FSMA market abuse regime: a review of the sunset clauses The ABI s Response to the HMT Treasury consultation paper Introduction The ABI welcomes the opportunity to respond to this consultation paper. ABI members are large institutional investors controlling funds worth some 1.3 trillion, including equity shareholdings equivalent to around one fifth of the UK market capitalisation. Insurers are responsible for investing a large proportion of the savings of the UK public, including the funds providing their pensions. As a result, ABI members as both issuers and investors - have a strong interest in the integrity and efficiency of financial markets and in promoting the confidence of the investing public. Matters relating to market abuse are of fundamental importance to them. We strongly support the retention of FSMA super-equivalent provisions. Our members views are unchanged: they were in favour of a wide scope of the market abuse regime at the time that FSMA came into existence and in favour of their retention when MAD was introduced. They believe the current UK regime has served the market well and the sunset clauses should therefore be extended indefinitely. As a rule, our members believe that EU directives should be interpreted and implemented in a proportionate way which best suits the interest of our markets. Sometimes this will mean seeking to minimize their impact. At other times it may be desirable to go beyond the directives, as is already the case with the Listing Rules. Such recourse to superequivalence should not be seen as bad in itself. The yardstick should be whether it brings additional benefits and confidence to the UK. This is just such a case. The breadth of the UK regime, and its principles-based nature, give investors the full confidence that firms will strive to create a culture where insider trading and market manipulation are unacceptable. This is one area where principles-based regulation really matters because the aim should not simply be to lay down detailed rules about what market participants can or cannot do (though prescription may still be necessary in some cases) but for senior managers to instill the right values in their firms. We believe that a contraction of the regime scope would be detrimental to the UK market. There are several reasons for this. First, it would seem odd to do so just as the European Commission is conducting its own review of the Market Abuse Directive. ESME has already published a paper outlining the main areas that may need to be amended and some are directly related to the difference between FSMA and the Market Abuse Directive. This could potentially mean that the UK industry has to implement regulatory changes twice in a very short period of time. We think this would pose unacceptable costs to all concerned.
Second, insider trading and market manipulation remain high. The recent case of unusual trading patterns of HBOS shares, which many suspected was the result of market manipulation, is not an isolated one: the FSA s own surveys of market cleanliness continue to show high levels of informed price movements preceding bids. The FSA s recently published Market Watch newsletter (no 26) confirms that this remains the case. Any regulatory move that aims to limit the regime may make matters worse by appearing to signal that the authorities are relaxed about the level of offences. We would also stress that, despite the largely theoretical nature of the debate around the definition of inside information, market abuse is not a victimless crime. In extreme cases, it can threaten the stability of large institutions and thus the financial system as a whole. But even the less dramatic cases erode market confidence which ultimately has an impact on shareholder value. It is shareholders that ultimately bear the cost and this is why we believe that the voice of our members, as owners of assets, needs to be heard.
Questions for Consultation ANNEX Q1: Do you consider that the superequivalences increase the effectiveness of our regime and have an effect on market integrity? Q2: Which of the identified differences do you see as most important and why? We believe that the superequivalences increase the effectiveness of the market abuse regime and that they should be retained. We do not think that the UK market can afford to see the standards slip and we would regard the expiry of the sunset clauses as a definite deterioration of those standards. First, our members are particularly concerned about the possibility of provisions based on the relevant information not generally available (RINGA) being deleted. HM Treasury states that when the wider definition of information which can be abused was introduced in 2001, a deliberate decision was taken to broaden its scope and use the relevant test, partly due to the difficulties experienced in proving the price sensitivity of a particular piece of information. In other words, the new definition was a response to a real problem. We do not believe that anything has changed to warrant different scope and we would therefore strongly support its retention. We think it represents a common-sense approach to market abuse regulation. Some of our members tell us that they find it easier to train staff in the meaning of RINGA than the in the market abuse definitions: the latter has too many components which may or may not be relevant in certain circumstances and that makes it harder both for the business to understand and practise, and for the compliance function to enforce. In addition, our members report no problems with the timing of companies disclosure of inside information in the UK. This would suggest that the current regime achieves the right balance. Judging by the ESME (European Securities Market Experts Group) report evaluating the EU legal framework, the same could not be said to be true in some of the other EU jurisdictions. There may be cases where a piece of information about an issuer would not (at that point in time) qualify for the status of inside information as defined by MAD but may nevertheless be abused. For example, information about what an issuer is planning to do or is likely to do is capable of being highly market sensitive. The abovementioned report by ESME shows that in the EU countries that do not make a distinction between the definitions of information that has to be disclosed and that which can be abused i.e. whose regime operates on the basis of a single definition of inside information derived from MAD there is a great deal of confusion about how the Directive is meant to operate in practice.
