INTRODUCTION
In this response, the Financial Regulator sets out various questions included in the text of the call for evidence and responds to each of those in turn. Where the Financial Regulator wishes to respond to a comment by the Commission, rather than a question, the relevant text is first quoted.
Section 1.2. Objectives and Scope of this report
The second paragraph of this section states that the “issue of supervisory and enforcement powers under the MAD is not being addressed in this document”.The Financial Regulator would ask the Commission to reflect further on the extent of this deferral given that there are certain evident issues relating to supervisory and enforcement powers which could be considered as part of the current review of the MAD by the Commission. These do not necessarily involve the imposition of additional administrative burdens on firms; the bulk of these issues involve the clarification of the legislative provisions to improve their enforceability.
Section 2.1. The Scope of the MAD
Subsection 2.1.1. Only regulated markets?
The analysis set out in this section in terms of the scope of the MAD concludes by asking:
“Do you consider that the scope of the MAD should go beyond regulated markets? In particular, should it be extended to cover MTFs?”
The key issue to be considered is whether issuers should have an option of raising capital from investors without having to comply with the regulatory obligations which apply when a company’s securities are admitted to trading on a regulated market. While it is desirable from a public policy perspective that smaller companies should have access to equity capital at as low a cost as possible, it is not clear that all investors are well placed to assess the higher risks involved if the protections provided for in the MAD for Regulated Markets do not apply. In other words, it is difficult to see why, if the protections are necessary for some markets, they would not be appropriate for all. In addition, the absence of these protections on some markets may distort behaviour and lead to regulatory arbitrage. On balance, therefore, the Financial Regulator is of the view that the scope of the MAD should be extended beyond regulated markets to include MTFs given their growing importance in the overall trading volumes in financial instruments and the similarities between the kinds of investors on Regulated Markets and what are sometimes called ‘junior markets’. Such an extension to the scope of the MAD would support the integrity of markets and a level playing field between regulated markets and alternative trading platforms. It should also facilitate the further development of the single market by supporting clarity for issuers who seek admission to trading on more than one market. It would be important that an appropriate transition period be provided for to allow issuers to make the necessary changes.
In the context of the additional obligations we are proposing for issuers further on in this response, we believe that CESR should be asked to consider whether listed investment funds should be excluded from the obligations on the management of inside information.
Subsection 2.1.2. What kind of financial instruments should be covered by the MAD, especially in comparison with the MiFID?
The analysis set out in this section in terms of the financial instruments covered by the MAD in comparison to those covered by the MiFID concludes by asking:
“Do you agree with an alignment of the MAD definition of financial instrument to the definition for the same concept provided for in MiFID? Do you think it could be useful to explain in more detail in the MAD what is meant by a financial instrument "whose value depends on another financial instrument" or to list asset classes, such as CFDs and CDS, which belong to this category?”
The Financial Regulator supports the proposed alignment of the MAD definition of financial instrument with the definition of financial instruments provided for in MiFID, which is significantly broader in scope. A non-exhaustive list of asset classes should be included.
Additional Issue for Consideration not addressed in Call for Evidence
Article 6 of the Directive requires issuers of financial instruments to inform the public as soon as possible of inside information which directly concerns the said issuers. In light of this provision, investors expect timely disclosure. The Financial Regulator has concerns about the practicality of enforcing this requirement unless individual culpability also attaches to individual persons within the issuers who take the key decisions in relation to what to disclose. TheCall for Evidence does not address the issue of extending culpability for failure to meet these obligations beyond that of the issuer to some of the persons defined in Article 2 (1)(a), i.e. persons who hold membership of the administrative, management or supervisory bodies of the issuer. Only those persons who do or should take the key decisions should be culpable. It should be open to issuers to specify who those persons are in order to limit individual culpability. We acknowledge that there would be an increase in Directors and Officers Liability Insurance, if this measure were introduced, and that should be taken into account in considering the matter. .
Section 2.2. Inside Information
Subsection 2.2.1 Definition of inside information: the general definition
The definition of inside information, as set out in the analysis, refers to “some qualitative and potentially abstract concepts like information of precise nature, not made public, or one which is considered as having an impact on market prices”, and states that “there does not seem to be a need to revise the concepts used to define inside information for MAD purposes”. The following question is then posed:
Question: Do you share this view as far as insider dealing prohibition is concerned? (see also next point for disclosure of inside information). If not, which concepts would you advise to modify and how?
