Money Pass, Wash Trade - name may change but the CME still is looking for it. Updated with ICE notice
Back on October 1, this blog looked at a CME disciplinary notice on "money pass" - pre-arranged trades between two account to move equity from one account to another. In the last two weeks (sorry, I was out at COP26 and wasn't keeping up on the blog), there have been two more similar disciplinary actions.
The first, issued on November 5 (notice here) was for an individual who "prearranged the execution of round-turn transactions in various options on Silver futures between (his) personal account and his employer’s account for the purpose of transferring equity to his personal account." Once again, the person did not respond to the CME inquiry and was fined $60K and suspended from CME markets for three years.
The second, issued as two notices on November 19, was a case where two individuals -prearranged trades to move money between their accounts. The interesting aspect in this set of cases is that one individual, notice here, was charged under Rule 432.G - general offense to pre-arrange trades to transfer equity - and Rule 576 - Tag50 violation - while the other individual was charged under Rule 534 - Wash Trades - for the opposite sides of the activity. Both were fined $40k and suspended for 20 days from the CME markets.
It should be noted that the later set of violations had a significantly lower fine and suspension period. There was no indication that the individuals in the latter case did not fail to respond to the CME inquiry. This responsiveness would be indicated from the note that the latter two individuals were fined in accordance with "an offer of settlement".
Two things to think of here:
First, there are multiple avenues for the CME to pursue activities that are undertaken to transfer equity - whether knowingly by both parties or only by one side of the activity - under the exchange rules. But all of them can be summarized by "no trades intended to transfer money between two accounts by individuals intending to use the exchange as the mechanism for transfer are legal". This is an activity that has been the focus of exchange trade surveillance models for years and they are still very effective in finding this activity and disciplining it.
Second, deciding to go silent and refuse to participate in an exchange inquiry is just going to make matters worse. Thinking you can force the exchange to drop an inquiry because you don't participate isn't going to work. They have all the trade and order level data - they don't need to prove intent. This is not a court action where there are rules of procedure and discovery. If they call you, get legal representation to help you but don't refuse to participate. It won't end well.
EU commodity exchange regulatory and disciplinary process is different than the US - here is another example
ICE Futures Europe issued a "Circular" - their version of what ICE Futures US call a "disciplinary notice" - yesterday regarding a spoofing case. The notice was directed to BNP Paribas ("PFU" in the circular) - not the trader. This is the big difference. As the circular indicates:
"where a trader at the PFU client entered large orders on one side of the orderbook, which appeared to be intended to attract trades against their iceberg orders on the opposite side of the orderbook. Shortly after the smaller orders traded, the trader deleted the large orders. These large orders were a significant percentage of the volume displayed at the relevant price levels. "
Unlike the US, action is directed to the broker. The circular says the action of the client of the broker is considered a breach of the rule but addresses the circular to the broker.
The disciplinary action then also diverges. The process was " PFU were given the opportunity to settle disciplinary proceedings at any stage with the Exchange. An agreement was reached and as per the same Rule, any terms of settlement agreed between the Compliance Officer and PFU were to be ratified by the Chair of the Authorisation, Rules and Conduct Committee (“the ARCC”). " The broker was the one in the disciplinary committee resolution - not the client company or the trader. Having been through any number of US actions, the trader is the one grilled and disciplined by a US exchange.
The oversight also is different - the circular indicates " In agreeing to the settlement terms, the Exchange noted that alerts were triggered in PFU’s surveillance systems and were appropriately investigated prior to the Exchange’s enquiries." In the US, the broker is not responsible for trade surveillance over the client's orders. This directs the disciplinary action directly back to the company and trader under the US model.
Finally, the disciple to the client was a different mechanism. The circular indicates "As a result, both parties agreed a settlement on the following terms:
• In respect of the matters described in this Circular, the PFU client had not acted in compliance with Exchange Rules Sections E2.2 (a) (xi) and G20.
• PFU has agreed to impose a suspension on the responsible trader at the PFU client from accessing ICE Futures Europe markets for 15 business days. "
The penalty is imposed by the broker and then the exchange agreed to the imposed penalty. This is a completely different structure.
This is pointed out to illustrate that companies who are used to the disciplinary process under the ICE Futures Europe markets is fundamentally different in very significant ways than the one used by the US exchanges. This should be recognized and reflected within a company's compliance program - the differences may call for different internal oversight and controls.
The CME issued a pair of disciplinary notices yesterday for a related set of "money pass" fines (the NYMEX notice is here). Money pass can be considered a specific form of pre-arranged trades where there is no position taken in the market but value is transferred from one account to another. This is normally performed by have a pair of round trip trades between the same accounts where one account profits and the other loses.
In this case, the individual fined was not only passing money between two accounts, the person was using someone else's Tag 50 (log in) to effectuate the transfer. The fine was $80,000 split between the NYMEX and CME and the individual was suspended from accessing any CME markets for five years.
The interesting part of this disciplinary action is that the NYMEX fine was related to Rules 533 - Simultaneous Buy and Sell Orders for Different Beneficial Owners, Rule 534 - Wash Trades Prohibited, and Rule 576 - Identification of Globex Terminal Operators. The CME disciplinary action was for violation of Rule 432.G - Money Pass Prohibited and Rule 576 - Identification of Globex Terminal Operators. The NYMEX has the same Rule 432.G but acted under the Wash Trade and Simultaneous Order Rules instead.
The prohibition arrives at the same place regardless of the set of rules applied but this points out that the exchanges have rules that, in instances, overlap. Since the practice does involve two offsetting trades with no intention of taking a position of risk in the market, money pass can be considered a special instance of wash trades.
The other instance that DCM has learned about in the past has been well out of the money options - buying and selling them between the same account - especially during periods of minimal activity and liquidity - has also been a place where this has occurred.
As some of the exchange concerns also relate to potential instances of passing money for other purposes that might implicate improper payments, firms should realize this is an area that exchanges have very specific surveillance models to detect. As with all rules, this is an area any firm should ensure it has the ability to detect any staff action to violate these rules.
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.