Sheep lead HBOS down

According to the FSA the recent HBOS share plunge was caused by traders depressing the share price and selling short with the opportunity to buy back once the rumour becomes unfounded and the market realizes the real share price. This is serious market manipulation and comes directly under the market abuse directive.

Its worth looking at the record of successful prosecutions over the last twenty years, my research shows a remarkably small percentage, considering the number of well known cases during this period. Of course any number of cases could have been dealt with quietly in attempt to save face all round. We will never know!

Trying to bring about any prosecution regarding a rumour is going to extremely difficult with the likelihood of factual evidence being short on the ground and circumstantial evidence unlikely to be strong enough, once challenged in court.

The truth is that a will-o'-the-wisp market rumour is almost impossible to track to the source and even if you could, how do you then tie in all complicit parties? Is everyone that has received an e-mail involved or those recorded on telephones? Is it a corporate issue? Market abuse could extend beyond the boundaries of reasonable prosecution. These are just a few reasons why the current system simply does not work.

All stock markets thrive on rumour and counter rumour, it was ever thus! With the internet providing no end of opportunities to seed an idea or produce a reaction the rumour mill has never been so productive. Existing legal sanctions prevent Blogs and the like from being defamatory but they can not prevent people thinking and determining their own perceptions of reality. So the problem of market abuse has the potential to get even bigger. Existing regulations have proved totally inadequate and with information and data becoming ever cheaper and more readily available, something new is required!

The most worrying aspect of the HBOS incident is the reaction of the market traders who all acted like sheep following one another and traded without thought or knowledge of the real situation and we know that greed is a huge motivating force for this particular flock of sheep.

Come to think of it Sheep is a more appropriate symbol to saddle the modern trader with rather than the noble Bear and Bull of bygone years. The lack of knowledge at the trading screens is only surpassed by that in the boardrooms of most financial institutions. Boardrooms love profit and highly satisfied clients sitting on huge positions, generating huge profits. In this climate the aggressive trader thrives. The traders move from bank to bank with an ever increasing reputation. Get out while the going is good and then sign on for another bank offering rich pickings and a signing on fee most people in the country would die for.

The speed that markets now react to false rumours and misconceptions has produced enormously high volatility. Swings of share prices within a normal trading day would have been front page news twenty years ago. New financial products based on short selling and moving the market with as least risk as possible, drive volatility within the market. It is in everyone's interest that this can happen as the biggest losers can be the pension funds. That is therefore why everyone should take a deep interest. We should all be calling for a market regulatory structure that has a far stronger deterrent for the reckless and the plain stupid. It used to be that traders only used the banks money but now structured finance offers the greedier trader the rich pickings of the client's assets. The banks apparently turn a blind eye and the regulator appears impotent, forlornly trumpeting the same old message that has proved in the past, not to work and will do so again in the future.

The measure of volatility and applying the measurement for collateral was an equation established in an old world where today's risks were never a factor. One could ask if the volatility risks based on unfounded rumour and actual intelligence should now be a new risk factor and added into the equation when determining a share price and collateral.    

The FSA has once again, not covered itself in much glory, with its quite pathetic response to the HBOS issue!

Markets do thrive on rumours! Some are true, many are not, but does the FSA really think that Banks knowingly throw millions of their capital at a deal based on some unattributed source? The truth is far more worrying. Banks simply do not know enough about the trading room and do not exert enough control of rogues who may be lurking in there. Then there is the sheep effect taking hold, as greedy traders protect their position and take a punt at the markets expense. The banks can be as much a casualty of these traders' actions as anyone but through complacency they can let a dangerous trader persist until it's too late to take effective preventative action.

The banks appear powerless to control the actions of the traders. The more successful the trader the less control is imparted. The golden boy trader is not likely to be rebuked if his annual P&L is contributing huge profits to the bank.

Unlike the days of yore, electronic dealing systems and trade data moves far faster than the ability of the market to understand the position. Many years ago the LSE's Topic system reported that Ronald Reagan had a heart attack and the market plummeted. Only some time later a correction issued as the name was Lonnie Donnigan. If it could happen then it can happen today a million times over.

Manipulation of the market and especially individual share prices is a criminal act but the FSA has to find a better way of monitoring and then sanctioning those that create a false market. Maybe sanctions should be kept within the industry rather than resorting to legal prosecutions, which are almost impossible to prove. Maybe the bank should be more accountable for the actions of individual dealers no matter how powerful? Maybe there should be some sort of suspension or yellow and red card notice?

My concern with the current regulatory arrangements is with the FSA. Do they really understand the business they regulate? What is the quality of people within the FSA? Are we asking the FSA to carryout an impossible task?

The evidence is mounting that the FSA is increasingly being shown to be out of its depth and it may be time to reflect on the intelligence in creating a single regulator! We certainly need a regulator but perhaps the old way with a specific regulator for each type of business actually works best.

Or perhaps the creation of an industry representative committee drawn from respected firms made up of highly qualified individuals who understand the business, operations and systems better should adjudicate on market malpractice and allow the industry to sanction its own returning to the days when the City was self regulating. This might be a better model than what we have today and have a better chance in preventing the continuous breakdown that we see in our newspapers and the many instances the go unreported.

Or what about even more radical idea! Why not make insider dealing an open market where rumours can be banded about with abandon allowing those that know the most to make the most! This might seem a step too far, but it would keep information usage above ground rather than driving it into murky corners and actually put the UK regulation on Market Abuse in line with most other markets!