The Financial Regulator does not share this view. Regulators tend to adopt the stance that information may be precise within the meaning of the definition, even though there are aspects of it which are not specifiable. There is also an argument that over time jurisprudence will emerge to clarify the position. However, the use of the word “precise” in the definition in Article 1 of the MAD does imply a test of precision and seems open to interpretation by Courts in too restrictive a manner, as there is a variety of information not of a “precise” or numerical nature which may impact on market prices. We are not convinced that the correct course is to await court decisions because regulators are obliged to anticipate the difficulty and modify their approach accordingly in order to make the most efficient use of their resources.
We therefore recommend that the word “precise” be removed from the general definition of inside information and the definition be rephrased so that it states that the information should be specific enough for it to be likely, on the balance of probabilities, that a definite view (which need not prove correct ex post) could be formed by a reasonable investor, who has come into possession of the information, about its probable impact on prices.
We have considered whether this could lead to rumours which come to the attention of the issuer being treated as inside information and we do not believe that it would. However, if this is a widespread concern, the matter could be dealt with by specifically excluding rumours from the definition. Issuers are not currently required to correct false rumours, and it would not be correct to require issuers to contradict every rumour in the market and any change should be so drafted so as not to have this consequence. We have also considered whether this would lead to premature disclosure of, for example, the state of play in relation to potential future initiatives, prior to such developments becoming a concrete item of information. If that were to happen, it could lead to a false market developing. We believe that the commercial incentives on issuers will tend to push them in the opposite direction. Consequently, false markets are unlikely to be caused by modification of the definition as suggested, provided that the concept of specific information as defined is retained. Were they, nevertheless, to occur, such false markets could quickly be dealt with by further disclosures.
We would emphasise, however, that there appears to be broad satisfaction in the market with the current definition and any such change should be preceded by full consultation.
Subsection 2.2.2. Dissemination of inside information and deferred disclosure mechanism
Section 2.2.2.1 The analysis set out in the first part of this section in respect of the general obligation of disclosure of inside information concludes with the question:
“Do you consider that any changes to the definition of inside information for disclosure purposes is necessary?”
The Financial Regulator believes the considerations it has set out above apply in this case also and that there should be only one definition of inside information..
The analysis set out in the second part of this section in respect of the deferred disclosure of inside information mechanism concludes with the questions:
“Do you agree that the described deficiencies of the deferred disclosure mechanism need to be addressed, possibly by way of amendments to the MAD framework? Do you consider that Level 3 guidance could be sufficient?”
The Financial Regulator accepts that there is significant uncertainty among market participants about the circumstances in which disclosures can be delayed and is of the view that the described deficiencies of the deferred disclosure mechanism should be addressed by way of amendment to the MAD framework to deal with the matters set out by the Commission; Level 3 guidance would be insufficient.
“Do you agree that the issuer may be exempted from disclosing inside information in situations when that information concerns emergency measures being prepared in case the issuer’s financial stability is endangered?”
The Financial Regulator supports this proposed exemption and believes it should be clear that the exemption applies both to the emergency measures and the circumstances giving rise to those measures. Appropriate protections against mis-use should be included.
We have considered whether the condition on deferred disclosure that the issuer be able to “ensure” the confidentiality of the information, may be excessive. We do not have evidence of cases where disclosure has been made prematurely because the issuer was not satisfied that it could definitely control, for example, all the employees of advisers who had knowledge of the information. If there were evidence elsewhere of this happening on any significant scale then it could justify a moderation of the condition.
We believe the reference to ‘informing the public’ in Article 6.1 should be replaced by ‘make public’ in order to be consistent with Article 1 and that the reference in Article 6.2 to “mislead the public” should be replaced by the phrase “mislead users of the market” for the same reason. The clear intent of the MAD is to prevent investors and potential investors being misled, but the existing text does not accurately reflect that.
Subsection 2.2.3.Prohibition of insider dealing
The analysis set out in this section concludes by stating that there is merit in considering the ECJ preliminary ruling before the services of the Commission envisage measures that would seek to clarify the apparent divergence of the two approaches and concludes with the question:
“Would you support this approach?”
