The FCA isn’t thrilled with “some firms”

Indeed, they’re not thrilled at all. In the most recent FCA Marketwatch 69, the regulatory agency appears to have broken away from its standard style. This Marketwatch is a whole lot more obsequious and possibly even a bit mysterious. Volume 69 formally addresses the transgressions of “some firms” a whopping 14 times. Hence, they’re making it clear that the FCA is watching a few financial institutions in particular, but they fall just short of calling out those firms by name. And they seem to have smaller firms in their crosshairs based on this statement, “…they [the new surveillance requirements] may also be particularly relevant for firms with less complex business models.” After reading this Marketwatch, I am convinced that some firms – and the executives who lead them – are now shaking in their shoes.

Nobody wants to be that guy or that financial firm that’s making headlines for all the wrong reasons. Sure, some publicists argue that all press is good press. But, in the wake of the titillating Depp-Heard trial, which is revealing one sordid detail after another, perhaps this position on “no such thing as bad press” will need to be reconsidered. Back to the banks governed by the rules of the FCA.

In some ways, the FCA is shouting out from the proverbial rooftops with their latest Marketwatch. Everyone in the financial industry reads these bulletins, right? So, one could argue that the FCA has issued a fair warning across the bow and all those within its wake had better be prepared for the storm that’s coming. Make no mistake – something is brewing – and it will not bode well for “some firms.”

Let’s break it down so that you can avoid becoming one of the FCA’s “some firms” they’re currently targeting. Specifically with the statement, “While it is for firms to assess what is appropriate and proportionate in the context of their specific business, some of the observations in this Market Watch may be useful.” Heed the FCA’s warning! As we’ve seen recently, the consequences for non-compliance can be costly as well as damaging to brand reputation. Larger firms may be better suited to weather the impending storm, but smaller firms will likely struggle to survive long enough until the waters are calm again.

Assessing Market Abuse Risk

Since this topic was the first one listed in Marketwatch 69, it’s probably fair to assume that it’s the FCA’s biggest hot button right now. It appears that the FCA is dissatisfied with those firms who bucket all forms of market abuse into a single category – all with the same level of risk. The FCA apparently wants to see greater granularity and specificity with variable risk across each sub-category of the major forms of market abuse.

Credit, AML, insider dealing, and market manipulation can all be further nuanced with sub-categories around layering, spoofing, wash trading, and even ramping. Plus, they can be further categorized based on application; comparatively, discretionary vs execution-only or client vs house trading. Not to mention the method of execution: electronic versus voice-brokered deals and the trading platform. Low trading volumes don’t necessarily reduce the inherent risks, either. Each activity carries a different level of risk, depending on its asset class, and the FCA wants to see that variability in risk assessments.

Trade Surveillance

If you aren’t monitoring everything, there’s your first big warning – start doing so! Alert scenarios need to be properly calibrated in accordance with the variable risk associated with different asset classes and instruments for each. Having a common threshold for all scenarios is ill-advised. The pricing and volume average in one asset class may be perfectly reasonable and should not attract suspicion, whereas exceeding those same metrics in another asset class should clearly flag an investigation. Conversely, setting an alert threshold too low will generate a lot of noise in the system, triggering unnecessary investigations which add costs and interfere with the investigations that truly need to be conducted.

Look-back periods appear to be another bone of contention with the FCA. Periods of 24 hours or less appear to be too short. Here, canceled and amended orders must also be part of the consideration set. Surveillance exception alerts must be monitored closely and assessed frequently for effectiveness. Ditto for whichever systems – human or third-party vendor – that are in place for trade surveillance. As technology changes, so do the capabilities for surveillance. The FCA does not yet appear to be drawing the line between acceptable and state-of-the-art, but rest assured, when they come knocking at your firm, you had better be prepared to defend whatever “acceptable” is.

Documentation

Crystal clear policies and processes have saved many a neck. A critical caveat is that, even with the best policies in the world, having a suboptimal or inadequate educational rollout for those policies could put some firms at risk. And, not surprisingly, the FCA is strongly encouraging that all policies be detailed and include guidance that directs analysts to the signs that suggest market abuse.

Out of Sight, Out of Mind

The FCA seemingly understands the value of offshore labor. However, in the same breath, they rightfully call out the need to apply the same level of scrutiny to all parts of the organization, regardless of their geographic location. Their findings include, “inadequate knowledge of alert logic and calibration; weak or no quality assurance work on triaging alerts; and insufficient management information (MI).” Stated more directly, the FCA is visibly concerned about firms where the right hand doesn’t know what the left hand is doing.

The Fox in the Henhouse

Clearly, the FCA favors redundancy where both the front office and the back-office compliance function both independently monitor the firm’s activity for market abuse. They’re also big fans of continuing education for all parties, training everyone to better understand market abuse, how to identify it, and how to escalate key observations. Inconsistency around identification and escalation are aspects of surveillance that the FCA takes issue with.

To sum up, the FCA is strongly urging firms to increase their specificity around risk assessment, bolster policy development with adequate training, and move towards standardization when it comes to market abuse identification and escalation. Some firms will heed the FCA’s warning – and some firms won’t. Which firm do you plan to be?