BY: SHALINA SETHI

Recently, regulatory arbitrage – the act of firms choosing to operate in markets that have a more favourable regulatory landscape – has given rise to concerns over its potential use for market distortions. These alternations, driven by the unlawful disclosure of insider information and market manipulation have created inconsistencies in the real value of assets – a major contributing factor to the 2008 Financial Crash. Anxieties caused by arbitrage have led to the introduction of harmonising measures, produced by the European Commission (EC) in the form of new legislation known as the Market Abuse Regulation (MAR) which came into effect on the 3rd July 2016. MAR aims to improve on the Market Abuse Directive (MAD) by developing on its existing scope to include a greater variety of trading venues and financial instruments, therefore providing regulators with the tools to better enforce penalties in order to discouraging market misuse.

Unlike MAD, MAR now encompasses additional financial instruments, including equity and commodity derivatives. In particular, it addresses trades on regulated markets, multilateral trading facilities and other organised trading facilities.[1] Thus, the creation of MAR is effectively the latest addition in attempts to streamline financial regulation. Yet, with MAR having only come into force within the last three months, questions over how effective its measures will be in mitigating market misuse is still to be determined. Nevertheless, MAR’s future impact can still be judged by assessing how it combats the most prominent features of market misuse.

Unlawful Disclosure of Insider Information

Insider information is defined as a private fact about the plans or condition of a publicly traded company that could provide a financial advantage over other investors. Such Information, which if made readily available, would have an unfair yet considerable effect on the value of financial instruments.[2] In order to alleviate this, one of MAR’s main objectives is to bring attention to this precise problem by forcing market participants to inform authorities - such as the Financial Conduct Authority (FCA) - if it has disclosed insider information or is aware of others who have.

A notable example of insider information includes the 2010 J.P. Morgan Chase/HSBC Market Manipulation Lawsuit. Girard Gibbs LLP represented investors in a class action lawsuit against J.P. Morgan Chase & Co. and HSBC, claiming that the banks breached antitrust laws by influencing the prices of silver futures and option contracts. The class action claims that J.P. Morgan and HSBC swayed the market by making considerable harmonised trades to artificially depress the price of silver. By lowering the price, the class action claims that these banks made substantial illegal profits whilst harming investors and reducing competition.
This case illustrates how companies must be clear on how and when inside information first arises, as well as be able to recognise who was responsible for the disclosure. Under MAR, any employee, who encounters inside information in the course of his or her work, such as those in corporate finance, legal and compliance, must be notified of the new guidelines and any amendments. They must then assess how inside information is presented and consider whether it conforms to the new requirements. Still, this method of enforcement remains up to the discretion of whistle-blowers rather than any sustained inspection from regulators. This leaves it likely that cases of market misuse will be overlooked due to the unwillingness of market actors to reveal wrongdoing.
However, typically when faced with reformed legislation, compliance officers are instructed to not only undertake a gap analysis to distinguish the key action points appropriate to their organisation, but also use the opportunity to perform a full review of the organisational measures necessary to conform with both old and new requirements. For MAR, this should include a review of corporate access policies, watch and restricted lists, personal account dealing policies, and reporting systems, to name a few. The FCA has looked to focus attentions by showing that it will fine and adopt prohibition orders against compliance officers if they do not take steps required to prevent, challenge and report market abuse.

Market Manipulation

Under Article 12 of MAR, market manipulation could be anything from intentionally providing misrepresentative signals or any other activity affecting the value of one or more financial instruments. An example of such market distortions is represented well by former ImClone CEO Samuel Waksal who was condemned to 87 months in prison and fined $3 million after pleading guilty to six counts of insider trading and fraud. Waksal sold ImClone stock after discovering regulators had denied an application for the company’s new cancer drug.
In this case, the aim behind MAR is to “upsurge market integrity and investor security, whilst ensuring a single rulebook and level playing field across the EU” (PwC, 2016)[3], specifically by way of monitoring and implementing processes to prevent the divulging of insider information and market manipulation.

Given the points discussed above, MAR has to some extent been effective in preventing insider trading. This has been achieved through amendments to relevant internal policies and record keeping arrangements, as well as comprehensive training provided to employees affected by these changes. Yet it still remains unclear to what extent MAR has been effective in view of the fact that the new regime has only been operating for a few short months. Overall, it is arguable that in the wake of the recent regulatory fines and increased transparency within financial markets, developments under MAR have taken steps in the right direction for market participants. Yet, given the expansion of MAR to cover new markets, platforms and behaviors, future questions ought to be raised over the practicality of its current methodology to ensure compliance.

[1] This also includes OTC derivatives where the assets are in scope financial instruments, such as credit default swaps, or off-market trading of securities that are listed for trading on any of the above venues.[2] Investopedia, http://www.investopedia.com/terms/i/insiderinformation.asp[3] PWC, http://www.pwc.co.uk/services/forensic-services/insights/market-abuse-regulation-2016.html