theICE US Futures issued a Disciplinary Notice in Case 2020-018 (notice here). The firm accepting the settlement had an existing spread exemption granted by the exchange. However, the notice indicates that the firm did not comply with the terms of the spread exemption during the spot month period "numerous instances" between November 2019 and June 2021 when it held positions in the Henry Hub LD1 contract in excess of the spot month limit. They noted that the company did not have adequate policies and processes in place to monitor "its positions or its compliance with the spread exemption". The company also didn't comply adequately with staff data requests.
We have the trifecta here - trading against an hedge exemption without actually having a valid basis for the exemption at the time the trades were in excess of the position limit, not monitoring the positions and compliance with the terms of the hedge exemption, and not responding adequately to an exchange inquiry.
DCM has written over and over again that a hedge exemption from an exchange is not "carte blanche" to trade up to the limit under any and all circumstances. It IS an opportunity to trade in excess of the position limit up to the exemption IF:
1. You can confirm that your current actions and supporting positions are such that the exemption, as seen through your CURRENT supporting positions, justifies exempting the excess position.
2. You actually have to the ability to monitor that what the underlying circumstances are and whether they comply with the exemption. If your current supporting positions support a lower exemption, then the lower exemption is what you are entitled too - not what is stated as the maximum in the exemption.
Finally, any company that feels it has the resources and capability to stall out an exchange inquiry just is wasting their time, their shareholders money on even more outside counsel fees, and, in the end, will pay even more fines. If they are asking you questions, tell them the truth and tell it up front. You are allowed to tell your version of the truth but that version can't include hiding facts.
The CME posted a pile of MRANs today - many are mostly applicable to brokers but they may impact you. The reason for the realeases are to make conforming changes to the rules to remove requirements associated with floor traing operations.The list is:
Don't just assume your broker statement is right - review it every day. New exchange summary action reinforces it
DCM is always amazed how often firms just assume anything from their broker must be correct. Then something like the notice of summary action against Morgan Stanley by the CME that was issued today reinforces the advice to always read your broker statement and check it.
The notice here regards a $2,500 fine from the exchange for improper recordkeeping. The action was because:
Pursuant to the results of a back office CTR exam, for trade dates February 23, 2021 through March 31, 2021, Morgan Stanley & Co. LLC’s data entry errors for sequenced cards, verbal orders, and floor orders exceeded the 10% threshold level mandated by Rule 536.F.
That is right, in just over a 30 day period the data entry errors exceeded 10%.
Just review your statements every day to make sure they are correct.
CFTC, not an exchange, fines Tyson Foods $1.5 million for position limit violations and false Form 204 filings - updated
In one of the larger position limits violation fines in recent history, the CFTC fined Tyson Foods for repeated violations of the CFTC position limits in soybean oil as well as for filing false Form 204 reports (which state the underlying cash positions that support a futures position for hedging.
The CFTC press release is here and it lays out a pattern of both position limit violations and false reporting to protect those positions.
The press release states that Tyson Foods violated the CFTC position limits under the Commodity Exchange Act for 590 days between January 2016 and January 2021 - which, assuming roughly 1,250 trading days in that period, is almost 50% of all trading days in the period. In addition, the CFTC states that for every month but 2 in that period Tyson Foods filed an incorrect Form 204.
The CFTC cites Tyson Foods cooperation with the investigation - including self-reporting violations that occurred after the state of the investigation - as the reason for " a reduced civil monetary penalty."
This should be noted by energy and metals trading firms as the new CFTC position limit rules will include certain energy and metals contracts under the direct CFTC position limits as of January 1, 2022.
Updated - the full CFTC order is now available here. The order clarifies several things:
First, Tyson filed the settlement offer and it was accepted - the $1.5 million was Tyson's proposal.
Second, in case it wasn't clear, the Form 204 filings are the representation by a company of its hedgeable position. In other words, filing an improper hedge exemption is akin to filing a false Form 204 - an incorrect hedge exemption request is not a false filing under Dodd Frank but energy and metals firms should be aware that under the new position limit rules effective January 1, 2022 the hedge exemption request to an exchange is also a bona fide exemption filing under the new CFTC position limits. You might check with counsel as to whether an incorrect hedge exemption request to an exchange might also be a violation of CFTC rules after that date.
