Monitoring orders and transactions – our expectations of firms

Speech by Patrick Spens, Head of Market Monitoring, the FSA, at the Futures Options Association Compliance Forum

Good afternoon and it is a pleasure to be able to speak to you this afternoon my name is Patrick Spens. I am the Head of Market Monitoring which will become part of the future Financial Conduct Authority or FCA.

I was asked here to speak regarding the FSA’s expectations on firm’s obligations with respect to the monitoring of orders and transactions, specifically in response to a letter from the FSA and other competent authorities sent on 14 December 2012.

Firstly I wish to provide some context to both my role and the soon to be established FCA’s objectives and philosophy.

My key responsibilities can be defined as follows:

  • pursuing the FSA’s credible deterrence strategy through market conduct enquiries and investigations which can then lead to targeted enforcement actions, under both civil and criminal regimes;
  • educating market participants about their obligations with respect to market abuse and transaction reporting;
  • enhancing our markets’ surveillance toolkit which includes interrogating transaction data to assess risks and identify trends through our Transaction Reporting database - ZEN;
  • supervising the transaction reporting and market abuse regimes; and
  • influencing European policy agendas in these areas.

The FCA’s overall strategic objective is to ‘make markets work well’. Additionally it will have three operational objectives of ensuring consumer protection, market integrity and competition is in the interests of consumers. The key differences as to how the FCA will regulate conduct will be through; new legislative powers and tools, a new approach to regulating and supervising firms and most importantly a change in culture that will enhance all levels of consumer protection.

Moving forward into the FCA, our view is that conduct risk can often be more efficiently addressed through thematic and educational work. We intend to execute a higher proportion of our conduct priorities, through this type of work or communication. I therefore address the reason for me being stood before you.

The letter was sent under coordination from multiple European regulators, though some of you may question the genesis of the letter. ESMA issued a call for evidence from any regulators who had seen evidence of layering or spoofing within their financial markets. We, as the FSA, responded, and from this, the letter that you received was born.

To address the question of ‘why did I receive this letter’, this communication was sent to:

  • UK firms which are members of UK or contributor countries regulated markets; and
  • non contributor country firms or third country firms which are members of the UK regulated markets (e.g. US firms or Luxembourgish firms)

Some may question why such a letter was sent under coordination of ESMA. As technology in conjunction with the Markets in Financial Instruments Directive (MiFID) continues to break down geographical and jurisdictional borders I believe we will see evermore cooperation between European regulators. Such cooperation will span policy setting, supervisory issues and regulatory investigations. This letter is a demonstration of such an approach.

The FSA is well versed in cross-border investigations – jointly undertaken criminal proceedings from the West Coast of the United States, to the island of Mayotte in the Indian Ocean with French authorities as a result of our market abuse investigations. We regularly seek assistance from, and provide assistance to other competent authorities in market abuse investigations around the globe. The FCA will continue to progress investigations across borders to further its credible deterrence strategy.

What does the FSA expect of firms’ monitoring procedures?

To address the primary reason for me being stood before you – what monitoring and controls does the FSA expect firms to have in place?

ESMA set out guidelines for market participants in relation to systems and controls in an automated trading environment – applicable for trading platforms and investment firms alike in 2012. Our letter highlighted some of the principles from these ESMA guidelines - organisational requirements to prevent market abuse (in particular market manipulation) in an automated trading environment. 

As a group you have diverse business models, diverse client bases, and trade diverse asset classes, for this reason there can be no single surveillance model or system which should be followed to ensure compliance with the regulation. Monitoring should ensure compliance with MiFID, and the Code of Market Conduct. As member firms of exchanges and platforms, monitoring should also ensure compliance with rules and regulations as set out by your platforms.  

The FSA expects that firms will have appropriate systems in place to monitor that messages being sent or received are compliant.  Layering and Spoofing was highlighted as a concern through our Market Watch publication (Issue No. 33) in August 2009.

Layering involves entering multiple orders at different prices on one side of the order book at, or slightly away from, the touch. This has the effect of moving the share price as the market adjusts to the fact that there has been an apparent shift in the balance of supply or demand. This is then followed by a trade or trades on the opposite side of the order book which take advantage of, and profit from, the share price movement engendered by the multiple layering orders.  This is in turn followed by the deletion of the large layering orders, and by a repetition of this behaviour in reverse on the other side of the order book.

What does appropriate mean?

We expect firms to perform surveillance in as close to real time as possible. Monitoring should ensure that your systems have sufficient time granularity that you are able to identify any strategies or individual orders that are potentially abusive, and retain the option to block or limit orders from entering a platform. Such a system should be capable of handling the volume of messages being sent, or received in the case of platforms.

