Developments in FX and US Treasuries Litigation

An interesting week. Two developments emerged concerning possible behind-the-scenes activities in two of the largest markets – foreign exchange (FX) and U.S. Treasuries (bills, notes and bonds). 

The New York Department of Financial Services (NY DFS) fined Credit Suisse $135 million for FX wrongdoing. And plaintiffs in a class action alleging manipulation in the U.S. Treasuries market filed a new complaint with additional allegations.

ForEx

The NY DFS consent order presents its findings that Credit Suisse engaged in a myriad of transgressions in the FX market – including: 

• Efforts to manipulate prices around the “fix” and improper sharing of customer information with traders at other banks, e.g.: 
• "... Trader 1 discussed with Trader 4 an effort to “unload” ammunition. Trader 1 stated “get ready unload on nzd,” to which Trader 4 replied, “I am. Nearly hit it last time.” As the fix drew near, Trader 1, referring to an unidentified co-conspirator, remarked “if he can’t get it lower we may be in trouble.” After apparent success, Trader 1 remarked “come to poppa,” while Trader 4 retorted, “phew.” "
• Attempts to front-run customer orders, e.g.: 
• " In one instance in February 2013, a Credit Suisse trader, Trader 1, disclosed potentially confidential information obtained from the Credit Suisse sales desk about FX trading associated with a pending merger and acquisition: “I think there’s some lhs2 action today at the fix on the back of tht massive m+a . . . massive caveat, info is from sales desk . . . but 4 o clock. . . . 16 yrds . . . something to do with the equity leg is going thru today . . . that’s the reason they saying the spot will be done.” "
• Collusion with other banks to maintain wide bid-offer spreads
• Price manipulation on behalf of certain customers, e.g.: 
• " On September 7, 2012, a Credit Suisse customer (“Customer 1”) enlisted the assistance of a Credit Suisse trader, Trader 18, in seeking to push down the price of the U.S. dollar/Turkish lira pairing. Customer 1 asked Trader 18, “can you walk down usdtry for me pls.” Trader 18 replied, “Yeah, no problem.” Customer 1 then stated, “just offer 1 at like 72 . . . just walk it brotha,” to which Trader 18 replied, “No sweat.” Customer 1 cheered on Trader 18, saying “come on . . . just walk it,” to which Trader 18 replied, “Collapsado.” Apparently upon achieving success, Customer 1 stated, “thks [Trader 18] for walking it down . . . great job . . . you really shellacked it.” Trader 18 quickly replied, “pleasure.” "
• Abuse of last look via its electronic platform
• Deliberately triggering (and front-running) customer stop-loss orders

This last item is particularly noteworthy – not because Credit Suisse is the first to be accused of intentionally triggering stop-loss orders (it’s not), but because the bank apparently wrote an algorithm to calculate the likelihood of successfully triggering stop-loss orders that were potentially ripe for targeting.  In so doing, the bank seems to have systematically developed a system for deciding which stop-loss orders to target.

The penalty imposed by the NY DFS is the first FX-related regulatory fine imposed against Credit Suisse. In contrast, Swiss competitor UBS has settled with the CFTC, Federal Reserve, FINMA (Swiss regulator) and FCA (UK regulator), as well as class action plaintiffs in the U.S. and Canada, for a total of nearly $1.3 billion. 

U.S. Treasuries 

In the consolidated complaint, styled In Re Treasuries Securities Auction Antitrust Litigation (1:15-md-02673), plaintiffs indicate that they have evidence in hand, such as chats and emails, which shows bank traders sharing customer order information with traders at other banks (but by our reading they don't seem to have produced said evidence). 

According to the complaint: 

“Plaintiffs have obtained documents relating to the DOJ’s ongoing investigation, which confirm that such trader communications occurred. These materials include online chat transcripts in which the Auction Defendants shared the identities (often using code phrases) of their indirect bidder customers, the details of those customers’ order flow, and other private customer information.” 