Third, the CFTC specifically cited that for some months the filed amount of cash positions in the Form 204 exceeded the actual cash positions held by Tyson. DCM has advised multiple clients that, just as the CFTC cited regarding the Form 204, exchange hedge exemption filings are a maximum authorized hedge exemption. The hedge exemption is actually only valid to the amount of bona fide hedges held by a company at any given time. In other words, if you have a hedge exemption for 2.500 lots based on a physical or other offsetting position you did hold it does not mean that hedge exemption is perpetual. Your current hedge exemption is actually based on your current bona fide hedge positions - if they have decreased from the time the hedge exemption was filed, then the hedge exemption has likewise declined. Your firm should be tracking your bona fide hedge positions versus your hedge exemption quantity.
Fourth, the order indicates that Tyson, when reviewing its calculations for the Form 204, found it was using incorrect conversion factors, mitting certain transactions from the calculations, and, in some cases, just taking its open futures positions, converting them to bushels equivalent, and reporting the futures overage as its cash positions. All of these factors contributed to filing inaccurate position reports to the CFTC - and all violations of CFTC rules.
Fifth, the CFTC has, in this case, generalized what Tyson did in a manner that will potentially be more broadly applicable. The order cites:
"it (is) unlawful for any person to make any contract for the purchase or sale of any commodity for future delivery on or subject to the rules of any contract market in excess of position limits established by the Commission, “unless such person files or causes to be filed with the properly designated officer of the Commission such reports regarding any transactions or positions [in excess of position limits] as the Commission may by rule or regulation require.”
Note this indicates any filing that is required - the hedge exemption filings to exchanges under the new position limit rules is a report required to be filed under CFTC rules. This would imply that the reasoning in this order could apply to any hedge exemption for the new CFTC position limits managed by the exchanges.
Sixth, the CFTC states that:
" it unlawful for any person to make any contract for the purchase or sale of any commodity for future delivery on or subject to the rules of any contract market in excess of position limits established by the Commission, unless, “in accordance with rules and regulations of the Commission, such person shall keep books and records of all such transactions and positions and transactions and positions in any such commodity traded on or subject to the rules of any other board of trade or electronic trading facility, and of cash or spot transactions in, and inventories and purchase and sale commitments of such commodity.” Section 4i specifies that “[s]uch books and records shall show complete details concerning all such transactions, positions, inventories, and commitments, including the names and addresses of all persons having any interest therein ….” Regulation 1.31(b)(3), 17 C.F.R. § 1.31(b)(3) (2020), specifies that such records shall be maintained for a period of five years.7 Regulation 1.31(c), 17 C.F.R. § 1.31(c) (2020), specifies that such records shall be created and retained in a form and manner that ensures the authenticity and reliability of such records. There is no scienter requirement for recordkeeping violations. "
This means that the is a recordkeeping requirement for all bona fide hedge transaction to support exceedance of a CFTC position limit that runs for five years after the date of the exceedance. DCM would not be surprised if a significant number of energy, agricultural, and metals trading firms do not have a specific process and procedure to cover this requirement.
This case turns out to be a very good refresher on the intricacies of CFTC position limits. It would be appropriate for many firms to review their existing process from identification of bona fide hedges, through filing of hedge exemptions, to recordkeeping for underlying physical positions. DCM is happy to help advise or even perform procedure reviews and controls test for interested parties.
When I talk with clients about ESG, the one point that always occurs is that ESG Is hard from a data perspective. Not just figuring out the ESG categories but also getting the data right. And that is without incorporating the carbon offset aspects into your risk and compliance controls and data systems. And now I am going to suggest it should be ven harder.
Why? Because the stark supposition of accuracy and precision protrayed in ESG reporting is a facade. And reporting should list some of that facade. Here is what I propose:
First, there should be multiple categories of carbon mitigation. The list would look like:
Second, companies should be required to track and report their ESG efforts based on the categories above. The carbon offsets based on probabalistic calculations should be gathered to calculate the range - the expected value they are relying on as well as the upward and, especially, downward limits of what may actually be achieved.