The Financial Regulator supports the Commission’s proposed approach. Depending on the outcome of the ECJ preliminary ruling, the Financial Regulator would favour the first approach articulated in this section in respect of the concept of “using inside information”. An amendment to the MAD should be made if this proves most effective to achieve a common approach across the EU.
Subsection 2.2.4 Three new tools to help detect suspicious transactions
Section 2.2.4.1. Insider ListsThe analysis set out in this section concludes with the question:
“Do you consider that the obligations to draw up lists of insiders are proportionate?”
While insider lists have proven of limited value, the Financial Regulator believes that further reflection is required before any change in this area is undertaken. The manner in which inside information is handled is critical to market transparency and the ability to check on trading by ‘insiders’ is an important regulatory tool. It is not a question of whether insider lists are ‘proportionate’. It is a question of determining how best to ensure that the circulation of information within issuers is capable of being investigated and that regulators can identify suspicious transactions. The ‘insider list’ approach should be assessed by contrast with a specific alternative which would have the prospect of delivering more precision with regard to who knew what, preferably at a low cost. Industry should be fully involved in devising an alternative, which should have regard to the tracing capabilities of modern record management systems. In assessing options, appropriate weight should be given to the fact that the ‘insider list’ system is now well established. It may be that options should be available at issuer’s discretion so that they can choose the option that is most cost effective for them while delivering information to regulators that meets a standard defined in legislation.
Section 2.2.4.2. Transaction reporting by managers and closely associated persons and subsequent disclosure
The analysis set out in this section suggests that certain improvements and clarifications in respect ofthe transaction reporting and disclosure mechanism for managers and closely associated persons may be necessary inorder to improve legal certainty and concludes with the question:
“Do you see a need for a regulatory action in the above areas? Would you suggest further improvements?”
The Financial Regulator agrees that some changes in respect of this mechanism may be desirable in order to ensure legal certainty. The Financial Regulator would suggest that consideration be given as to whether the issue of grants of security over shares by persons falling within the scope of Article 6(4) should be included in the reporting/disclosure mechanism. We are currently considering whether to propose an initiative at member State level on this point. We would prefer that there would be a common approach throughout the EU on this point.
It is unclear to us why directors would be engaging in small transactions in shares of their own company. However, the inclusion of the figure of €5,000 (Article 6(2) Directive 2004/72/EC) as the lower threshold for disclosures seems too specific and rigid and we believe the threshold figure should be set by CESR and subject to periodic review by it. CESR should have the option of specifying an annual cumulative threshold which would trigger retrospective disclosure to the market of each constituent transaction. This would prevent manipulation of the lower threshold figure. CESR should also be asked to consider whether the obligations on managers to notify transactions should extend to service providers to listed investment funds, including investment managers, and to unlisted mutual funds or whether the Directive should be clarified to exclude them.
Section 2.2.4.3. Reporting of suspicious transactions
The analysis set out in this section suggests that reporting of suspicious transactions couldbe further enhanced by making it approximate a whistle blowing measure and concludes with the question:
“Do you agree that rules on suspicious transactions reporting do not require modifications?
The Financial Regulator is of the view that the suspicious transaction reporting mechanism would be significantly enhanced by making it approximate a whistle blowing measure. Market abuse is notoriously difficult to investigate and the incentives for persons to cooperate with investigators are limited. It should be possible for regulators to publish and operate schemes under which persons may avoid sanction for breaches of market abuse law in return for cooperation with the investigation of such breaches. It should also be possible for persons to receive limited employment protection where they disclose information concerning breaches of securities law by their employer or others.
Subsection 2.2.5 The competent authorities’ right of access to telephone and existing data traffic records
The analysis set out in this section suggests that it may be necessary to amend the MAD and/or the e-privacy Directive in order to remove any uncertainties on the rights of competent authorities to require telephone and data traffic records in the course of their proceedings against market abuse and concludes with the question:
“Do you consider that an amendment of the MAD is necessary?”While an amendment of the MAD may or may not be necessary, the Financial Regulator is of the view that it would be desirable to ensure certainty.
Additional Issue for Consideration not addressed in Call for EvidenceThe Call for Evidence does not address the issue of requiring issuers to maintain appropriate records and procedures in relation to the identification and handling of potential inside information. The Financial Regulator is concerned that the market abuse framework does not require the issuer to maintain clearly documented systems and controls and proper records in respect of their procedures for identifying whether information in their possession is inside information and whether changes in their circumstances would give rise to situations where an announcement to the market should be made. Regulators should have the power to impose rules in this regard on the market and directions on individual issuers.
