Welcome to the May edition of Markets View! This month we bring you a sumptuous spread of snack-sized stories from the world of markets. From the latest regulatory fines for trade errors (hot off the press) to the new UK EMIR reporting rules, developments in the voluntary carbon space and more. Without any further ado, let’s get started!
Trade Errors: Under Control, or Under-Controlled?
The FCA and PRA have just published details of fines of over £60m levied in connection with insufficient pre-trade systems and controls.
These failures enabled a trader accidentally to order the sale of $444bn worth of equities, rather than the intended $58m (this was caused by mistakenly inputting the order value into the unit quantity field within the firm’s order management system). All told, on 02 May 2022 (a UK bank holiday) some $1.4bn worth of equities were sold on European exchanges before the trader cancelled the order.
It’s not that the firm didn’t have pre-trade controls: the experienced trader in question overrode 711 warning messages; two hard blocks in the system then managed to prevent $248bn of orders from progressing, and further controls immediately blocked several more. But $189bn still got sent to a trading algorithm, to be sold over the rest of the day. The firm’s monitoring teams failed to pick up on the issue in time to prevent it, not helped of course by the fact that the incident arose on a holiday day.
The FCA and PRA identified breaches of their respective Principles and specific rules intended to ensure that trading systems prevent the sending of erroneous orders. The PRA, meanwhile, noted that the incident emerged amid previously identified weaknesses that had not been remediated adequately or quickly enough. Hence the fines – which, it’s worth noting, incorporate a discount and come on top of the $48m losses already caused to the firm by the incident.
The clear takeaway for firms: check those systems and controls! Blocks need to be sufficient, alerts need to do their job, and there has to be effective real-time monitoring.
EMIR: Re-fits and Starts
Counterparties who report derivatives under EU and UK EMIR will be aware that this year is seeing important changes to the reporting rules under both regimes. The new EU EMIR Refit rules came into force on 29 April, and the UK’s changes will follow on 30 September.
As a reminder, the overall effect of these changes is to introduce more fields, more standardisation, more specificity and more obligations (including a new misreporting notification obligation). Back in November we published an Insights article with a handy recap for the buy-side, looking across both the EU and the UK.
The Bank of England and FCA first consulted on amending UK EMIR reporting back in November 2021. Their aim was to align the UK reporting framework with international-level guidance issued in April 2018 by the CPMI-IOSCO. In February 2023, they published a joint Policy Statement, which contained final rules and the promise of supporting guidance.
They are now working on the guidance itself, which takes the form of Q&As. They have split the task into two parts:
An initial consultation opened in March. That consultation handled the first tranche of topics, and we now have the corresponding set of Q&As. You may have seen that last week we published a further Insights article covering how the Q&As will impact firms who are subject to UK EMIR – be sure to check this out for the latest analysis.
A second consultation, which opened this month and closes on 12 June, covers the remainder of the topics.
Ultimately, the Q&As will be applicable from 30 September 2024, at the same time as the new UK derivatives reporting regime itself comes into play.
We are advising a number of clients on the new EMIR reporting requirements, including in the context of their delegated reporting arrangements and their misreporting notification obligations. If you would like to discuss any aspect of the new reporting requirements with us, please do get in touch with Craig Bisson and Paul Metcalfe.
MiFID3 Rumbles On – New RTS Consultation
Readers of recent editions of Markets View will know all about the reforms of the EU MiFID/MiFIR regime introduced earlier this year. When we last left the topic back in March, the changes technically became effective that month, but in several cases we were still awaiting the preparation of underlying secondary legislation to tell us how they’ll work.
Things are slowly moving along. Just this week ESMA published its MiFIR Review Consultation Package, covering 3 areas:
Proposed amendments to RTS 2 on pre- and post- trade transparency for non-equity (under Arts 9, 11 and 20 MiFIR)
Draft proposals for a new RTS on “reasonable commercial basis” (RCB) (under Art 13 MiFIR)
Proposed amendments to RTS 23 on reference data (under Art 27 MiFIR)
For firms wanting to contribute a response, the deadline is 28 August 2024 and all responses should be submitted here. ESMA is due to publish its final report and draft RTSs by the end of the year.
All Eyes on the VCM
There’s been a flurry of papers recently on the voluntary carbon market (VCM), and two in particular caught our eyes. Last month, ISDA published a paper called “Navigating the Risks of Greenwashing in the Voluntary Carbon Market”. The International Emissions Trading Association (IETA), meanwhile, published their own paper on “Guidelines for High Integrity Use of Voluntary Carbon Credits”.