Third, companies should be required to have the same accoounting and risk control programs on place regarding their carbon related investments. In is not just possible but, in my opinion, highly likely that some comapny in the next five to ten years will have a huge restatement in the financial reports because they have determined that their investment in carbon offsets will produce significantly less carbon offsets i the future than they have estimated. And that would lead to a write down in asset value.
Finally, there need to be standards for reporting what happens if a company determines its prior ESG reports were incorrrect. Will this cause a restatement of prior financial returns? Is there a shareholder cause of action (think institutional investors with a stated "sustainable" focus) because their investment in the firm was induced by incorrect financial reports? Currently, to DCM's understanding, restatement of ESG voluntary reporting is also voluntary. Itshould be noted that some firms have voluntarily restated prior year information in their voluntary report - one instance we found had the information on restatements in a footnotes in a data appendix with no indication of the amount of change. If ESG reporting is supposed to let investors know how firms are assisting in energy transformation and decarbonization, then adjustments - especially those that indicate prior year information overstated corporate achievements - should be up front and direct.
All of this makes ESG reporting harder but investors have a right to know what company efforts really entail and how they are performing.
Unique twist on wash trades - CME fines another exchange for facilitating wash trades for its customer accounts
CME fined the Mercantile Exchange of Vietnam for enabling customer wash trade s - the notice is here. The exchange was fined for "acting as an intermediary for its customers who cannot access a foreign exchange directly, executed transactions in various Agriculture futures products between two accounts with common beneficial ownership. MXVC executed the opposing buy and sell orders with the knowledge and intent that the orders would trade opposite one another." So, the exchange was entering and executing orders for its customers in CME products and the CME discerned the activity.
The CME also fined two individuals for their participation in the activities, one for placing the orders as well as the ubiquitous "Tag50: violation, the other for placing the orders. Their notices are here and here. The traders were fined $10,000 each. The trader with the Tag50 violation was suspended from the CME for two weeks, the other trader for one week. The exchange was fined $30,000.
The interesting pieces of this set of facts if the CME cites trades on a single day as the underlying issue. So, the CME surveillance is adequate to review all the trades on a single day, including trades entered by another exchange, and trace them back to the accounts behind the exchange and find:
1. Wash trades between accounts held by a beneficial owner;
2. The Tag50 violation by an individual trader for those transactions;
3. Make a case the Disciplinary Committee upheld.
And the exchange was also found to have not provided compliance training for its staff as required.
Again, think of the quality of surveillance to find this needle in a haystack - do you really think you "are too small for them to worry about"?
CME issues a new notice on disruptive trading FAQ, following ICE US Futures last week - very important distinctions between the two
eThe DCM blog covered the ICE US Futures update of its FAQ on disruptive trading orders last week. On Monday, the CME issued a new MRAN (Market Regulation Advisory Notice) covering many of the similar areas (the full notice is here). It covers many of the same areas.
The answer to the fifth question in the "FAQ on CME Rule 575" has been changed to reflect, as ICE US did, that companies are "expected to take reasonable steps or otherwise have controls to prevent, detect, and mitigate the occurrence of errors or system anomalies, and their impact on the market. Failure to take reasonable steps to prevent, detect, and mitigate such errors, anomalies, or impacts may violate Rules 575.C.2., 575.D., 432.W. (“Failure to Supervise”), or other Exchange rules. " This is very similar to the ICE notice and creates a residual risk around a fat finger or other incorrect order message even if the order is not considered "disruptive trading". The approach is slightly different as ICE US changed the wording to indicate an erroneous order would not normally be considered disruptive trading while CME left the language as "An unintentional, accidental, or “fat-finger” order will not constitute a violation of Rule 575" (and therefore no disruptive trading ) but left the application of other rule violations as the avenue for discipline.
