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Brussels, 20 October 2011
1. What is market abuse and how is it currently regulated?
Adopted in early 2003, the Market Abuse Directive (MAD)1 has introduced a comprehensive framework to tackle insider dealing and market manipulation practices, jointly referred to as "market abuse". The Directive aims to increase investor confidence and market integrity by prohibiting those who possess inside information from trading in related financial instruments ("insider trading"), and by prohibiting the manipulation of markets through practices such as spreading false information or rumours and conducting trades that result in abnormal prices. ("market manipulation").
In essence, market abuse may occur when investors have been unreasonably disadvantaged, directly or indirectly, by others who:
The MAD creates some tools to prevent and detect market abuses, like insiders' lists, suspicious transaction reports and the disclosure of managers' share transactions. It also obliges issuers of financial instruments traded on a regulated market to make public as soon as possible inside information that they possess, with limited possibilities to delay.
In order to promote enforcement, the Directive gives national competent authorities powers of investigation (such as access to data or on-site inspections) and the power to take administrative measures or impose "effective, proportionate and dissuasive" sanctions.
2. Why is the MAD being reviewed?
The MAD introduced a framework to harmonise core concepts and rules on market abuse and strengthen cooperation between regulators. However, a number of problems have been identified by the Commission and these can be broadly categorised in five groups:
This is why the Commission has adopted proposals to replace the MAD with a Regulation on Market Abuse (MAR) and a Directive on criminal sanctions for market abuse.
Proposal for a Market Abuse Regulation (MAR)
3. What are the main objectives of the proposal for a Regulation?
The proposal for a Regulation aims to update and strengthen the existing framework to ensure market integrity and investor protection provided by the Market Abuse Directive. The new framework will ensure regulation keeps pace with market developments, strengthens the fight against market abuse across commodity and related derivative markets, reinforces the investigative and administrative sanctioning powers of regulators and harmonises certain key elements while reducing administrative burdens on SME issuers where possible.
4. How do the MAR proposals fit in with the MiFID review proposals, and other recent initiatives such as those on OTC derivatives and short-selling?
Together, MAD and MiFID guarantee the competitiveness, efficiency and integrity of EU financial markets. They need to be updated in tandem to ensure that they are fully coherent and support each other's objectives and principles. Moreover, the pan-EU competition facilitated by MiFID has given rise to new challenges in terms of cross-border supervision. Harmonisation of the rules and competent authorities' powers is a necessary step.
The importance of market integrity has also been highlighted by the current global economic and financial crisis. In this context, the Group of Twenty (G20) agreed to strengthen financial supervision and regulation and to build a framework of internationally agreed high standards. In line with the G20 findings, the report by the High-Level Group on Financial Supervision in the EU recommended that "a sound prudential and conduct of business framework for the financial sector must rest on strong supervisory and sanctioning regimes".
The importance of the efficient functioning of the MAD was underlined in the Commission Communication "Driving European recovery"2, which intends to tackle the most important shortcomings in the markets that have been observed in the current financial crisis. In its Communication on "Ensuring efficient, safe and sound derivatives markets: Future policy actions", the Commission said it would extend MAD’s relevant provisions to comprehensively cover derivatives markets3. The importance of efficient coverage of OTC transactions in derivatives has been stressed also in discussions at various international fora4 including the G20 and the International Organisation of Securities Commissions as well as in the recent US Treasury Financial Regulatory Reform programme5.
5. What changes does the proposal make so that market abuse legislation keeps pace with market developments?
The MAD is based on the concept of prohibiting insider dealing or market manipulation in financial instruments which are admitted to trading on a regulated market. However, since the adoption of MiFID6, financial instruments have been increasingly traded on multilateral trading facilities (MTFs), on other types of organised trading facilities (OTFs), such as swap execution facilities or broker crossing systems, or only traded OTC. These new trading venues and facilities have provided more competition to existing regulated markets, gaining an increased share of liquidity and attracting a broader ranger of investors. But the increase in trading across different venues has made it more difficult to monitor for possible market abuse. Therefore the proposal extends the scope of the market abuse framework to apply to any financial instrument admitted to trading on an MTF or organised trading facility, as well as to any related financial instruments traded OTC which can have an effect on the covered underlying market. This is necessary to avoid any regulatory arbitrage among trading venues, to ensure that the protection of investors and the integrity of markets are preserved on a level playing field in the whole Union, and to ensure that market manipulation of such financial instruments through derivatives traded OTC, such as credit default swaps (CDS), is clearly prohibited.
6. What does the proposal do to tackle market abuse occurring across both financial and commodity markets, which are international by nature?