The consequences of a single definition are very real: either the issuers disclose information too early which could mislead the market and lead to volatility, or they try to delay disclosure for as long as possible which may mean that information could legitimately be abused before it becomes inside information. Keeping the RINGA provisions means that, wherever the regulators choose to set the threshold for preciseness or price sensitivity in relation to the information that has to be disclosed by issuers, information can become abusable at an earlier stage. Second, we think it would be short-sighted to limit the application of the regime to just the transactions themselves, rather than the wider notion of behaviour. Although the abuse would usually manifest itself through dealing, and we would not wish to encourage the idea that certain behaviours automatically constitute market abuse, the HMT s examples nevertheless show that there are plenty of other instances where market could be misled even though no action is taking place. Ultimately, this can be equally damaging to market confidence. It is also feasible that the conditions imposed by MAD mean that the exercise could be more easily construed as box-ticking and the rules therefore circumvented in practice. Third, the scope of the regime in relation to particular instruments is crucial and we agree with the Treasury that the pace of innovation and the increasing complexity of capital markets mean that the more encompassing wording derived from FSMA is better suited to catch instruments like CDS. Our members do not think that the wider definition is in any way onerous and we do not see why it should be replaced. Finally, we would support any provision that makes it easier to prosecute insider rings. Although there is no evidence to show that the recent case of HBOS share price volatility (which prompted the FSA to publicly warn market participants that it would not tolerate market abuse) was the work of an insider ring, there has been some media speculation that this has been the case. It is not hard to see how those intent on abusing the market would be sophisticated enough to cover their tracks when passing information to each other. It is therefore important to preserve the provisions which mean the authorities require no proof of how the information being abused was obtained. Q3: Do you have any further evidence on the practical operation of the superequivalences since the introduction of MAD? Our members report no specific cases related to superequivalences. We recognize there have been no enforcement cases brought under the FSMA provisions between 2005 and 2007. We would concur with the HMT that, considering the low number of market abuse enforcement cases generally, this in itself does not constitute a proof that the rules are not important. We would argue more strongly that the super-equivalences act as a deterrent and may dissuade market participants from perpetrating market abuse though their value as a disincentive is undoubtedly hard to quantify.
We are not convinced by the arguments for letting the clauses expire based on legal costs and training regimes inconsistencies. We hear no such complaints from our own members and we believe that the market knowledge of the regime as a whole is reasonably high. We recognize that there may be an impact of different market abuse standards on firms cross-border operations. However, there is little evidence that the uneven implementation across the EU is in fact damaging UK firms competitiveness. On the contrary, one could argue that the higher standard of super-equivalent provisions actually enhances the quality of the UK market and therefore benefits all market participants. The cost of producing country-specific training manuals seems to us a small price to pay in comparison. Q4: Do you agree that we should extend the sunset clauses for a limited period until the results of the EU review are known? We disagree and we think the provisions should be extended indefinitely. If the outcomes of the EU review require changes to be made, these could be made in due course. We would strongly disagree with allowing the sunset clauses to expire before the results of the EU review are known. This could result in additional costs for firms as they may be forced to amend practices, manuals, training programmes and so on twice in a short period of time. Q5: Do you agree that an extension until 2010 would allow sufficient time to assess the outcome of the EU review? See our answer to Question 4. If the HM Treasury decided to extend the provisions temporarily, we would suggest that an extension until 2010 might not be sufficient to assess the outcomes of the EU review. It may take some time before the review is completed and any changes are embedded in legislation across all the member states. Q6: Do you have any initial views on the EU Review and what the UK priorities for change should be? The ESME review identifies some of the areas in which the implementation of the MAD has been uneven or problematic across the EU. In particular, it singles out the definition of inside information as being at the heart of widespread inconsistencies of behaviour and failure to comply with Directive requirements. We agree with ESME that this should be addressed at the EU level as a priority. Failure to do so could result in the continuation of divergent market abuse regimes. (CESR s review of administrative and criminal sanctions under MAD in the EU
shows this is already the case to a certain extent due to differences in member states legal systems.) We agree with ESME that a more straightforward solution would be to distinguish between the inside information as it determines the need for disclosure and inside information as it applies to the obligation to refrain from abusive trading or encouraging abusive trading in relevant financial instruments. This could, we think, effectively replicate the current position in the UK. However, this would involve making changes at Level 1 of MAD. We acknowledge that it would be challenging but we do not think that Level 3 guidance is sufficient in this case. Some jurisdictions might not recognize it as legally binding, which would be a serious limitation in the context of market abuse regulation. Research cited by the HMT shows it is the enforcement of the regime that matters rather than its mere existence. It is therefore important to have a regime that is enforceable. If changing Level 1 were to prove unachievable, it would be worth exploring whether the distinctions could be made clearer in Level 2 text as ESME suggests. Q7: Do you have any views on the need to update the 1993 Criminal Justice Act? We do not have any views at present. Q8: Do you agree with the analysis of the costs and benefits for the different implementation options, including the impact on competition and small firms? We broadly agree with the cost-benefit analysis except we think too little attention is paid to the costs of losing market confidence stemming from market abuse. These costs are hard to quantify and may get overlooked when juxtaposed with the more easily quantifiable costs of compliance. Q9: Are there any alternative options, or combinations of the proposed options, that should be considered? We do not have any alternative proposals. Q10: Do you agree with our policy proposal? If not, please specify your reasons. We do not agree with the policy proposal. We would wish to see the sunset clauses extended indefinitely, as we believe this provides the best possible outcome for the UK market.