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The Financial Services Authority (FSA) is today publishing the results of its latest work to measure the cleanliness of UK financial markets OP25 – Updated Measurement of Market Cleanliness. The recent exercise extended the period examined to include trading data from 2004/2005 as well as improving the methodology used to determine the level of market cleanliness.
The results show that in 2004/05 there was a significant decrease in the level of possible informed trading ahead of FTSE 350 companies' trading announcements, with only 2% of significant announcements being preceded by informed price movements compared to 11.1% in the period 2002/03 and 19.6% in 1998-2000. The 2005 figures also include the six month period following the introduction of the new Disclosure Rules for listed companies under the Market Abuse Directive.
For takeover announcements there was a decrease in the level of possible informed trading ahead of takeover announcements from 32.4% in 2004 to 23.7% in 2005. But the level still remains high and little changed from the situation in 2000 of 24% before the implementation of the Financial Services and Markets Act.
Sally Dewar, Director of Markets Division, said:
"We are pleased to see the improving trend in market cleanliness with the addition of the 2005 data. However, the figures for takeover announcements, although moving in the right direction, remain a cause for particular concern and there will be no let up in our efforts to tackle the problems in this area.
"These results reinforce the importance of our ongoing work on market abuse and in particular our current review into the handling of inside information in mergers and acquisitions."
The methodology
The methodology measures market cleanliness by looking at the extent to which share prices move ahead of the regulatory announcements that companies make to the market. The same methodology as OP23 has been used in the latest analysis but with some amendments made following feedback on last year's paper.
First, the way in which informed price movements (IPM) are identified has been adjusted so that, for example, it takes better account of volatility in the share price. This reduces the risk that the research incorrectly identifies an IPM as having occurred during a period of increased volatility prior to a regulatory announcement. Equally, it reduces the risk of a failure to spot an IPM where volatility has reduced over time. Second, the researchers concluded that it is best to treat all takeover announcements as significant rather than just those which led to a very large price movement once the disclosure has been made, as all such announcements may be considered to be economically significant.
Finally, the team also extended the analysis to examine the behaviour of trading volumes ahead of announcements and how changes in the sample could affect the measure over time.
The analysis
The research covered two types of market announcements: regulatory disclosures about the trading performance of FTSE 350 companies in the periods 1998-2000; 2002/03; and 2004/05; and takeover announcements for listed companies made in 2000 and 2002-2005. In both types of announcement the researchers looked for abnormal price movements around the time of the disclosure which would indicate the possible availability of information that may be of use to an insider trader. They then looked for the cases where these 'significant announcements' were preceded by an apparent IPM that could suggest informed trading had occurred. The market cleanliness measure is the ratio of informed price movements to significant announcements.
Although a useful statistical study, it is important to recognise that the scope of the review does have some limitations. First, given the data and techniques at its disposal it focused only on insider trading – which is just one form of market abuse. Second, it only considered 'cash' equities, rather than derivative or other instruments.
The FSA will continue to repeat the analysis as data for subsequent years becomes available.
