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”):
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:
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):
For those cases, the investment firm shall have systems that enable them to:
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:
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)”.
If the order and transaction flow is observed from the venue perspective, a sign of disorderly trading can be due to either:
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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