Reading over the media coverage of the Fifth Anniversary of Dodd-Frank this week, made me think about how much things have changed in such a short time -- not just in terms of the massive regulatory overhaul in our capital markets, but particularly in the OTC derivatives markets and how we all do business today.
In recent years, financial markets in the both United States and in EMEA have changed enormously. The markets have become increasingly global, new trading venues, platforms, and products have entered the market, and technological developments, including high frequency trading (HFT), have had such an impact that new rules were written to address their influence.
In the US, the Commodity Futures Trading Commission (CFTC) has broad statutory authority to prohibit and prosecute fraud, deception, price manipulation, and false reporting. And as we all know, the Securities Exchange Commission (SEC) broadly prohibits fraud-based manipulative schemes and even the attempt to use such schemes “in connection with any exchange based swap, or contract of sale of any commodity in interstate commerce.” Both organizations have increased in breadth and influence over the past five years.
CFTC Rules 180.1 and 180.2
are relatively new statutory anti-manipulation powers. These rules prohibit any person, directly or indirectly, in connection with a swap, sales contract for any commodity, or any futures contract or related option to “intentionally or recklessly”:
- “Use or employ, or attempt to use or employ any manipulative device, scheme or artifice to defraud”;
- “Make, or attempt to make, any untrue or misleading statement of a material fact or to omit to state a material fact necessary in order to make the statement made not untrue or misleading”;
- “Engage, or attempt to engage, in any act, practice, or course of business, which operates or would operate as a fraud or deceit upon any person”; or,
- “Deliver or cause to be delivered, or attempt to deliver or cause to be delivered, for transmission through … any means of communication whatsoever, a false or misleading or inaccurate report concerning crop or market information or conditions that affect or tend to affect the price of any commodity in interstate commerce, knowing, or acting in reckless disregard of the fact that such report is false, misleading or inaccurate.”
CFTC Rule 180.2 re-codifies the Dodd-Frank Section 753 prohibitions on price manipulation and attempted price manipulation in connection with swaps, cash commodity transactions, and futures (and related options).
In the European Union, there have been other massive changes. First, we have the adoption, in April 2014, of the new Market Abuse Regulation
(MAR) as well as a new directive on criminal sanctions (MAD II, also known as the Criminal Sanctions for Market Abuse Directive or CSMAD). MAR and MAD II will become applicable for most purposes in July 2016. MAR will extend the coverage of civil market abuse rules to a wider range of markets from July 2016, and MiFID II will extend and strengthen many conducts of business rules from 2017.
This particular regulatory action has created significant changes in trading culture. Many financial firms have upgraded their internal guidance and training programs on acceptable trading practices. And, in the United Kingdom, the Banking Standards Board has been established by leading firms to promote high standards of behavior and competence across the UK banking industry.
Market participants have also invested in larger compliance teams and are starting to develop more sophisticated forms of electronic surveillance of their own staff’s trading and broader behaviors. Market participants report early signs of a greater willingness on the part of some firms to be open about the reasons for disciplining those found to have engaged in misconduct.
Whistleblowing arrangements have been strengthened at several firms. And regulators will have access to progressively larger amounts of transaction data in many markets over the coming years from new reporting requirements under EMIR, MiFID II and other new regulations.
The scope of the MAD II covers a greater variety of financial instruments (in line with the MiFID II reform) and other trading venues and to add new definitions of inside information seeks to adapt the EU rules to the new market reality and new technologies.
As these rules take shape and are rolled out, further analysis is required to determine if the transparency in these markets and increased regulations have been effective tools, or whether they will need fine tuning or further expansion. We need to be sensitive to liquidity levels and market participants adapting to this framework. I believe that increased fines and introduction to criminal proceedings in EMEA for misconducts and intentional manipulation should encourage market participants to take this very seriously and pay even greater attention to the regulatory overhaul and its impact on their institutions.