Commodity spot markets and related derivative markets are highly interconnected and market abuse may take place across these markets. This raises special concerns for spot markets because transparency rules and market integrity apply to derivatives markets but not to the related spot markets. It is beyond the scope of the Regulation to govern directly those non-financial markets, which should be subject to specific and sectoral regulation and supervision as provided for in the field of energy by the recently adopted European Parliament and Council Regulation on energy market integrity and transparency (REMIT)7. However, the lack of a clear and binding definition under the existing MAD of inside information in relation to commodity derivatives markets may allow information asymmetries in connection with those related spot markets. This means that under the current market abuse framework, investors in commodity derivatives may be less protected than investors in derivatives of financial markets.
Therefore, since a person can benefit from inside information in a spot market by trading on a financial market, the proposal for a regulation on market abuse aligns the definition of inside information in relation to commodity derivatives to the general definition of inside information, by extending it to price sensitive information which is relevant to the related spot commodity contract as well as to the derivative itself. This will ensure legal certainty and better information for investors.
Moreover, the MAD only prohibits any manipulation which distorts the price of financial instruments. As certain transactions in the derivatives markets can also be used to manipulate the price of the related spot markets, and transactions in the spot markets can be used to manipulate derivatives markets, the definition of market manipulation is extended in the Regulation to also capture these types of cross-market manipulation.
The Regulation also introduces an obligation to cooperate and exchange information between financial regulators and the regulators of spot commodity markets where they exist to ensure a consolidated overview of financial and spot markets and to detect and sanction cross-market and cross-border abuses. It gives financial regulators the power to require that data on spot markets be submitted directly to them in a specified format.
7. How does the proposal deal with emission allowances?
Emission allowances are reclassified as financial instruments as part of the proposal for a regulation on markets in financial instruments (see MEMO/11/716). As a result, they will also fall into the scope of the market abuse framework. As it is typically not the issuer of an emission allowance who possesses inside information, the standard definition of inside information does not sufficiently ensure disclosure of relevant inside information. Therefore, a specific definition of inside information for emission allowances is introduced. The obligation to disclose inside information will be effectively placed on companies with large installations regulated by the EU Emissions Trading System, as it is they who possess the relevant information. For more information on emission allowances, see also MEMO/11/719).
8. How does the proposal reinforce the powers of competent authorities to detect market abuse?
The proposal includes a number of measures to ensure regulators have access to the information they need to detect and sanction market abuse. The proposal extends suspicious transaction reporting to orders and to OTC transactions. It clarifies that regulators can obtain existing telephone and data traffic records from telecoms operators where there is a reasonable suspicion of insider dealing or market manipulation (as defined in the proposal for a Directive) in violation of the Regulation or the Directive. It also grants competent authorities access to private documents or premises where there is a reasonable suspicion of insider dealing or market manipulation (as defined in the Directive) in violation of the Regulation or the Directive, subject to a judicial warrant. It also requires Member States to provide for the protection of whistleblowers and sets common rules where incentives are provided to them for reporting information about market abuse. Finally a new offence of "attempted market manipulation" is introduced to make it possible for regulators to impose a sanction in cases where someone tries to manipulate the market but does not succeed in actually trading.
9. How does the proposal strengthen the administrative sanctions that can be imposed for market abuse?
Since the sanctions currently available to regulators are often weak and lacking a deterrent effect, the proposal introduces greater harmonisation of administrative sanctions. Common principles are proposed, notably that fines should not be less than the profit made from market abuse where this can be determined, and the maximum fine should not be less than two times any such profit. For natural persons, the maximum fine should not be less than €5 million, and for legal persons it should not be less than 10% of annual turnover, with Member States being free to exceed these limits. In imposing sanctions, competent authorities should take account of other aggravating or mitigating factors, such as the gravity of the offence, previous offences or a suspect's cooperation with an investigation.
In parallel, a proposal for a Directive on criminal sanctions for market abuse requires Member States to introduce criminal sanctions for the offences of insider dealing and market manipulation as defined in the Directive, where these are committed intentionally (see below).
10. What does the proposal do to reduce administrative burdens, especially on SME issuers?
Insiders' lists are an important tool for competent authorities when investigating possible market abuse. However, differences in national laws implementing the MAD have imposed unnecessary administrative burdens on issuers. The Regulation aims to eliminate these by providing that the precise data to be included in such lists should be defined in delegated acts and implementing technical standards adopted by the Commission.
Applying the new market abuse framework of the Regulation in an undifferentiated manner to all SME growth markets may deter issuers on those markets from raising capital on the capital markets. Without prejudice to the objectives of preserving the integrity and transparency of financial markets and of protecting investors, the proposal therefore adapts the market abuse framework to the characteristics and needs of issuers whose financial instruments are admitted to trading on SME growth markets. The scope and size of the business of those issuers is more restricted and the events giving rise to the need to disclose inside information are typically more limited than those of larger issuers. The Regulation therefore requires those issuers to disclose inside information in a modified and simplified market-specific way. Such inside information may be published by those SME growth markets, on behalf of those issuers, in accordance with a standardised content and format defined in implementing technical standards adopted by the Commission. Those issuers are also exempt, under certain conditions, from the obligation to keep and constantly update insiders' lists.
