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Good practices in supervision of wash trades by investment service providers and special trading situations
The FIN-FSA has drawn the attention of traders to wash trades and has addressed the issue, for example in Market Newsletter 1/20231, after which the Financial Supervisory Authority has surveyed the practices of investment service providers in the supervision of wash trades. Based on the survey, this article reviews best practices of investment service providers to prevent wash trades. The article also discusses special trading situations.
A wash trade refers to, for example, a situation in which a trader trades with itself at a trading venue, such as Nasdaq Helsinki. In such cases, the buy and sell orders placed by the trader are executed at the trading venue as a trade, either in whole or in part. A trade can also be considered a wash trade if the same party or different but colluding parties enter buy and sell orders to trade at or nearly at the same time, with very similar quantity and similar price (improper matched orders).2
Market manipulation means, among other things, placing trades or orders that give, or are likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument3. Wash trades artificially increase the trading volume of a financial instrument in the trading venue, creating a misleading picture of supply and demand, which is particularly evident with thinly traded financial instruments. Wash trades may also affect the price of a financial instrument, but price change is not a prerequisite for the identifying characteristics of market manipulation to be met.
The FIN-FSA may impose an administrative penalty payment for wash trades or submit a request for investigation to the police. Market manipulation is punishable under the Penal Code.
FIN-FSA has surveyed practices of investment service providers in supervision of wash trades
Article 16 of the Market Abuse Regulation (EU) 596/2014 (MAR) requires all persons professionally arranging or executing transactions to establish and maintain effective arrangements, systems and procedures to detect and report suspicious orders and transactions.
The FIN-FSA has surveyed the practices of selected investment service providers with regard to how they have arranged the supervision of wash trades. Based on the survey, the FIN-FSA recommends for investment service providers the following practices to prevent wash trades. It is in the interest of all market participants that wash trading is prevented in advance as comprehensively and effectively as possible. The practices set out below also serve the interests of investment service providers’ clients by reducing the risk of clients being suspected of market manipulation.
Wash trades can be effectively prevented with automated blocking mechanisms
Based on the survey, a number of investment service providers have automated blocking mechanisms in place that reduce the risk that orders placed by clients will result in a trade in which they would be both the buyer and the seller. The FIN-FSA generally considers automated wash trade blocking mechanisms to be good practice.
One of the most effective ways to prevent wash trades is to put in place an automated blocking mechanism that prevents a client from placing an order that would lead to a trade with an opposing order placed by the client through the same broker (so-called hard block). Some investment service providers have in place functionality to warn clients that an order they are placing may result in a trade with a previous order they have placed in the opposite direction. Such functionality (so-called soft block) does not prevent the order, however, and is therefore less effective in preventing wash trades.
Wash trade also refers to a situation in which the same person is the investment decision-maker on both the buying and selling sides of an executed trade. Thus, for example, situations in which a person makes the investment decision in a trade on behalf of both themselves and their investment company, or on behalf of a family member by power of attorney, may, as a general rule, be considered wash trades. Entities may seek to improve the prevention of wash trades by taking into account in the blocking functionality of the trading service not only the beneficiary but also the person who made the investment decision regarding the order.
Other key factors enhancing the prevention and supervision of wash trades
The expertise of the personnel who receive, transmit and execute orders has a key role in ensuring the effectiveness and comprehensiveness of the supervision of market manipulation as required by regulations. Maintaining this expertise is supported by sufficient and regular training. The FIN-FSA draws the attention of investment service providers to ensuring that entities’ internal guidelines specify as precisely and clearly as possible the internal processes for detecting and reporting suspicious transactions and orders, also on the practical level. In addition, internal guidelines should be regularly reviewed and updated as necessary.
Increasing clients’ understanding of the provisions and prohibitions related to market manipulation will help to reduce the risk that they will enter into a trade that could be considered a wash trade or some other form of market manipulation. Based on the survey, investment service providers are also seeking to guide their clients in a preventive way, for example by providing clients with guidelines or otherwise communicating with them.
If an investment service provider does not have in place the above-mentioned automated blocking mechanisms, even more emphasis falls on the comprehensiveness and effectiveness of the investment service provider’s post-trade surveillance. One way for entities to ensure an adequate level of surveillance is to introduce an automated trading surveillance system that generates alerts about possible or attempted wash trades. With regard to surveillance system alerts, the level of monitoring can be improved by, for example, including in the alerts not only the beneficiary but also the person who made the investment decision regarding the order.
The FIN-FSA reminds entities that, according to Article 16 of the Market Abuse Regulation (MAR), the competent authority must be notified without delay of orders and transactions that may involve manipulation or attempted manipulation4.
Special trading situations
A client might contact the investment service provider in order to execute a trade that might be considered a wash trade. In such cases, the investment service provider must make it clear to the client that the desired order or orders must be executed in such a way that the prohibition of market manipulation under the Market Abuse Regulation or other regulations are not violated. It is prohibited to enter into a wash trade, even if the underlying purpose of the trade is not to influence the market.
The FIN-FSA emphasises that negotiated trades (so-called block trades) in accordance with the rules of a trading venue that are reported to a trading venue, such as Nasdaq Helsinki, and in which the same person makes the investment decision on both the buying and selling side of the trade, may, as a general rule, be regarded as wash trades. Such a situation may arise, for example, if a person makes the investment decision in a trade on behalf of both themselves and their investment company or on behalf of a family member by power of attorney. An investment service provider should accordingly not execute the client’s orders as a negotiated trade to be reported to the trading venue if, according to the information available to the investment service provider, the client would be the investment decision-maker on both the buying and selling side of the trade. If, instead of a negotiated trade, the client’s orders are executed on the trading venue in an order book with other market participants, care must be taken to ensure that the order book does not show price changes that could be considered misleading and thereby possible market manipulation.
As a wash trade can also be considered a trade where the investment decision-makers in the trade are technically reported as different parties, but in fact the investment decision is made by the same person on both sides of the trade.
The FIN-FSA reminds traders that they should primarily contact their own broker if they have any questions or uncertainties about trading.
For further information, please contact:
- Juha Manu, Senior Supervisor, juha.manu(at)fiva.fi or tel. +358 9 183 5323
- Hermanni Teräväinen, Senior Supervisor, hermanni.teravainen(at)fiva.fi or tel. +358 9 183 5346
1 Wash trades prohibited as market manipulation - Market Newsletter 1/2023 – 25.5.2023 - www.finanssivalvonta.fi.
2 Commission Delegated Regulation (EU) 2016/522 Annex II, Section 1, Point 3 a) and c).
3 Market manipulation is defined in Article 12 of the Market Abuse Regulation (EU No 596/2014) and prohibited in Article 15. Annex II of Commission Delegated Regulation (EU) 2016/522 specifies the indicators of market manipulation in Annex I of the Market Abuse Regulation.
4 Reporting obligation concerning the prevention and detection of market abuse - Issuers and investors - www.finanssivalvonta.fi.