The first global crackdown on the $615-trillion derivatives market gained momentum on Tuesday when US regulators unveiled a new tool to police would-be fraudsters and European officials urged tighter controls. Moving to rein in vast markets that were only loosely policed going into the 2007-2008 financial crisis, the US Commodity Futures Trading Commission laid out plans for foiling traders seeking to manipulate prices or defraud investors.
From "quote stuffing" and "spoofing" to "banging the close," certain trading practices were being eyed closely by the CFTC, though the agency stopped short, for now, of proposing specific rules to curb high-frequency trading. The CFTC's actions came as global regulators late on Monday urged national authorities to consider restricting derivatives trades that are not centrally cleared, or run through an open process that reduces risk and increases accountability.
The Financial Stability Board (FSB), based in Switzerland, under orders from the Group of 20 leading economies, is examining ways to standardise derivatives markets and have more of transactions processed through central clearinghouses. Much of the world's derivatives trading occurs in New York, Chicago and London. US changes are under way to impose more clearing and reporting of credit default swaps as required under sweeping US financial markets reform legislation approved in July.
The FSB is trying to make oversight of derivatives uniform globally to reduce chances that traders will shop from country to country for the most lenient regulatory regime. The G20 agreed at a 2009 summit in Pittsburgh to move all standardised off-exchange derivatives onto exchanges or electronic platforms by the end of 2012 - a goal closely aligned with reforms being pursued under Obama administration reforms.
CFTC CLARIFYING RULE In its latest set of proposed rules following the sprawling US reforms, the CFTC sought to clear up confusion about its traditional test for price manipulation, an effort to improve on its dismal record of winning only one such case in its 36-year history.
The rule, which will apply to all markets overseen by the CFTC, including swaps, also creates a "broad, catch-all anti-fraud provision" that does not require the CFTC to prove a trader fully intended to cause fraud, CFTC officials said. The CFTC's only successful manipulation case was against a broker charged with manipulating prices for electricity futures in 1998.
The agency's five commissioners agreed at a hearing on Tuesday to advance the proposal for 60 days of comment. They must vote again to finalise the plan by next July. The Dodd-Frank law approved in July 2010 also requires the CFTC to ban three disruptive trading practices as of July 2011. Included are "spoofing", where traders make bids or offers but cancel them before execution and "banging the close," or buying a big position before trading closes, then offsetting the position in the final moments to manipulate the closing price.
"QUOTE STUFFING' EYED "Quote stuffing," or flooding the market with large numbers of rapid-fire orders and cancelling them almost immediately, is also under scrutiny, as is possibly writing new rules requiring traders to test and monitor their algorithms, or sequences of rapid trade orders. For months, CFTC commissioners have said the agency needs to use its new powers to counter disruptive trades made by high-frequency algorithms.
The European Union on Tuesday agreed on the final form of new rules for hedge funds and other alternative investment firms in talks the European Parliament said in a statement. The rules would put the sector under the eye of a pan-European watchdog. The final version of the regulatory regime is set for a full vote next month in the legislature.
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