The Last Look…

A frisson of excitement rippled through financial markets last week when one of its recent “darlings” was banned by a regulator for what was cited as market manipulation, but which clearly took advantage of the market structure. This then, allows me to have a crack at two favourite targets – equity markets and fixes!

I am talking, of course, about the banning of Jane Street by India’s SEBI over accusations it manipulated bank stocks and indices – charges the firm denies and will appeal. SEBI says Jane Street was buying up bank stocks and components of the Nifty Index, which tracks those stocks, on expiry days, pushing the market higher, before buying puts on the Index (and selling calls apparently), and then, as expiry neared, dumping their original position and cashing in on both that and the options positions.

It could be argued that the firm was merely taking advantage of a market structure weakness – one that is all too common in equity index markets where expiries have seen all sorts of fun and games over the years. Was this, therefore, just another case of a firm spying an opportunity and being banned because they thought of something no-one else did?

Another factor was how Jane Street’s buying in the morning duped people into thinking bank stocks were going up – and would stay up. In certain circumstances, I would argue that if people are dumb enough to blindly follow anything they see in markets, then they deserve everything they get.

The problem with that sentiment, however, is the mix of market participants in equities markets. Luckily enough in FX, while they are often too close for my liking, institutional players are not operating closely alongside retail punters. It is clear that in this instance, there were a few retail punters caught up. Again, should this just be seen as a case where “consenting adults” rules come in to play? You want to play in the markets, particularly intraday, then understand the risks it comes with.

I understand we want to protect the retail punters from being run over too often, but the reality is those involved are almost all day traders, and as such are – or should be – well aware of the risks involved. Part of the problem is these traders are sold “bots” from all sorts of sources, many of which blindly follow market data and are ripe for exploitation – in effect they are a modern-day version of what used to be called “spoofing” in FX markets in the voice days.

To explain this to the kids (and middle-aged readers – I’m getting old!) “spoofing” in the 1980s involved buying or selling in the market away from your natural interest. The idea was certain counterparties (and they were uniquely other banks) were nervous about certain players’ flow and would clear out the risk immediately. This wasn’t really enough though, but there were firms who would not only clear the risk, they would position with the big player. This meant by, for instance, selling 30 or 40 million to targeted counterparties, the actual effect would be to have 60-70 million sold, thus pushing the market lower. This done, the original seller – who was actually a buyer of perhaps 250-300 million – would be able to create 10-15 pips of room on the downside to help their average.

I have argued previously that this should not be termed “spoofing” as such, because the original player did actually sell – it wasn’t just a case of flooding the market with offers and there had to be an intention to deal because they did actually deal. At any time, it could have gone wrong and they were left with a rising market and an extra 30-40 million to buy.

Clearly, it took place over a longer time frame, but was Jane Street’s trading any different?

Well yes it was, for several reasons – and while this column has thus far laid out reasons why the firm should not have been hit hard, there are others that suggest SEBI got it right.

Firstly, the firm was accused of wash trading – and it is notable that SEBI has banned the firm and all affiliates from trading in India’s derivatives markets.

Wash trading – deals between affiliates – on any scale, is clearly market abuse. The firm concerned is generating false market data and importantly, trying to create the image of a liquid market – something that would be critical to this strategy as it needs enough players involved to actually get out of positions as expiry nears.

Wash trading is why FX venues do not allow multiple connections or IDs – it’s some 13 years since then-Thomson Reuters suspended (for a couple of days at Christmas if I remember rightly!) Lucid Markets for having just such a framework, so perhaps we should question why firms in some equity markets are allowed them? Surely the exchanges involved can see the opportunity for market abuse – why not stop it before it can happen?

Secondly – and to me most importantly – Jane Street says it was merely operating as a market maker, but does the modern day market maker take on large positions? To an outsider such as myself, most of these “market makers” in exchange markets are operating a quasi-broking model, where instead of charging brokerage, they make a small turn over every trade.

To many of these firms, therefore, building up a large position is cause for alarm bells to ring rather than celebration, they simply do not take large positions – certainly not market-moving positions – for a significant time, so how was this trading part of “normal” market making activities? I am not au fait with the rules of Indian derivatives markets, but I wonder if market makers are meant to stay in the “broker” box, and not take on positions?

Another question I would have is simple, if this strategy works so well and is allowed under market rules, why wasn’t it used on non-expiry days? I understand that there is more interest on those days and people are more alert to trading activity (which is why fixes are such a generally bad idea), but so many players nowadays are, as I noted, using “bots” or trading off the back of market data, that surely it would work on other days as well?

What is to stop a player buying in the morning and selling in the afternoon? Nothing. If, however, those other players are not pressurised by an imminent need to roll or expire positions…?

Overall then, there are too many questions about this type of activity for it to easily pass the sniff test. That is not to say an appeal will not succeed, but it may be on a technicality. What should also happen, however, is the local (and global) authorities should take a long hard look at how these markets operate. India will not be the only place such activity is possible – why put firms in harm’s way by leaving loopholes open?

I do genuinely understand that, to paraphrase Winston Churchill “fixes are the worst possible form of market benchmark – apart from every other form available”, but surely there are enough very clever people out there to seriously consider better ways to set benchmark values?

colin@thefullfx.com