological 'arms race' only accessible to a few, front-running through detection of 'large orders' patterns, large-scale market abuse, conflict of interest in HFT-owned trading platforms);
3. stability and resilience of markets (trend-increasing effect, rogue algorithms, direct electronic access of non-regulated firms to trading venues).

The second risk area identified recognises that although HFT does not introduce new market abuse practices, it does allow them to be executed:

• a) on a larger scale, and
• b) in a manner more difficult to detect.

More investigation is clearly needed to assess the impact of HFT on market abuse. The text advocates the setting up of an advisory committee with ESMA made up of national experts to investigate the link between HFT and the potential for market abuse with a view to increasing its knowledge on the issue, and to enable ESMA to inform the Commission of emerging abusive practices which will then be incorporated into the scope of the definition of market manipulation.

The new Market Abuse Framework must also be future proof. For this reason, current abusive practices (quote stuffing, layering and spoofing) will be included in delegated acts. These acts will then be updated as a result of ESMA's recommendations on emerging abusive market practices.

Full draft report

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