Revising the European Market Abuse Regime: The Legislative Proposals
Proposal for a Regulation of the European Parliament and of the Council on insider dealing and market manipulation (market abuse), COM(2011) 651 final of 20 October 2011; Proposal for a Directive of the European Parliament and of the Council on criminal sanctions for insider dealing and market manipulation, COM(2011) 654 final of 20 October 2011;
To strengthen the fight against market abuse, the European Commission has, after lengthy consultation,1 published a set of formal legislative proposals to reform the existing market abuse regime. The proposals were published in tandem with the Commission’s proposals to revise the Markets in Financial Instruments Directive (MiFID),2 to ensure that the Market Abuse Directive (MAD)3 and MiFID continue to complement each other’s aims and objectives.
Reasons for Change
Adopted some eight years ago, MAD introduced a comprehensive framework to tackle insider dealing and market manipulation across Europe. Together with a number of implementing measures,4 MAD sought to increase investor protection and maintain the integrity of Europe’s financial markets by forbidding those privy to inside information from trading in related financial instruments and by prohibiting the manipulation of markets through practices such as spreading rumours or conducting trades that secure prices at abnormal levels.
However, recent developments (e.g., the growth of new trading platforms, commodities and commodity derivatives trading, over-the-counter (OTC) trading, and high frequency trading) have outpaced a number of provisions within MAD and, in consequence, fall out of its scope. Moreover, the spate of market abuse cases that arose both during and in the wake of the financial crisis highlights the need for regulators across Europe to be given stronger investigative and sanctioning powers.
Structure of Proposals
With these issues in mind, the Commission considered it necessary to strengthen the existing market abuse framework. The Commission proposes replacing MAD in its entirety with a Regulation on market abuse, which would have direct effect on EU market participants without national transposition.
It also proposes a Directive on criminal sanctions for market abuse that prescribes minimum rules on criminal offences and sanctions for insider dealing and market manipulation. As a Directive, though, its provisions would need to be transposed into the national law of all 27 EU Member States.5 This is the first legislative proposal to be made under the new Article 83(2) of the Lisbon Treaty,6 which provides for the adoption of common minimum rules on criminal law in certain circumstances.
Scope of the Proposals
The most notable issues arising out of the Commission’s proposals are outlined below.
— Extending the Scope of the Regime
At present, MAD only prohibits market abuse in relation to financial instruments admitted to trading on a regulated market. Since 2003, however, financial instruments have increasingly been traded on multilateral trading facilities and other types of organised trading facilities (OTF) (e.g., broker crossing networks, which are systems operated by investment firms that primarily internally match client orders), or only traded OTC.
The Commission proposes closing this loophole by bringing the definition of financial instruments in MAD in line with the definition used in MiFID II. As such, MAD will apply to any financial instrument admitted to trading on an MFT or OTF, as well as to any related instruments traded OTC that can impact the covered underlying market. Notably, credit default swaps will therefore fall within the scope of the regime.
— Commodity Markets
At present, the definition of “inside information” for commodity derivatives includes information that relates to the derivative, but not the information that relates to the spot commodity contract. A person can, however, benefit from inside information in a spot market by trading on a related derivative market. Acknowledging the lack of a clear and binding definition, the Commission proposes extending the definition to cover all price sensitive information that is related to the relevant spot commodity contract or to the derivative itself.
The Commission also proposes giving regulators access to continuous data on spot commodity markets, submitted to them directly in a specified format, in order to help them detect insider dealing and market manipulation in commodity derivatives markets. Arguably, however, this is likely to increase the reporting burden on individual firms.
— Emission Allowances
Emission allowances will be reclassified as financial instruments under MiFID II. As such, they will also fall within the scope of the market abuse regime. The obligations to disclose inside information will fall on participants in the emissions allowance market rather than issuers, as they, rather than issuers, will hold the relevant information suitable for disclosure. Smaller participants, whose activities are not likely to have a material impact on the price of emission allowances or the consequential risks of insider dealing, will be exempt from this requirement. Appropriate thresholds are still to be decided.
