The Last Look…
Posted by Colin Lambert. Last updated: September 5, 2022
Apart from “stops at”, has there ever been a more persistent rumour in FX markets than those about a big player “protecting a barrier”? For years, the only story FX sales people seemed able to come up with was about a sovereign player trading around supposed barriers.
My point is that few should be surprised by allegations – and they remain just that – of a hedge fund manager deliberately trying to trigger a digital payout of $20 million, according to the rumour mill it’s been going on for decades. This case, as is often the way, does raise a few queries, however, in spite of the fact that, whatever one’s thoughts on the rights and wrongs of the alleged actions, it’s not a good look. Pick probably the thinnest trading day of the year, and trade in large, in an EM pair, at the Asian open; that’s not the actions of someone concerned about market impact, and it’s a classic time for an ambush.
As reported by us and others, the US Department of Justice alleges that Neil Phillips at Glen Point Capital sold $725 million in a couple of hours in USD/ZAR – (sarcasm alert) a currency pair famous for being highly liquid and non-volatile. I am not well-versed in ZAR markets, but friends of mine who are, tell me that is large volume even during European hours, let alone at the mainland Asian open following a major holiday.
For context, in the 2016 BIS Turnover Survey, daily ZAR spot turnover was put at $16 billion, so $666 million per hour, but heavily biased, no doubt, to European hours – this was a big trade for the time of day/year.
It was also a volatile time in the ZAR with Cyril Ramaphosa being elected president, something that was seen as positive for the rand. USD/ZAR fell from 14.50 to just above 12.50 in a couple of months leading up to the election (refer to earlier statement about the lack of volatility).
According to the DoJ charges, the pair bottomed out at 12.52 in the week before Christmas 2017 and on Boxing Day, it alleges that the executing bank – named as Nomura by Bloomberg News – sold about $100 million which saw the market drop five big figures, but fail to breach 12.50. It is interesting the chat following the sale of another $400-odd million saw the bank suggest that it was $100 million to get it 25 points lower, therefore another 200 was needed.
Was the writer of the barrier option on the other side trying furiously not to trigger the option? If so, what do we think about that?
In some ways this is counter-intuitive, because in modern FX markets, where LPs are more averse to holding sustained risk, one would have thought that after $100 million got it five big figures lower, the fact that momentum had slowed meant there was serious interest on the other side.
So, question one. That is a large amount to get it done, who was on the bid? Was the writer of the barrier option on the other side trying furiously not to trigger the option? If so, what do we think about that? Is that, by the DoJ’s understanding of the law, also manipulation? We’ll never know of course, but it would be interesting to hear.
Secondly, at no time does the DoJ deal with the question every FX trader wants to know the answer to – where did he buy them back? Not only was it a thin time of the day/year, but surely the move lower, in spite of how much it cost to get it done, would have thinned liquidity out further, unless the buyer had more to do? Either way, buying back $725 million, especially in a market that historically has leaked like a sieve information-wise, could have been ”interesting” as we used to say. That said, I suppose even an average loss of 10 big figures is only about $5.7 million. The tracking error must have worked out, or, if it happened as alleged, the firm must have held the position for later disposal in more liquid markets, which in USD/ZAR is brave!
A third question is, in spite of it being early-ish days for the FX Global Code, the bank executing the trades doesn’t come out in a good light earlier, for it can easily be argued that the behaviour of the relationship person at that shop was in breach of several Principles of the Code, not least 12, “Without limitation, Market Participants handling Client orders may decline a transaction when there are grounds to believe that the intent is to disrupt or distort market functioning. Market Participants should escalate as appropriate.”
Do we need to look at episodes such as this and re-think how high-lows and barriers are triggered? Do we need, perhaps, a blackout window, during which, new lows and highs cannot be set?
As a pointed aside, this episode, notwithstanding the legal outcome, is a black eye for those who argue the Code is a sell-side only solution to a sell-side only problem. Here is clear evidence that suspicious activity can arise from buy side actions (and yes, I am being restrained here). This is actually recognised by the Code, for one of the examples supporting Principle 12 actually deals with a hedge fund triggering an exotic option in Asian hours – prescient!
More generally, two thoughts to close. It would be helpful if US regulators recognised the Code as the acceptable (minimum) standard and state, as the UK and Australian regulators have, that they will use it as a benchmark for deciding the acceptability, or otherwise, of a player’s actions. In such a circumstance, all FX market participants would be put on notice and Code adoption would get a huge boost.
Secondly, and away from conduct issues, one final question: Do we need to look at episodes such as this and re-think how high-lows and barriers are triggered? Do we need, perhaps, a blackout window, during which, new lows and highs cannot be set?
Personally, in spite of the thin nature of markets around the New York close/Asian open, I think that is a measure fraught with danger and difficulty. That does not mean, however, we shouldn’t discuss potential solutions to what has always been a risk in FX markets.