FSA statement on market timing

Most occurrences have been short-lived with fund managers taking swift action to terminate relationships where clients have attempted to time funds. The FSA has asked fund managers to calculate the effect of market timing and it is expected that this will form the basis for compensating payments to be made to the funds in some cases.

Total amounts involved are still being calculated but are likely to be less than 5 million.

Michael Foot, FSA Managing Director, said:

"The picture we have uncovered is generally quite an encouraging one. Although there is evidence of market timing having occurred within our authorised funds, looking at all the evidence we have amassed, we can find no sign either that market timing is widespread or that it has been a major source of detriment to long term investors."

Key Findings

While some evidence of limited market timing activity was uncovered, the relationships between the UK CIS fund managers concerned and the market timing clients appear to be of a different nature to those uncovered in the US, where there has been evidence of significant financial benefit to fund managers as a result of their relationships. In the UK, we examined 9,620 transactions as part of our investigation. In fact, only 118 eventually required follow up during on site visits.

The FSA's work found no evidence of late trading in the UK authorised CIS. It appears this is due in large part to the industry framework: where deals are placed directly with the fund manager before valuation points, and the important control function provided by the trustee in UK funds. The FSA will be undertaking further work to confirm its view of trustee oversight.

We believe that our Principles and Rules provide sufficient tools to enable firms to manage the conflicts of interests posed by market timers. Among these tools are the ability to price underlying assets at a fair value and the ability to refuse to sell units to suspected market timers, as well as a number of measures to reduce dilution and to otherwise increase the cost (and so decrease the attractiveness) of market timing activity.

Mr Foot went on to say:

"We have amassed a considerable amount of evidence which leads us to this broadly reassuring conclusion and in doing so it would not be surprising if we have sensitised fund managers to the risks they run with respect to market timing and to the need for robust controls and active monitoring. But we will also undoubtedly have alerted some potential market timers. Doing nothing more in this area is therefore not an option for us."

Next steps

The FSA is undertaking further work on a number of issues: The FSA will continue to look to fund managers to demonstrate management of conflicts of interest in accordance with the FSA's Principles-based regime. Potential conflicts arise whenever market professionals are permitted to invest in funds at the potential expense of long term investors. Steps to manage conflicts could include not dealing with market professionals if there are any questions about their motives or the potential impact on long term investors.

The FSA will be pushing ahead with the package of reforms to the regulation of funds in the UK (CP 185) that were published last year. This included amendments to the rules that would clarify the measures available to deter market timing. These measures include the use of fair value pricing (use of a best estimate where underlying prices are likely to have moved materially) and clarification of the scope for declining to deal. We have been particularly encouraged by the willingness of industry participants to embrace fair value pricing and we are looking to them to work up concrete proposals for this. The firms asked that we implement the proposals on fair value pricing that we made in CP185 for existing funds and this, subject to the approval of the FSA's board, is something we intend to do.

The FSA is encouraging managers of unit linked funds that are not covered by the more detailed CIS regime to adopt the tools in the CIS regime to allow them to avoid potential detriment to investors from market timing. Firms are reminded that the FSA Principles apply.

Firms have pointed out the problem caused by order aggregators who place combined deals for several customers, which may hide the activities of market timers. While recognising these difficulties, we remind firms of their obligations. If fund managers are unable to satisfy themselves that potentially suspicious deals are not on behalf of market timers, we suggest they use the range of tools at their disposal and do not allow any unduly preferential dealing arrangements.

Notes for editors

1. 1. This review concentrated on stale price market timing, a practice of trading in a fund which is valued by reference to out-of-date (stale) prices, e.g. a fund invested in US assets which has a valuation point of 12 noon will need to use the previous night's US closing prices. Publicly available information gives investors an indication of the direction and size of potential market movements when a market re-opens. A customer seeking to take advantage of a stale price effect is not in breach of FSA rules, however this activity operates to the detriment of long term holders who lose out as a result of the dilution of the fund. Hence the need for fund managers to manage conflicts of interest fairly, both between itself and its customers and between a customer and another client.

   2. Late trading requires cooperation between a fund manager and its customer. It is the wholly illegal practice of permitting a customer to enter an order or withdraw an existing order in a CIS after a fund's valuation point, other than on justifiable administrative grounds. The counterparty would explicitly be provided with the ability to undertake trades at advantageous times and hence prices in a way which allows them to profit to the clear detriment of long term investors.

   3. The sample of firms included in FSA's review have funds under management of 160bn. It is estimated that authorised CIS have a total value of 220bn. (Figures as at September 2003.) FSA collated data from 31 firms and undertook on-site visits to 25 firms.

   4. At his meeting on 10 December 2003 with the CEOs of firms included in FSA's review, FSA Chairman Callum McCarthy announced his intention to pursue solutions to market timing issues with industry representatives. A meeting with industry representatives took place in January 2004, when industry proposed the use of Fair Value Pricing in preference to mandatory shifts in funds' valuation points.

   5. The scope of FSA's enquiries related only to authorised Collective Investment Schemes. It did not include all forms of active trading, for which deterrent tools are already available e.g. discretionary dilution levies. FSA will be conducting a review of single and dual pricing of CIS later this year which will look more closely at the effects of active trading.

   6. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection of consumers; and fighting financial crime.

   7. The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.