The Regulation clarifies the scope of the reporting obligations in relation to managers' transactions. These reports serve important purposes by deterring managers from insider trading and providing useful information to the market about the manager's view on the price movements of the shares of the issuers. The Regulation clarifies that any transaction made by a person exercising discretion on behalf of a manager of an issuer or whereby the manager pledges or lends his shares must also be reported to the competent authorities and be made accessible to the public. Moreover, it introduces a threshold of €20 000, uniform in all Member States, which triggers the obligation to report such manager's transactions. This higher threshold will contribute also to reducing the administrative burden on SMEs.
11. What are the next steps in the adoption of the proposal for a Regulation?
The proposal now passes to the European Parliament and the Council for negotiation and adoption. Once adopted the regulation would apply from 24 months after its entry into force.
Proposal for a Directive on Criminal Sanctions for Market Abuse
12. Why propose a separate Directive on Criminal Sanctions for Market Abuse?
The Market Abuse Directive currently requires Member States to adopt administrative sanctions which are effective, proportionate and dissuasive, and leaves them free to decide whether or not to impose criminal sanctions. An assessment of existing sanctions regimes by the Commission shows that the current sanctions are lacking impact and are insufficiently dissuasive, which results in ineffective enforcement of the Directive. In addition, the definition of which forms of insider dealing or market manipulation constitute criminal offences diverges considerably from Member State to Member State.
For example, five Member States do not provide for criminal sanctions for disclosure of inside information by primary insiders and eight Member States do not do so for secondary insiders. Since market abuse can be carried out across borders, this divergence undermines the internal market and leaves a certain scope for perpetrators of market abuse to carry out such abuse in jurisdictions which do not provide for criminal sanctions for a particular offence.
The Commission considers that minimum rules on criminal offences and on criminal sanctions for market abuse are essential for ensuring the effectiveness of the EU policy on market integrity. Criminal sanctions demonstrate social disapproval of a qualitatively different nature compared to administrative sanctions or compensation mechanisms under civil law. Common minimum rules on the definition of criminal offences for the most serious market abuse offences would also facilitate the cooperation of law enforcement and judicial authorities in the Union, especially considering that the offences are in many cases committed across borders.
13. Which offences will be subject to criminal sanctions?
The proposal for a Directive defines the two offences, insider dealing and market manipulation, which should be regarded by Member States as criminal offences if committed intentionally. In line with the scope of the proposed Market Abuse Regulation, transactions for certain purposes are excluded from the scope: buy-backs and stabilisation programmes, monetary policy and debt management activities and activities concerning emission allowances in pursuit of climate policy.
The proposal also requires Member States to criminalise inciting, aiding and abetting insider dealing and market manipulation, as well as attempts at these forms of market abuse. Liability should also be extended to legal persons.
14. What are the requirements for criminal sanctions?
The Directive requires Member States to ensure that the criminal offences defined in the Directive are punishable by criminal sanctions which are effective, proportionate and dissuasive.
The proposal includes a review clause requiring the Commission to report to the European Parliament and Council within four years of the Directive's entry into force on the application of this Directive and, if necessary, on the need to review it, in particular with regard to the appropriateness of introducing common minimum rules on types and levels of criminal sanctions. If appropriate, the report shall be accompanied by legislative proposals.
15. What are the next steps in the adoption of the proposal for a Directive?
The proposal now passes to the European Parliament and the Council for negotiation and adoption. Once adopted, Member States will have two years to transpose the Directive into national law.
More information is available at:
Directive 2003/6/EC of the European Parliament and of the Council of 28 January 2003, on insider dealing and market manipulation. OJ L, 12 April2003, p 16.
COM (2009)114 of 4th March 2009.
COM(2009) 563 final, 20.10.2009
IOSCO notes that "The high level of interconnectivity between credit derivatives, the obligations of the underlying reference entities e.g., corporate bonds, equities and cash markets means market misconduct (manipulation and insider trading) and disruptions in one market can affect another.", Consultation Report on Unregulated Markets and Products, May 2009, p. 28.
"Market integrity concerns should be addressed by making whatever amendments to the CEA and the securities laws which are necessary to ensure that the CFTC and the SEC, consistent with their respective missions, have clear, unimpeded authority to police and prevent fraud, market manipulation, and other market abuses involving all OTC derivatives." Financial Regulatory Reform. A New Foundation: Rebuilding Financial Supervision and Regulation, Dept. of Treasury, June 2009. p.48;
Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments. OJ L 145, 30.4.2004.