A key recurring message is that we’re really going to need the VCM if we are to have a chance of meeting the world’s Paris Agreement targets. In particular, it could help us decarbonise more efficiently and more ambitiously, if companies can buy voluntary carbon credits (VCCs) that have a lower marginal cost than other measures.
ISDA’s analysis seeks to get to the root causes of ‘greenwashing’ in the VCM. It breaks the problem down by distinguishing two key categories of risks: the “system-level risks” (based on overstating the overall positive effects of VCCs, for example due to double-counting or inconsistencies between standards) and the “credit-level risks” (based on overstating the positive effects of particular VCC-generating activities). These are timely contributions to the greenwashing debate, which has of course moved rapidly up the regulatory agenda of late, notably via the FCA’s newly-minted Anti-Greenwashing Rule (on which ISDA also commented earlier this year) and the EU’s new Greenwashing Directive.
IETA’s Guidelines, meanwhile, are more of a ‘how-to’ guide for companies looking to use the VCM to decarbonise their business. They present a picture where the VCM is one of several “mitigation levers” available for meeting targets; it ranks below outright emissions avoidance / reduction in the overall hierarchy of available measures, but can still offer value – for example in hard-to-abate sectors. A core message here is the need for companies to be transparent about their emissions and how they are using VCCs to meet their targets.
These papers come at an uncertain time for the VCM, which remains dogged by questions of quality and integrity around VCCs – you may recall most recently the controversy that blew up around the SBTi’s announcement that it intended to allow companies to use VCCs to meet their upstream/downstream emissions targets. It’s heartening to see the likes of ISDA and IETA lend their weight to addressing these issues, but only time will tell whether the kinds of initiatives being put forward here will be enough galvanise the action needed to scale the VCM.
CRCF – Removing with the Times
Staying on carbon, EU politicians reached a provisional political agreement on establishing a Carbon Removals Certification Framework (CRCF). This voluntary framework aims to increase the deployment of high-quality carbon removal and soil emission reduction activities within the EU.
The essential job of the new framework is to define and categorise the activities in question, in other words to tell us what high-quality carbon removals / reductions actually look like. To that end, it adopts ingeniously-styled ‘QUALITY’ criteria, of Quantification, Additionality, Long-term storage and SustainabilITY. Work is ongoing to develop the detailed certification methodologies for the various sub-types. Looked at in the round, this can be seen as the EU establishing an accounting standard for carbon, which will form a key taxonomical component of a whole range of ‘green’ initiatives.
Of most relevance to us is how this affects the carbon markets. The EU’s plan is that projects which generate certificates under the CRCF will ultimately be able to bring tradeable “certified units” to market. This amounts to the creation of the EU’s very own voluntary carbon standard under which such units can be verified, issued and traded (with the limitation that the carbon removal must take place within the EU itself). There’s an open question here as to whether and how these units may be accounted for as ‘negative emissions’ in the EU ETS – a topic you may recall we touched on in Markets View back in March.
All of which is well and good. However, a word of caution: there’s a long way to go yet. Creating the certification methodologies that underpin the new carbon accounting framework is not going to be an easy (or apolitical) exercise by any means. Nor, for that matter, will establishing and overseeing trading in the credits themselves. Ultimately, it’ll be some time before we find out whether the CRCF ends up setting the new global bar for credit quality and integrity, or results in a messy compromise. In any case, don’t expect trading in EU certified units to be up and running for at least a couple of years.
Who Surveys Surveillance? – FCA Markets Watch 79
Chiming with the large fine just published, the FCA’s latest Market Watch looks at market abuse surveillance failures, emphasizing the importance of testing to ensure effective systems and procedures as required by the UK Market Abuse Regulation (UK MAR). The FCA identifies a range of failures around market abuse surveillance, particularly with regard to surveillance alerts not working as expected. This can have a big impact, particularly given that in some instances, faults may have gone undetected for weeks, months or even years.
The FCA set out examples of three different malfunctions they have observed, and the reasons for them. These case studies neatly demonstrate how simple mistakes made at an early stage (e.g. when setting up/coding surveillance systems) can result in significant gaps in firms’ surveillance data – a problem that may be compounded by lack of rigorous testing and questioning.
Finally, the Market Watch also sets out the findings of the FCA’s 2023 peer review of how nine investment banks test the efficacy of their client order front running models. The findings point to a few areas where the FCA thinks firms could do more when it comes to mitigating the risks of surveillance failures. These are presented as a series of questions that firms should be asking themselves regarding their data governance, model testing and model implementation and amendment.
