On 27 May, 2020, the UK Financial Conduct Authority (FCA) published the 63rd edition of its Market Watch newsletter. The newsletter sets out the FCA’s expectations for market conduct in the context of increased capital-raising events and alternative working arrangements due to COVID-19.
Throughout the pandemic, the FCA has been working to maintain high standards of conduct and make reasonable adjustments to its rules. While the FCA recognises that the COVID-19 pandemic has caused significant uncertainty and hitherto unprecedented operational challenges due to the prevalence of remote working policies, the FCA still expects all market participants, including issuers, advisors and anyone handling inside information, to continue to act in a manner that supports the integrity and orderly functioning of financial markets. This includes complying with all their obligations under relevant regulation, including the Market Abuse Regulation (MAR).
MAR Inside Information Obligations
Issuers and Advisors
General. Issuers must continue to assess carefully what information constitutes inside information and have regard to how the current COVID-19 pandemic and policy changes may affect the materiality of certain information. In making these assessments, issuers should consider what information a reasonable investor would take into account when making investment decisions at this time and monitor whether any new information is materially different from information that had previously been announced and might now be misleading.
Insider lists. Issuers must continue to ensure that all staff, advisers and proxies who have access to inside information are included on insider lists and that the reason for their inclusion is recorded. Given the different risks that arise from working from home, issuers may also want to retrain persons on insider lists, ensuring that they are aware of when they have access to inside information and their duties in relation to insider dealing and the unlawful disclosure of that information.
Delayed disclosure of inside information. Unless the relevant provisions on delayed disclosure under Articles 17(4) (or where applicable 17(5)) of MAR apply, issuers should comply with their obligation to disclose inside information that concerns them as soon as possible. This is necessary to prevent misleading information being circulated. Where disclosure of information is to be delayed, firms must have regard to whether such delayed disclosure is materially different to previous public information such that it may mislead the market.
All Market Participants
General. The prohibitions on unlawful disclosure and insider dealing under MAR apply to individuals who know or ought to know that they possess inside information. Inside information can be disclosed only where necessary in the exercise of employment, professional or regulatory duties, even if the intended recipient owes a duty of confidentiality and/or is included on an insider list.
Firms should continually assess whether their procedures adequately reduce the risk of unlawful disclosure and insider dealing. Among other things, firms should confirm to the recipient of inside information that the information provided amounts to inside information, and make clear the restrictions around handling such information. Firms should also restrict access to inside information to only those who need it for the proper fulfillment of their roles.
Market soundings. The MAR market soundings regime provides a framework for controlling inside information when market participants undertake “wall crossings.” The inside information disclosed and received under this regime must be strictly controlled to reduce the risk of unlawful disclosure and insider dealing. For example, disclosing market participants should maintain records of the relevant communications. Receiving participants should assess whether the information disclosed contains inside information, be aware of their obligations around use of the information and communicate that information only to persons that are fulfilling the specific duty to provide an opinion to the issuer.
Personal account dealing. In Market Watch 62, the FCA shared its concerns about personal account dealing (PAD – where employees of an authorised firm trade for themselves rather than for clients). Given the potentially heightened risks of personal dealing for staff working from home, firms should consider and ensure that they have appropriate controls around PAD in accordance with COB 11.7 and 11.7A of the FCA rules.
All of the points made by the FCA above are not new and simply reinforce existing law and practice. However, the risks of getting it wrong have increased during the period of the COVID-19 pandemic, where centralised compliance systems and frameworks may not be as effective where many individuals are working from a home environment. For example, staff might be sending sensitive documents to personal email accounts for editing or printing on a home computer, or printing sensitive documents on home printers used by other members of the household. Members of a household might also be discussing sensitive information on conference calls within earshot of other members of the same household, and thus inadvertently disclose inside information. The risks of such information being inadvertently disclosed have become higher, since such calls would now be taking place throughout the work day at home, rather than on isolated occasions.
Firms will need to be proactive in ensuring they have appropriate controls around the flow of inside information, PAD and related issues and that their employees are aware of the consequences of insider trading and market abuse generally.
Market participants should also be aware of the cross-border nature of market abuse rules, including the potential scope for liability in multiple jurisdictions. Sidley partners Sara George and Nader Salehi noted in a recent Daily Telegraph article (“Risks of insider trading will return to haunt investors”) that even where the UK does not take action on market abuse, the U.S. often does, considering any abusive trade on a U.S. exchange, or which affects American investors or the integrity of its markets, to be within its jurisdiction.
Market participants must ensure that they continue to meet the obligations imposed by the Short Selling Regulation (SSR) to support the functioning of the market.
