Let's ask the question a different way - are you willing to spend over $10K per month just to size the pre-open?
In a pair of linked cases issued today, the CME fined a company $75K total for entering "Lean Hogs, Feeder Cattle and Live Cattle spread futures orders on CME Globex during the pre‐opening period that were not made for the purpose of executing bona fide transactions, but instead to identify the depth of the order book." They noted the orders caused the indicative opening price to fluctuate. They issued an order for the Trader for very similar actions - in the same markets - for trades in a different year.
As DCM has been noting, the company got the bigger fine - $75K - for failure to train and supervise. This is a common them - if you don't have a track record of effective training and oversight, the company is considered to be at least allowing - if not encouraging - inappropriate behavior. The notice is here
Many firms train about manipulative behavior during market trading but don't always stress that the pre-open is still observed for disruptive trading. In many instances, with the reduced activity in the pre-open, the pre-open may be easier for the exchanges to see the impact of transient orders.
In the case covering the same issue, the trader was fined $20K and suspended from any market access for ten days. The notice is here
This occurred several years after the corporate case - an indication that this is an ongoing concern that the exchanges watch for. There had been previous cases in the agricultural markets with even larger fines for just a small number of pre-open disruptive trading action.
(Sigh) - no, your clever maneuver to make a wash not look like a wash doesn't work. It was not a pair of EFRPs.
In the continuing exploration of how one can try to arrange their book through trades that will disguise a wash trade, Nomura was just fined $30K for reporting two EFRP trades that just so happened to work together to act as a wash trade between two accounts with common beneficial owner. The exchange noted the trades and asked for documentation of the physical delivery contracts behind the EFRP.
Yes, a exchange can ask through a "special call" for production of the specific physical delivery contracts behind an EFRP. Failure to have an executed physical contract prior to the futures transactions converts the declared EFRP into an illegal off-market futures transaction. There were a significant number of special calls in the energy and agricultural markets in the late 2000's regarding EFRPs - the largest fine I recall was a $5MM fine of Morgan Stanley for a pattern of EFRP abuse.
In this case, Nomura appears to have used two EFRPs to consummate the two sides of a wash trade without having underlying supporting documentation.
This fine appears to be above the norm for a single EFRP violation. My opinion is that the use of non-valid EFRPs to attempt to disguise a wash trade led to a heavier penalty. I would note that the CME disciplinary notice here did not include specific language that indicated my opinion was the motivating factor for the level of the penalty.
This, once again, proves that the exchanges have the ability to peruse all executions to determine if beneficial accounts are on both sides of the transaction and then to drill deeper into why this would occur. The level of information about account attribution significantly increased with the revised Form 40 and this type of analysis is much easier for the exchanges to perform.
Once again, the CME has fined a company and a trader for wash trades. The trades were between two accounts with the same beneficial owner and, the CME notes, were designed to delta hedge OTC options. So - the intent to actually do the trades is fairly easy to find. But so is are the trades.
The company, in this case a bank, gets all its transactions. It knows its accounts and beneficial owners. How hard is it to set up a simple match (mind you, on a large scale, it is still a lot of data to go through) that says look at all trades. Compare whether the buy and sell side of the same transaction are in our executions. Compare the accounts - do they have the same beneficial owner? If yes, possible wash trade. There is additional data in the exchange data feed that can let you scrub out trades where there is the same account or accounts with the same beneficial owner as allowable. Yes, there are trades where the same account is matched on both sides of the transaction that are allowed under exchange rules. Failing to understand the allowable filters and the data needed to operate those filters and how to get the data and store it is one of the primary reasons for massive false positive issues. But that is a discussion for another day.
But just having done that would have avoided the disciplinary impacts. The company was fined $40K for "failure to supervise" and, more importantly, is probably on the exchange radar as not doing a thorough job of compliance oversight - meaning the exchange has to look closer at future issues since the company compliance is not seen as reliable. In addition, the trader was fined $10K and suspended from the access to the exchange for 5 days. That is 5 days someone else has to manage that person's book - and most desks don't have spare people just lying around.
So, understanding what is easy and what is hard and where the risks are is a central component to effective compliance. It is just the cost of entry to trading in today's electronic markets. Don't treat it as an incidental cost of doing business and end up with even great issues.
The notice for the company is here and the trader here
Block trades are a very useful trading tool and a legal "ex pit" transaction. They can allow you greater ease of execution, increased large volume liquidity, and can avoid having a firm "step in front of you" in the market. But they come with reporting rules for bilateral block trades that people some times overlook.
The largest action in this area in the last decade was a $14MM civil fine of Morgan Stanley by the CFTC for a TAS block trade reporting issue. The CME notice is here. But there was recent CME fine for $135K to a firm for multiple reporting failures regarding NYMEX energy block trades in 2017. (note, we had a prior blog entry on the fact that issues with the exchanges may take time to proceed). The disciplinary notice is here.
The CME fine was for both block trade reporting issues and failure to train staff properly - leading to another of the "failure to supervise" issues that have become common recently. It should be noted that failure to report a block trade properly changes it from a legal "ex pit" transaction to, literally, an illegal off exchange future transaction. Block trade training is not that difficult and should be on your basic exchange rules training program.
DCM is an advisory firm providing strategic and compliance services to commodity market participants - whether end user, producer, trading or marketing firm.
Back on December 5th of last year a trader was fined for behavior that ICE considered manual spoofing. The fine was low for this type of behavior - $15K. The trader was also suspended from the market for 9 weeks.
Obviously the check hasn't arrived yet. So, on January 25, an additional notice was issued extending the trading access denial until the fine was paid in full.
