Financial Regulatory Forum

COLUMN-Even sober brokers can abuse markets out of hours: Kemp

By Reuters Staff
June 29, 2010

– John Kemp is a Reuters market analyst. The views expressed are his own –

By John Kemp

LONDON, June 29 (Reuters) – With its decision to fine and ban a former oil broker for manipulating the price of Brent crude oil last year as a result of trading while drunk, Britain’s Financial Services Authority (FSA) has continued its push to introduce higher standards into trading on the London commodity markets.

Former PVM oil broker Stephen Noel Perkins was so drunk he had a limited recollection of events and had been in an alcohol induced blackout, according to the FSA’s notice announcing a minimum five-year ban and fining him 72,000 pounds.

Drunkenness certainly adds colour to the case. But its real significance is much wider. It applies equally to market participants who are sober as well as those trading under the influence of drink and drugs.

For the FSA concluded Perkins manipulated the market through his “clear pattern of trading” in large volumes at a time when the market was normally thin, creating a “false and misleading impression” and “securing the price of the Brent contract at an abnormal level”.

The ban seems to relate primarily to his fitness and propriety and to be grounded in the fact the trades were unauthorised and he subsequently tried to cover them up (paragraphs 6.1 and 6.3).

The FSA concluded the trader “poses an extreme risk to the market when drunk”. On the two days in question, the trader had been “drinking so heavily that he was not capable of assessing the consequences of his actions”.

But the fine was grounded more in market abuse (paragraph 6.2). It appears it could have been imposed even if the trader had not been drunk and the trades had not been unauthorised. The fact they gave a misleading impression of supply and demand in thinly traded conditions and caused prices to rise to an abnormal or artificial level would, it seems, have been enough for the FSA to conclude the trading was abusive.

Setting aside the traders’ drunkenness, the FSA has for the second time in a month outlined what it considers to be abusive trading.

In the first period of trading on 30 June 2009, as reviewed by the FSA, Perkins bought 9,045 lots and sold 1,920, to build a net long position of 7,125 (equivalent to 7,125,000 barrels of crude oil).

The volume and position was large by any measure, but especially in relation to normal turnover at that time of the night, which the FSA pegs around 514 lots. As a result, Perkins accounted for 69 percent of the volume traded in that period.

It caused prices to rise $1.65 (2.3 percent) between his first and last trade, and as much as $2.09 (2.9 percent) at one point. Big moves at any time, but especially in the London night, when the market is usually inactive other than when there is a geopolitical event. Prices promptly dropped when he stopped bidding.

The Perkins case is extreme because the trading was clearly irrational. But it does establish trading volumes do not need to be that high (9,000 lots) or move the market much (2.5 percent) to be considered potentially abusive. Perkins was operating in size, but he was not cornering the global oil market. And a $2 move was enough, it did not need to be $10.

Moreover, the FSA placed particular emphasis on the fact his trades gave a misleading impression at a time when the market would usually be quiet. There is a clear implication the regulator will not tolerate trading in size which deliberately or recklessly causes or exploits thin volumes to generate a large movement in the tape.

The Perkins case is consistent with the recent case against coffee options broker Andrew Kerr, where the FSA sanctioned the broker for using trades in size to manipulate prices during the option-pricing reference period. It is also consistent with the CFTC’s recent penalty on a hedge fund for attempting to affect settlement prices in NYMEX platinum and palladium via last minute trades. [ID:nLDE6511XB].

Sizeable trades in thinly traded markets are starting to attract heightened scrutiny and less forgiving regulatory review than in the past. In this sense, commodity markets are catching up with publicly traded equities, where market participants understand that they will be held to higher standards when trading around sensitive times and must exercise special care.

Crucially, the FSA makes clear that trades which move the price must be executed for “legitimate reasons” and “in conformity with accepted market practices” (paragraphs 27 and 35). That requirement applies to all market participants — drunk or sober. Seeking a better “mark” or a good chart print would clearly fall outside that definition.

Because the features of the Perkins case were so bizarre, it is dangerous to generalise too much. But equally it would be unwise to ascribe it all to drink and suggest the case was sui generis or unique with no wider applicability. There is a clear trend in all these cases that shows the net is tightening. The expected standard of behaviour in commodity markets is moving more closely into line with equities and bonds.

(Editing by Keiron Henderson)

((john.kemp@thomsonreuters.com; Reuters messaging: john.kemp.thomsonreuters.com@reuters.net; +44 207 542 9726))

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