Restrictions on Uncovered Short Sales in Shares
The SSR prohibits uncovered short sales of shares. Investors must therefore ensure that they enter into a short sale of a share only where they have
- borrowed the share,
- entered into an agreement to borrow the share or
- have an arrangement with a third party who confirms that the share has been located and which enables settlement of the short sale to be effected when due.
Agreements or arrangements which do not work in practice are unlikely to satisfy the requirements in the SSR.
Net Short Position Reporting
SSR also requires investors who hold significant net short positions to provide certain notifications. Following the European Securities and Markets Authority’s (ESMA) decision to reduce the relevant net short position threshold under the SSR from 0.2% to 0.1%, investors must notify the FCA when they hold a net short position that equals or exceeds 0.1% of the issued share capital of the company and each time the position increases or reduces by 0.1%. The FCA publicly discloses net short positions of 0.5% or over of the issued share capital of a company on a daily basis on its Short Selling webpage.
Short Selling Monitoring, Restrictions and Enforcement Powers
The FCA continues to monitor short-selling activity and may ask firms for further information regarding the reported net positions. Where there has been a failure of the obligations under the SSR, the FCA has a range of powers available against such firms, including censuring and imposing fines. Where an individual is found to have carried out abusive trades in contravention of MAR, that person may be prohibited from managing/dealing or be imprisoned if the individual has committed criminal offences under the Criminal Justice Act 1993 or Part 7 of the Financial Services Act 2012.
The FCA has simply restated the existing rules on short selling under the SSR. On the issue of borrows/locates for uncovered short sales in shares, however, it is notable that the FCA states: “Agreements or arrangements which do not work in practice are unlikely to satisfy the requirements in the SSR.” Firms should review their arrangements to check that the borrows/locates that they have are not merely a case of form over substance.
On the topic of net short position reporting, please see this Sidley Update, which discusses ESMA’s decision reducing the net short position reporting threshold from 0.2% to 0.1%.
The FCA has received reports of a small number of banks exerting pressure on corporate clients to secure roles on equity mandates that the issuer would not otherwise appoint them to. Such actions may be in breach of FCA rules or principles, and the FCA will not hesitate to take action if such reports are substantiated. Firms should compete on the merits of their services and terms rather than imposing undue pressure on issuers or restricting their choice.
Market Conduct During Credit Events
Recapitalisation exercises involve many forms of valuable and legitimate engagement between issuers and their creditors, including those which also hold positions in credit default swaps (CDS). In June and September 2019 statements, the FCA, along with the U.S. Securities and Exchange Commission and Commodity Futures Trading Commission, in 2019 expressed its concerns regarding “opportunistic strategies” and their adverse effect on the integrity, confidence and reputation of markets. Market participants must continue to comply with their MAR obligations, and the FCA will continue to monitor compliance with these obligations.
The “opportunistic strategies” the FCA refers to include what have been referred to as “manufactured credit events” or “narrowly tailored credit events.” Please see this article by Sidley partners on Regulatory Scrutiny of Manufactured Credit Events, which was written as commentary to the FCA’s June 2019 statement.
The FCA reiterates the importance of undertaking regular risk assessments to identify firms’ market abuse risks and, in particular, reviewing such risk assessments in times of extraordinary market activity. These risk assessments can enable firms to adapt their surveillance systems to ensure that they are able to adequately detect new, or greater, market abuse risks. Firms should ensure that their approach is tailored to the risks they are exposed to and does not diminish the appropriateness and effectiveness of their surveillance.
ESMA’s MAR Q&A 6.1 clarifies that MAR market surveillance requirements apply broadly to persons professionally arranging and executing transactions which includes asset managers, alternative asset managers and proprietary traders.
Given that most staff of regulated firms are working from home during the coronavirus pandemic, it will be important for firms to ensure that their policies and procedures are clear on how staff engage in their advisory, management and trading activities. Calls that are in scope of the telephone recording requirement still need to be recorded, and staff should be using only communication methods that can be tracked and recorded.
FCA Market Monitoring
The FCA is continuing to monitor primary market and associated secondary market activities to identify behaviours which may affect the integrity and orderly functioning of the market during this time and deploying its available resources to do so. The FCA will use a range of tools to do so, including transaction reporting, order book reporting, inside information disclosures, price movement monitoring and reporting on net short positions.
Among the FCA’s ongoing measures to monitor the market are requesting information and making inquiries where it identifies behaviour which is potentially abusive or in danger of creating a disorderly market.
Firms should seek to cooperate to the fullest extent possible with the FCA when asked to provide information, and to explain the measures they are taking to meet their regulatory obligations.
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