Market abuse risks for the buy-side not limited to insider dealing

At a recent market abuse event it became obvious that the general feeling in the room was that market manipulation risks are not the primary concern for many asset managers. Although insider dealing was seen as the main market abuse risk for buy-side firms, the risk of market manipulation should be treated just as seriously.

Ability to manipulate prices

Buy-side firms have historically been seen as users of markets but over the last few years they have increasingly been able to directly impact the price formation process and, with it, the potential to create a false and misleading impression of trading interest.

A significant percentage of asset managers are now direct market participants on trading venues, mainly multi-lateral trading facilities but some regulated markets too. In addition, with the advent of direct electronic access, asset managers can directly route orders to a wide variety of markets, including via the use of algorithmic trading.

The ability to manipulate prices can also come through the usage of non-binding Indications of Interest (IOI) messages, misuse of Request for Quote functionality, conditional orders and “off-venue crosses” and so, it becomes clear that the risk of market manipulation exists quite broadly at inherent level. Lastly, the ability to release false and misleading news is there for any market user.

Motivation

Where clients and funds sit on large positions (long or short) there can be a heightened focus on whether the positions are showing a paper profit or loss, and this focus can intensify on key dates and at year end.

Market manipulation at year end

An interesting market abuse case involved Stefan Chaligné, a fund manager, and Patrick Sejean, a trader, who bought shares minutes before Chaligné’s lviron Fund was to be valued. The value of the fund was artificially inflated and Chaligné’s performance fee boosted by more than £260,000.

Sejean emailed the following to an unnamed colleague shortly after speaking to Chaligné: “Please buy in the last hour of trading …The goal is to put each stock price as high as possible at the close, so if you want you can buy most of the volume at the close.”

The purchase of shares on New Year’s Eve resulted in a 2.9% uplift in the value of the £70m fund at year end. The UK’s regulator fined Mr Chaligné (the fund manager) £900,000 plus €362,950 disgorgement of benefit (profits gained from the manipulation). Lastly, the fund manager was deemed not a fit and proper person and was banned from performing any regulated activity.

Although this case, from 2013, highlights the importance of trade and communications surveillance, importantly, the fund manager could now independently use direct electronic access to transmit orders directly to the market.

Market abuse risk assessments

While it’s impossible to eliminate all risks, some market manipulation risks can be reduced through using centralised dealing desks and having a robust market abuse control framework in place.

Conducting up-to-date and periodic market abuse risk assessments will help a firm identify the risks and ultimately help mitigate them where possible.  It also demonstrates to internal audit and risk management teams, as well as regulators that a firm has the correct risk assessment policies and procedures in place and is doing all it can to reduce the risk of the firm committing or facilitating market abuse.

• For more information on Kaizen’s Market Abuse Risk Assessment Framework or proprietary surveillance solutions, please contact us.