Investors using alternative data could fall foul of European Union market abuse rules as regulators may see some of the data as non-public information, according to lawyers.
Derived from non-traditional sources of information about companies and the economy, such as social media, credit card transactions and bank trading flows, new datasets are a hot topic in systematic investing. But whether some such data can be deemed public or not is a “grey area”, and investors found to be using non-public information potentially risk fines or even losing their authorisation to trade, says Andrew Tuson, partner at Berwin Leighton Paisner.
“There is a level of uncertainty because regulators have not issued clear guidance on the use of alternative data and may not be familiar with how quickly the market is moving and how people are using different information,” he says.
The EU’s Market Abuse Regulation, in force since 2016, prohibits trading based on “inside information”, defined as information that has not been made public and is precise enough to move the price of specific securities.
The condition of being public means datasets compiled, for example, by scraping thousands of public websites or counting the number of cars in shop car parks to gauge sales activity are not inside information.
But it is less clear how regulators will treat information that is not widely available – for instance, if an investor has bought from a data vendor data sourced from one company that provides insights into the sales of another.
A key consideration is that EU rules are based on a principle of “unfair advantage”, a senior lawyer at another UK-based firm explains. “It’s about market transparency and a level playing field,” he says.
In line with this principle of fairness, how information is acquired is critical, he says.
Guidance from the UK’s Financial Conduct Authority (FCA) under the prior EU market abuse regime indicates that information known only to a few people can be deemed public if nothing would stop others gaining access to the same information. The example given is of an investor on a train who sees a factory on fire and is able to trade on that knowledge.
“If you break into a listed company’s headquarters and ransack their filing cabinets, clearly that is illegitimate,” the senior lawyer says. “But you often hear the question: what if you go into 200 stores and interview the store managers? Is that crossing the line? It’s those kinds of judgment questions that can be difficult.”
If the information is only being made available to one or two entities on the basis of a fee, it is more difficult to say it is publicly available informationAndrew Tuson, Berwin Leighton Paisner
One view is that the act of selling data makes it public information.
Past guidance from the Committee of European Securities Regulators, which preceded the European Securities and Markets Authority, said publicly available information can include information disclosed by a third party on a commercial basis.
It remains unclear, though, how widely available data needs to be for regulators to consider it public. Some sellers of alternative data sell their information to only one or a few investment firms and charge a premium for the exclusive access. But others are much more cautious in their interpretation of the rules: one vendor Risk.net spoke to would not sell data with any level of exclusivity in the EU lest the data be deemed non-public.
Tuson of Berwin Leighton Paisner says: “If the information is being offered to any member of the public or any sort of information source [aggregator], then it is easier to claim the information is publicly available. But if the information is only being made available to one or two entities on the basis of a fee, it is more difficult to say it is publicly available information.”
Regulators are likely to act to in some cases to rectify what they will see as unfair advantage, he adds, noting that the FCA has been increasingly active in enforcing market abuse rules.
Some vendors say most of the new data available is either compiled from public sources, or is blended or only useful in combination with other data, meaning it could not be seen as precise enough to affect prices on its own.
Users of alternative data should also bear in mind that inside information can come from a wide variety of sources.
“It is not only the company that can have inside information about itself,” Tuson says. “Another entity can have inside information that is unknown to the company – for example, a regulator that is about to launch an investigation that could have an impact on the price of the stock, or a star analyst who is about to produce a report that could move the market in the stock of the company.”
Lawyers say European investors are only now beginning to ask about the permissibility of trading based on new types of data and they have to contend with market abuse rules that are less clear-cut than their equivalent in the US.
Jonathan Streeter, partner at US law firm Dechert, says that under US law, only information that is material, non-public and violates some duty to keep it confidential is viewed as inside information.
Much alternative data will be treated as material and non-public, he says, so investors in the US must be careful to ensure no duty of confidentiality has been breached: “At every step along the way you have to make sure no-one is taking information and using it in ways that are not permitted by the party they are contracting with.”
“The thing that gives me heartburn,” Streeter adds, “is when a vendor is not willing to explain how they can assure me they have permission to have this data. When I don’t get a good answer on that, I tell the client: don’t buy it.
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