IF the Securities and Exchange Commission of Pakistan (SECP) had the time to go through the studies put out regularly by the Financial Services Authority(FCA) of the UK on insider trading, it could learn some useful lessons in at least keeping a tab on how much of this menace is going on at the three stock exchanges in the country, especially at the Karachi Stock Exchange which has been compared by some to a casino.

According to the latest FCA study made public on March 7, insider trading is widespread on the London markets in spite of the City watchdog’s campaign to keep the market clean. It showed that 23.7 per cent of takeover announcements in 2005 were preceded by price movements that indicated possible insider trading.

The FCA is an independent non-governmental body given statutory powers by the Financial Service and Market Act 2000. It is financed by the financial services industry and the Treasury appoints its board. It is accountable to the Treasury ministers and through them to Parliament. Interestingly, it regulates the very industry which finances it. It has wide-ranging rule making, investigatory and enforcement powers in order to meet the following four statutory objectives.

• market confidence: maintaining confidence in the financial system;

• public awareness: promoting public understanding of the financial system;

• consumer protection: securing the appropriate degree of protection for consumers; and

• the reduction of financial crime: reducing the extent to which it is possible for a business to be used for a purpose connected with financial crime. According to the published material, there has been an improvement in the situation compared to the last year as the results of the new study 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 two per cent of significant announcements being preceded by informed price movements compared to 11.1 per cent in the period 2002/03 and 19.6 per cent 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.

There was a decrease in the level of possible informed trading ahead of takeover announcements from 32.4 per cent in 2004 to 23.7 per cent in 2005. But the level still remains high and little changed from the situation in 2000 of 24 per cent before the implementation of the Financial Services and Markets Act.

The FCA 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 used for earlier analysis was 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 is said to reduce 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 authors of the study 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 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.

US authorities do not keep statistics in the same way, but they have expressed similar fears about insider trading. The New York Stock Exchange referred twice as many suspicious trades to US regulators for possible investigation in 2006 as it did in 2004, and federal prosecutors have recently broken up two separate trading rings that allegedly capitalised on information from Wall Street banks.

The timing of the publication of the FCA study is also significant because it has come at a time when the world markets including the London Stock Exchange were just about coming out of a bad dream. Many believe that the world has not seen the last of this nightmare. But others insist that no crash is imminent. They attribute the jitters to a slow down of the US economy because of a signficant slow down in consumer spending, the sudden appreciation of the interest free Japanese Yen, a steep drop in the Shanghai market and the shenanigans of the hedge funds and private equity which looking for the cheapest sources of funds have been exploring the Japanese Yen.

Now that the Japanese Yen has appreciated and China not wanting to see any financial crisis in the country until well past the Olympics has seemingly intervened in the Shanghai market to stabilise it and with the US economy trying to make do with new incentives for the consumers to spend, market watchers hope that the Exchanges would rebound and get back to their normal and steady fluctuations, notwithstanding the FCA report on wide-spread prevalence of insider trading at the LSE.