The UK’s Financial Services Authority published a methodology that aims to measure the cleanliness of financial markets by looking at the extent to which share prices move ahead of the regulatory announcements that companies are required to make to the market.

FSA researchers analyzed 1,500 markets announcement in two categories: take-over bids in 2000 and 2004; and announcements about the trading performance of FTSE 350 listed companies between 1998 and 2003.

They then examined announcements that led to a large or abnormal share price movement since these are the announcements most likely to contain information of use to an insider trader. They then assessed the proportion of such announcements that, in fact, were preceded by an apparent “informed price movement” that could mean that some trading on unpublished information occurred.

The results do not show exactly how much market abuse is going on, but the researchers detected price movements which suggested that some informed trading may have taken place prior to 28.9% of the takeover announcements and 21.7% of the FTSE 350 trading announcements which were identified as being most likely to contain information of use to an insider trader.

The analysis of FTSE 350 announcements covers a period before new securities legislation establishing the FSA (known as the Financial Services and Markets Act) came into effect, and a later period, when the FSMA was in force but the FSA had yet to complete any enforcement action against market abuse. The analysis indicated that there was no change in market cleanliness in relation to announcements by FTSE 350 listed companies. The analysis of announcements relating to takeovers included 2004, when five misuse of information cases were completed, and showed that there was a small but statistically significant increase in informed price movements suggesting a deterioration in market cleanliness.

“The analysis shows that there was no improvement in market cleanliness in the period after the introduction of the FSA’s new powers, and before any high-profile enforcement cases were concluded. This suggests that visible enforcement action may be the key tool in our work to reduce market abuse,” said Hector Sants, FSA managing director.

The FSA intends to repeat the analysis later this year for later periods. If this future work shows a change in the level of the measure for takeover announcements of more than four percentage points (up or down), this would indicate a change in the frequency of informed trading, it says. Similarly, a change in the FTSE350 announcements measure of more than eight percentage points (up or down) would indicate a change in the frequency of informed trading.

The regulator says that the methodology should enable it to measure, over time, its success in tackling market abuse. The initiative is part of the FSA’s drive to establish key indicators that will help it understand better how successful it is at achieving the intended benefits of regulation.

“Our future success in reducing market abuse should be measured not by gut feel or fines levied, but by using a robust, analytical tool that will stand the test of time,” Sants added. “The methodology we have developed gives us such a tool and is an important step forward in establishing the starting point against which the FSA’s future work in tackling market abuse should be judged.”