Any system in place will require human intervention and judgement during the process to determine the level of suspicion and whether this warrants a disclosure to the relevant competent authority. Staff undertaking monitoring should be sufficiently trained to understand the strategies that may be undertaken and regulations relating to market abuse, specifically market manipulation. Staff undertaking monitoring should have sufficient authority to challenge and take necessary action when reviewing trading flows.

 As a firm you should ensure you have appropriate systems and governance in place that referrals of suspicious behaviour are made where appropriate, and in a timely fashion.  As part of our supervisory process we may choose to question any near misses – where suspicious trading has been escalated but not reported to the FSA – that have resulted from your monitoring and surveillance. We would expect you to demonstrate a full audit trail of decision taking, and the rationale for these.

DMA providers

I wish to dwell on direct market access (DMA) providers, and the responsibility you have for the trading of your clients. Without adequate systems and controls in place you leave yourselves exposed to risks outside of your control. I would urge you to consider whether systems and controls in place are sufficiently advanced and robust to monitor effectively. You are reminded that you remain solely responsible for all orders submitted under your trading codes.

When providing direct market access, those staff undertaking monitoring should understand the scale and complexity of a client’s trading, and their historical trading behaviour.

Limits should exist around clients trading to ensure fair and orderly trading, with automatic rejection of orders that violate such parameters. As DMA provider you should retain absolute control over any pre-trade controls , clients of DMA should not have the ability to modify such controls. All trades should pass through pre-trade controls before being sent to a regulated market – not doing so is prohibited under MiFID. It is prudent to regularly review clients’ due diligence, and assess whether limits in place are adequate. At intervals which you deem appropriate you should consider whether the trading patterns observed are consistent with the client’s stated trading objectives.

Any monitoring systems employed by firms should be able to separately identify orders received from clients as opposed to proprietary trades, with the ability to immediately suspend or halt one client’s access if required.

Previously we have visited firms who have purchased complex off-the-shelf systems in order to generate alerts, yet alerts were either not reviewed, reviewed in an untimely manner, or there was a failure to escalate any concerns.

Whatever your solution, it has to be appropriate for your business and reviewed on a regular basis to make sure it continues to be fit for purpose.

Education – a focus of Market Monitoring

In 2012 our Market Monitoring team received significant press coverage when we reiterated to firms their obligations under the Suspicious Transaction Report (STR) regime. The STR regime places an obligation on regulated firms to notify the FSA of any reasonable suspicions of market abuse. 

We believe the STR regime has been working well and we appreciate the good quality submission of STRs that we receive from many firms. STRs have become a central pillar of our credible deterrence agenda and we rely on firms submitting good quality STRs to maintain confidence in the financial system.

Notwithstanding this, I wrote to all firms who have the permission ‘arranging deals in investments’ to remind them of their obligations. The purpose of the STR letter, and the letter on layering and spoofing, was one and the same – education.

I will share with you now some of the responses received as part of our STR work. These highlighted the need for us to continue an educational agenda. 

From a firm offering life insurance:

  • ‘For us a suspicious transaction would be if someone took out a policy on someone else and then shot them dead; we’d certainly report that…’
  • ‘STRs? Short trading rules? Please advise and I will provide all the information we have on the subject.’
  • ‘We are a strict agency broker dealing mainly with regulated institutional fund management groups, so perhaps the scope or desire to manipulate prices is mitigated’ – the firm call themselves a ‘boutique investment bank’
  • ‘We do not deal on the basis of insider information or otherwise knowingly commit market abuse’

Within Market Monitoring we wish to attempt to ensure that education is as important as litigation, and the progression of market abuse enquiries. Whilst enforcement outcomes related to market abuse serve as a deterrent and message to the market, we view education as a greater mitigant of market abuse. My message to you is that we are the final line of defence, you are the front line and we are in this together.

STRs and the ESMA guidelines

As I have said, we rely on firms submitting good quality STRs in order to deliver our market abuse agenda. This is very much a partnership and hence we are keen to educate firms so that we can work towards the joint objective of market integrity.

STRs will remain a central pillar of our market abuse enquires. However, as we continually enhance our technology you will receive greater challenge on failure to submit STRs, which in turn will bring your market abuse systems and controls into question. I remind you that firms with systems and controls deemed not sufficient may be subject to either supervisory or enforcement action. We will always be proportionate in our approach looking at the full suite of supervisory tools available, with enforcement reserved for the most egregious cases.

We may seek to visit any regulated firm to help assess the adequacy of the systems and controls in place to comply with both the ESMA guidelines and UK regulation – as we move to more thematic-based supervision, visits of this nature will become a common feature. Whilst we normally expect to give reasonable notice of a visit, on rare occasions we may seek to access premises without notice. The prospect of unannounced visits is intended to encourage firms to comply with the requirements and standards under the regulatory system at all times.

