FCA TR15/1 - asset management firms and the risk of market abuse

The FCA has published its findings following a thematic review (TR15/1) of how asset management firms control the risk of committing market abuse, insider dealing and market manipulation. The main finding is that firms generally had systems and controls in place to combat market abuse but that these were only comprehensive in a small number of firms. Key areas that the FCA identified for improvement included: ensuring that practices and procedures operate effectively and cover all material risks; how firms control, assess and manage the possibility of receiving inside information; and the effectiveness of post-trade surveillance. The main message from the FCA is that combatting the risk of market abuse is a question for asset management firms and they cannot rely on others (such as the listed companies or investment banks) to ensure that inside information is identified.

The FCA review looked at six areas in particular and gives some examples of good and bad practice which we have summarised below. These practice examples will be a useful checklist for firms to compare their own systems and procedures against to assess whether they meet the regulator's expectations, although some practice examples will not be relevant to all types and sizes of asset management firms. No formal action will be taken by the FCA following the thematic review findings however the FCA will be providing individual feedback to the firms involved in the review and otherwise will follow up through routine supervisory work.

1. Managing the risk that inside information could be received but not identified

The FCA noted that firms generally had effective policies to identify and capture inside information that is intentionally received through wall crossings by investment banks but most did not have effective policies for unintentionally received inside information from a sounding when that wall crossing is not taken up, for example. Firms also generally had practices to avoid unnecessary receipt of inside information when company specific research was being conducted but these were often informal and inconsistently applied.

Good practice

• an initial point of contact for soundings, independent of fund managers which could reject soundings without sharing information with fund managers
• an independent assessment procedure of information received to verify that it was not inside information
• a written assessment by fund managers whether inside information had been received following a sounding
• avoiding contact with investee companies during close periods, other than in exceptional circumstances and following pre-approval from compliance
• restrictions on meetings with consultants who had recently worked for listed companies
• requirements on consultants to confirm they would not disclose inside information
• record-keeping requirements on fund managers following meetings with consultants

Poor practice

• no requirements on fund managers to confirm whether inside information has been received after a sounding
• a fund manager taking no further action despite receiving the name of the company that was planning corporate action during a sounding (which creates the risk of another fund manager trading in the company's shares while inside information was held in the firm)
• a fund manager meeting with management of a listed company less than a week before the company published its results
• no documentation or record-keeping controls and requirements
• compliance unaware of an investment team's use of an alpha capture system
• general belief that the issue of inside information was the responsibility of the listed companies, investment banks and other research providers to assess, not the fund manager

2. Controlling access to inside information and managing the risk of improper disclosure

The FCA has focused on how firms handle the risk of receiving inside information through improper disclosure. Generally the FCA found that firms used restricted lists to document inside information that was received which covered all employees, not just some named individuals. All firms had a "need to know" policy which the FCA praised.

Good practice

• a detailed log of who knows inside information
• knowledge of inside information is restricted to the wall crossed person, other team members on a "need to know" basis and compliance
• inside information is not shared with senior management or traders unless they try to trade the stock (and even then, they are only informed of the restriction, not the inside information)

Poor practice

• all traders are notified when inside information is received (as an interim measure until system blocks are in place)
• details about the inside information are circulated to a wider audience than those who "need to know"

3. Pre-trade controls to prevent market manipulation and insider dealing

Only three firms reviewed by the FCA did not have segregated equity dealing functions and in most firms dealers had a reporting line independent of the fund manager. Only two firms reviewed did not use system based pre-trade controls to prevent trading in the restricted company securities following receipt of inside information. Pre-trade controls ranged from a hard block to warning prompts that had to be overridden to be able to trade. The key area here for the FCA was how firms prevented trading when a portfolio manager has access to inside information.

Good practice

• where volume of trades is too small to merit a segregated equity dealing function, all fund managers' orders must be signed off by an independent colleague
• trading function is situated in a secure, segregated area (which reduces the risk of other fund managers finding out about, say, large blocks being traded)
• telephone recording for mobile lines
• record-keeping requirements for investment decisions

Poor practice

• no independent check prior to an order being placed
• segregated, independent equity dealing function for all except one of the fund management teams because the fund manager of that team thought dealing would be improved if the dealer sat within his team
• no system-based trade restrictions following receipt of inside information and notifications to all dealers when inside information had been received to prevent dealing

4. Post-trade surveillance

The FCA identified only two firms that had an effective post-trade surveillance programme to identify market abuse. The FCA stressed that post-trade surveillance plays a key role in detecting and deterring market abuse and the FCA expects senior management at firms to ensure that controls are in place and are working effectively.

Good practice

• using statistical analysis to identify post-trade price movements to trigger surveillance
• post-trade surveillance highlights patterns of successful trading in advance of company announcements leading to a full investigation
• regular monitoring of recorded telephone lines with sample listening to calls

Poor practice

• using same percentage change across all markets when setting price move triggers
• no documentation of research process
• quarterly analysis of investment performance, rather than trade level analysis

5. Personal account dealing policies

All firms had a PA dealing policy in accordance with FCA rules and the FCA reiterated that firms should review their PA dealing policies to ensure they comply with COBS11.7 requirements. Note, we consider some of the examples below to have limited application in many instances where for certain reasons, they may not be relevant.

Good practice

• pre-trade approval required for PA dealing
• post-trade review to monitor suspicious activity

Poor practice

• no requirements about what time would be required between a PA trade and a fund trade
• requirement that fund manager does not PA trade within one hour of a fund trade

6. Training

Only one firm reviewed did not conduct training on market abuse and most firms gave market abuse training as part of the new joiner process as well as an annual refresher. The online training point (see poor practice below) may raise a few chuckles…!

Good practice

• face-to-face training to complement online training
• use real life examples from the firm's own experience as part of training

Poor practice

• online training only
• evidence that staff complete online training in half the stipulated time