China’s HFT Criminal Case a Taste of Official Post-Crash Policy

 “While the charge is market manipulation instead of using HFT, it’s interesting to see what the court’s narrative would be on HFT in its judgment,” said Ken Chen, a Shanghai-based analyst with KGI Securities. “China currently doesn’t have an official definition or regulation on HFT, so the court ruling could offer some insights on what the government thinks of it.”

High-frequency trading rose to prominence as financial markets switched from human to computer trading. HFT firms use cutting-edge systems to trade in fractions of a second, trying to profit from even the smallest price moves by being the first to the market. Critics say the strategies exacerbate volatility as their approach accentuates swings.

As well as Yishidun, registered as being in the city of Zhangjiagang in Jiangsu province, two of its executives along with an executive from China Fortune Futures were charged.

Gao Yan, one of the Yishidun executives charged and general manager at the firm, borrowed 31 accounts from friends, relatives and special corporations for the firm to use, Xinhua News Agency, the government’s official news service, reported in November, citing the Shanghai police department. Yishidun self-traded, and also placed large batches of orders far away from the market price, the news agency said. It made illicit profits of more than 2 billion yuan ($301 million), and Gao Yan transferred almost 200 million yuan of that out of the country, Xinhua reported.

To read a QuickTake explainer on high-speed trading, click here.

“Eastern Dragon is aware that the Chinese authorities have charged the company and two of its employees with market manipulation. After several months of speculation, this development comes as no surprise,” a London-based spokesman for the firm said by e-mail, using the company’s English name.

“We have undertaken a full audit trail of our trading activities during the summer of 2015 and we have engaged independent experts to review this information,” the spokesman said. “Eastern Dragon is ready to defend its position in court when required to do so.”

Lin Jian, the lawyer for Gao Yan, declined to comment. A spokeswoman at China Fortune Futures declined to comment, citing the fact that the case is ongoing.

HFT Blamed

China’s $6.6 trillion equity market is free from HFT because buying and selling a stock in the same day is banned. But some derivatives contracts are available to super-fast traders, whose interest helped China’s index futures market briefly become the world’s biggest last year. Regulators blamed the heightened activity for helping fuel the stock boom and subsequent bust, and in response imposed curbs that cut volume by 99 percent.

At least two people from Yishidun, including Gao Yan, were arrested last year in the wake of the market crash. The China Securities Regulatory Commission handed the case to the Ministry of Public Security on July 9, 2015, according to court documents, and the Shanghai police department started its investigation that day.

The regulator in October released draft rules proposing that traders who use automated orders must report certain information and wait for a review before they’re allowed to execute their strategies. Industry feedback was that the plans were too stringent, said Natasha Xie, a Shanghai-based partner with Jun He Law Offices, and they were put on hold in May, according to local media. The CSRC didn’t respond to faxes seeking comment on the status of the draft proposals or the Yishidun case.

Trader Suit

Gao Yan earlier this year filed a lawsuit against the CSRC, claiming the regulator exceeded its authority when it told the police Yishidun’s trading activities had affected the prices and volume of stock-index futures and constituted manipulation of the futures market.

The suit claimed the CSRC doesn’t have the right to determine the crime of manipulating securities, and that the “high-frequency automated trading” referred to in the allegations is not a behavior clearly defined in Chinese law. A Beijing court rejected Gao’s suit on April 28, court documents show.

Sun Shiqi, a Shanghai-based partner with law firm Jingtian & Gongcheng, said it’s hard to win a market manipulation case in China, especially a criminal one. Prosecutors must prove malicious intent, but there’s no definition of what would constitute such behavior, he said.

“The Yishidun case will test the government’s stance on HFT and automated trading,” said Sun. “Because there is a lack of quantitative standards, courts have great discretion in this type of cases.”

“The ruling will set the bar for future cases and sends a message to market participants on what they can and cannot do,” he said.