What does Market Abuse REALLY look like for Wealth Managers?

Damon Batten, Managing Consultant, Head of Capital Markets for Bovill, addressed PIMFA’s recent Financial Crime conference on where our industry currently sits regarding the Market Abuse Regulation (MAR).

There’s been increased focus on the Market Abuse area since the FCA recently issued their ‘Dear CEO’ portfolio letters, describing their approach to supervision. There is significant frustration that, despite the fact that the Market Abuse Regulation (MAR) has been in place since 2016, firms have not done enough to abide by the rules.

Batten suggested that many firms are still lagging behind in terms of putting appropriate controls in place and that this is partly due to a lack of understanding of the types of risk involved.

First under the spotlight was the risk of insider dealing originating from the client, which he splits into three categories – Discretionary Management, Execution Only and Advisory.

In principle, the risk of a client indulging in insider dealing for Discretionary accounts is low as the manager is responsible for all investment decisions but, in some firms at least, the reality might not be as simple. Batten stated that there have been examples where the client has had some influence and/or input into the decision-making process. Whilst this possibility needs to be taken into account, he classifies the attendant risk as medium/low.

At the other end of the scale, the risk in the Execution Only space is much higher. Here, certain clients may misuse your operation to deal on inside information. As Batten says, this risk may be heightened if the client happens to be a wealthy, influential individual still active in the industry.

Advisory is classed as medium-high risk, despite the client having limited input in investment decisions. Danger may lurk where the target investment originates with the client.

He then discussed internal, insider dealing risks from a staff perspective, starting with the Client Management area, which he again classified as a medium/high risk.

Staff who do indulge in this type of activity may not be looking for immediate personal gain in this – it may be that they use insider information to boost their client’s profits, merely generating kudos for themselves. He also highlighted the high risk that insider information can, sometimes unwittingly, originate in-house via research departments, showing a need for closer monitoring of the Personal Account Dealing function.

Incidental inside information, appearing by accident or as a product of other business, is harder to track and carries a medium-high risk of misuse.

Next up was the risk of Market Manipulation, again pertaining to staff and split into three sub-sectors; Dealing Desk, Liquid and Illiquid investments.

Batten described the risk emanating from the Dealing Desk as medium-low, depending in part on the sophistication of internal arrangements and the prevailing internal incentives to try to outperform the market. Liquid Investments also fell into this medium-low category but with price positioning cited as a possible cause for concern.

However, the risk is significantly higher when it comes to Illiquid Investments. Here, firms should consider the extent to which individuals may be able to pursue strategies such as market cornering or ‘pump and dump’, a form of securities fraud that involves artificially inflating the price of an owned stock through false and misleading positive statements, in order to sell the cheaply purchased stock at a higher price.

Training and observation will go a long way to ameliorating much of the risk.

Almost all discussions on Market Abuse begin with a market abuse risk assessment which, if not already existing, needs to be put in place as a matter of urgency. The FCA currently have the unofficial expectation that firms will think about which controls are most appropriate to their firm and then tailor them specifically. As Batten puts it, ‘They don’t want to see factory settings being used’.

Thereafter, firms should consider the risks from all angles; client versus staff, client accounts and relationship types, liquid versus illiquid instruments and the various potential sources of inside information. They should also question whether staff are actually aware of what constitutes insider dealing and institute training programs where appropriate.

Ultimately, he believes that conduct and culture training are significantly more effective that an over-use of internal surveillance.