Understanding market abuse in the age of market surveillance 2.0.

Part 3: Spotting how offenders conceal information and other tell-tale signs

In this three-part blog series, Capco’s Jeroen Aumand looks at how market abuse is being perpetrated and the challenges for new market surveillance controls/ solutions. Part 1 provided a definition of market abuse and the techniques used for gaining market information. Part 2 reviewed how offenders try to influence the market. Now in Part 3 we examine how offenders hide information and other noteworthy behaviours.


Hiding information

“Carte blanche”. Trading with unauthorised funds

Traders’ funds are limited, so that a shift in their position does not impact the bank’s overall risk. For someone to alter their own trading limits, they need either special access or social engineering skills (personal manipulation) to persuade or coerce someone else to change the limits. Bribing a colleague or calling out a so-called favour with a friend, for example. If all other attempts fail, hiding a position in plain sight is the next available option.


“Hiding in plain sight”. Concealing P&L within the firm

There are a few options available for an ill-intentioned trader to hide positions. An unauthorised trade can be hidden within a (legitimate) trade (e.g. leg of a complex derivative product). A false hedge can be put in place to create the illusion of a “low to no” risk in place by creating false correlation between two risk reducing instruments or non-fungible positions.

A trade PNL can be mispriced on derivative position by tweaking the “tail”. A trader can also try to stay outside the control office radar by cancelling, correcting and amending trades or by reporting late or long dated trades (e.g. the trade settlement takes place in a year’s time instead of a three day settlement).

Trading books are another opportunity to hide positions. A trader can use false/unassigned non-standard books using accounts/ products/counterparts. For example, a trader could spread his position over multiple legal entities, where the individual risk would be acceptable per entity - but would be unacceptable taken as a whole. Last, but not least, any individual who can freely alter their own P&L statements can run their very own Ponzi scheme, by simply collecting and pocketing investors’ money without risking the investment.


“Friends on the outside”. Hide P&L outside the firm

Facilitators (business connections, friends or relatives), located within competitive firms, could house temporary trades by trading repeatedly, with no significant P&L generated between their organisations.


Professional misconduct to gain unfair advantage over clients and competitors

“The Playground Bully.” Driving cost price

Rogue traders who intimidated class-mates in the school playground can re-run history by flexing their capital muscles. This involves ramping up the trading costs for smaller firms. The market bully can do this by repeatedly trading small lots. For example he trades 1000 x 1 trading lot, where a smaller firm will have to pay out fees for 1000 trades.


“The Block Shot.” Prevent trading

In some instances, a firm could refuse, block or delay market access to a competitor. On the market, assets trading by auction can be blocked by sending an order that breaches the trading barrier.


“Poison pill.” Trading against the bank

Trading activities at banks come and go. A senior executive can encourage a disastrous trade at a bank department’s expense. The senior executive will profit from a bonus by closing down the rotten activity and “saving” the bank money.


“Pay to play." Maximising commissions by inciting over trading

Any individual whose bonus is based solely on the number of trades being generated has a direct interest in inciting his clients to trade more frequently than they actually require. Being detached from the outcome, such offenders gain by proposing frequent rebalancing of their client assets or enticing trades with no-to-low interest for their client.

Finally, in our list of market abuses, there are two points that do not fall under our earlier definitions but are worth mentioning:

“There’s no such thing as perfection.” Platform inefficiencies

Execution venues are popping up like mushrooms. Their performance in responding to order volumes (latency) and in handling those volumes (capacity) is not equal across every venue. Sophisticated setups can send bulk orders to deliberately put the execution venue’s “plumbing” under strain and profit from the latencies created. Further, the probability of a computer defect (even a small one) existing somewhere is non-negligible. In the wrong hands, it could be exploited to gain an unfair advantage either internally or externally.


“Make up your own rules.” Special trading rules

The development of special rules on trading platforms such as “Paid for trades” may create legitimate business opportunities. But it also spawns grey areas where new market abuse examples can emerge. “Opaque” communication is often given as an example. This can be prevented by issuing explicit guidelines on how to communicate clearly with the outside world.

In summary, there is a multitude of ways rogue bankers can distort regular market practice and deviate from fair play. The impact can be relatively minor and isolated – but still lead to illegal personal gain. On the other end of the spectrum such activities may result in widespread market-adverse effects and a fundamental loss of trust in the concept of a fair and functioning market.

For bank staff, informed vigilance at all times remains the best defence. If a market movement or trend looks full-on odd, or even just a little “off”, the chances are that it is worth further scrutiny. If it is legitimate, nothing is lost. If not, there may well be a chance to uncover and prevent fraud, and protect both the bank and the market. For banks, when facing market abuse, indifference and inertia are never an option.


About the Author

jeroen aumand

Jeroen Aumand is a Senior Consultant based in Capco’s London office. He has over a decade of experience in trading, sales and market surveillance for equity derivatives.


The content and opinions posted on this blog and any corresponding comments are the personal opinions of the original authors, not those of Capco.