Image Copyright: Financial Conduct Authority
The FCA has published its 73rd Market Watch Newsletter, discussing its observations and findings from the recent market abuse peer review into firms that offer Contracts for Difference ('CFDs') and Spread Bets (‘CFD providers’). This edition is closely linked to Market Watch 69, which discusses firms’ arrangements for market abuse surveillance - drawing on observations from the FCA's engagements with small and medium-sized firms.
The CFD and spread bet market abuse peer review looked at nine firms' processes and procedures and risk assessments, assessing each firm’s business model, market abuse risks, and arrangements for detecting and reporting market manipulation. The aim was to better understand how firms that offer CFDs and spread bets are identifying and reporting potential market abuse and to raise standards.
The 73rd Market Watch Newsletter sets out the findings from the review and focuses on CFDs and spread bets because of the associated market abuse risks, including:
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CFDs and spread bets are particularly vulnerable to being used for insider dealing due to their speculative and leveraged nature, with single stock equities being the predominant risk.
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They are a significant source of the FCA’s Suspicious Transaction and Order Reports (‘STORs’).
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Gaps in surveillance were observed, namely in non-equity asset classes.
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The FCA are concerned about a potential increase in cross-market/cross-product manipulation involving CFDs and spread bets – where spread bets and CFDs are used to realize profits following manipulative practices in the underlying market via other firms.
The FCA’s overall findings were largely positive. All firms have surveillance in place to detect insider dealing, most of which are considered effective. However, there are some weaknesses, such as the lack of consideration of market abuse risks in non-equity asset classes and market manipulation, and a number of areas that require improvement.
Areas that require improvement identified in Market Watch 73:
Market abuse risks
Problem: Not all firms could demonstrate they had considered all market abuse risks relevant to their business.
FCA’s view on the issue: Risk assessments need to be more thorough. “To maintain effective arrangements, systems, and procedures to detect and report suspicious orders and transactions, firms need to understand how they could facilitate market abuse. If done properly, undertaking a risk assessment is an effective and efficient way of achieving this. It enables a firm to document all the market abuse risks that apply to its business and consider what monitoring it needs to detect them in a structured and comprehensive way. A general assessment of market abuse policies and procedures does not achieve this.”
Surveillance systems
Problem: Most firms do not have effective surveillance for non-equity asset classes, and a range of different setups are used. Another area of concern is that firms do not monitor for unrealized profits, either specifically, or by capturing them via discrete alerts, such as news or price movements, which operate independently of profit. There are circumstances where clients may not necessarily close positions quickly. Where this happens, and firms do not consider unrealized profits, they will fail to identify potential market abuse.
FCA’s view on the issue: Firms should consider whether their surveillance coverage is adequate for market manipulation and in non-equity asset classes. Firms that review all trading activity before an event, rather than limit investigations to the alerted trading, will be more effective at identifying potential market abuse that falls outside the system parameters.
How SteelEye helps: SteelEye’s insider trading model works on fixed income and equities. It also monitors for unrealized profit. The platform has full coverage for CFDs and spread bets.
Surveillance – market manipulation – narrowing the spread
Problem: Cross-market/product manipulation seems to be increasing using CFDs and spread bets, where activity aims to influence the prices of spread bets or CFDs by narrowing the spread in the underlying market, typically in illiquid stocks. In their review, the FCA found that while most firms were aware of this activity, no firm had listed it in their risk assessments or had Compliance-based surveillance to detect it. The FCA previously took enforcement actions on this kind of behavior in 2011 (FCA vs. Barnett Michael Alexander), and 2022 (FCA vs. Corrada Abbattista).
FCA’s view on the issue: Firms should consider surveillance alerts to detect cross-market/product manipulation.
How SteelEye helps: SteelEye’s insider trading module looks at cross-product manipulation so that firms can set up surveillance-based alerts to detect this type of activity.
Surveillance alert investigations
Problem: When reviewing alerts, some firms are not considering the client’s trading history. While many factors are important when creating an overall picture of a client or event, a client’s trading history is an important factor to consider to sufficiently assess reasonable suspicion of market abuse. “For example, when firms look at the publication of a blog article or increased options volumes, considering the probability of a client consistently trading only in those stocks where a blog article/increased options volume was followed by a significant news story and movement in price would be helpful in detecting market abuse.”
FCA’s view on the issue: Firms should include all relevant information available to them when investigating alerts and ensure they record the rationale for their risk mitigation.
How SteelEye helps: SteelEye considers previous trading history, market data, news, and unrealized profit to refine the detection of market abuse risk. The solution creates a past behavior profile for the entity to detect unusual behavior ahead of an event. All this data is available to analysts when investigating alerts so compliance teams get a complete picture of a client or event.
READ FCA'S MARKET WATCH 73
Key features of SteelEye's insider trading model:
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Link cash with Derivatives and runs on Net Notional Value
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Works on FI and Equity
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Generates Alerts from News and Market Data
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Removed sector variations from Market Data moves
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Creates a past behavior profile for the entity to detect unusual behavior ahead of the event
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Tests unexpected behavior
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Tests on trades size compared to the security positions
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About SteelEye
Turn Supervision into Super Vision. SteelEye is the first and only truly integrated trade and communications surveillance solution. We empower financial firms with the data-driven tools and complete insights they need to focus on what matters, all from a single platform.
State-of-the-art algorithms and intelligent alerts proactively detect market manipulation and compliance breaches, while our holistic data model – which combines communications, trades, orders, news, and market data – provides intelligent insights and deep analytics. Founded in 2017, SteelEye has offices in the UK, North America, Portugal, and India. For further information, visit steel-eye.com.
