Market Abuse Update

This post comes to us from Leonard Ng of Sidley Austin LLP.

The new EU Market Abuse Regulation (‘MAR’) will apply from 3 July 2016 and replace the existing Market Abuse Directive (‘MAD’). In anticipation of the application of MAR, we at Sidley Austin recently published a paper detailing some of the key considerations for EU and non-EU investment managers. The paper is available here.

Although our paper covers a wide variety of issues that should be considered by investment managers, this post highlights in particular the issues arising from the broad extraterritorial scope of MAR and its application to non-EU persons who may be unaware of its import.

Whilst MAD applies the market abuse offences to financial instruments admitted to trading on EU ‘regulated markets’ (eg the Main Market of the London Stock Exchange), MAR significantly expands the scope of financial instruments covered to include those financial instruments traded on EU multilateral trading facilities (MTFs) and organised trading facilities (OTFs). OTFs are a new type of EU trading venue created pursuant to MiFID II (expected to be implemented from 3 January 2018), for the trading of non-equity instruments such as bonds and derivatives.

Although the existing MAD regime has always been extraterritorial in nature, the expansion of financial instruments in scope under MAR will make it easier for market participants to be caught within the EU market abuse framework without necessarily realising it. What might appear at first glance to be a purely non-EU transaction in relation to financial instruments issued by a non-EU issuer might well be subject to MAR on the basis that the non-EU issuer’s financial instruments are also traded on an EU trading venue. It would not matter if very little trading actually takes place on the EU trading venue. In this regard, MAR differs from the EU Short Selling Regulation, which exempts from its scope the shares of issuers whose ‘principal trading venue’ is outside the EU.

For example, two US counterparties could be trading in the bonds of a US issuer on the New York Stock Exchange.  However, those bonds might also be traded on an OTF operated by an EU investment bank. In this scenario, the US counterparties may be completely unaware that the EU market abuse rules and standards under MAR apply.  Although MAR requires the European Securities and Markets Authority (ESMA) to publish a consolidated list of all financial instruments within the scope of MAR, that list will not be available until MiFID II is implemented in January 2018. In any event, MAR makes clear that ESMA’s list ‘shall not limit the scope of this Regulation’, so the absence of an issuer from that list is not necessarily determinative.

The US standard for insider dealing, particularly after the Second Circuit’s decision in United States v. Newman, differs quite markedly from the EU standard under MAR; it is generally more difficult for insider dealing to be proven by the authorities in the US.  This raises the interesting question of whether an EU regulator might seek – on its own or upon the encouragement of a US regulator – to impose the EU standards under MAR where there is no nexus with the EU other than the fact that the relevant instrument was traded on an EU trading venue.

At the same time, the fact that a financial instrument is within the scope of MAR means, in theory, that other MAR obligations, such as rules on cancelling or amending orders, or market sounding standards, apply.  For example, under MAR, the use of inside information to cancel or amend previously placed orders constitutes insider dealing. In the US, however, if any inside information relating to an outstanding order is received, it is commonplace to cancel the order so that the trade is not completed. Similarly, a non-EU broker is probably not expecting to have to comply with the process specified by MAR when conducting a market sounding for a non-EU issuer, and for a non-EU recipient of that market sounding to have to comply with ESMA’s market sounding guidelines, solely on the basis that the non-EU issuer’s shares might also be traded on an EU MTF.

In practice, one would expect that EU regulators would require that a sufficient EU-nexus be present before taking any enforcement action, but in the absence of such a concept having a legislative or formal footing, it may be challenging for market participants to make judgement calls as to the view a particular EU regulator may take.