This is the sort of thing you should consider as a "flag risk" for your management. This notice was sent 7 weeks after the original notice - not the full 9 weeks. Regardless, I would imagine every compliance officer would not want their management calling asking about this additional notice.
Consider paying any assessed fine well prior to the due date for any exchange fine - otherwise you might be explaining this follow on notice to senior management.
One thing to note is that compliance problems don't always bite quickly. This month, the CME fined an individual $50K and suspended him for three years from the markets. This order was issued January 7, 2019. The Probable Cause Committee meeting was in August, 2018. The alleged behavior was in October, 2017.
The full time line is over 14 months. This points out one of the critical factors that comes up frequently in any compliance discussion with a client - can you quickly and accurately recreate data and activity AFTER the fact. A simple concept is that the faster you can respond to a regulator or exchange's inquiry with complete documentation of the incident, your internal analysis and resolution, the more likely you are to have a more favorable resolution with the party inquiring.
If, on the other hand, you have to spend three weeks even figuring out what happened the inquiring party is going to wonder why you weren't even looking. Remember, regulators and exchanges don't have all your information. Rational trading behavior and disruptive trading CAN look the same. Being prepared can make a difference in the time and effort you have to spend on resolving an inquiry.
The CBOT notice is here - https://www.cmegroup.com/notices/disciplinary/2019/01/cbot-16-0571-bc-2-benn-hepworth.html#pageNumber=1. Think about how you would be able to respond to a question about alleged wash trades.
Much of the recent spoofing disciplinary activity has been coming from the CME. However, within the last two weeks ICE US Futures issued a disciplinary notice for "trade practice violations" and "Conduct detrimental to the Exchange" relating to placing of orders without intent to execute. The fact pattern is classic "spoofing" - large orders on one side and smaller on the other. Small orders execute and large order immediately cancelled. The question becomes "what are traders thinking"?
It should be noted, the disciplinary notice talks of a "pattern" of this behavior. We frequently talk to our clients about detecting patterns - one off occurrences may not be controlling.
I had a recent conversation with a client about this activity. I have been on the desk (I helped build one of the largest physical natural gas desks back in the 1990's) and had a competitor step in front of my bid. I raised the bid - they stepped in front again. By the fourth time I said "$%#@* this (or something equivalent), I will sell that price" and hit the bid. That is not spoofing. However, doing that 10 times a day starts too look less and less like I was responding to competitor pressure and more and more like I intended the result. Do it 10 times a day for a week and it is a pattern.
This becomes a question of when the pattern exceeds your compliance risk tolerance? That is the question that a good compliance program allows you to answer - when has this pattern become one I feel is too close to prohibited behavior and the explanation is too thin to accept? That is a question you should be able to answer.
The result in this case was a $15K suspension and a 9 week suspension from trading in the market. The full notice is here - https://www.theice.com/publicdocs/futures_us/disciplinary_notices/ICE_Futures_US_Brian_Soldano_20181205.pdf.
Did you know there have been multiple instances of disruptive trading penalties in the CME pre-open?
The pre-open period for exchange markets serve and important function. They allow the exchange to assess volume and price interest before the markets start to trade to allow an orderly initiation of the trading day. And using the pre-open to assess or influence the opening price as an individual trader is not allowed.
The CME just fined two individuals for disruptive trading in the pre-open for entering trades without the intent to execute (the indications in the pre-open must still represent transactions the trader would intend to execute. The CME noted:
"The entry and cancellation of these orders caused fluctuations in the publicly displayed Indicative Opening Price."
The CME also indicated that the trades were cancelled by using crossed market orders (see our previous blog on November 29, 2018 about cross-block being used for disruptive trading).
Finally, one of the two individuals was also cited for allowing another person to use their Tag50 log in ID to enter crossed trades.
So, once again we have individuals believing they can use the cross-blocking function to cancel trades for purposes of influencing market pricing.
They were fined $15K a piece and suspended from the market for 20 days. The notice that included the Tag50 reference is here - https://www.cmegroup.com/notices/disciplinary/2018/12/cme-16-0584-bc-jason-berry.html#pageNumber=1
It could also be useful to read up on the rules regarding the pre-open and how orders work in the market. The CME notice on market and instrument states is here - https://www.cmegroup.com/confluence/display/EPICSANDBOX/Market+and+Instrument+States. One important market state to note is that during the pre=open there is a period where market orders cannot be cancelled.
ICE US just fined a company $37.5K for having an ATS that violated Rule 4.02 and required them to cease violating Rule 4.02 and also Rule 401. What is an ATS? It is any system that can enter or cancel an order on an exchange without human intervention based on programmed logic. What is rule 402 you ask? It is the disruptive trading practices section. The Rule 401 violation came because of the wording of 4.01:
"Every Person shall diligently supervise the Exchange-related activities of such Person's employees and agents. For purposes of this Rule, the term “agent” includes any Exchange-related activities associated with automated trading systems that generate, submit and/or cancel messages without human intervention. Every Person shall also be responsible for the acts and omissions of such employees and agents." (my emphasis).
Therefore, if a trader builds a model that automatically triggers trade orders, there is strict liability for supervision of the algorithm's logic. This means that you have an obligation to test the logic of your algorithms to make sure they don't violate disruptive trading rules. For example, if you have an algo that has logic cancelling bids anytime the market offer gets within a certain value of that bid or when the bid stack between that bid and the market bid, you may have an issue with potential disruptive trading - read spoofing.
DCM staff have observed that major firms have adopted an internal compliance structure for annual review of all automated trading systems -have you done something like that?