European Prop Trading Group Acts to Uphold Market Values

Terry Flanagan

With the reputation of Europe’s financial services industry hanging in the balance following scandal after scandal, a proprietary trading group is making a stand against market manipulation in a bid to safeguard market integrity.

In May, the European Securities and Markets Authority (Esma), the pan-European regulator, issued a set of rules to better monitor algorithmic trading practices such as high-frequency trading and these guidelines are now being applied by national regulators across the whole of the European Union. Esma wants to foster convergence in supervisory practices regarding automated trading across the 27-nation bloc and help in providing a level playing field to investors.

The FIA European Principal Traders Association (FIA EPTA), a Brussels-based lobbyist which represents firms that trade their own capital on European exchange-traded markets such as Knight Capital, Optiver, Getco, Citadel Securities and Quantlab Financial, this week published a set of best practices to help principal trading firms prevent market manipulation and reduce risks.

“Technological progress has transformed the trading landscape in recent years,” said Remco Lenterman, chairman of FIA EPTA. “These changes have brought substantial efficiencies and other benefits to the market, but they have also introduced new sources of risks to the markets.

“We’ve therefore drafted these best practices to help firms prevent market manipulation and manage risks. Market manipulation is not only morally reprehensible, but also carries a hefty price tag for the market, in particular for those that are providers of liquidity.”

Lenterman added that its members, as major providers of liquidity on regulated trading platforms and counterparties to a large percentage of trades on these platforms, back fair and transparent markets that are free from abusive trading practices.

In its guidelines, called ‘Market Integrity Framework: Best Practices to Preserve Market Integrity’, FIA EPTA says it builds on Esma’s automated trading rules as well as existing EU regulation and seeks to provide guidance to trading firms as they establish their internal policies, procedures and codes of conduct. The best practices include the hiring and training of employees; detection of market manipulation including monitoring, alerts, record-keeping and internal reviews; access and oversight, conformance testing and error control; pre-trade risk management including risk limits, price collars, fat-finger limits and kill buttons; and trade and post-trade risk management including cancel-on-disconnect functionality, back-up execution facilities, post-trade limits and filled order validity.

And as national regulators move into action over the Esma guidelines, market participants are being warned that their firms must be well positioned to comply. The rules, despite being introduced in May, are likely to be fully enforced from around October.

“It is clear that the financial services industry now stands at a crossroads,” said Magnus Almqvist, senior compliance expert at trading and technology firm SunGard’s Protegent business unit, which provides compliance and surveillance solutions. “It can choose to display corporate responsibility, fully engage in the legislative process and prudently manage compliance risk. The alternative—stonewalling regulator efforts and ignoring public criticism—will inevitably lead to a decline of not only the industry’s reputation but the industry itself.”

In its guidelines, Esma urges firms to monitor in real time their electronic trading systems and lists four types of market abuse. The first category is that of ping orders, where you enter small orders in order to ascertain the level of hidden orders and is particularly used to assess what is resting on a dark platform. The second category of market manipulation is quote stuffing, whereby large numbers of orders and/or cancellations/updates to orders are entered so as to create uncertainty for other participants, slowing down their process and to camouflage their own strategy.

Thirdly, there is momentum ignition, which is the entry of orders or a series of orders intended to start or exacerbate a trend, and to encourage other participants to accelerate or extend the trend in order to create an opportunity to unwind/open a position at a favorable price. And finally, there is layering and spoofing, where a trader submits multiple orders often away from the touch on one side of the order book with the intention of executing a trade on the other side of the order book. Once that trade has taken place, the manipulative orders will be removed.

“Certain quarters have pushed back on Esma,” Justin Amos, co-founder and chief operating officer of Redkite Financial Markets, a market surveillance provider, told Markets Media last month. “Some are more positive over Esma than others. But to be able to monitor the automated world you must do it in an automated fashion in real time, or in as real time as possible. We think Esma’s approach is the best way to find out what is going on.”

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