Abusive trading disquiet overshadows gaming unease

Three times as many buy-side traders fear abusive trading tactics such as front running and insider trading as are worried about being gamed in dark pools, according to the results of theTRADEnews.com’s latest monthly poll.
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Three times as many buy-side traders fear abusive trading tactics such as front running and insider trading as are worried about being gamed in dark pools, according to the results of theTRADEnews.com’s latest monthly poll.

A total of 60% of survey participants said they were most concerned about types of abusive trading, while just 18% put gaming at the top of their list of irregular market behaviours to watch our for. A further 16% of respondents said market abnormalities such as unexpected spikes and concentrations in trading activity were their biggest cause for concern.

Giles Nelson, senior director of strategy at Progress Apama, the algorithmic trading and complex event processing division of Progress Software, says fears about market abuse are understandable given unprecedented levels of innovation in trading technologies and tactics.

“It’s not surprising that most poll respondents are concerned about market abuse when the mainstream media and politicians are criticising a range of trading practices, from use of dark pools and flash orders to high-frequency trading in general,” he says. “But it’s important not to lump all these together with market abuse, i.e. the intentional manipulation of markets for risk-free profit. High-frequency traders are legitimately placing orders using low-latency technologies to take advantage of arbitrage opportunities thrown up by market inefficiencies.”

According to Stuart Calder, product director, Northern Europe, Linedata Services, a supplier of asset management software, there is still plenty of evidence of prices moving ahead of price-sensitive information becoming generally available, despite increased regulation and efforts to enforce transparency. “Insider trading, and related forms of market abuse, are notoriously hard to prove, and the incentives for the dishonest remain high in relation to the risks,” he says.

Nelson also acknowledges that longer-term factors also underpinned buy-side worries, such as their well-established unease about the risks of too close a relationship between the sell-side’s proprietary and client flow trading operations.

“The temptation to take advantage of the information provided by client flow will always be there,” says Nelson. “But regulators, exchanges and brokers all now recognise the need for closer monitoring of trade flows and trader behaviour. Brokers need to be able to monitor their own flows so that they can not only respond quickly to any enquiry about their trading activity from a regulator or exchange, but also improve their internal controls against market abuse to a level that will satisfy buy-side clients.”

Pan-European multilateral trading facility Turquoise is among a number of trading venues that have invested in technology to monitor potential market abuse and has implemented stringent anti-gaming logic in its dark pool. But Adrian Farnham, the firm’s COO, says technology is only part of the picture.

“Cases of abusive trading are rare, but it is essential that operators of trading facilities have robust systems in place to monitor market activity in real-time,” he says. “This technology must also be coupled with the right team which can supervise this process and parse the irregular from the potentially abusive.”

Farnham agrees with Progress Apama that market surveillance should not be left to the regulators alone. “Ensuring the integrity of transactions is part of a venue’s commitment to customer protection and is a valuable part of Turquoise’s proposition in its own right,” he said.

Technology is seen by many as an enabler of trading behaviours that buy-side firms have to be aware of, including both high-frequency trading strategies that use low-latency technologies to exploit market information faster than the majority of market participants, and abusive trading strategies based on illegal use of data gleaned from client flow and other sources.

The role of technology associated with this behavior probably heightens the fear, especially with all of the press around high-frequency trading lately,” says Don DeLoach, CEO and president, Aleri, a complex event stream processing software firm. “That said, technology will play an increasingly important role in preventing this very behavior. It will be interesting to see how the market, as well as the regulators move forward regarding such abuse.”

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