Cleaning Up London's Financial Markets

Regulator Hector Sants is striving to stamp out insider trading and other abuses in the City

Hector Sants has seen a lot of history. In a financial-services career that goes back to 1977, he has witnessed the extinction of most British investment banks and the transformation of the City of London from a rather insular place to perhaps the world's most cosmopolitan financial center. Now, the 50-year-old Oxford graduate has become a powerful regulator of London's financial markets—and he has his eye on cleaning up abuses.

Sants knows the business well, having previously served as the chief executive for Europe, Middle East, and Africa for Credit Suisse First Boston. In 2004, he was recruited to be the managing director for wholesale markets at the City of London's chief regulator, the Financial Services Authority (FSA)—the British equivalent to the U.S. Securities & Exchange Commission, but with a wider mandate.

The trading activities of banks, hedge funds, and other big hitters fall under Sants' purview. His worry: Market abuse and insider trading remain a problem in the City and elsewhere. "It appears not to have improved, and may well have deteriorated," he said in a recent interview at the FSA's Canary Wharf offices.


According to a recent FSA study, roughly one-third of takeover bid announcements by London-listed companies between 2001 and 2004 were preceded by unusual price movements, indicating that inside information may have been used by market participants. The study showed that the instances of unusual trading rose despite tougher rules against insider trading coming into effect in 2001.

Insider trading has always been a factor in financial markets, but it has grown in sophistication along with the City. Sants thinks that the complexity of today's financial world is magnifying the potential for market abuse. Sants notes that many merger transactions these days involve multiple advisers and, therefore, a greatly increased number of individuals with access to inside information.

Other areas he thinks are potential sources of market abuse: private-equity transactions and leaks to traders in credit products from teams evaluating corporate creditworthiness. "The opportunities (for insider trading) have grown," he says. "There is more information out there."


Conflicts of interest, which have always abounded in financial services, are also becoming increasingly difficult to manage. The FSA worries, for instance, that because hedge funds provide such a big chunk of trading commissions for financial institutions, the firms will be tempted to leak information to these top clients. Hedge funds themselves are also a big source of concern. In a speech last month, an FSA official, Rebecca Jones, referred to the agency's "perception" that "some hedge funds are testing the boundaries of acceptable practice concerning insider trading and market manipulation."

As a veteran industry insider, Sants was recruited to help the FSA deal with all of this complexity. He has been plowing ahead on several fronts: He has hired more market-surveillance people, and he has launched a $28 million upgrade of the FSA's IT-monitoring systems. Every week the FSA delves into a dozen or so trades flagged by its computers or other methods as potentially suspicious.

Sants also is focusing proactively on specific practices he thinks could be prone to abuse. The FSA, for instance, is currently looking into possible information misuse in the credit markets, in particular, information transfers between credit traders and analysts. Also, it's examining possible misbehavior ahead of M&A announcements.


It has previously done work in the area known as "wall crossing," which happens when an investment bank pre-markets an offering by calling hedge funds and other institutional investors to gauge their interest. Before gaining access to the information on the potential deal, fund managers are required to agree not to use it in trading.

But Sants says "wall crossing" looked like such a potential minefield that he asked banks to provide a list of those who had been wall crossed on roughly 10 deals.

Wall crossing produced one of the FSA's highest-profile enforcement cases. On Feb. 11, 2003, Philippe Jabre, a managing director of GLG Partners LP, one of London's largest hedge funds, received information from Goldman Sachs (GS) as part of the pre-marketing of a new issue of convertible preference shares in Sumitomo Mitsui Financial Group (SFMG). The information was deemed wall crossing, and GLG was restricted from dealing in the securities until the issue was announced.

According to the FSA, Jabre then "breached this restriction by short selling around $16 million SFMG ordinary shares" and made a substantial profit for his GLG Market Neutral Fund after the issue was announced on Feb. 17. On Aug. 1, 2006, the FSA fined Jabre and GLG about $1.4 million each for "market abuse and breaching FSA principles." A spokesperson for Jabre says he believes the FSA was wrong.


Sants has slapped the wrists of a couple of other high-profile institutions. On June 28, 2005, the agency fined Citigroup Global Markets Limited (C) $26 million for the massive disruption it caused in the European government bonds market in July, 2004. The so-called Dr. Evil scheme involved building up substantial long positions in bonds and then quickly selling them off.

The FSA also levied an $11.6 million penalty on Deutsche Bank (DB) on Apr. 11, 2006. One of its traders gave instructions to the Deutsche's proprietary trading desk, which invests the bank's own money in the market, about trading in shares of Swedish truck maker Scania, while also being involved in managing an offering of the same shares.

Still, there have been relatively few high-profile collars. The fines, too, seem relatively low; one hears in the City that they are viewed almost as a cost of doing business. Sants replies that the FSA is "in the business of deterrence, not enforcement." And the FSA has publicly said it will raise the levels of its fines.


Other observers concede the FSA has a very tough job. "I think the FSA is doing the best it can and has a good reputation," says Antonio Roma, associate director of the BNP Paribas Hedge Fund Centre of London Business School. "It is not easy to detect market patterns resulting from the use of inside information."

The numerous stock markets and different regulators in Europe also complicate a regulator's task. Despite his run-in with the British authorities, Jabre is already raising an estimated $2 billion for a new fund. He plans to set up shop in Geneva, out of the FSA's reach.

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