Protecting market integrity vital
Negative effects of misconduct ripple out far beyond initial questionable trade
The integrity of our capital markets is the FMA’s core business. Insider trading, market manipulation and other unethical trading activity undermine market integrity and erode investor confidence in the markets at a fundamental level.
This is true regardless of the scale of the trading misconduct and whether the perpetrators made money, or whether there are identifiable victims. Trading misconduct was identified as a strategic risk in FMA’s 2017 Strategic Risk Outlook. It’s likely to remain a strategic risk for as long as the FMA produces Risk Outlooks.
When it comes to trading activity, participants have to believe that all trades are legitimate and based on transparent and equally-available information. This is essential to promote confident participation in the markets. Also, it is only fair to those participants who comply willingly with the law and do not look for ways to circumvent or take advantage of the rules.
This year has seen market manipulation and insider trading cases before the Courts.
The occasional commentator has questioned why the FMA and the Crown have bothered with cases where there appeared to be minimal gain to the perpetrators.
This subjective argument of measuring harm by relative scales ignores the well-trodden fact that trading misconduct has a multilayered effect on the market.
The negative effects of this activity ripple out far beyond the immediate consequences of the particular questionable trade. You don’t know, for example, what other trading conduct was altered because of the misconduct that took place.
We know that bringing cases before the courts has a deterrence element. But there is also a broader hygiene factor for participants in the markets having concrete, real world examples to test their own organisation’s processes and systems. Firms have tightened processes and provided further training following these cases to prevent these issues arising.
Additionally, overseas research into market manipulation and insider trading laws tells us that legislation that is not enforced could be worse than no legislation at all.
To be effective and to demonstrate that the rules have consequences then the law must be upheld. The mere existence of the laws is not sufficient to promote confidence and integrity in the market, nor is it sufficient to deter misconduct.
That same research also points to the higher cost of capital when market integrity is undermined. Capital also becomes more expensive as people lose trust and confidence in the transparency and integrity of information available to them. This is part of the public cost associated with illegitimate trading. The Financial Markets Conduct Act explicitly points to damage to the reputation of the markets as a key principle in consideration of the potential harms caused by this activity.
We are mindful of the reputation of our markets both with local
To be effective and to demonstrate that the rules have consequences then the law must be upheld.
investors but also the foreign investors who make up such a large part of trading on our markets.
Finding and then taking action on examples of these prohibited activities is both difficult and complex. But the manifest benefits in reducing the costs of capital and supporting investor confidence justifies these efforts.
We work closely with NZX to analyse trading activity when NZX surveillance picks up unusual patterns, or we receive intelligence from the market.
The FMA has finite resources so we need to be a risk-based, intelligence-led regulator focusing our attention on the worst harms to investors and the markets.
If those issues are serious and they meet the threshold for a formal investigation this becomes — necessarily — a huge commitment to see through a course of action.
Market integrity will remain our core business and the foundation for one of our strategic priorities. The ingredients that support market integrity and confidence also flow through into our other priorities, notably governance and culture.
Maintaining standards of good conduct requires constant attention and commitment from senior management and boards to put strong systems and processes in place. Robust infrastructure and process need to be bound together with strong principles and principled judgment.
If we want to develop a national culture of informed investment in deeper capital markets, then businesses need to develop internal cultures that reflect a genuine commitment to integrity.
We will continue to invest in regulatory action that may be expensive, complex and where it may be difficult to identify any individual who has directly suffered harm.
This is because we expect our actions to have a significant impact on the markets as a whole and the long-term performance of NZ Inc.
Garth Stanis is director of capital markets at the Financial Markets Authority.