The FCA has previously conducted thematic reviews on asset management firms and the risk of market abuse, though a thorough follow-up review has not occurred since the original publication in 2015. Based on recent observations and client examples, and as part of our wider insight series on tackling market abuse (see Tackling market abuse: Blocking threats for brokers), we’ve identified several common risks asset managers are facing.

Knowledge of trading strategy

Unlike brokers, asset managers have the advantage of knowing the context or rationale for trading strategies or instructions. Whether this is information held within an order management system or detailed within the minutes of an investment committee meeting, the surveillance team at asset management firms should be able to access and review the rationale for trade instructions.

This is an important tool when it comes to effective surveillance. The surveillance analyst can compare the rationale against the actions taken and consider whether there is any divergence, which could be indicative of suspicious activity. For example, if the instruction stated “price has been on the rise, and selling now whilst the market is active” the analyst should look to verify the claim. Where this cannot be substantiated, this could be indicative of other (perhaps suspicious) reasons for the trade.

Keep in mind that rationales along the lines of “building position following a successful meeting with the issuer” should act as a prompt to review the recording or minutes of said meeting.

Rationale can also act as a prompt for reviews of communications surveillance. Some asset managers meet with senior individuals of issuers to consider investment opportunities. Such interactions are inevitably high risk for unlawful disclosure.

Surveillance analysts should keep in mind that rationales along the lines of “building position following a successful meeting with the issuer” should act as a prompt to review the recording or minutes of said meeting and consider whether any inside information may have been leaked.

A chosen trading strategy and business model is also very important when considering the impact an asset manager could have on a market. Realistically, the typically retail individual does not trade in volumes large enough to move the price of a financial instrument (unless they’re trading exceptionally large amounts and/or they’re trading in micro-cap or small cap instruments).

But an asset manager is likely to be trading in volumes far higher and could be in a position to move the price of a small or medium cap stock. Price movements of large cap stocks may also be possible for the largest asset managers if the trade is large enough and liquidity levels permit.

To mitigate the risks arising from these scenarios, asset managers should ensure surveillance parameters take into account the characteristics of an asset managers trading strategy.

Market soundings

On the topic of insider trading, asset managers may also need to contend with the market soundings regime. Market soundings allow issuers to gather information on investor interest, opinions and price discovery. Asset managers are often targeted as their significant buying power can give useful insight into the market’s pricing expectations.

Despite a well-established regime in the UK, many asset managers are still falling foul of the rules. As described in its Market Watch 75, the FCA has observed many firms failing to establish strong controls to prevent them from trading in the particular issuer during a market sounding event.

Specifically, the FCA found that firms were trading in an issuer during the “consent” stage of the market sounding. Whilst the market sounding had not been communicated at that stage, with enough information, the FCA found that one could infer information and trade in advance of the sounding. If timed correctly, this could be financially advantageous, though runs the risk of amounting to insider trading.

Many asset managers do not want to engage in market soundings as they can place restrictions on their trading activity.

Asset managers may also suffer from inadvertent market soundings. Many asset managers do not want to engage in market soundings as they can place restrictions on their trading activity. Nonetheless, and despite warnings messages, asset managers can still be affected by incoming communications which reveal a market sounding without there having been a desire from the asset manager.

Even with the most effective controls, there is little to prevent someone contacting a firm and stating “I have some positive news about issuer X and a new issue they’re planning to launch in response to their upcoming successful end of year figures. Would you like to know more?”. Asset managers are then forced to restrict trading on the issuer despite never having asked for the information.

Top tips for asset managers therefore include:

• strong controls over access to inside information and managing unlawful disclosure;
• identifying where you may receive inside information incidentally and establishing preventative and detective measures;
• strong trade and communications surveillance to identify where inside information may have been leaked or traded upon.

Training

Asset managers should also ensure they’re dedicating sufficient effort to deliver relevant training to the business. As described above, the trading strategies of an asset manager will differ from the behaviors seen at a brokerage firm. Staff need to ensure they receive relevant and tailored training that includes real-life scenarios from the asset manager daily activities. This could include:

• covering the typical investment decision making and trading strategies used by portfolio managers and trading desks;
• understanding how the MAR behaviors apply to asset managers, with a focus on those that are of most relevance to the company (which will be leveraged from the MARA);
• training on the awareness needed to identify where inside information has been received inadvertently, along with guidance on how this should be handled (no further disclosure) and notified to the relevant individual or teams (usually compliance or a set “gatekeeper(s)”.

Training should also be provided to surveillance teams that allow them to better understand the suspicious scenarios that may arise for this business model.