UK: More Change? Market Abuse Directive Regime

Last Updated: 5 July 2010
Article by Daren Allen, Elisabeth Bremner and Michael McKee

The Market Abuse Directive ("MAD") was adopted as law on 28th January 2003 and was accompanied, in due course, by a number of European implementing measures as well.  Article 17 of MAD provided for review of the Directive once the Directive had been in force for 4 years.  However, as yet, there has been no major published European Commission review of the Directive.

Behind the scenes the European Commission has been collecting information about the operation of the Directive and it is expected to make recommendations for changes to it.  The Commission is holding a major conference on this topic in Brussels on 2nd July 2010 at which Michael McKee of DLA Piper will be speaking.

The main additional material relating to the Directive which has been published since the Directive and the Implementing Measures became law has been three sets of CESR guidelines together with descriptions of certain "accepted market practices".  All of these documents can be found on CESR's website.

Given this relatively limited European material relating to the Directive what aspects of the Directive might be likely to change – and are there other areas which it would be good to look at even if the Commission is not thinking about them?

Extension of Directive to cover derivatives

One of the major consequences of the financial crisis is a deep seated concern about the over the counter nature of derivatives.  This has also been accentuated by recent claims that some of the difficulties experienced with regard to sovereign debt were made worse by banks betting against countries such as Greece and Portugal through taking out credit default swaps against the sovereign risk of such countries.  There does not seem to be any evidence supporting such claims – but given the impact of the European sovereign debt crisis on the Eurozone many countries are, nonetheless, keen to regulate derivatives in many new ways.

One of the objectives agreed by the G20 countries was to deliberately force more derivatives to be cleared centrally and to also encourage more derivatives to be traded on exchanges.  This is to be achieved by amendments to MIFID and a new Directive focused on standards for central counterparties.

A natural corollary of this would be to extend the scope of MAD to cover the trading in some, or all, derivatives.  The Commission's conference contains a session entitled "Ensuring comprehensive and appropriate coverage of derivative markets in the MAD" which is likely to look at this issue.

Extension of Directive to cover MTFs

When MAD was adopted the EU did not have a definition of a "multilateral trading facility"  ("MTF") and the EU was still thinking in terms of exchanges as the place where securities were bought and sold.  Consequently the offences in MAD were focused around the concept of misuse of inside information, or market manipulation, in relation to "financial instruments" and Article 9 of MAD stated that the Directive applied to "any financial instrument admitted to trading on a regulated market in at least one Member State".

Since then the Markets in Financial Instruments Directive ("MIFID") has been passed and this includes a regulatory architecture for MTFs.  A range of MTFs have become active as competitors to exchanges e.g. Chi-X and BATS in European equity trading with Chi-X, for example, taking a significant share of pan-European transactions.

Exchanges, and particularly their trade body, FESE, the Federation of European Stock Exchanges, have been pressing for MAD to be extended to apply to MTFs as well.  The Commission and securities regulators are both understood to agree with this and such an extension is very likely to happen. The Commission's conference contains a session called "Closing the Remaining Regulatory Gaps" which says it will cover questions such as whether the EU should move from a focus on "regulated markets" to a focus on "organised markets" including MTFs.

Improving Enforcement

The EU does not have formal power to set penalties and sanctions for breach of national law – including, in this context, setting penalties for breach of MAD.  When MAD was implemented Member States set down a wide range of different sanctions for market abuse.  Somewhere like Austria, for example, made the maximum penalty a relatively trifling fine.  This contrasts with the UK where an unlimited fine can be imposed for civil market abuse.

In Europe the regulators responsible for policing MAD meet in a sub-committee of CESR.  This is called CESR-Pol.  While they have significantly developed cross-border cooperation since MAD was implemented they find that many of them have to refer action across to prosecutors within their country and that the penalties imposed differ significantly from country to country.

A third session of the conference is entitled "Strengthening the investigative and sanctioning powers of competent authorities."

Insiders Lists

MAD was the first major Directive of the great wave of EU legislation which made up the Financial Services Action Plan.  As a result the EU was still familiarising itself with the securities markets and there are some aspects of the Directive which involve rather vague definitions and rather cumbersome processes.

Article 6.3 of the Directive requires "issuers, or persons acting on their behalf" to draw up a list of those working for them who have access to inside information.  In practice this provision has tended to result in rather cumbersome and expensive requirements to produce lists which are not necessarily, in themselves, particularly helpful to regulators when they launch a market abuse investigation.

In 2007 ESME, the European Securities Markets Expert Group, a body of practitioners created by the Commission, conducted a "first evaluation" of the operation of MAD.  This looked at insider lists and concluded that:

"While the effectiveness of insider lists in preventing market abuse practices remains uncertain, the obligation to draw up such a list has created, in some ESME members' opinion, significant administrative burdens, for larger companies in particular."

ESME recognised the difficulty of changing MAD itself but considered that further convergence through work in CESR might help.  This led to CESR guidelines relating to insider lists.  Arguably, however, this is only papering over the cracks – as there are still differences across member states and the best CESR has been able to develop is a system of mutual recognition which means that the countries with the most onerous requirements for lists still apply their own rules.

The fourth panel in the conference is entitled "Moving towards a single rulebook. Reducing administrative burdens, especially on SMEs."  This panel may look, among other things, at insider lists.

The definition of insider dealing

The ESME report of 2007 identified a problem with the MAD definition of "inside information".  The Directive has a single definition.  Previously EU law had had two tests.  The first applied to issuers of securities and required the company issuing to inform the public as soon as possible of any major new developments in its sphere of activity which were not public knowledge and might lead to substantial movements in the price of its shares.  The second related to insider dealing and defined inside information as information which has not been made public and is of a precise nature relating to issuers of transferable securities which, if it were made public, would be likely to have a significant effect on the price of the security in question.

MAD's definition applies to both an issuer bringing information into the public domain by way of announcement and to the offence of trading on inside information – and its connected offences such as tipping off.

This has posed practical problems for issuers in particular  - and ESME considered that the single definition could actually increase both market manipulation and insider trading.  A major issue is that the definition, when read in conjunction with other requirements in MAD such as Article 6.1 requires issuers of financial instruments to inform the public "as soon as possible" of inside information which directly concerns those issuers.  This means that issuers often are required to issue announcements at such an early stage in developing situations that there is a risk of creating false market expectations and even manipulation. CESR and many national regulators have tended to interpret the obligation in a way which so strongly encourages prompt disclosure that most corporates feel that they cannot hold off announcing information – even when they have not had time to properly evaluate it.

ESME's preference was to return to the position before MAD and have two separate definitions. 

It is understood, however, that the Commission does not consider that such a change is necessary and are unlikely to propose this.  Others, particularly in jurisdictions where the announcements process is very speedy and well policed may well differ.

Overall it appears likely that, at a minimum, there will be legislative changes proposed to the MAD implementing measures – and possibly to the Directive itself.

Experience of the negotiation of the original MAD shows that, in view of its subject matter, it tends to arouse strong views in politicians – who often find it difficult to distinguish between ordinary market participants and those who abuse the market.

Now that the financial crisis has intervened and politicians and the media are even more negative about participants in financial markets there is a real risk that any legislative proposals by the Commission will rouse strong, but not necessarily well-informed, emotions.  Yet again it will be necessary to be vigilant about further financial services "reform".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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