— Redefining Market Manipulation
The definition of “market manipulation” in MAD is already broadly drafted, purposely to capture new abusive forms of trading or strategies. It should be noted, though, that the UK definition of market manipulation, set out at section 118 of the Financial Services and Markets Act 2000 (FSMA) (as amended), is cast even wider.
In the Commission’s view, it is necessary to expand the definition further and to provide examples of market manipulation to demonstrate the ways in which the market may be manipulated, especially through strategies using algorithmic trading and high frequency trading such as quote stuffing, layering, and spoofing.
— Attempted Market Manipulation
While MAD currently prohibits attempts to engage in insider dealing, it does not similarly prohibit attempts to engage in market manipulation. Therefore, to sanction for market manipulation, a regulator must demonstrate that either an order was placed or a transaction was executed.
There are, however, situations where a person takes steps to manipulate the market but either an order is not placed or a transaction is not executed. In such cases, despite a wealth of evidence at times, no action can be taken under MAD.
The proposals seek to remedy this issue by introducing a new offence of attempted market manipulation. Regulators across the EU will therefore be able to take action in cases of market manipulation, without having to prove a causal link between the behaviour and movements in price.
— Disclosure Requirements
While issuers are required to inform the public as soon as possible of relevant inside information, they may, in certain circumstances, delay public disclosure. Regulators are not, however, notified of this fact.
Under the proposed Regulation, issuers will be required to inform regulators of their decision to delay disclosure, immediately after a disclosure is made. Issuers will remain responsible for determining whether a delay is justified.
Where inside information is systemically important, and it is in the public interest to delay disclosure, regulators will have the power to allow a delay for a limited period. This will help to avoid the losses that could result from the failure of a systemically important issuer. Small- and medium-sized enterprises will be subject to a simplified and more proportionate regime.
— Supervisory Powers
While, in certain circumstances, the UK’s Financial Services Authority (FSA) may enter premises and seize documents,7 and request telephone and data traffic records from investment firms and telecoms operators,8 many regulators in other Member States do not have such powers.
To strengthen their investigative powers, securities regulators across the EU will have the power to enter private premises and seize documents, after having secured judicial consent. They will also be able to request existing data and traffic records from investment firms or telecoms operators, where a reasonable suspicion exists that such records may be relevant to prove market abuse.
Moreover, Member States will also be required to provide for the protection of whistleblowers reporting suspected market abuse, with the possibility of financial incentives for those reporting salient information that leads to a monetary sanction. This, to some extent, mirrors the new rules in force under the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act, under which the Securities and Exchange Commission is obliged to pay monetary awards, subject to limitations, to whistleblowers who voluntarily provide information that leads to a recovery of more than $1 million. While the UK already has legislation in place to protect whistleblowers, limited financial compensation is available and only in relation to cartel activity. Against this backdrop of international regulatory change, the UK may, in the long-term, follow suit.
— Criminalising Market Abuse
At present, Member States are free to adopt different sanctioning regimes for market abuse, so long as they are “effective, proportionate and dissuasive.”9 This has, however, led to an extreme degree of divergence which can easily lead to regulatory arbitrage.
Recognising that effective sanctions can have a strong deterrent effect, the Commission proposes EU-wide rules to ensure minimum criminal sanctions for both insider dealing and market manipulation (including inciting, aiding and abetting, and attempts to engage in both types of market abuse). This will help to ensure a more uniform approach across the EU. However, the FSA already has the power to bring criminal prosecutions. The likely result of this provision in the UK is therefore the introduction of harsher sanctions, which is also in line with the FSA’s policy of “credible deterrence.”
The proposals will now pass to the European Parliament and the European Council for negotiation. It is hoped that agreement will be reached before the end of the year. Once adopted, the Regulation will apply 24 months after its entry into force and Member States will have the same time in which to transpose the Directive’s provisions into national law.
This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.
©2011 Bloomberg Finance L.P. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of Bloomberg Finance L.P.