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Acting as a vital access point to financial services for retail customers, wealth managers, investment managers, and financial advisors may face the market abuse risks present for other groups such as brokers and asset managers. Indeed, firms in the financial sector still face challenges with information barriers to prevent unlawful disclosure of inside information, adequate surveillance, and appropriate governance structures. Despite this, wealth and investment managers also face their own unique challenges that are worth being aware of if you want to put adequate solutions in place.
In recent years, this sector has faced several regulatory challenges in response to the Consumer Duty rules. Setting higher standards for financial services primarily focuses on the support, pricing, and information customers receive for services and products. However, it also indirectly leads to greater market integrity. Clients who are fully informed of the investment risks they face are better placed to make informed investment decisions, which in turn can lead to better and clearer trading practices. The market abuse regulations align here, also seeking to improve market integrity and investor protection.
Varying investment and advisory services
Brokers offering execution only services may have little or no insight into the client rationale, whereas asset managers will have that information from their investment makers (portfolio manager and/or investment committees). Wealth and investment managers and financial advisers will likely face both if they offer a variety of services. It’s not uncommon for firms to offer a combination of, or all, execution only, advisory, and / or discretionary investment management services.
As a result, you should consider the specific market abuse risks arising from these services. More importantly, review the effectiveness of systems and controls in place preventing and detecting market abuse across all these services and be prepared to establish bespoke controls for each service. You may find that a particular control is only effective for one business line, but not the remaining, therefore requiring a range of tailored controls to address the specific risks.
For example, a firm’s surveillance investigation checklist for a discretionary investment trade may consider different factors than those arising from an execution only trade. Similar to brokers, without knowledge of the rationale, the surveillance analyst may need to further consider why a trade was placed – something that’s less challenging under a discretionary investment model.
Ensure you’ve appropriately identified market abuse risks per business line and establish effective controls, with bespoke controls per business line where needed. The control framework should stem from your market abuse risk assessment, which itself should assess the specific risks arising from each business line.
Proprietary positions
If you’re also taking a proprietary position, additional controls are needed to avoid conflicts between the proprietary team and the client facing team. Front running (trading ahead of a client investment) is a real risk here if information barriers are not appropriately established.
Governance structures should also be put in place to prevent individuals from having undue influence over both the proprietary and client positions. Without strong controls, an individual could be at risk of influencing a client’s investment decision, especially if there’s a discretionary mandate in place, to the benefit of the proprietary position. For example, an aggregate client and proprietary trade could now be large enough to benefit from decreased brokerage rates, despite the trade not being most suitable for the client.
Firms managing proprietary and client positions should consider:
- whether to split client and proprietary orders to avoid commercial conflicts arising from bulk orders
- the information barriers in place to prevent proprietary orders front running client orders
- if senior individuals overseeing both business lines need to recuse themselves from investment decisions to avoid and/or manage conflicts
- whether there’s a potential for clients to disclose inside information, accidentally or otherwise, which could lead to insider trading for the proprietary position.
Firms that have asset management and investment management business lines will certainly need to give considered thought to these risks, especially if you’re providing advisory services or taking discretionary investment decisions to investment in your own funds provided by the asset management business within the wider group.
PA dealing and in-house research
If you conduct in-house research to inform advisory or discretionary decisions, you could face PA dealing risks where inadequate controls exist. This is similar to the front running risk posed by proprietary positions, as where a firm’s research team isn’t segregated from the client facing team there’s a risk that PA dealing requests from employees will arrive in advance of client orders. This is the case whether it’s under a discretionary mandate, or from a client order following financial advice. In either case, the employee could anticipate that the client order(s) will impact the price of the financial instrument, especially if the investment mandate applies to multiple clients and an aggregated order is placed and seek to benefit from the subsequent price move.
Strong PA dealing controls can counter this risk, including:
- regular training on the PA dealing processes, for example when notifications and pre-approval is required
- regular training on market abuse and the links it has to PA dealing
- pre-trade notification processes and accurate records of all PA deals requested, approved, and declined
- accurate records of contracts notes to validate client PA deals
- PA dealing monitoring, for example comparing contracts notes compared to original PA dealing requests.
How can Bovill Newgate help you navigate market abuse risks?
Our specialist team can help you manage any market abuse challenges and can set up processes to help you spot any risks on the horizon. Our advice includes selecting surveillance systems, calibrating alerts, and designing case management processes.
We also carry out case reviews where suspicions of market abuse have arisen and offer a market abuse managed service in partnership with KRM 22.
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