The FSA is getting tougher on transaction reporting. Failure to comply with the rules may mean large fines and a loss of confidence by the regulator, say Monique Melis and Simon Appleton of Kinetic Partners.
After many years of being saddled with a poor reputation of both failing to act and, when doing so, seemingly ineffectively, the UK financial services regulator, the Financial Services Authority (FSA), is emerging as a stronger financial markets supervisor. Keen to assert its authority and power as a regulator, the FSA has recently become more proactive in investigating cases of financial crime and market abuse and exercising its fining and criminal powers, sending the message that the iron fist can, and will, come down on firms and individuals who are abusing the market.
The upshot of this drive has been a necessary focus on stronger, more technical regulation in the industry, instrumental in deterring and detecting potential offenders.
One point of this focus has been the systems and controls in place regarding transaction reporting, one of the key tools the FSA uses in this task. In the UK, all regulated firms are required to report trading data to the regulator through ‘approved reporting mechanisms’ by trade date plus one day (T+1). In addition, the FSA has access to client identification on all these trades. Although transaction reporting has long been regulated, initially by the Securities and Futures Authority and now by the FSA, it has more recently been brought to the forefront as a real danger area for firms that do not comply.
Let this be a lesson
The £2.45m (€2.93m) penalty fine imposed on Barclays last year for reporting failures was significantly higher than previous penalties imposed for transaction reporting errors, highlighting to all firms that a strong, sound transaction reporting procedure and compliance checks for accuracy are vital within any firm. It has also given an important lesson to the UK regulated community, as Barclays itself was not subject to an investigation; simply, the integrity of the data supplied to the regulator was not adequate, which was detected when the FSA was investigating a matter not involving the firm.
Increasingly high-profile and complex insider dealing cases, such as Galleon in the US and now several in the UK, show that the FSA is now following in the footsteps of the SEC by backing up the use of dawn raids with the encouragement of whisleblowing and plea bargaining in order to avoid criminal conviction.
However, these headline-grabbing events will follow the painstaking analysis of vital evidence with transaction reports invariably facilitating the detection of offenders and development of cases. Dawn raids and tougher market abuse fines are only possible if evidence is built up through the careful and diligent analysis of the daily transaction reports made by brokers and, increasingly, fund managers. The accuracy of the evidence depends on the accuracy of the transaction reports, so those firms who misreport will feel the iron fist as much as the market abusers. With other market abuse and transaction reporting failure cases in the pipeline, these cases serve as a warning to other firms that the FSA will not tolerate inadequate systems and controls in this important area, and that when they do act, firms and individuals will be hit hard.
What is the issue?
With the FSA cracking down on poor compliance with transaction reporting responsibilities, firms absolutely need to put systems and actions in place to ensure they are completely up to scratch with this important area of regulation. Supervision has for many years picked up firms during supervisory visits for poor transaction data. Supervision liaise with the Transaction Monitoring Unit in preparation for an ‘Arrow’ visit. They are looking for poor, insufficient reporting and incorrect reporting. The FSA can only operate well in the area of combating market abuse if it has data to work with, hence the heavy fines for poor reporting of data, or failure to report, as well as incorrect reporting.
None of this is new. Firms have always been required to comply with these rules, but the issue is that the FSA is now stronger, more intrusive, and will take action against poor compliance, as we have seen, whereas before, perhaps, it neglected to do so. Non-compliance with the rules risks large fines, on top of which there is a loss of confidence between the firm and the regulator – something which is not easy to repair.
Who’s to blame?
Assigning responsibility is a key factor in getting transaction reporting right. Responsibility falls on many heads, not just those of compliance professionals, and it is important that everyone in the firm understands this and knows their role. Transaction reporting is not merely a compliance issue, it is a supervision requirement and thus involves senior management, IT and operations.
Many fund managers also think transaction reporting is a sell-side broker issue, which is a myth. The portfolio fund management reporting exemption may soon be removed as part of a Mifid review and, in any event, there are many trading scenarios where the buy-side firm will need to report transactions directly to the FSA – for example, when counterparties are based outside the European Economic Area or when stock is crossed between two funds, to name but two.
Essentially, all decisions and processes should be documented and action taken to make sure the firm is fully on top of this complex area.
How can you protect your firm?
It is important to recognise that ignorance in this area is simply not an excuse. It is a firm’s responsibility to be in control of their transaction reporting procedures and to provide the best possible data to the FSA. Firms should follow the guidelines set out in the FSA’s Transaction Reporting User Pack (TRUP) and Market Watch newsletters, and ensure they are up to date with the messages on the regulatory agenda. This is required and expected by the regulator.
Further, conducting regular face-to-face training for staff, as opposed to computer-based training, is important to raise awareness and prevention. This is consistent with Market Watch 24, which states: “It is essential that staff operating within HFMs [hedge fund managers] receive appropriate and regular training on market abuse. In general, a firm should tailor this to the type of business it undertakes and it should contain practical examples relevant to the business.”
Keeping staff updated about current cases of market conduct and learning the lessons that come out of these is important. Firms should analyse the outcomes of the cases published on the FSA website, and be prepared to take remedial action, if necessary, in order to ensure best practice in the area of market conduct controls.
Reviewing, verifying and improving transaction reporting processes on a regular basis should now be a key operational aspect within any regulated firm, not just something done when things go wrong. This includes assessing the reporting mechanism used and analysing transactions conducted and reports made to the FSA.
If firms have issues complying with the rules, it is up to them to find a solution; the FSA is there to provide guidance but not to pick up the pieces of those firms that fail to comply. Firms need to get their transaction reporting operations in order, be it internally or by outsourcing.
Worth the trouble
Transaction reporting is a hot issue in today’s regulatory environment, and with the FSA cracking down on transaction reporting practices it is well worth the trouble for firms to ensure they have a comprehensive system in place to safeguard the firm against poor performance in this area. Compliance with transaction reporting practices is one step towards rebuilding regulator and investor trust in the industry, in this new era of heavy regulation, as well as, importantly, cleaning up the industry in terms of financial crime and market abuse. Non-compliance is not an option, with the heavy fine for Barclays serving as an important lesson.
• Monique Melis is a member of Kinetic Partners. Simon Appleton is a consultant.
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