As our STR supervisory focus develops we will question not only the quantity received relative to transaction volumes but the quality and timeliness of STRs submitted. When firms are submitting STRs you should clearly articulate the rationale for deeming the transaction(s) to be suspicious – whether based on abnormal behaviour relative to trading history, or repetitive behaviour. Where firms fail to provide such information we will endeavour to contact firms to understand the reasons for suspicion.

The STR rules, specifically SUP 15.10 state that an STR should be submitted ‘without delay’. We would expect firms to notify the regulator at the point of having reached ‘reasonable grounds for suspicion’, regardless of whether any internal report into the trading was complete. Should a firm wish to continue an internal investigation the FSA is happy to receive copies of final reports, regardless of their outcome. Due to evidential challenges posed from delayed notification we will be looking to discuss with firms where we do not view their submissions as timely.

A point I feel worth reiterating is that the STR regime is not limited to equity products. Perhaps unsurprisingly, the vast majority of STRs we receive are in respect of equity-linked products, but, for example, the bond and commodity markets are just as important, and we would encourage the same level of scrutiny from firms.

Swift Trade

I wish to draw your attention to a case that was recently upheld by the Upper Tribunal – Swift Trade. We fined Swift Trade £8m for knowingly engaging in manipulative trading, in this instance layering. The tribunal described the activity as ‘as serious a case of market abuse as might be imagined’, noting further that ‘this was a prolonged, cynical course of market abuse committed by a company which... exhibited a wholesale disregard of regulatory requirements: it was, in short, a company which acted as if the rules did not apply to it, and modified its behaviour ... only in order that it might carry on doing what it had been doing before, but with better concealment’.

For over one year Swift engaged in systematic and deliberate manipulation – layering on the London Stock Exchange (LSE). This trading was widespread and repetitive involving tens of thousands of orders by many individual traders. We estimate that in 2007 Swift placed 13m orders on the LSE. This trading led to a false or misleading impression of supply and demand and an artificial share price to the detriment of other market participants. The FSA’s view is that such conduct, if unchecked, could undermine market confidence.

Swift Trade placed the large orders in order to give a false and misleading impression of supply and demand. The large orders were not intended to be traded. They were carefully placed close enough to the touch price (i.e. the best bid and offer prevailing in the market at the time) to give a false and misleading impression of supply and demand, but far enough away to minimise the risk that they would be traded. The short life of these large orders, together with their distance from the prevailing touch, effectively minimised any risk that they would be executed.  The trading activity caused the share price to be positioned at an artificial level, from which Swift Trade profited directly (they would buy ‘low’ and sell ‘high’ and therefore profit as a result of the price movements that they had created).

The tribunal found that ‘the trading we have described was deliberate, manipulative, designed to deceive other market users, successful in that aim, and undertaken for motives of profit...   and we have no doubt it was the product of a directing mind’

Swift Trade argued that its trading was not market abuse because its orders were not in shares but in derivatives (CFDs) which were hedged in corresponding orders in shares on the LSE. The Tribunal dismissed this argument as contrary to common sense and market practice, and was satisfied that the derivative orders were placed in the knowledge and expectation that the DMA providers would immediately and automatically match them with hedging orders in shares

This case highlighted the obligation on platforms, DMA providers and firms themselves to ensure appropriate checks and balances are in place. Whilst we decided not to take action against the DMA provider in this instance, we assess each case based on its relative merits. I wish to make it clear that should DMA providers not comply with their obligations we will always consider whether disciplinary actions are appropriate.

Since 2010 the FSA has seen increases in the number of final notices issued in relation to market manipulation. As detection methods become more sophisticated, manipulative behaviour is likely to become ever easier to identify by firms, platforms and the FSA.

We have, since 2010, increased our number of final notices in relation to market manipulation, having issued 14 in total with 11 of these in the last two years.


I hope that you’ll have seen from what I’ve said today that as we move towards the FCA a more pre-emptive and thematic supervisory approach will be taken. The FCA will deliver greater intensity of conduct supervision than that which you have been used to previously.

You should take away from this talk the following key messages:

  • Management of conduct risk is key to the new approach to financial regulation.
  • Cultural change will manifest itself within the FCA and within industry.
  • The supervisory model being developed within the FCA will deliver greater intensity of conduct supervision than that to which you have been used to previously.
  • Education, training and good systems and controls can lead to better conduct.
  • Finally, credible deterrence is here to stay.

We will look to engage with industry where practical, issuing educational pieces on best practice and compliance with relevant regulation.  

My hope is that as the FCA comes into existence it will work closely with industry and consumers in order to achieve better outcomes for retail consumers and ensure market integrity for wholesale market participants.