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?