H.M. TREASURY

FINANCIAL SERVICES AND MARKETS ACT

MARKET ABUSE: PRESCRIBED MARKETS AND QUALIFYING INVESTMENTS ORDER

DECEMBER 2000

Previous Consultation

1. The June 1999 consultation document explained that the aim of the new market abuse regime was to protect the proper operation of UK financial markets. It proposed three criteria for determining which markets should be covered:

i. The expectations of markets participants as to the integrity of the market.

ii. The reliance market participants place on the market for dissemination of information relevant to the value of investments traded on that market and on the market’s facilities, including its role in price formation.

iii. The wider economic importance of the market.

2. On the basis of the above criteria the consultation document proposed that the markets to be prescribed should be the six then-recognised UK investment exchanges. However, it added that the new regime was not coterminous with recognition and that it was possible that non-recognised exchanges might at some point be prescribed. The 1999 consultation document proposed that all investments that were admitted to trading under the rules of a prescribed market should be covered by the regime.

3. Many of the responses to the original consultation document focused on fundamental aspects of the proposed new market abuse regime, and decisions on those aspects have since been taken by Parliament in the passage of the Act itself.

4. Responses to the consultation document also contained many useful comments on the specific matters covered by the proposed order. Most respondents agreed in principle with the three suggested criteria for determining which markets to prescribe, but there were differing views on which markets met those criteria.

5. Respondents had concerns about the drafting of paragraph 3 (2) of the 1999 draft order which prescribed as qualifying investments “any investment of a kind which, at the time this Order is made, is admitted to trading under the rules of any market [that has been] prescribed”. They pointed out that the phrase “admitted to trading” might not have the same scope as the phrase “traded on” which is used in the primary legislation. They also suggested that the phrase “of a kind” was ambiguous and might be interpreted to mean any investments similar to those admitted to trading on a prescribed market. Some respondents also asked what would happen to new investments (or types of investment) admitted to trading after the Order was made.

6. We accept the validity of many of these points and have reflected this in the new draft of the order. Accordingly, it no longer refers to investments which are “admitted to trading” but simply recognises that in this respect the scope of the regime is determined by the Act itself. Section 118 of the Act already requires that the qualifying investments must be “traded on” a prescribed market. The role of the Order is simply to prescribe markets which can be the subject of market abuse and the investments which are qualifying investments in those markets.

7. As to the latter, the new draft makes clear that the word “investments” has the same meaning as that assigned to it in the Regulated Activities Order, which will be made under Section 22 of the Act (see Regulated Activities Order – Second Consultation Document, October 2000). In this context the use of the phrase “of a kind” simply reflects the nature of the power in section 22, which is a power to specify “kinds” of investments. We, therefore, do not think that the new draft is ambiguous in the way respondents felt the previous draft was. Finally, unlike the previous draft, the new Order does not limit qualifying investments to those traded on a prescribed market at the time of the Order is made. Accordingly, any investment traded on a prescribed market will be covered.

The Scope Of The New Regime

8. Many of the respondents to the earlier consultation were concerned about the scope of the new regime. They also wanted the order to define the scope of the regime more clearly. In line with this, it is likely that respondents would want the current draft to specify exactly what was meant by the phrase “traded on a prescribed market”. However, while section 118 of the Act gives the Treasury the power to prescribe which markets and which investments the market abuse regimes applies to, it does not give the Treasury the power to define the phrase “traded on”, which is used in the Act itself. Under Section 157 of the Act the Financial Services Authority has the power to issue guidance on this issue (as on others), but in the event of any dispute final decisions on what is meant by “traded on” will be a matter for the Financial Services and Markets Tribunal .

9. We do not believe, however, that many disputes on this issue are likely. The Act does not require the behaviour itself to be behaviour that takes the form of trading on a prescribed market, and accordingly whether or not there has been trading on a prescribed market is not likely to be a central issue in most market abuse cases. The behaviour does have to be behaviour in relation to qualifying investments traded on a prescribed market, but in most cases there will be no dispute that the investments are so traded. If on the contrary there is no significant trading in the investments on a prescribed market, it seems unlikely that the behaviour would meet the tests for market abuse set out in Section 118 of the Act. The purpose of the Act is to enable action to be taken against anyone who abuses a prescribed market in a qualifying investment. However, if there is no trading in a particular investment on a prescribed market, it is difficult to see that there is much potential for abuse of the market.

10. Another fear raised in consultation on the 1999 draft order was that people outside the UK might fall within the scope of the UK’s market abuse regime without their knowing that this was the case and that actions by them that were acceptable in their home country might be unacceptable under the regime.

11. However, it is clear that the Act’s aim of protecting prescribed markets in the UK would not be achieved if the market abuse provisions were confined solely to behaviour in the UK. Section 118 (5) therefore makes clear that behaviour covered by the regime can include any behaviour in relation to qualifying investments traded on a prescribed market which is situated in the UK or electronically accessible in the UK.

12. It is important to note, however, that the Act also makes clear that behaviour only qualifies as market abuse if it is likely to be regarded by a regular user of a prescribed market “as a failure on the part of the person or persons concerned to observe the standard of behaviour reasonably expected of a person in his or their position in relation to the market” (Section 118 (c)). In this way the Act recognises the importance of the person’s position in relation to the market and this is built into the regular user test.

Other Issues

13. Respondents to the consultation generally agreed with the criteria for determining which markets to prescribe set out in the 1999 consultation document (and repeated in paragraph 1 above), and we continue to think these are the correct criteria. We are aware that the volume of trading on the various UK exchanges differs significantly. However, in view of the first criterion in particular we consider that any UK-based investment exchange that is recognised should also be prescribed. Moreover, account must be taken of the potential as well as actual significance of an exchange. The new draft order therefore prescribes recognised investment exchanges as such rather than prescribing individual recognised investment exchanges by name (as the 1999 order did). This will also obviate the need to amend the Order every time an exchange is recognised (or derecognised).

14. However, we remain of the view the market abuse regime is not necessarily coterminous with recognition. It is quite possible that at some future date situations will arise where a body meets the criteria for prescription but does not wish to apply for recognition as a recognised investment exchange. In those circumstances we would consider seeking to amend the order to add such a body to the list of prescribed markets. The FSA is currently reviewing the regulatory requirements for alternative trading systems and when this framework is settled, we consider whether the order should be extended explicitly to cover trading on such systems.

15. Finally, the new draft Order relates to all investments traded on a prescribed market. Neither responses to the earlier consultation nor more recent discussions we have had with recognised investment exchanges suggested that some investments on a particular market should be covered by the market abuse regime, while others were not. Rather the consensus was that the purposes of the market abuse regime would best be served if all investments traded on a prescribed market were covered.