02 May 2023

The FCA's latest Market Watch 73


The FCA's latest edition of Market Watch focusses on their recent market abuse peer review in relation to firms that offer CFDs and spread bets ("CFD providers").

Although the focus in on CFD providers, many of the FCA's factual findings and their observations as to what constitutes good and bad practice would equally apply to firms engaged in listed securities and derivatives trading as part of their business.

CFDs, insider dealing and market manipulation

The FCA observe that CFDs and spread bets are particularly vulnerable to being used for insider dealing due to their speculative and leveraged nature, and note that they are a major source of Suspicious Transaction and Order Reports ("STORs").

However, they also point to a potential increase in a type of manipulative behaviour where spread bets and CFDs are being used to realise profits following manipulative practices in the underlying market via other firms. The FCA analysed firm data and selected 9 firms, asking for information about their business models, market abuse risks and arrangements for detecting and reporting market abuse, including policies and procedures, risk assessments and relevant management information. They also conducted supervisory visits to 7 firms.

Key findings

1. Some positives, but firms need to assess not only their procedures, but also the underlying market abuse risks across all asset classes, including non-equity classes

The FCA say their overall findings were largely positive. All of the firms had surveillance in place to detect insider dealing, most of which were considered to be effective. However, there were weaknesses including in particular a lack of consideration of market abuse risks in non-equity asset classes and market manipulation, leading to gaps in surveillance. They highlight compliance with SYSC 6.1.1R; the requirement to establish, implement and maintain adequate policies and procedures sufficient to ensure compliance with obligations under the regulatory system and countering risks that the firm might be used to further financial crime.

There was "significant improvement from firms in meeting this obligation; firms are generally acting appropriately in dealing with clients of concern". On the other hand, they say many firms lacked a formally documented framework in this context.

Focussing on areas requiring improvement, the FCA say that while firms recognised insider dealing in single stock equities as the predominant market abuse risk, some firms failed to show they had considered all market abuse risks relevant to their business. While some firms had a market abuse risk assessment which documented their consideration of different market abuse risks, other firms, while documenting their assessment of their market abuse policies and procedures, failed to document an assessment of the market abuse risks applicable to their business.

All of the firms offered CFDs and/or spread bets in non-equity asset classes, but there was little consideration of these in their market abuse risk assessments, and limited detail about market manipulation in all asset classes.

To maintain effective arrangements to detect and report suspicious orders and transactions, firms needed to understand how they could facilitate market abuse. Undertaking such a risk assessment would be an effective way of achieving this, enabling firms to document all the market abuse risks that apply to their business, and identifying what monitoring was needed to detect them. The FCA made clear that "[a] general assessment of market abuse policies and procedures does not achieve this."

Even if certain types of market manipulation risk may be lower for the CFD provider sector, they were still relevant. The FCA refer to such as order-based manipulation by clients with direct market access ("DMA"), indirect manipulation through CFD firms’ hedging activities where clients may anticipate their CFD or spread bet orders will be replicated in the underlying market, and where clients use other firms to manipulate prices in the underlying market and profit using their CFDs or spread bets. The risk of manipulation can also differ within asset classes as well as between asset classes. For example, client trading in less liquid stocks, such as AIM market stocks, could offer a greater opportunity for manipulation and firms should consider how market abuse may occur in other asset classes via CFDs. The FCA say firms that consider their entire business, including different asset classes and execution methods, were more effective in identifying applicable risks.

2. Order-based manipulation - "narrowing the spread"

More specifically, the FCA's review considered that what they refer to as "narrowing the spread" manipulation may be on the increase. This behaviour is aimed at moving the prices of CFDs/spread bets by narrowing the spread in the underlying market, typically in illiquid stocks. Orders are placed on the order book via a DMA broker (using either CFDs or cash equities) to buy (or sell) an underlying security at prices higher (or lower) than the current best bid (or offer). This narrows the spread of the underlying security, leading to a change in the execution price of the related CFD/spread bet. The same (or connected) participant then trades in the opposite direction, in larger size, in a derivative referencing that underlying security such as a CFD, often at another broker, benefiting from the improved price. The DMA order is typically cancelled before it trades. This type of manipulative behaviour can involve multiple brokers and sometimes multiple clients.

While some firms were not aware of this activity, most knew of it, and some had submitted STORs in relation to identified instances. However, none of the firms reviewed had listed this behaviour in their risk assessments nor had surveillance processes to detect it. At best, trading/hedging desks which monitored profit were sometimes directed to flag the activity to compliance and one firm triggered alerts where clients were consistently making profits opening and closing positions within a short time frame.

Since CFD providers were often at the centre of this activity, they were key to identifying and reporting it, and the FCA say they should consider whether surveillance alerts "would" (we assume they mean should be created or tailored to) more effectively and consistently identify it. Firms providing clients with DMA should also be aware of the potential activity where clients are improving the best bid or offer – particularly if using very small order sizes – and rarely executing those orders.

We note that this "narrowing the spread" behaviour is unlike what is commonly referred to as "spoofing", where for example large orders are placed away from the "touch" – below the best bid/buy (or above the best ask/sell price) on one side of the order book, with no intention of executing the order but creating the impression of demand (or supply), and thus moving the market price in order to execute an order or orders, often smaller in size, at a better price on the other side of the book. The large order is then cancelled. The orders in the FCA's description are to buy (or sell) an underlying security at prices higher (or lower) than the current best bid (or offer). Presumably, those orders are not executed/hit, even though attractively priced, because the underlying security is illiquid/thinly traded.

3. Market abuse surveillance responsibilities

All firms had policies and procedures setting out roles and responsibilities for market abuse surveillance. Where those responsibilities lay varied from firm to firm. All firms had a procedure to escalate alerts where suspicions could not be mitigated, and the person responsible for Compliance Oversight (the SMF16) at all firms was the ultimate decision-maker on whether to submit a STOR.