The answer to the eleventh question in the FAQ again makes a divergence in the ICE US and CME answers to a very similar question. ICE US, last week, answered a question on large market orders by indicating a large order could be deemed disruptive if "if the entry disrupts the orderly conduct of trading in the markets, including, but not limited to, effecting price or volume aberrations." The CME answer speaks directly to orders placed "an order for a quantity larger than a market participant expects to trade in electronic markets subject to a pro-rata matching algorithm? ", a subtle but important distinction. The CME focuses the issue in a very different area by stating "However, it is considered an act detrimental to the welfare of the Exchange and may be a violation of other Exchange rules for a market participant to enter an order without the ability to satisfy, by any means, the financial obligations attendant to the transaction that would result from full execution of the order. Participants should be prepared to, and capable of, handling the financial obligations and risk attendant to the full execution of their orders without disrupting the market." This is the first instance that DCM has noted of an exchange indicating that submitting an order that a firm cannot satisfy its financial obligations to can fall within the disruptive trading violations.
The answer to the thirteenth question follows ICE US's new answer on "orderly execution". CME adds a sentence to the answer that "Additional factors that may be considered include, but are not limited to, the impact to other market participants’ ability to trade, engage in price discovery, or manage risk. " This differs in that ICE US pointed to "a market disruption or system anomaly" in its answer, this has been omitted in the sentence added by the CME.
The answer to the twenty third question subtly changes the FAQ answer regarding intentionally corrupted or malformed data packets. The prior answer indicated purposefully corrupting or malforming data packets has the potential to disrupt. The new answer now reads "Purposefully submitting intentionally corrupted or malformed data packets". This new answer indicates both the submission and the intent to corrupt need to be present.
There is a new example that illustrates the language in Question 23. describes a situation where an algorithm is designed to intentionally submit an incomplete data packet to negate the order being constructed. This may be considered disruptive to the Exchange systems and be a violation of Rule 575.
ICE Futures US issued a new FAQ on disruptive trading rules. There are some significant changes in here - especially several of the later items where entirely new FAQ answers have been added. The full notice is here
Here are the things that have changed:
1. The pattern of all messages - not just those alleged to be entered without intent to execute - is important. This would explicitly allow ICE to broaden its allegations to include the interaction of orders intended to be executed and those alleged to be without intent;
2. Added "indicative opening price" to the specific list of prices impacted by disruptive trading - the pre-open has been part of CME disruptive trading disciplinary actions. DCM cannot find any actions for pre-open activity discipline by ICE Futures US in the past so this may open new doors here;
3. Specific reference to whether a firm used industry best practices in designing, testing, implementing, changing, monitoring and documenting an automated trading system. I would note the last item in that list - DCM has observed instances where automated system documentation has been less than adequate. ICE US Futures is setting the bar fairly high by requiring best practices documentation;
4. ICE US added "made inactive" to the type of message actions that may not be considered disruptive trading;
5. There are significant changes in the language regarding orders entered by mistake or error. The language adds a qualifier to the idea that errors will not be considered a violation to read errors are not typically considered an error - moving errors back into potential disruptive trading. The requirement is now that "reasonable actions" be taken to correct the error and there is an expectation that there will be controls to prevent, detect, and mitigate errors or systemic anomalies (which would indicate automated trading system errors). This places an affirmative responsibility to have controls in place. They add "Failure to take reasonable steps to prevent, detect, and mitigate such errors, anomalies, or impacts may result in a violation of Exchange Rule 4.01" and then they refer to the "duty to supervise" obligation;
6. New FAQ question on stop orders indicating they are not an order entered without intent to execute. However, the answer then indicates that the stop order must be intended to execute if the stop order conditions are met. So, a stop order is not a disruptive trading action on its face but it still can constitute a disruptive practice is used improperly;
7. A new sentence has been added to the definition of "orderly execution" by including impacts on other market participant's ability to transact: "Additional factors for consideration include, but are not limited to, whether a market disruption or system anomaly limited the ability of market participants to trade, engage in price discovery, or manage risk." An example might be an order that triggers a market halt;
8. They have brought in circumstances from recent cases to flesh out factor for ICE determining an act was done with intent or reckless disregard by indicating that " furnishing false information, failing to furnish information or making false statements to Market Regulation staff is a violation of Exchange Rules." There have been recent instances where firms accused of disruptive trading have provided incomplete or incorrect information in defense of their actions, this could make such actions a factor in determinations of a rule violation;
9. The FAQ on orders "igniting momentum" as a disruptive practice has been modified to cover a single order as well as multiple orders - a single order can now be considered a disruptive trade under this modification,
10. The FAQ on pre-open disruptive trading has been modified to remove the specification of "related to the pre-open" to other actions, such as orders prior to the pre-open. This may make the assertion that an action prior to or around the pre-open but was not "related to the pre-open" less effective against an exchange action,
11. There is a new FAQ specifically indicating a broker and execution clerk has an independent duty to assure customer orders do not violate disruptive trading rules and customer or employer instructions are not a defense.