For this to work effectively, Regulators would need the power to regulate the handling of potentially inside information by issuers. To achieve that, the Directive would need to be amended to include a concept of ‘potentially inside information’, i.e. information which has characteristics of a general, commercial or strategic significance for the issuer such that it is information which should be formally assessed to establish whether it is - or with the passage of anticipated events would be likely to become - sufficiently relevant to the market for it to meet the definition of inside information. Once again, it is important to emphasise that this definition should not cover market rumours and the definition should be so drafted as to explicitly exclude such rumours.
Section 2.3. Market Manipulation
Subsection 2.3.1 Definition of market manipulation by transactions/orders to trade
The analysis concludes that the definition seems to operate well and that a broad definition and broad concepts are necessary to embrace all the different types of manipulation. As a consequence, the analysis concludes that no legislative change is envisaged and raises the question:
“Do you think that the definition of market manipulation should be amended? If this is the case, what elements of the definition should be reconsidered?
The definition of market manipulation talks about ‘securing’ the price at a certain level. This imposes too high a standard given the variety of influences on the price of a security. While the manipulative action may influence the price, it is always going to be very difficult to show that it ‘secured’ the price at any level. Market manipulation can have taken place without the price having been secured at any given level. Consequently, the Financial Regulator is of the view that the word ‘secure’ should be replaced by a less prescriptive term.
The Financial Regulator is also of the view that there is an apparent gap in the definition of market manipulation in Article 1(2)(a) which should be addressed in order to enhance the market abuse framework, namely that an attempt to secure the price may not count as market manipulation if it fails or, for example, if a broker, concerned at possible manipulation, refuses to execute an order.
Combining these two points, the suggested amendment to the definition is as follows: “….which affects or attempts to affect, by a person, or persons acting in collaboration, the price of one or several financial instruments towards an abnormal or artificial level”.
Additional Issues for Consideration not addressed in Call for Evidence
(i)The Call for Evidence does not address the issue of requiring relevant persons holding a MiFID authorisation (i.e. investment firm, credit institution, issuer or persons concerned in their management) to maintain appropriate records in relation to the handling of market rumours. The Financial Regulator is concerned that the market abuse framework does not require persons to maintain clearly documented systems and controls and proper records in respect of supervising staff handling market rumours in order that individual staff members, while keeping clients informed of developments, do not inadvertently or carelessly circulate or exaggerate unlikely rumours. Regulators should have the power to impose rules in this regard on the market and directions on relevant persons.(ii)The MAD (Article 6(5) 2003/6/EC) includes provisions that recommendations concerning shares cannot be published on an anonymous basis. The Financial Regulator believes that this introduces a doubt which creates an artificial basis for avoidance of the underlying intention of the Directive. It is possible on an anonymous basis to publish an assessment of the commercial position of a company and a review of its share price movements and, provided that there is no 'buy'/'sell', the issue of whether the ban on anonymous recommendations applies remains debatable. While institutional investors will not be susceptible to this kind of device, retail investors are unlikely to be sensitive to the absence of a formal buy/sell recommendation. The Financial Regulator believes that the publication of commentary on an anonymous basis is inappropriate. We recognise that commentary may be made on the internet on an effectively anonymous basis as part of internet chat. To exclude this from the proposal we believe that the ban on publishing anonymous research on the commercial standing of a company or the performance of its shares should be confined to situations where the research is sold.
Subsection 2.3.4. Short selling
The analysis set out in this section, recognising the ongoing global debate on short selling, concludes that a more harmonised approach on short selling measures could eliminate undesirable regulatory arbitrage between Member States and sets out a number of issues for consideration by asking the following questions:
“Do you see a need for a comprehensive framework for short selling? If so, should it be addressed in the Market Abuse Directive? What issues should such a regime cover? Should short sellers be required to report positions to competent authorities? Under which conditions should naked short selling be allowed? Should competent authorities be able to take emergency measures (e.g. temporary bans on short selling or on naked short selling) within prescribed limits when they need to address specific market risks and disruptions”?
The Financial Regulator will provide its views on this matter within the context of CESR.
Markets Supervision Department