On 19 November 2024, the United Kingdom Financial Conduct Authority published a Research Note ‘A revision of our market cleanliness statistic methodology’ for its Market Cleanliness Statistic. This measure, designed to assess the extent of abnormal price movements prior to major corporate events such as takeover announcements, serves as an indicator of potential insider trading and market manipulation in the United Kingdom’s equity markets. The revision addresses long-standing limitations and aims to enhance the robustness and inclusivity of the statistic, reinforcing the United Kingdom’s Financial Conduct Authority’s commitment to ensuring transparency and fairness in financial markets.
The revision was necessitated by three issues in the current methodology. First, the previous approach failed to account for abnormal trading activity on the day of an announcement made during market hours, leading to the potential underestimation of insider trading activity. Second, firms that issued multiple takeover announcements within a single estimation period were excluded from the analysis, which limited the dataset and potentially reduced the statistic’s reliability. Third, the methodology did not adequately account for periods of heightened market volatility, such as those caused by macroeconomic shocks like the COVID-19 pandemic or geopolitical events, which could distort the results and create biases in the interpretation of market cleanliness.
The United Kingdom’s Financial Conduct Authority’s new methodology introduces advancements to address these shortcomings. It now incorporates intraday trading data, analyzing price movements at five-minute intervals rather than relying solely on end-of-day prices. This change ensures that trading activity occurring shortly before an announcement during market hours is included in the analysis, providing a more comprehensive picture of potential information leakage. The estimation window, which previously covered 240 trading days, has been shortened to 60 days. This adjustment increases the number of eligible events for analysis while maintaining statistical integrity, allowing the methodology to include firms with multiple takeover announcements within a year, provided those announcements are spaced at least one quarter apart. The United Kingdom’s Financial Conduct Authority has implemented a cross-sectional market comparison test to better account for market-wide volatility. By comparing abnormal price movements in the stock of interest to those of a representative market sample, the new methodology distinguishes firm-specific movements from broader market trends, reducing the risk of false positives and negatives.
The revised methodology has yielded a higher Market Cleanliness Statistic compared to previous calculations. This increase is primarily attributed to the broader scope and enhanced sensitivity of the new approach, particularly its ability to detect abnormal pre-announcement price movements that occur on the same day as a takeover announcement. The United Kingdom’s Financial Conduct Authority emphasized that this does not indicate a decline in market cleanliness but rather reflects the improved detection capabilities of the revised methodology. The new approach reduces the exclusion of events and minimises biases introduced by market volatility, making the statistic more representative of the actual state of market behavior.
The analysis supporting these changes was conducted using data from 285 takeover announcements in the United Kingdom between 2020 and 2023. Intraday price data was sourced at five-minute intervals, ensuring a higher resolution of trading activity. While the changes significantly improve the methodology, the United Kingdom’s Financial Conduct Authority acknowledged certain limitations, including the relatively short timeframe for intraday data analysis and the potential impact of sampling intervals on results. Moreover, the Market Cleanliness Statistic remains an indirect indicator of insider trading, as abnormal price movements can also result from legitimate trading activities such as media speculation or financial analysis.
This revision aligns with international best practices, as similar measures are employed by other regulators, including the Australian Securities and Investments Commission, to monitor and improve market transparency. By incorporating cutting-edge methodologies and addressing known limitations, the United Kingdom’s Financial Conduct Authority aims to maintain the United Kingdom’s position as a global leader in financial regulation.
Beginning in 2024, the United Kingdom’s Financial Conduct Authority will implement this revised methodology in its annual reporting. Stakeholders are encouraged to provide feedback on the changes, particularly the use of intraday data and the application of the cross-sectional market comparison test.
(Source: https://www.fca.org.uk/news/news-stories/revision-our-market-cleanliness-statistic-methodology, https://www.fca.org.uk/publications/research-notes/research-note-revision-our-market-cleanliness-statistic-methodology, https://www.fca.org.uk/publication/research-notes/revision-market-cleanliness-statistic-methodology.pdf)