12. New FAQ answer indicating that orders used to test ICE connectivity or data feed are orders entered without intent to execute and, as such, are disruptive. This should be something every shop needs to make their IT staff aware of.
13. New FAQ on negative price orders indicating they are NOT disruptive on the face. However, use of these orders to induce other market participants to trade or to mislead others of market conditions is disruptive trading. They note that "orders entered significantly away from the best bid or best offer will be scrutinized by the Exchange as potentially entered with the intent to establish a market price that does not reflect the true state of the market".
14. New FAQ answer on large orders - the answer is yes, they can be disruptive and it is the market participants obligation to know their market and assure that order don't distort "the integrity of the settlement prices".
There are some very significant shifts indicated in these answers - it would be appropriate to review both your controls and your monitoring to confirm these news rules don't create gaps in your coverage.
Often, CME disciplinary notices can offer insight into how the CME weaves together its oversight capabilities. Ih this set of notices, all cited under CME-19-1140 - BC 1 through 8, eight different individuals were charged with violating CME Rule 575 - Disruptive Trading Practices. The citation was in all instances related to entering orders without the intent to execute.
The insight comes from the facts that all eight participated in foreign exchange markets but not all of them in the same markets. neither did they all participate in identical times periods. This would indicate that the CME surveillance team managed to stitch together a coordinated effort to spoof the market by eight individuals over different markets at different times. There is no indication that would lead one to believe these individauls were, or were not, acting inside the same company or through the same broker. But in some manner, the staff managed to place together a set of evidence that led the CME Disciplinary Committee to bring these charges.
And, once again, the individuals charged failed to respond to the charges with a written response. As is the standard action, the Committee deemed the charges to have been admitted to by the actor alleged to have committed them.
Each individual was fined between $30,000 and $55,000. All of them are also suspended from any direct or indirect access to any DCM, DCO, or SEF owned or controlled by the CME for five years after the date the fine is paid.
As big data analysis is more deeply implemented by the CFTC and exchanges, the visibility of more difuse and smaller actors becomes easier to detect. Firms are encouraged to let go of the belief that "we are just too small for them to see what we are doing". The reality is that the haystack is getting easier and easier to sort through. Is it worth losing access to market liquidity to save a little on the budget?
Last week, the CFTC issued a notice that it had fined Amaggi Exportação e Importação Ltda. $175,000 for multiple reporting violations associated with CFTC Form 204 (reporting for positions in cash positions in grains and soy products). This is a long standing set of reports that allows the CFTC to connect cash positions with futures holdings for its oversight and surveillance activities.
The firm had failed to file the required reports for more than a one year period. After filing the overdue reports, eight of the reports were incorrect.
Firms should remember that the CFTC reporting requirements are obligatory regardless of their trading location - activity in US futures markets is, part and parcel, an acceptance of the CFTC's jurisdiction.
While the CFTC's new position limits in energy and other products became effective on March 21, 2021, compliance is due by January 1, 2022 for all twenty five contracts under CFTC position limits (up from nine). It is mandatory for firms trading in the products now covered by CFTC position limits, as opposed to the general coverage of exchange futures under exchange rules subject to CFTC position limit oversight, to be compliant with both the CFTC and exchange rules that now cover the CFTC position limt contracts. The rules for the 9 "legacy contracts" and the addition 16 new agricultural, energy and metals also include new rules including "economically equivalent" swap contracts under the position limt rules.
Firms should be well underway on identifying obligations under these new rules and implementing both process and data systems requirements to assure compliance. Please contact DCM if you have questions concerning the application of these rules to your activities, potential impacts of these rules on your risk and compliance programs, and your preparations for compliance.