Interestingly, plaintiffs have broadened the scope of the complaint, to include wrongdoing in the secondary market.  Plaintiffs allege, anew, that dealer banks have conspired to boycott trading platforms that would enable market participants to trade with each other on anonymous all-to-all platforms, such as eSpeed and Direct Match: the theory being that all-to-all trading platforms could be a threat to the status quo of dealer dominance of the secondary trading market, potentially putting dealer trading revenues at risk. 

The boycotting allegations are similar to those made against interest rate swap and credit default swap dealers in cases such as In Re Interest Rate Swaps Antitrust Litigation (1:16-md-02704) and Tera Group, Inc. et al v. Citigroup, Inc. et al (1:17-cv-04302).


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For more detailed coverage of these matters, visit our piece here.

Was Information Fed Pre-Fed?

Last Wednesday the Fed concluded its two-day Federal Open Market Committee (FOMC) meeting and issued its statement, deciding to hold the Fed Funds rate between 0.25% and 0.50%, as expected. The accompanying economic projections show that Fed policy-makers currently expect to raise rates only twice this year, down from their December median projection of 4 rate hikes in 2016. Markets responded in kind to the Fed’s more accommodating monetary stance, with 2-year yields falling, the dollar weakening, and gold rallying. 

One of our readers passed along a chart showing an 890,000 share spike in volume in GLD (the SPDR Gold Shares ETF) about 20 minutes before the 2:00 FOMC statement release — a volume spike which doesn’t create any noticeable spike in the market. We dug into Bloomberg’s “Trade/Quote Recap” data and found that there was a single execution of 825,000 shares. 

Source: Bloomberg 

Our reader was suspicious of the timing, suggesting that perhaps the statement and updated projections had been leaked. 

We certainly would not dismiss the possibility of information leakage and the timing of the block trade certainly is curious, but it’s worth being skeptical in this instance: there are plenty of innocent explanations for a block trade in GLD — even one so close to the release of the FOMC statement: 

First up, is a trade of 825,000 shares of GLD all that unusual? According to Bloomberg, and not counting opening and closing crosses, there were 36 trades of 500,000 shares or more (ranging up to 1.8 million shares per trade) in the previous 30 trading days. So while trades of half a million shares or more of GLD are not exactly an hourly occurrence, they do occur slightly more than once per day. 

Next, we cannot ignore the (albeit remote) possibilities that (1) investors (or traders) weren’t targeting the vanilla GLD, as much as delta-hedging a large options position or (2) that the GLD transaction was part of an arbitrage strategy in which a trader bought or sold GLD shares against a short or long position in gold futures. (If we assume a delta of .50 for an at-the-money option, then an 825k share cash position suggests the options position would be around 1.65 million shares, or 16,500 contracts.) 

Finally, we can’t be sure that this trade was initiated by a buyer — there are, of course, two sides to every trade.[1] Perhaps the customer initiating the trade was a seller and the broker-dealer bought the block (or found the other side of the trade) in order to facilitate a customer sell order.  In other words, maybe it was a large seller, looking to get out of a long position before the Fed decision. We have no way of knowing which side of the trade the customer was on, nor whether the broker-dealer took principal risk or found the other side of the trade. (FINRA would, however, be able to dig further, if so inclined, via the OATS system, which enables them to monitor the detailed history and execution of orders.)

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[1] We do know, per Bloomberg, that the trade was reported via FINRA’s ADF, which means that the execution did not occur on an exchange. So, it could have occurred in a dark pool or other Alternative Trading System (ATS) venue, but more likely it was done through an institutional broker. 

Flash Spoofing, and "Normal" Market Operations

The criminal case filed by the DoJ against U.K. trader Navinder Sarao is the latest case to capture the media’s attention in what must be the early stages of a series of investigations into what we’ll broadly term “issues of market manipulation.”

 The potential for manipulative behavior has been garnering more attention over the past year since Michael Lewis’s “Flash Boys” more forcefully drew regulatory attention to issues around high frequency trading (HFT) activities and current market structures.

