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MARKET MAKING OR MANIPULATION ?

Events last week have asked the market a serious question . Do our  regulators have the respect or trading knowledge to understand market making from manipulation ?

Currently under  "the Volcker rule " they are able to name traders as "guilty" with little or no real evidence ; the probe into Lloyds banks gilt traders activity is a good example on how regulation has halted liquidity .  In their desperate quest to find manipulation  they have provided the catalyst of liquidity drying up !

     Exchanges need market makers to provide volume and liquidity to their numerous contracts and they pay handsomely for this privilege ; these monies provide a cushion for market makers losses when contracts become fast and volatile ; however it does appear that a few market makers now refuse to accept losses and perhaps the role of market making needs addressing ?

  The problem is our regulators appear to have no idea  how to separate manipulation from market making  and have placed them in the same jar ; real time supervision would of solved this issue . Market making and providing a two way market is currently a brave and challenging career as your positions are nearly almost immediately offside especially in these current trading conditions ; however in quieter markets the advantages are beneficial , market makers have to accept that by accepting the carrot it will occasionally be nibbled  and hence why exchanges pay them so much !

Regulators need to understand and quickly that without market makers there may be no manipulation BUT there will also be no market in which to trade  and their current handling of the UK gilt market  has severely drained the contract of liquidity .  Do we have a cure ? Perhaps real time regulation would help and tagged traders especially market makers ; even an independent committee who oversee the choice of market makers at exchanges ?

LASTLY my view on MIFID2  is that market makers will be exempt from any charges of manipulation or market abuse as they are providing a service !  This could be very dangerous in the wrong hands and a very stupid decision  as it will put them both in the same jar ! 

 

 

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Comments: (1)

Tayloe Draughon
Tayloe Draughon - CloudQuant - Chicago 11 January, 2016, 15:20Be the first to give this comment the thumbs up 0 likes

Great thoughts Neil Crammond!

The compliance staff in brokerage and trading firms must have the fore knowledge, tools, and ability to defend Market Making activity when the regulators come knocking at the door.

This is not limited to any one market, or jurisdiction. Rather it is a global electronic trading issue.

Consider this scenario:
Time 1. A market maker is 2 ticks wide on 500 contracts in some market.
Time 2. He gets filled and is now long 475 contracts.
Time 3. He still has an appetite for another 25 contracts, but not nearly as much so he moves his bid to 6 ticks below the market. (Offer remains at 2 ticks wide)

At Time 3 his open orders in the market appear as bid qty 25 / offer qty 500.

This on the surface is appears to be a spoofing - market manipulation play. Yet it is entirely normal market making.

Given this example, the Brokerage Firm, and the market maker, must be able to defend against the regulatory or compliance inquiry. This will require:

A. Documented procedures in the KYC process of the traders and market makers to show that they were approved for this type of trading.

B. Tools that show the whole picture and not just the picture at Time 3.

C. Trained, and active supervisory teams that can see this activity in its entirety and prove that it was properly supervised and proper.