Conduct and Market Abuse#

MiFID II and UK MiFID#

The Markets in Financial Instruments Directive (MiFID II, in force from January 2018) and the regulation that goes with it (MiFIR) set out how investment services and trading venues work. The UK kept these rules after Brexit as UK law, and has been changing them since. The main areas are:

MiFID II themes#
Theme	What it requires
Transparency	Pre-trade and post-trade publication of prices and volumes for trading venues and for many instruments, including some OTC derivatives, so that market participants can see prices.
Best execution	Firms must take all sufficient steps to get the best result for the client, and must monitor and show it.
Transaction reporting	Reports of each trade to the regulator by the next day, with details on the instrument, the price, the parties and the decision maker.
Product governance	The producers and distributors of products must set a target market, and check that the product is suitable.
Recordkeeping	Records of communications and orders that lead to a transaction, including phone calls and electronic messages.

The transparency rules produce public data, such as the prices and volumes of trades, that can be used as evidence of the market for the valuation of instruments. For some derivatives the data is limited, and it can be delayed.

Market abuse#

The Market Abuse Regulation (UK MAR) prohibits three main types of behaviour:

Insider dealing: trading, or recommending a trade, using inside information, which is precise, not public and likely to have a significant effect on the price.
Unlawful disclosure: passing on inside information other than in the proper course of duties.
Market manipulation: giving false or misleading signals about the supply of, demand for or price of an instrument, or fixing the price at an abnormal level.

Firms must have systems to detect and report suspicious orders and transactions to the FCA, through suspicious transaction and order reports (STORs). The US has its own rules in the Securities Exchange Act and the Commodity Exchange Act, and the SEC and the CFTC prosecute manipulation and spoofing.

Mismarking#

The deliberate mismarking of a position can be both a market abuse and a breach of the firm’s accounting and control duties. A trader who has an incentive to show a better profit can mark the book away from where it could be sold, particularly in illiquid products. IPV is the control that is designed to catch this, which is why regulators want to see that it is independent of the front office and that the escalation of breaks is real. Several well-known losses at large banks have involved a failure of the independent price verification, and they have led to fines and to reviews of the controls.

Benchmarks and the end of LIBOR#

Benchmarks such as LIBOR underpin the pricing of a large amount of financial products. After evidence that panel banks had manipulated the submissions, the benchmarks were regulated, in the UK through the Benchmarks Regulation with the FCA as the regulator. LIBOR was then replaced with rates based on actual transactions.

Transition from LIBOR to risk-free rates#
Currency	Replacement rate	Cessation of LIBOR
GBP	SONIA (Sterling Overnight Index Average).	End of 2021, with a synthetic rate for a time for legacy contracts that could not be moved.
USD	SOFR (Secured Overnight Financing Rate).	Panel ended in June 2023, with a synthetic rate for a time for legacy contracts.
EUR	€STR (Euro Short-Term Rate), alongside the continuing EURIBOR.	EUR LIBOR ended at the end of 2021. EURIBOR is a separate benchmark, which is still published after a change of method.
JPY, CHF	TONA and SARON.	End of 2021, with a synthetic JPY rate to the end of 2022.

The transition had large effects on valuation:

the discount curves changed from LIBOR-based to overnight rate curves, and the basis between the two had to be handled
the legacy trades needed fallback terms in the contracts, with a spread adjustment, to move to the new rates
the markets for the new rates were initially thin at long maturities, so the inputs had less evidence, and had to be verified carefully
the clearing houses converted their discounting, which moved value between counterparties and was compensated in cash

Senior managers and conduct rules#

The conduct standards apply to individuals as well as to firms. See Governance: Model Risk, Accountability and Data for the Senior Managers and Certification Regime.

UK, EU and US compared#

Conduct regulation by region#
Topic	UK	EU	US
Investment markets rules	UK MiFID and UK MiFIR, with the FCA Handbook.	MiFID II and MiFIR.	Securities and Exchange Act, and Dodd-Frank.
Market abuse	UK MAR.	MAR.	Anti-fraud and anti-manipulation provisions, enforced by the SEC and the CFTC.
Benchmarks	UK Benchmarks Regulation.	EU Benchmarks Regulation.	Rules by sector, with the Alternative Reference Rates Committee, convened by the Fed, leading the move to SOFR.

A valuation control view#

Independence: the IPV team should report outside the front office, and the process for challenging marks and escalating differences should be documented and tested.
Market data governance: the pricing contributions that the bank makes to consensus services or benchmarks need controls, so that they reflect actual market levels and they are not influenced by trading positions.
Benchmark and curve changes: a change of benchmark, curve methodology or convention affects the valuation, the sensitivities and the P&L, and it needs sign-off and clear communication.
Surveillance: unusual marks, and a pattern of marks that favour a desk’s position, should be visible to compliance, and the IPV results are a useful input to surveillance.
Records: the evidence used to verify a price, such as the quotes, the screenshots and the discussions, should be kept, in line with the recordkeeping rules.