Regulators have received their fair share of criticism for taking nearly five years to investigate the Flash Crash, finally getting around to examining orders, and not just executions. 

While Mr. Flash Crash protests that he has “not done anything wrong apart from being good at my job,” regulators clearly have their sights on spoofing.  Just last week came news of the CFTC bringing civil charges against two prop traders in the UAE for allegedly spoofing in the gold and silver futures markets. All of this comes on the heels of several other low-profile players charged with spoofing over the past couple of years, such as Panther Trading. 

Spoofing, sometimes referred to as “hype & dump,” is basically when a trader enters orders with the sole purpose of influencing market prices and with no intention of actually executing those orders. 

Obviously the law does not require traders to openly state their intentions regarding whether they are buying or selling, and how much. Likewise, we don’t play poker with our cards face up. But what type of bluffing is kosher? To what lengths can one go to cloak his intentions so that others don’t run ahead, increasing transaction costs?

Kraft was recently hit with a CFTC complaint regarding its wheat futures trading, and this case seems to be more of a gray area.

But there's more to come, no doubt.

The general areas of interest concern front-running, spoofing, time advantages, and trading on insider information. Just a couple of weeks ago, we saw a situation which must fall smack in the middle of the realm of the regulatory whip: the Aussie dollar moved significantly just (milliseconds) before the announcement by the Reserve Bank of Australia (RBA). But even worse – this has now happened three consecutive times!

Let’s have a look at the overall movement, just before 3am, and then we’ll focus on the movement and its occurrence just before news came out.

Here's the movement, generally, at 00:30.

But the important note is the movement occurs just moments before (any) news is released.  See all the news items at the top?  Each news item corresponds to a blue box in the graph.

The first one, the rate decision, "flashes" into our screen, just AFTER the movement.

It's worth mentioning that we're not alone in discovering this market movement. The Australian Securities and Investment Commission is on top of things, having opened an investigation into these wild, yet accurate, swings.  Notices have purportedly "been sent to many financial institutions and platform providers to understand the basis of the trading on these markets at the point in time of interest." More troubling, however, is that preliminary findings have revealed to ASIC that:

"moves in the Australian Dollar ahead of the announcement to be as a result of normal market operations in an environment of lower liquidity immediately ahead of the RBA announcement. The reduction in liquidity providers is a usual occurrence prior to announcement in all markets. Much of the trading reviewed to date was linked to position unwinds by automated trading accounts linked to risk management logic and not misconduct." 

Call us skeptical (or sceptical, given they're in Australia).

One more likely explanation is that the news was leaked, or sold, to one or more firms that could execute quickly based on an incredibly fast network connection, likely linked to an algorithm. (If not, why wait for the seconds or milliseconds before the announcement – why not execute a minute before, or two minutes before?) 

So that opens up the door to the question of “time advantages” – more specifically, whether some preferred clientele can buy early access to the news. Let’s just say, it’s a little like gambling on a football game, in which most people are watching on tape-delay, but some gamblers are allowed to see the game “real-time.” The real-time gamblers can add or remove bets once the game is really finished, while the other gamblers with the lagged connection don’t yet know the final result. Can we call that a rigged market? 

The next legal question becomes: do the ordinary gamblers know that the preferred gamblers have a time advantage, or whether they know that they’re on a lagged connection (and that others are not). In other words, there’s the question of proper disclosure. Whether or not the market is rigged in favor of some parties, should the “unfavored” parties have been made aware of their material disadvantage?

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For more on Time Advantages in the Financial Markets, and corrective actions taking place, visit any of the following links:

The Crucial Piece of Information That Big Traders Get Before Everyone Else

Firm Stops Giving High-Speed Traders Direct Access to Releases: Warren Buffett Involved in Berkshire Unit Business Wire's Decision to End Practice

Traders May Have Gained Early Word on Fed Policy, Study Finds

Thomson Reuters ends early access to key market data

Behind One Second of Trading Mayhem
(Article chronicles impact of earnings results released to paid clients milliseconds before news services released earnings, while those results impacted closing price of shares.)