The FCA observed that they often see responsibility for market abuse surveillance resting with an independent compliance function but that for smaller firms, it may be proportionate for responsibility to rest with teams or individuals outside compliance. Where that was the case, firms which had considered and mitigated potential conflicts though independent oversight and quality assurance had more effective surveillance arrangements.

4. Surveillance systems

All of the firms used an in-house solution for insider dealing surveillance, using one or more of price movement, profit and news event in a variety of combinations, to trigger alerts. All but 2 firms considered both realised and unrealised profits, and firms used a variety of lookback periods for their insider dealing surveillance ranging from 30 days to as little as 24 hours. Most firms relied on their trading desks to detect market manipulation with little or no independent oversight from compliance. Significantly, the FCA say that most firms did not have effective surveillance for non-equity asset classes.

The FCA considered that while most firms could demonstrate their insider dealing alerts were largely effective, they were concerned that a number of firms did not monitor for unrealised profits either specifically or by capturing them via discrete alerts, such as news or price movements. Where firms do not consider unrealised profits, the FCA are concerned they will fail to identify potential market abuse.

In addition, the FCA say that some firms had not adequately considered how long inside information might exist for and used a ‘lookback period’ that was too short and which therefore might fail to identify instances of suspicious trading. The FCA also considered reviewing all trading activity prior to an event would be more effective at identifying potential market abuse. Firms should also consider whether their surveillance coverage is adequate for market manipulation in non-equity asset classes.

5. Surveillance alert investigations

When reviewing insider dealing alerts, some firms placed significant weight on factors such as increased option volumes, financial blog articles and bulletin boards, analyst recommendations and stock sentiment, using one or more of them as the sole mitigation without considering the client’s trading history. Other firms considered those factors in conjunction with a review of the client’s trading history. The FCA considered that clients' trading history is an important factor to consider to sufficiently assess reasonable suspicion of market abuse. Firms also needed to ensure they record the rationale for any mitigation of suspicion.

Some firms captured and used data on clients’ IP addresses and advertising IDs (unique user ID assigned to a device) to identify potential collusion or links with previously off-boarded clients when investigating suspicious transactions. The FCA advocate that firms should use all relevant information available to them in identifying suspicious clients and connections.

6. Front office and the "tipping off" risk

The FCA found that compliance was generally reluctant to provide feedback to front office staff on surveillance matters due to concern about tipping off. However, the FCA say firms need to strike the right balance when engaging with front office on surveillance matters. While submission of a STOR should only be shared on a need-to-know basis, this should not prevent compliance from challenging and educating front office staff where the front office had not identified or escalated suspicions. While a level of caution was understandable, some firms found using real-world examples was helpful in improving staff understanding of obligations.

The FCA also noted front office staff were reluctant to refuse an order from a client or execute a trade, even if they believed the client was seeking to trade manipulatively or based on inside information. Again, this was out of concern for tipping off the client. Where front office holds information which leads them to conclude that a client is seeking to trade either manipulatively or based on inside information, the FCA make clear that they should refuse to accept that order where able to do so; compliance policies should be clear and appropriate action should be taken if they are breached. The FCA indicate that the front office should also escalate to compliance to consider if a STOR for attempted market abuse is needed and (unsurprisingly) STOR submissions should not be disclosed to the client.

7. Countering the risk of market abuse-related financial crime

All firms visited demonstrated they were acting in accordance with their SYSC 6.1.1R obligations as they apply to market abuse, undertaking monitoring and appearing to be proactive in either exiting or restricting clients of concern.

The FCA observed various approaches as to whether a certain number of STORs might result in offboarding a client or just a client review. In most firms, the decision to restrict or offboard clients rested with compliance or a committee that is independent from senior management. The FCA's view is that firms’ policies and monitoring had significantly improved, and that there was no "one size fits all" solution. That said, the most effective policies had both quantitative and qualitative measures and have a "common sense override".

The FCA considered that a formalised structure, with appropriate flexibility, will help firms take consistent, appropriate and prompt action, with responsibility for applying the framework and decision-making resting with compliance or a committee rather than senior management being preferrable. This would also help firms make consistent and appropriate decisions, free of conflicts of interest. Keeping good records of discussions about clients and decisions is also important.

Overall, while the FCA's findings were encouraging, there was still room for improvement in the formalisation and documentation of firms' risk appetite framework, and firms should also regularly review their SYSC arrangements to ensure they remain effective and fit for purpose.

8. Next steps for CFD providers

CFD providers should consider the points made and take steps to ensure that their systems and procedures for detecting and reporting potential market abuse, and more generally to counter the risk they are used to further market abuse-related financial crime, are appropriate and proportionate to the scale, size and nature of their business activities. The FCA say they will continue to visit CFD providers and other firms to assess their STOR arrangements and work to ensure they meet their regulatory obligations.


Many of the FCA's observations will be of interest not only to CFD providers but also to other firms which engage in trading activities in respect of shares, bonds, other fixed income securities and derivatives including swaps, options and/or CFDs. The FCA's suggestions as to best practice and identified failings should be taken seriously by firms and indeed the FCA frequently allude in enforcement proceedings and enforcement notices to its Market Watch publications as "fair warning" of what is expected of firms.

There are some simple steps that can be taken to accommodate most of the FCA's suggestions and the FCA's declaration that they will “continue to visit CFD providers and other firms” to assess their STOR arrangements reinforces the need to address the concerns highlighted. The full Market Watch can be found here.



Fran Legg

Fran Legg

T:  +44 20 7809 2031 M:  Email Fran | Vcard Office:  London