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Illegal trading comes under pressure as the FSB flexes its muscles

11 June 2014 Jonathan Faurie
Jonathan Faurie, FAnews Journalist

Jonathan Faurie, FAnews Journalist

While the end results of investments is largely unpredictable, there is a lot of thought and science which goes into analysing the markets and giving the public appropriate investment advice.

One of the classical pieces of advice is that investors should never put all of their eggs into one basket. Diversity encourages prosperity as investments in a portfolio that are performing well will support the investments which are going through a bad patch.

The Financial Services Board (FSB) has noticed the need for this and has recently issued a directive which restricts platforms which facilitates trading in their own securities.

Making its intentions clear

Solly Keetse, FSB Head of Directorate Market Abuse, says that the FSB has specific goals in mind with issuing this directive.

"The draft Directive intends to regularise the affairs of all unlicensed exchanges that facilitate trade only in their own securities, either by these exchanges ceasing the illegal unlicensed exchange activities and therefore not falling within the ambit of the Financial Markets Act, 2012 (FMA), or by them obtaining the requisite license to operate an exchange.”

This will illuminate some of the over the counter trading of securities which does not have the relevant licence to do so by the FSB.

"The FSB does not want to ban all over the counter trading. If the manner of trading falls within the definition of an exchange as defined by the FSB, the entity must be licensed as such. If the entity trades in a manner which does not fall within the FSB's definition of an exchange, it does not need to be licensed. One of the objects of the FMA is investor protection. The licensing requirements of the FMA are intended to ensure that certain basic safeguards for investors, who trade on an exchange, are in place. The Registrar of Securities Services (Registrar) is obliged to apply the law that puts investor protection front and centre,” says Keetse.

He adds that if the exchange is not licensed, investors are not protected in that market because the FMA does not apply. Market abuse provisions such as insider trading, market manipulation and false reporting also only apply to regulated markets.

"Investors in these unlicensed exchanges are therefore vulnerable to market abuses, such as insider trading and price manipulation. A first time investor who feels that there is not a level playing field, as other people have inside information from which they are benefiting to his detriment, or that the share price is being manipulated, won't continue to invest in such a market. Such investor needs protection,” says Keetse.

Currently, the FSB is aware of approximately 15 companies that facilitate over the counter trading in their own securities in such a manner that would likely require an exchange licence.

Taking the high road could be the only option

Some may think that the FSB is forcing companies to play a high stakes game by forcing them to list on the JSE. However, Keetse says that the issue at hand relates unlicensed exchange platforms which are outlawed in terms of the FMA. It is therefore more about the manner in which trading takes place on some platforms.

If a company does want to register with the FSB, there are fixed licence application fees of R450 000 as prescribed by Board Notice under the FMA and variable costs such as legal, audit, surveillance and insurance costs. The variable costs would differ from operator to operator.

"The Applicant must pay the costs. However, the applicant may raise these funds in different ways, which are not prescribed by the FSB. The FSB believes that these costs are minimal when compared with the losses that can be suffered by investors trading on an unregulated platform,” says Keetse.

The high road does have its benefits

While this may seem to be very costly and time consuming, companies who do adopt this approach may reap significant benefits.

Keetse points out that investors will be protected by the provisions of the FMA. There will be market surveillance to ensure that insider trading and price manipulation is combated. "There will also be safeguards to ensure that there is pre & post trade transparency; transparent price formation and safeguards against market infrastructure failures. These well regulated safeguards could lead to increased liquidity in the shares of the issuer and an increase in confidence in the share,” says Keetse.

He adds that the FSB's interpretation of the law does not change the law. All persons who believe that they may be operating unlicensed exchanges, should therefore consider obtaining legal advice to ensure that their conduct is legal.

A view into the future

In the past, there have been certain industry role players which have questioned the FSB's ability to flex its muscles and come down on companies who do deviate from the laws which have been handed down by the FSB.

This however changes when the FSB moves towards the Twin Peaks model in 2015 where it becomes the market conduct regulator rather than its dual role of formulating laws and making sure that companies adhere to them. Perhaps this draft directive is the first signs that the FSB will have the ability to flex its muscles and come down hard on offending companies.

Editor's Thoughts:
Whether this will offer the public the protection that they need remains to be seen. This also may unintentionally cause confusion in the industry and create unnecessary bottlenecks. Compliance to this may prove to be costly. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.

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