Scope of MAR/CSMAD/MiFID II legislation

By Christer Wennerberg, Senior VP Market Structure Strategy
May 11, 2016
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July 3rd 2016, is a sharp deadline. By that date investment firms must have systems and procedures in place to prevent and detect market abuse and attempted market abuse, as specified in the Market Abuse Regulation (MAR).

The bar will be raised even further on January 3rd 2018, when MiFID II is expected to apply, introducing even more rigorous requirements on market abuse detection and prevention.

MAR and CSMAD will replace MAD

There is a Market Abuse Directive in application today (2003/6/EC). However, not all member states have criminal sanctions in place for breaching the law, nor is the legislation harmonized throughout Europe. The new Directive (CSMAD) will cater for establishing a common criminal sanction regime throughout Europe for serious cases of Market Abuse.  The new regime will include both administrative sanctions (“fines”) and criminal sanctions (“imprisonment”):

  • Fines up to 5 MEUR on individuals and 15 MEUR, or 15% on turnover, on firms.
  • Criminal sanctions up to four-year imprisonment will apply under CSMAD.

Scope of MAR

Somewhat simplified, the focus of MAR is to prevent intentional abusive behavior, behavior that is risking to “harm the integrity of financial markets and public confidence in securities, derivatives and benchmarks”.

Three major areas of MAR impact trading:

MAR 1 Shapes

One important aspect of MAR relates to the prevention and detection of market manipulation (Article 16). The requirements are described in detail in ESMA 2015/1455 Technical standards, Paragraph 6, “Suspicious transaction and order reporting”.

The scope of the new market abuse regulation, regarding “Suspicious transaction and order reporting” includes (ref: RTS ESMA/2015/1455):

  • “Every order, including quotes, irrespective of its type”
  • “Effective and ongoing monitoring of all orders and all transactions”
  • “Irrespective of the types of clients concerned”
  • “Whether the orders were placed or transactions executed on or outside a trading venue”
  • “Orders and transactions relating to any financial instrument”

For those cases, the investment firm shall have systems that enable them to:

  • Prevent
  • Detect
  • Investigate
  • Report

Market Abuse and attempted Market Abuse

For most firms, this means that they will be required to have an automated system for detection of suspicious transactions. For those firms with limited complexity in their business, the automation requirements are limited. Those firms must explain to their Competent Authority upon request, how they manage the alerts, and why such (limited) level of automation is appropriate. However, ESMA is of the view that, in most cases, an automated system is required.

Scope of MiFID II as related to algorithmic trading

Somewhat simplified, the activities aimed at preventing market abuse stated in MIFID II, also strive to prevent unintentional abusive behavior, such as algorithms going berserk, resulting in orders and transactions that may cause market disruptions.

If an investment firm conducts algorithmic trading, it will have to comply with the organizational requirements in the Directive 2014/65/EU. The Regulatory Technical Standards ESMA/2015/1464 lists detailed monitoring requirements. One example is Article 16 in RTS 6:

  • “Investment firms shall, during the hours they are sending orders to the trading venues, monitor in real-time all algorithmic trading activity that takes place under their code, including that of their clients, for signs of disorderly trading, including from a cross-market, cross-asset class, or cross-product perspective, in cases where the firm or its clients engage in such activities”.
  • “Real-time monitoring of algorithms shall be undertaken by the trader in charge of the algorithm and also by an independent risk control function”.
  • “Monitoring systems shall have real-time alerts to assist staff in identifying any unanticipated activities undertaken by an algorithm”.
  • “These monitoring systems shall also provide alerts in relation to algorithms and DEA orders triggering circuit breakers of a trading venue”.
  • “Real-time alerts shall be generated within 5 seconds of the relevant event”.

Summary of legislation scope

There is a significant overlap between MAR and MiFID II. The ultimate goal of both is to protect market integrity and the public confidence in capital markets. Somewhat simplified, MAR targets intentional market abuse whereas MiFID II also covers organizational requirements in order to protect against market disruptions due to un-intentional behavior (i.e. mistakes). 

ESMA note from October 2nd 2015 on Implementation delays

“Although this note concentrates on MiFID, there is also a very clear link between the MAR applicability date (envisaged for July 2016) and the tools for supervising it (contained in MiFID and the data systems linked to it)”.

 MAR 1 2 shapes

If the order and transaction flow is observed from the venue perspective, a sign of disorderly trading can be due to either:

  • Intentional market abuse, e g “quote stuffing” with the purpose of delaying market data for other participants, and consequently make a profit of the information asymmetry.
  • Un-intentional market abuse, e g “quote flooding” due to a bug in the system, the trading system floods the market with erroneous orders.
  • Noise. The actual order flow is extreme, but may be of natural causes (e g when the market is in distress).

All three cases may look the same, so it is crucial for the investment firm and the venue to be able to detect the difference and prevent abusive behavior. This can only be done by using sophisticated tools for monitoring and analysis of orders and transactions, and sequences of orders and transactions. 

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