Market Abuse Regulation (MAR) took effect across the European Union in July, replacing the previous Market Abuse Directive (MAD) regime on insider trading and market manipulation.
Intent is the focus of the MAR regime, which covers abusive practices including suspicious orders and activity. MAR brings technological innovations and new trading practices like high-frequency trading (HFT) and algorithmic trading into scope. Designed to improve confidence in the integrity of the European markets, MAR increases investor protection and awareness by mandating greater transparency in all activity, including all market orders whether they are transacted or not. MAR establishes substantial EU-wide investigatory and sanctioning standards to empower authorities in their effective process and prosecution of infringements, and it carries substantial monetary and punitive sanctions across a coordinated regime of criminal offenses.
But, while MAR is based in and targets banks in the EU, it is not without ramifications for those outside the Union. MAR’s implementation has the capacity to directly and indirectly impact financial institutions all over the world. Here are the some of the ways it could do that.
Effects on Liquidity and Transparency
The interplay between the MAR and the Markets in Financial Instruments Directive (MiFID II) regimes is intentional, as they strive to strengthen market integrity by improving transparency and investor protection. However, financial stability requires more than just improved integrity; it requires investor confidence in market liquidity. Reliance on accurate market data free of manipulation, abusive practices and intentionally misleading information is critical to liquidity and ultimately to the stability of increasingly interconnected global markets.
MAR expands market abuse rules to new instruments on existing regulated exchanges and the over-the-counter (OTC) market for derivatives, as well as expanding scope to new multilateral trading facilities (MTF). MAR’s scope expansion includes derivatives, benchmarks and spot commodity contracts covering all instruments whose value depends on, is derived from or has an effect on the price or value of another financial instrument traded on a relevant venue. Building on MAR, the MiFID II regime further extends to instruments admitted to organized trading facilities (OTF), small and medium-sized enterprises (SME), growth markets and ESG emission allowances (that establish a minimum threshold of carbon dioxide equivalent and rated thermal output, for example).
Implications for the U.S. Market
The combined MAR and MiFID II effect on liquidity cannot be overstated, given they effectively expand the notion of an exchange and will require all fixed income instruments and derivatives to be traded on a relevant exchange. Although most fixed income instruments are listed on an exchange, historically most do not trade on their exchange; rather, they usually trade directly from dealer to investor or via a third-party platform or, increasingly, between investors directly. At nearly $40 trillion, or 57 percent of the global total, the U.S. fixed income market represents the world’s largest fixed income market, according to the Bank of International Standards (BIS). Given the expanded instruments scope of MAR across fixed income, derivatives, benchmarks and spot commodity contracts and the sheer size and activity of the U.S. markets, every market participant — whether inside or outside the EU — must now monitor the instruments it trades to verify whether MAR applies.
Evolving Trade Strategies
Market manipulation can pose systemic financial risk and, considering the interconnectedness of the markets, foul-play in the EU could easily become a contagion on the world stage. New trading strategies, instruments and data sets represent new opportunities for manipulation, which MAR hopes to mitigate to the benefit of all.
For example, benchmarks — particularly in fixed income, currencies and commodities — have implications for most financial instruments, including derivatives. Manipulation of benchmarks seriously undermines market confidence and may result in significant losses to investors or distort the real economy.
Algorithmic and high-frequency trading platforms have also been used to manipulate markets in the past and can create an abusive effect through the placing of orders to a trading venue which disrupts or delays the functioning of the trading system.
To the extent that the use of new technologies with susceptibility to any manipulation continues to increase, the entire financial system is at risk. MAR seeks to protect all working markets from these types of abuses, not just those in the EU.
Financial Regulatory Reform
The modern financial regulatory regime is extraordinarily complex, constantly changing and cross-jurisdictional. Banks, brokerages, asset managers and funds today require unbiased outsourced risk and regulatory reporting solutions and services. Regulatory focus on transparency and greater accountability requires firms to take a more strategic, integrated approach to compliance.
Historically, no single regulator saw its job as protecting the economy and financial system as a whole. Today, regulators taking a broad view are instituting new rules-based and capital-based reform packages designed to restore confidence in financial markets, protect participants and promote more transparent risk management processes. The convergence of regulations and risk management is transforming the way supervisory and oversight bodies function.
Regulatory emphasis on establishing an industrywide liquidity risk management framework of minimum adequacy standards and new disclosures and reporting requirements is illustrative of this view. MAR’s focus on these issues is a framework for compliance that fits not just its specific model, but the shifting philosophies of regulation required by the modern world.
Data Governance
MAR compliance necessitates that financial firms implement a flexible, integrated, multi-asset class research management solution for investment recommendations disclosures of interests and conflicts of interest. Integrating research with client data is the key to compliance.
The technology infrastructure used to more effectively manage data should cover the complete range of asset classes, including fixed income, equity, FX, commodities and derivatives. Consideration must also be given to the security of the CRM and management reporting options used, as the configuration of taxonomy that allows organizations to comply with any potential regulatory updates or client requests.
Turn the Challenges of MAR into Competitive Advantages
MAR requires financial firms arranging transactions and providing investment recommendations to do so in an objective and transparent manner, disclosing all interests and conflicts of interests. It also requires effective arrangements, systems and procedures for identifying insiders and surveillance of suspicious orders, activity and transactions. Although MAR does not specifically require new automated technology, we believe it is crucial. Connecting existing inefficient and disparate systems into an efficient, dynamic, integrated system is a difficult challenge, but it is critical to regulatory compliance, complete and accurate information, better risk management and better trading decisions that ultimately lead to greater profits.
Commitment to technological innovation is evidenced by a distinct cultural embrace from financial firms which see past the regulatory “letter of the law” to the strategic, long-term “spirit of the law” effecting positive behavioral changes in conduct around a consistently client-centric model. A corporate cultural shift starts at the top and cascades down, opening new pathways of innovation throughout the firm.
Implementing an integrated research management solution can provide enhanced data governance like this and allow those impacted by the implementation of MAR and MiFID II to make better trading decisions, smarter investment recommendations and increase profit potential.
Francis Reed, Jr. is an experienced capital markets professional with extensive fixed income trading, structuring and sales expertise at top-tier investment banks like Morgan Stanley, UBS, Lehman Brothers and Barclays Capital. Presently, Fran is a global regulatory strategist at FactSet Research Systems. Fran is an industry author and speaker on topics including debt capital markets, financial regulatory reform, housing reform and public policy matters. Over his career, Fran has managed institutional trading and sales teams for large complex investors like the U.S. Government Sponsored Enterprises (GSEs), European Supra, Sovereign and Agencies (SSAs), central banks, commercial banks, hedge funds, insurance companies and asset managers.
