Is Trade Compliance really just doing the part of managing risks of trading that the desk heads don’t want to do or don’t have time to do?
Yes, that question is meant to be provocative, but it has a real purpose. It is to illustrate the fundamental role that trade compliance is performing these days. The roles currently seem to be:
The reality is compliance becomes a very simple function if the head of desk has the interest in examining the staff actions, understands them, and cares if they go off the rails. Then, the compliance function is simply to notice when someone unintentionally steps out of bounds and helps the head of desk correct the mistake before it becomes a major issue.
When the head of desk does not care and understand or, worse, actively supports improper “how” and “why” actions, compliance becomes a game of “find the rat in the basement”. In that case, compliance has to create enough different views and analyses of data to be sure there are no shadows to hide in. The latter case of active or passive encouragement of improper behavior has created what DCM see as the basis for the expansion of compliance into “conduct risk”.
If the original oversight of trade compliance was to keep staff with bad intentions from actively breaking rules on their own, DCM looks to conduct risk compliance as the attempt to keep good staff from doing bad things because “that is the way everyone here does it” or “I didn’t know that was wrong” or “my boss told me I have to get more client revenue or I lose my job”. Look at all those excuses:
DCM believes it is really that simple. The role of compliance in a company is determined by:
One final point – some may quibble about whether the questions I posit cover such things as money pass trades or wash trades to move positions from one account to the other. I would just note that “why you are making trades” would cover trades intended to defraud or hide a shift of positions. So, trades that are executed for reasons other than direct P&L impact should still be detected in standard compliance oversight.
This is the first in a number of pieces discussing why and how desks, risk, and compliance should be seen as supporting, not conflicting, functions. To paraphrase what someone who led the compliance function of a major money center bank once said to an industry group “We are not three walls holding out the barbarians. There is only one wall, we are all on it, and we work together or we fail.”
Dynamic Commodity Management is some old guys who traded, managed risk, and wrote compliance oversight from the strategies to policies and procedures to actually pulling the trigger. We are happy to have conversations and provide support from strategy to execution to the C-suite down to the cutting room floor.
About me (Tom Lord)
By way of explanation - I admit to being a dinosaur – my first trades in the energy industry were for Section 7 “emergency gas purchases” (go ahead, I’ll wait until you look up what that was). This is a way of saying that the trades that are executed today didn’t yet exist when I started (there were no options in natural gas and power in 1977, prices were regulated and the contracts had zero vol). I have the fun claim of being the originator on the first ever prepaid natural gas sale financed by a tax-free bond (with Municipal Gas Authority of Georgia). I have seen many of the ways people break the rules, try to bend them, or just screw up. It is best to keep the core focus simple. That is what we are trying to do here.
ICE US Futures publishes margin parameter changes for US NGLs and Petchems - worth understanding the structure
Here at DCM, we have been focused more on the market compliance rules lately and have let the risk management portions of the rulebooks be a lesser focus. Bad on us, because the risk management parts of the rulebook really bite you when the markets go into hypervolatility. And today's notice from ICE US Futures here is one example.
First, the notice is for changes in the ICE US margins on certain contracts - but the notice immediately references that "For each of the IFUS Energy Contracts, ICE Clear Europe determines the margin rate that is charged to clearing members that carry positions in these contracts. The Exchange minimum margin requirements for outright and straddle positions are based upon the ICE Clear Europe margin rate". As many can remember, there have been significant debates between the US and EU regulators over the past several years as to the proper margin calculations - ICE uses a single margin engine but does adjust US and EU for different "MPOR" - Margin period of Risk (one day for OIl and a number of US energy related products and emissions).
Second, the ICE Europe margin instructions for energy have multiple links to .csv files for relevant risk data - I assume trading desk risk managers have reviewed this. What is interesting here is that the "scanning ranges and tiering" data file is dated April 27. So you have new files to be effective Monday that are on the website now. There are a number of NGL contracts that have significant discount changes - the shift in these rates is both up and down down. (I would also note that the power references were changed earlier this week).
In addition, the inter-month spread rates were changed (increases across the board), strategy spread rates changed (frequently in excess of 25% and some in excess of 100%), and inter-commodity spread rates as well - and while the notice covered NGLs and Petchems the biggest changes I noted in inter-commodity spread rate changes was in wet freight cargo.
This is just to note that,
a. Smaller shops need to know the ICE EU margin process if they are trading energies;
b. ICE is publishing the changes the Friday before they go into effect - put these in place for remote operations across a weekend will be a pain if you do your own internal version of the calcs; and
c. all traders should think through the expected market impacts of changing margin calcs in the NGLs markets (which are less liquid) in this hypervolatile market.
The ICE EU risk management (margin) page is here
CME and ICE change options pricing model in a way that is likely to impact consumer collars and make them go "ouch". Hint, it covers negative prices.
Both CME and ICE (US and Europe) have published circulars related to the collapse below zero of the crude contracts.
CME published a brief little note here on April 21 - effective yesterday - changing the settlement pricing model for options in over 60 crude and refined contracts to the Bachelier model (which is interesting since Bachelier died in 1946 so I am not sure how he got option pricing down).
ICE US and ICE Europe both issued their notices today - ICE US covering 9 crude contracts and 5 options contracts (all crude outrights only - CME covered BALMOs and others) while ICE Europe covered 13 crude contracts and 3 options contracts (all crude but including Brent and US BALMOs). The ICE US notice is here and the ICE Europe is here.
The big impacts here are going to be on any entity short puts - under standard option models
Many commentators and the exchanges themselves have indicated that COVID 19 will not cause exchange and regulator oversight to cease. The ICE just punctuated that thought with a notice today of a two month suspension from exchange access for a trader.
The suspension is the result of placing orders without intent to execute (large orders on one side of the market while executing small orders on the other and then cancelling the large orders - classic spoofing) on one single day in December 2016. No monetary fine but a two month suspension. The notice is here
I would just like everyone to imagine the difficulty, cost, and risk associated with an exchange inquiry into your trading activity while you are in remote operations. How do you have the compliance officer manage the call with the trader? How do you get outside counsel access to your records? How does your compliance officer access phone recordings?
The ides of managing an inquiry in this environment is even more daunting than in normal circumstances. I think all compliance officers should think about how their business continuity plan addresses remote management of an inquiry. This also might recommend a note to all trading staff that even greater caution than usual might be a good thing.
DCM hopes all of you are staying safe and healthy and that all industry companies and staff can weather this with minimal impacts. Our best to all of you.
Please fell free to reach out to us for advice and questions in these difficult times - even if you have not been a client in the past, know that we feel all of us have to pitch in and help to keep everyone going these days.